## 1marea2019004

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---

### Executive summary and model application
- Purpose: Assess potential for well-sequenced labor and product market reforms to promote growth and job creation in Morocco using a Dynamic General Equilibrium model with informal product and labor markets.
- Main quantitative result:
  - Implementing simultaneous reforms in the labor and product markets could add about 2.5 percent of GDP growth and reduce unemployment by about 2.2 percentage points after five years.
- Sequencing insight:
  - If reforms must be introduced sequentially, starting with product market reforms is more effective in boosting output in the short-run.
  - Starting with labor market reforms would reduce unemployment faster in the short-run.
- Objective: Identify the most welfare-enhancing package of reforms and quantify short- and medium-term effects on output and unemployment.

### Recent macro trends and labor market outcomes
- Growth and macro performance:
  - GDP growth averaged about 5 percent in the 2000s.
  - Between 2010 and 2017, growth slowed and averaged 3.6 percent.
  - Public debt increased to 65 percent of GDP in 2017.
  - International reserves declined to about five months of imports in recent years.
  - Government plan target (2017): raise economic growth to 4.5-5.5 percent and reduce unemployment to 8.5 percent by 2021.
- Labor force and unemployment:
  - Labor force participation rate declined from 53.1 percent in 2000 to 46.2 percent in 2018.
  - Female labor force participation rate: 22.2 percent in 2018.
  - Unemployment: hovered around 10 percent in the last decade.
  - Youth unemployment: 26 percent.
  - Graduates unemployment: 17.1 percent.
  - Underemployment: around 10 percent (16.1 percent for the youth).
  - Combined under- or unemployment among youth: 33 percent (50 percent in urban areas).
- Employment structure and informality:
  - Private sector represents about 88 percent of total employment.
  - Private sector job creation (2005–2015): increased by 11.2 percent; public sector by 8.2 percent.
  - Informal economy share: 11.5 percent of nonagricultural GDP (2014 survey).
  - Informal units: 1.68 million units in 2014, increasing at an average rate of 1.2 percent per year since 2007; 71 percent concentrated in urban areas.
  - Informal employment levels:
    - 2014: 2,376 million jobs.
    - 2007: 2,216 million jobs.
    - 1999: 1,902 million jobs.
  - Share of informal sector employment in non-agricultural employment: 36.3 percent in 2014 (37.3 percent in 2007).
  - Investment in informal sector: represented only 1 percent of total investment in 2014.

### Key constraints identified
- Education and skills mismatch:
  - About 63 percent of employed people are without a diploma (45.2 percent in urban areas; 81.7 percent in rural areas).
  - Higher-level graduates represent only 11.4 percent.
  - Vocational outcomes:
    - Unemployment rate among trainees: 24.5 percent in 2017.
    - Unemployment rate for general education graduates: 16 percent.
    - For vocational training graduates employed, 33 percent occupy positions below their qualification (compared to 11 percent for general education).
- Labor market regulations and protections:
  - Restrictions to the use of fixed-term contracts: allowed only in specific cases; maximum contract duration one year, renewable only once in limited cases.
  - Firing regulations: dismissal justified only for serious professional misconduct in most cases; unfair dismissal procedures introduce uncertainty for employers.
  - Minimum wage: Morocco has a high ratio of minimum to average wages; in 2015 the minimum wage in urban areas represented almost 100 percent of national income per capita.
  - Social protection coverage: only a minority of workers covered; system highly fragmented; current unemployment insurance provides replacement income for up to six months.
- Business environment progress and constraints:
  - Doing Business: gained 68 ranks between 2010 and 2019 (from 128th to 60th).
  - SME credit: about 16 percent of total credit and stagnant.
  - Payment delays: average payment delays increased from 66 days in 2015 to 99 days in 2017; share of firms facing delays greater than 120 days surged to 42 percent in 2017 from 13 percent in 2016.
  - Corruption: over 20 percent of enterprises in the 2013 Enterprise Survey indicate corruption is the largest impediment to doing business in Morocco (compared to 7 percent in the MENA region).

