In developing economies, substantial economic activity takes place in the informal labor market, beyond the reach of government policy. Labor market policies, which by definition apply only to the formal-sector labor market, then have important spillover effects. The relative sizes of the informal and formal sector labor markets adjust, the skill composition of the workforce in the two sectors changes, etc. In this paper, we build an equilibrium search and matching model to analyze the effects of labor market policies in a developing economy. Our model extends Mortensen and Pissarides (1994) by allowing for ex ante worker heterogeneity with respect to formal-sector productivity. We analyze the effects of labor market policy on informal- and formal-sector output, on the division of the workforce into unemployment, informal-sector employment and formal-sector employment, and on wages. Finally, our model allows us to examine the distributional implications of labor market policy; specifically, we analyze how labor market policy affects the distributions of wages and productivities across formal-sector matches.
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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number
744.
Length: Date of creation: 03 Dec 2006 Date of revision: Handle: RePEc:red:sed006:744
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Find related papers by JEL classification: J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search J65 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment Insurance; Severance Pay; Plant Closings D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information O11 - Economic Development, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
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