Labor market policies, informality and misallocation
Indian Growth and Development Review
ISSN: 1753-8254
Article publication date: 30 November 2021
Issue publication date: 14 March 2022
Abstract
Purpose
The purpose of this paper is to understand labor market regulations and their consequences for the allocation of resources.
Design/methodology/approach
This paper constructs a theoretical model to study labor market regulations in developing countries and how it affects the allocation of resources between the less productive informal activities and more productive formal activities. It also provides empirical support for some theoretical results using cross-country data.
Findings
When workers are risk-averse and the market for insurance against labor income risk is missing, regulations that provide insurance to workers (such as severance payments) reduce misallocation. However, regulations that simply create barriers to the dismissal of workers increase misallocation and end up reducing the welfare of workers. This study also provides some empirical evidence broadly consistent with the theoretical results using cross-country data. While dismissal regulations increase the share of informal employment, severance payments to workers do not.
Research limitations/implications
The empirical exercise is constrained by the lack of availability of good data on the informal sector.
Originality/value
The analysis of the alternative labor market regulations analyzed in this paper in the presence of risk-averse workers is an original contribution to the literature.
Keywords
Acknowledgements
This is a much revised version of a working paper that was circulated as Ranjan et al. (2018). We would like to thank the seminar participants at LSU, ISI Delhi, Jadavpur University, UC-Irvine, CSU-LA and the participants at the Asian Development Bank Conference on “Future of Jobs in Asia,” Manila (2016), for valuable comments.
Citation
Jha, P. and Hasan, R. (2022), "Labor market policies, informality and misallocation", Indian Growth and Development Review, Vol. 15 No. 1, pp. 18-59. https://doi.org/10.1108/IGDR-05-2021-0067
Publisher
:Emerald Publishing Limited
Copyright © 2021, Emerald Publishing Limited