### Model structure and calibration (overview)
- Model type and data:
  - Small open-economy dynamic general equilibrium model with informal product and labor markets, calibrated for Morocco using quarterly data between 2000 and 2017.
  - Model developed by Anand and Khera (2016) and Munkacsi and Saxegaard (2017).
- Formal vs informal sector distinctions:
  - Only formal sector labor income is taxed.
  - Government purchases only formal goods; investment is a function of formal goods only.
  - Labor productivity is lower in the informal sector.
  - Formal goods are traded abroad; informal goods are not.
  - Hiring costs and entry costs are higher in the formal sector; rigidities are lower in the informal economy.
- Key behavioral and institutional parameters (selected calibration values):
  - Discount rate: 0.98.
  - Physical capital depreciation rate: 0.045.
  - Formal capital income share: 0.5.
  - Informal capital income share: 0.1.
  - Home inflation (%, y-o-y): 2.
  - Exit rate of formal retailers: 0.32.
  - Exit rate of informal retailers: 0.5.
  - Firing probability in the formal sector: 0.15.
  - Firing probability in the informal sector: 0.45.
  - Ratio of hiring cost to wage in the formal sector: 1.75.
  - Ratio of hiring cost to wage in the informal sector: 0.44.
  - Elasticity of substitution between home and foreign goods: 0.6.
  - Home bias: 0.8.
  - Export price elasticity: 2.
  - Share of income tax revenue to GDP (%): 0.04.
  - Exchange rate pass-through to import prices: 0.4.
  - Entry cost in the formal sector (in months of production): 2.07.
  - Entry cost in the informal sector (in months of production): 0.52.
  - Elasticity of hiring cost w.r.t. hiring probability (formal and informal): 0.5.
  - Elasticity of substitution between the formal and informal goods: 1.5.
  - Formal bargaining power of workers: 0.5.
  - Informal bargaining power of workers: 0.1.

### Simulation experiments and main quantitative results
- Reform magnitudes and scenarios:
  - Simulated reforms are a 10 percent decrease in formal firms’ entry costs and/or a 10 percent decrease in formal firms’ hiring costs.
  - Scenarios: isolated decreases, coordinated simultaneous reforms, and sequential reforms (one reform introduced after the other with a ten-year lag).
- Isolated reform results after 5 years:
  - 10 percent decrease in entry costs:
    - GDP increases by 1.4 percent after 5 years.
    - Unemployment falls by -0.5 percentage point.
    - Formal employment increases by 0.8 percentage point.
    - Formal wage: +1.3 (index or percent as reported).
    - Consumption: +0.7 (index or percent as reported).
    - Investment (% GDP): +1.7.
  - 10 percent decrease in hiring costs:
    - GDP increases by 1.1 percent after 5 years.
    - Unemployment falls by -1.7 percentage points.
    - Formal employment increases by 3.4 percentage points.
    - Formal wage: -0.12 (index or percent as reported).
    - Consumption: +0.5 (index or percent as reported).
    - Investment (% GDP): +0.8.
- Combined (simultaneous) reforms after 5 years:
  - 10 percent decrease in both entry and hiring costs:
    - GDP increases by 2.5 percent after 5 years.
    - Unemployment falls by -2.2 percentage points.
    - Formal employment increases by 4.2 percentage points.
    - Formal wage: +0.1 (index or percent as reported).
    - Consumption: +1.2 (index or percent as reported).
    - Investment (% GDP): +2.5.
  - Interpretation: impacts are additive with no tradeoff; combined PMRs and LMRs reinforce formality, output, and employment gains.
- Sequential reform results (20-year horizon; two sequencing scenarios):
  - Scenario S1: start with entry-cost reductions, then hiring-cost reductions.
    - Output grows faster in the first step and then converges gradually to the new steady state.
  - Scenario S2: start with hiring-cost reductions, then entry-cost reductions.
    - Unemployment falls more quickly and remains lower for longer.
  - Quantitative comparison:
    - On average, the growth gain under S1 relative to S2 is about 0.5 pp.
    - Under S2, the unemployment rate is lower than under S1 by 0.6 pp over the projection period.
  - Policy implication: sequencing choice involves a short-run tradeoff between faster GDP growth (start with PMRs) and faster unemployment reduction (start with LMRs).

