Job Market Paper|
The Repression of Informal Labor: Aggregate Effects and Transition Dynamics
(Joint with Gustavo Pereira) [Slides]
This paper studies the effects of public policies designed to fight informal labor activity. We propose a general equilibrium model with heterogeneous agents in which the income process follows from a search model. We calibrate it to generate stylized income/informality facts from Brazilian household-level data. Firms opt between offering formal or informal contracts and have heterogeneous ability to operate informally. Such heterogeneity leads some productive firms to choose informal contracts. It allows the model to produce similar income averages among high-income workers in the formal and informal sector, a property we find in the data. We then use the model to simulate the economy's response to the repression of informal labor activity by the government. Our simulation suggests that short and long-run impacts differ. General equilibrium effects matter for both. In the long run, households' welfare and average firm productivity improve, and unemployment decreases. However, in the short run, reduced aggregate savings leads to a 4% increase in interest rates and a 2.5% increase in the unemployment rate. We also show that if the government fails to transfer back to households the additional tax revenue, these effects hold in the long run as well. In addition, if the policy is anticipated by economic agents, then output declines and informality increases prior to implementation. In all cases, households with greater wealth experience larger welfare gains.
Informality, Risk Premia, and the Business Cycle
(Joint with Gustavo Pereira)
This paper introduces the idea that the breakdown of the workforce into formal and informal jobs is akin to an aggregate portfolio choice. The decision to formalize trades off the higher productivity of formal workers with the risk of not being able to fire them due to large regulatory costs. We embed this payoff structure in a business cycle search model with formality choice by employers, who assess the value of a match using discount rates that allow for a time-varying price of risk. We calibrate the model with data from Brazil. The model produces two main patterns: a payoff effect that makes informal firms' firing sensitive to the business cycle, and a portfolio rebalancing effect, whereby a higher price of risk during downturns induces firms to shift their hiring towards informal workers. The model-predicted cyclicality of transitions from unemployment to formal and informal jobs, as well as the cyclicality of transitions to unemployment - both of which we do not target in our estimation - are consistent with the data. The predictions are at odds with the data when the model is calibrated with constant discount rates. The results indicate that properly accounting for the price of risk is essential for understanding the dynamics of the informal sector.
Work in Progress
Dynamic Fiscal Policy with Frictional Labor Markets
(Joint with Gustavo Pereira)