### Policy recommendations and priorities
- Combined reform priority:
  - Coordinated implementation of labor and product market reforms yields the largest gains—about 2.5 percent of GDP growth and a 2.2 percentage point reduction in unemployment after five years.
- Sequencing guidance if reforms are staggered:
  - Start with product market reforms to maximize short-run output gains.
  - Start with labor market reforms to reduce unemployment faster in the short-run.
- Complementary measures:
  - Address education and training mismatches (including vocational training quality and labor-market relevance).
  - Rationalize social protection programs to broaden coverage and facilitate introduction of comprehensive unemployment insurance.
  - Reduce barriers to firm entry and simplify bureaucratic procedures to limit informality and support formal job creation.
  - Facilitate SME access to finance and curb payment delays and corruption.
  - Align minimum wage with labor productivity and ease restrictions on fixed-term contracts, especially for youth and new job seekers.
- Attention to distributional impacts and political economy constraints:
  - Coordinate reforms to manage distributional consequences and build public support for difficult reforms.

### Annex — steady state fit (selected statistics)
- Investment as a share of GDP:
  - Data average 32.1 percent; Min 26.4; Max 39.1; Model 31.7 percent. Data source: HCP 2000-2017.
- Household consumption as a share of GDP:
  - Data average 58.5 percent; Min 56.5; Max 61.6; Model 58.6 percent. Data source: HCP 2000-2017.
- Public consumption as a share of GDP:
  - Data average 18.4 percent; Min 16.8; Max 19.9; Model 18.3 percent. Data source: HCP 2000-2017.
- Imports of goods and services as a share of GDP:
  - Data average 41.1 percent; Min 30.8; Max 50.2; Model 40.4 percent. Data source: HCP 2000-2017.
- Exports of goods and services as a share of GDP:
  - Data average 32.1 percent; Min 26.8; Max 37.1; Model 31.7 percent. Data source: HCP 2000-2017.
- Unemployment rate:
  - Data average 10.2 percent; Min 8.9; Max 13.4; Model 10.2 percent. Data source: HCP 2000-2017.
- Shadow economy as a share of GDP:
  - Data 17.9 percent (Min 11.5*; Max 24.2**); Model 17.9 percent. Data source: HCP-2013/2014. Note: * excluding agriculture, ** including agriculture.
- Shadow economy as a share of total employment:
  - Data average 37.3 percent; Min 22.1*; Max 52.5**; Model 45.4 percent. Data source: HCP 2013/2014.

*Source: April 30, 2019; INTERNATIONAL MONETARY FUND.*

### 1. Nonagricultural Growth Decomposition ______________________________________________________ 3

### 1. Nonagricultural Growth Decomposition

### Executive summary and model application
- Purpose: Assess potential for well-sequenced labor and product market reforms to promote growth and job creation in Morocco using a Dynamic General Equilibrium model with informal product and labor markets.
- Main quantitative result: Implementing simultaneous reforms in the labor and product markets could add about 2.5 percent of GDP growth and reduce unemployment by about 2.2 percentage points after five years.
- Sequencing insight:
  - If reforms must be introduced sequentially, starting with product market reforms is more effective in boosting output in the short-run.
  - Starting with labor market reforms would reduce unemployment faster in the short-run.
- Objective: Identify the most welfare-enhancing package of reforms and quantify short- and medium-term effects on output and unemployment.

### Background and rationale
- Recent reform efforts: Government planned ambitious structural reforms in education, the labor market, the business environment, and public sector governance (2017).
- Need for coordination: Emphasis on coordination and sequencing to avoid stakeholder blockages or incoherent policies; government created a dedicated commission under the Head of government in 2017.
- Role of TFP: Relatively low and volatile total factor productivity (TFP) growth, which has slowed since the global financial crisis, is an important constraint to stronger growth.

### Literature context on LMRs and PMRs
- Channels: TFP is a main channel through which structural reforms affect growth.
- Product market reforms (PMRs): Evidence that low market competition slows productivity growth; liberalizing product markets can improve efficiency and boost job creation.
- Labor market reforms (LMRs): Studies find lower firing costs can temporarily increase unemployment in the initial year but reverse thereafter; stringent employment protection tends to lower productivity growth and hurts disadvantaged workers (women, less educated, youth).
- Coordination/sequencing: Combining LMRs and PMRs generally has greater impact on output and employment and leads to lower informality; some studies suggest starting with LMRs due to shorter adjustment periods, while others note timing matters with respect to economic slack.

### Recent trends in growth and macro performance (selected figures)
- Growth history:
  - GDP growth averaged about 5 percent in the 2000s.
  - Between 2010 and 2017, growth slowed and averaged 3.6 percent.
- Fiscal and external positions:
  - Public debt increased to 65 percent of GDP in 2017.
  - International reserves declined to about five months of imports in recent years.
- Policy targets (government plan referenced for 2017):
  - Raise economic growth to 4.5-5.5 percent and reduce unemployment to 8.5 percent by 2021.

### Growth–employment nexus and labor market outcomes (selected figures)
- Labor force participation:
  - Working-age population growth outpaced labor force growth, yielding a decline in the labor force participation rate from 53.1 percent in 2000 to 46.2 percent in 2018.
  - Female labor force participation rate: 22.2 percent in 2018.
- Unemployment levels and groups:
  - Unemployment has hovered around 10 percent in the last decade.
  - Youth unemployment: 26 percent.
  - Graduates unemployment: 17.1 percent.
  - Underemployment: around 10 percent (16.1 percent for the youth).
  - Combined under- or unemployment among youth: 33 percent (50 percent in urban areas).
- Employment structure:
  - Private sector represents about 88 percent of total employment.
  - Between 2005 and 2015, private sector job creation increased by 11.2 percent, public sector by 8.2 percent.

### Key constraints in the labor market
- Education and skills mismatch:
  - About 63 percent of employed people are without a diploma (45.2 percent in urban areas; 81.7 percent in rural areas).
  - Higher-level graduates represent only 11.4 percent.
  - Vocational training: higher ratio of vocational trainees than MENA average, but weak job prospects:
    - Unemployment rate among trainees: 24.5 percent in 2017.
    - Unemployment rate for general education graduates: 16 percent.
    - For vocational training graduates employed, 33 percent occupy positions below their qualification (compared to 11 percent for general education).
- Labor market regulations (selected features and comparisons):
  - Restrictions to the use of fixed-term contracts: allowed only in specific cases; maximum contract duration one year, renewable only once in limited cases.
  - Firing regulations: dismissal justified only for serious professional misconduct in most cases; unfair dismissal procedures introduce uncertainty for employers.
  - Minimum wage: Morocco has a high ratio of minimum to average wages; in 2015 the minimum wage in urban areas represented almost 100 percent of national income per capita.
  - Social protection coverage: only a minority of workers covered; system highly fragmented; current unemployment insurance provides replacement income for up to six months.
- Informal economy:
  - Informal economy share: 11.5 percent of nonagricultural GDP (2014 survey).
  - Informal units: 1.68 million units in 2014, increasing at an average rate of 1.2 percent per year since 2007; 71 percent concentrated in urban areas.
  - Informal employment (levels reported):
    - 2014: 2,376 million jobs.
    - 2007: 2,216 million jobs.
    - 1999: 1,902 million jobs.
  - Share of informal sector employment in non-agricultural employment: 36.3 percent in 2014 (37.3 percent in 2007).
  - Investment in informal sector: represented only 1 percent of total investment in 2014.

### Business environment progress
- Reforms: Efforts to ease procedures (customs, property rights, enterprise creation) and improve investor protection.
- Outcomes: Sustained inflows of foreign investment and improved rankings.
  - Doing Business: gained 68 ranks between 2010 and 2019 (from 128th to 60th).

### Policy implications and priorities (synthesis of findings)
- Combined reforms: Coordinated implementation of labor and product market reforms yields the largest gains—about 2.5 percent of GDP growth and a 2.2 percentage point reduction in unemployment after five years.
- Sequencing recommendations if reforms must be staggered:
  - Start with product market reforms to maximize short-run output gains.
  - Start with labor market reforms to reduce unemployment faster in the short-run.
- Complementary measures:
  - Address education and training mismatches (including vocational training quality and labor-market relevance).
  - Rationalize social protection programs to broaden coverage and facilitate introduction of comprehensive unemployment insurance.
  - Reduce barriers to firm entry and simplify bureaucratic procedures to limit informality and support formal job creation.
- Attention to distributional impacts and political economy constraints: Coordinate reforms to manage distributional consequences and build public support for difficult reforms.

*Source: April 30, 2019; INTERNATIONAL MONETARY FUND.*

### 18.      Further reforms would help promote more private sector-led growth. A survey of

### 18. Further reforms would help promote more private sector-led growth. A survey of

### Key constraints to private sector-led growth
- SME access to finance
  - SME credit is about 16 percent of total credit and has been stagnant in recent years; collateral requirements can be high.
  - 76 percent of large enterprises in the 2013 World Bank enterprise survey had a bank loan or a line of credit, compared to 42 and 57 percent of small and medium enterprises, respectively.
  - IMF (2019) estimated that greater SME financial inclusion could help increase economic growth in Middle Eastern countries by about 0.5 percentage point annually.
- Payment delays
  - Average payment delays increased from 66 days in 2015 to 99 days in 2017 (the new regulatory framework aims at 60 days).
  - The percentage of firms facing delays greater than 120 days surged to 42 percent in 2017 from 13 percent in 2016, with delays of up to 158 days for very small enterprises.
  - The government created an Observatory of payment delays to address this issue.
- Corruption
  - Over 20 percent of enterprises in the World Bank’s 2013 Enterprise Survey indicate corruption is the largest impediment to doing business in Morocco, compared to 7 percent in the MENA region.
- Competition
  - SMEs often face barriers to entry or monopolies/oligopolies that favor dominant positions.
  - Reactivation of the Competition Council in 2018 should support progress in promoting market competition.

### Selected reform priorities (Table 1)
- Reforms that could reduce formal firms’ entry costs include:
  - Simplification of administrative procedures
  - Facilitation of SME access to finance
  - Promotion of fair market competition
  - Strengthening of anti-corruption measures
- Reforms that could reduce formal firms’ hiring costs include:
  - Reduction of bureaucratic hiring costs
  - Better education and training
  - Easing of hiring and firing regulations
  - Alignment of minimum wage with labor productivity

### Empirical approach — model features
- Model type and data
  - A small open-economy dynamic general equilibrium model with informal product and labor markets, calibrated for Morocco using quarterly data between 2000 and 2017.
  - Model developed by Anand and Khera (2016) and Munkacsi and Saxegaard (2017).
- Key structural distinctions between formal and informal sectors
  - Only formal sector labor income is taxed.
  - Government purchases only formal goods; investment is a function of formal goods only.
  - Labor productivity is lower in the informal sector.
  - Formal goods are traded abroad; informal goods are not.
  - Hiring costs and entry costs are higher in the formal sector; rigidities (hiring regulations, training needs, administrative costs, firing difficulties) are lower in the informal economy.
- Caveat
  - The model is restricted to two sectors (formal and informal); direct analysis of specific reforms is approximated through impacts on broad aggregates.

### Main simulation experiments
- Reform magnitudes and scenarios
  - Simulated reforms are a 10 percent decrease in formal firms’ entry costs and/or a 10 percent decrease in formal firms’ hiring costs.
  - Scenarios: isolated/isolated decreases, coordinated simultaneous reforms, and sequential reforms (one reform introduced after the other with a ten-year lag).
- Isolated reform results (after 5 years)
  - 10 percent decrease in entry costs:
    - GDP increases by 1.4 percent after 5 years.
    - Unemployment falls by -0.5 percentage point.
    - Formal employment increases by 0.8 percentage point.
    - Formal wage: +1.3 (index or percent as reported).
    - Consumption: +0.7 (index or percent as reported).
    - Investment (% GDP): +1.7.
    - Interpretation: entry-cost reduction is very effective at boosting GDP via lower markups, higher real wages, higher household wealth, and higher private investment, but has limited impact on job creation due to increased capital intensity given unchanged labor market regulations.
  - 10 percent decrease in hiring costs:
    - GDP increases by 1.1 percent after 5 years.
    - Unemployment falls by -1.7 percentage points.
    - Formal employment increases by 3.4 percentage points.
    - Formal wage: -0.12 (index or percent as reported).
    - Consumption: +0.5 (index or percent as reported).
    - Investment (% GDP): +0.8.
    - Interpretation: lowering hiring costs significantly boosts formal job creation both in the short and long run; higher investment supports output despite a minor decline in formal wages.
- Combined (simultaneous) reform results (after 5 years)
  - 10 percent decrease in both entry and hiring costs (reform package):
    - GDP increases by 2.5 percent after 5 years.
    - Unemployment falls by -2.2 percentage points.
    - Formal employment increases by 4.2 percentage points.
    - Formal wage: +0.1 (index or percent as reported).
    - Consumption: +1.2 (index or percent as reported).
    - Investment (% GDP): +2.5.
  - Interpretation: impacts are additive with no tradeoff; combined PMRs and LMRs reinforce formality, output, and employment gains.
- Sequential reform results (20-year horizon; two sequencing scenarios)
  - Scenario S1: start with entry-cost reductions, then hiring-cost reductions.
    - Output grows faster in the first step and then converges gradually to the new steady state.
  - Scenario S2: start with hiring-cost reductions, then entry-cost reductions.
    - Unemployment falls more quickly and remains lower for longer.
  - Quantitative comparison:
    - On average, the growth gain under S1 relative to S2 is about 0.5 pp.
    - Under S2, the unemployment rate is lower than under S1 by 0.6 pp over the projection period.
  - Policy implication: sequencing choice involves a short-run tradeoff between faster GDP growth (start with PMRs) and faster unemployment reduction (start with LMRs).

### Conclusions and policy recommendations
- Overall impacts
  - A reform package combining reductions in hiring costs and entry costs yields greater impact: reduction of unemployment by 2 percentage points and an increase in GDP by about 2.5 points after 5 years.
- Policy priorities
  - Accelerate labor market reforms (LMRs) to complement ongoing improvements in the business environment to optimize effects under subdued growth and high unemployment, especially among youth.
  - Specific LMR measures:
    - Make contracts more flexible (e.g., relax restrictions on fixed-term contracts, especially for youth and new job seekers).
    - Implement more efficient procedures for dismissal while strengthening social and unemployment safety nets.
    - Align minimum wage with labor productivity.
    - Improve education and vocational training to reduce skill mismatches and lower hiring costs.
  - Specific PMR measures:
    - Simplify administrative procedures and reduce firms’ barriers to entry.
    - Curb corruption.
    - Enhance SME access to finance.
    - Promote fair market competition (reactivation of the Competition Council should support progress).
- Final assessment
  - Well-sequenced and coordinated structural reforms—particularly those that lower hiring costs—are likely to substantially increase output and formal employment over the medium term and promote more job-rich, private sector-led growth in Morocco.

*Source: 18. Further reforms would help promote more private sector-led growth. A survey of — IMF content unit 1marea2019004*

### 4.      Retailer good producers

### 1marea2019004 - 4.      Retailer good producers

### Retailer optimization and profits
- Retailer maximizes expected discounted stream of future profits: E Q Prof = max ∑_{t=0}^{∞} Q_{t,k} Prof_{t,k}.
- One-period profit expression involves: Ps_Ft, Ps_Pt, MCs_Ft (price final firm s pays for wholesale goods), Ps_PP, QDR, and production/price terms as in the source text.
- In equilibrium all intermediate firms (i ∈ (0,1)) follow the same optimization; notation often omits the i subscript for simplicity.

### Investment and capital goods
- Capital producer owns physical capital and invests to produce new physical capital subject to a capital adjustment cost following Bernanke and others (1999).
- Profit maximization condition for investment uses Q_t (price of physical capital) and includes adjustment cost φ and depreciation δ.
- Capital law of motion modified because price of investment differs from general economy-wide price level: only goods produced in the formal sector can be used for investment.
- Aggregate investment is a composite of home produced and imported goods with elasticity/aggregation parameters as in the source.

### Labor market dynamics
- Labor force fixed at 1; unemployment rate UNEMP_t = 1 − L_Ft − L_It.
- Employment law of motion: L_{Ft} = (1 − probf_{Ft}) L_{Ft−1} + hires (probabilities and timing described).
- Exogenous firing probabilities: probf_{Ft} (formal) and probf_{It} (informal).
- Hiring cost function: HCF_{Ft} = HCF_{α} (probh_{Ft})^{HCF_{β}}, where:
  - hiring probability probh_{Ft} = U_{t−1} + probf_{t−1} + L_{It−1} + L_{Ft−1} (as given in source),
  - HCF_{β} is per capita hiring cost and labor market deregulation variable,
  - HCF_{α} is the elasticity of hiring cost with respect to hiring probability.
- Hiring can come from both initially unemployed and those just fired in any sector.

### Wage bargaining
- Real wages determined by Nash bargaining proxied by weighted maximization of worker and firm value functions.
- Bargaining setup: max_{w} [λ_F (V_F − V_U) + (1−λ_F)(J_F − J_U)] in formal sector (analogous for informal), where:
  - λ_{Ft} is bargaining power in formal sector,
  - V_{Ft}, V_{It}, V_{U t} are value functions of formal worker, informal worker, and unemployed,
  - J_{S t} is value function of firms in sector S (formal or informal).

### Trade
- Exports QX_t respond to relative export price with elasticity alphax: QX_t = (P_Xt / P^*_t)^{−alphax}.
- Imports QM_t equal sum of imported consumer goods C_f^t, imported investment goods I_f^t, and imported government consumption goods G_f^{t}: QM_t = C_{f t} + I_{f t} + G_{f t}.

### Fiscal policy
- Government collects labor taxes from formal sector τ_{F,t} and lump-sum tax Tax_t to fund government spending P_{Ft} G_t and unemployment insurance WU_t U_t.
- Government issues domestic-currency public debt Debt_t to smooth temporary revenue/spending fluctuations; dynamic debt equation provided in source (log-linear form with targets and shocks).
- Government spending split between domestic goods H_t^G and foreign goods f_t^G using CES-like aggregation with parameters η and α and investment share distinctions.
- Fiscal rules:
  - Public debt-to-GDP ratio Debt_t / Z_t targeted around DEBTGDPbar via log-linear adjustment including rho, taxF terms, and epsTax.
  - Government spending-to-GDP ratio targeted around Gbar via analogous adjustment with rhoG and epsG.
  - Labor tax rates and unemployment allowance WU kept around fixed levels _taxF_employeebar and WUbar; lump-sum tax Tax_t adjusts per the log-linear rules shown in the source.

### Monetary policy
- Central bank follows inflation targeting with interest rate smoothing and responses to deviations of inflation and output from steady state.
- Policy reaction function specified in log-linear form: i_t depends on past i_{t−1}, deviations of PIE_t and ZZ_t from steady state, and smoothing/response parameters (gamma terms and epsilons) as detailed in source.

### Market clearing and production
- Demand for formal goods QDF_t equals sum: CF_t + IH_t + GH_t + QX_t.
- Demand for informal goods QDI_t equals CI_t (only used for informal consumption).
- Hiring costs and firm entry costs create frictions that generate a wedge between production and demand for formal and informal goods; reducing these frictions can increase production and consumption.
- Production functions for formal and informal sectors incorporate entry costs, hiring/firing frictions, prices, and adjustment terms as presented in the source.
- GDP aggregates components adjusted by relative prices as given in the source expression.

### Annex II — Evaluating the Steady State (key statistics)
- Investment as a share of GDP: Data average 32.1 percent; Min 26.4; Max 39.1; Model 31.7 percent. Data source: HCP 2000-2017.
- Household consumption as a share of GDP: Data average 58.5 percent; Min 56.5; Max 61.6; Model 58.6 percent. Data source: HCP 2000-2017.
- Public consumption as a share of GDP: Data average 18.4 percent; Min 16.8; Max 19.9; Model 18.3 percent. Data source: HCP 2000-2017.
- Imports of goods and services as a share of GDP: Data average 41.1 percent; Min 30.8; Max 50.2; Model 40.4 percent. Data source: HCP 2000-2017.
- Exports of goods and services as a share of GDP: Data average 32.1 percent; Min 26.8; Max 37.1; Model 31.7 percent. Data source: HCP 2000-2017.
- Unemployment rate: Data average 10.2 percent; Min 8.9; Max 13.4; Model 10.2 percent. Data source: HCP 2000-2017.
- Shadow economy as a share of GDP: Data 17.9 percent (Min 11.5*; Max 24.2**); Model 17.9 percent. Data source: HCP-2013/2014. Note: * excluding agriculture, ** including agriculture.
- Shadow economy as a share of total employment: Data average 37.3 percent; Min 22.1*; Max 52.5**; Model 45.4 percent. Data source: HCP 2013/2014.

### Annex III — Calibration of steady state parameters (selected values)
- Discount rate: 0.98.
- Physical capital depreciation rate: 0.045.
- Formal capital income share: 0.5.
- Informal capital income share: 0.1.
- Home inflation (%, y-o-y): 2.
- Exit rate of formal retailers: 0.32.
- Exit rate of informal retailers: 0.5.
- Firing probability in the formal sector: 0.15.
- Firing probability in the informal sector: 0.45.
- Ratio of hiring cost to wage in the formal sector: 1.75.
- Ratio of hiring cost to wage in the informal sector: 0.44.
- Elasticity of substitution between home and foreign goods: 0.6.
- Home bias: 0.8.
- Export price elasticity: 2.
- Share of income tax revenue to GDP (%): 0.04.
- Exchange rate pass-through to import prices: 0.4.
- Entry cost in the formal sector (in months of production): 2.07.
- Entry cost in the informal sector (in months of production): 0.52.
- Elasticity of hiring cost w.r.t. hiring probability (formal and informal): 0.5.
- Elasticity of substitution between the formal and informal goods: 1.5.
- Formal bargaining power of workers: 0.5.
- Informal bargaining power of workers: 0.1.
- Note: Several robustness checks performed to ensure main findings are not sensitive to these calibration assumptions.

*Source: IMF — 1marea2019004 - 4.      Retailer good producers (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1marea2019004.pdf_