{
  "title": "Labor Market Informality and the Business Cycle",
  "publication": "IMF Working Papers, November 20, 2020",
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  "summary": "Labor market informality is a pervasive feature of most developing economies. Motivated by the empirical regularity that the labor informality rate falls with GDP per capita, both at business cycle frequency and in a cross-section of countries, and that the Okun's coefficient falls with the level of labor informality, we build a small open-economy dynamic stochastic general equilibrium model with two sectors, formal and informal, which can replicate these key stylized facts. The model is calibrated to Colombia. The results show that labor market and tax reforms play an important role in changing the informality rate but also caution against over-optimism - with low GDP per capita, informality will always be relatively high as there is insufficient demand for formal goods. Quantitatively we find that higher productivity in the formal sector is key in explaining the difference between Colombia and countries with significantly lower informality. We use the model to study how labor informality and labor market frictions mediate the cyclical response of the economy to shocks, including commodity price shocks which are particularly relevant in Latin America. Informality is shown to play an important role as a shock absorber with the informal-formal margin limiting movements in the employed-unemployed margin.",
  "authors": [
    "Frederic Lambert",
    "Andrea Pescatori",
    "Frederik G Toscani"
  ],
  "publishDate": "2020-11-20",
  "series": "IMF Working Papers",
  "sections": [
    {
      "heading": "Executive summary",
      "content": "- Labor market informality is a pervasive feature of most developing economies.\n- Empirical regularities motivating the work:\n  - The labor informality rate falls with GDP per capita, both at business cycle frequency and in a cross-section of countries.\n  - Okun's coefficient falls with the level of labor informality.\n- The authors build a small open-economy dynamic stochastic general equilibrium model with two sectors, formal and informal, calibrated to Colombia.\n- Main high-level conclusions:\n  - Labor market and tax reforms play an important role in changing the informality rate.\n  - With low GDP per capita, informality will always be relatively high because there is insufficient demand for formal goods.\n  - Higher productivity in the formal sector is key in explaining differences between Colombia and countries with significantly lower informality.\n  - Informality acts as a shock absorber: the informal–formal margin limits movements in the employed–unemployed margin."
    },
    {
      "heading": "Model and calibration",
      "content": "- Model type:\n  - Small open-economy dynamic stochastic general equilibrium (DSGE) model.\n  - Two sectors: formal and informal.\n- Calibration:\n  - The model is calibrated to Colombia."
    },
    {
      "heading": "Quantitative findings and stylized facts replicated",
      "content": "- The model replicates the following stylized facts described in the paper:\n  - The labor informality rate falls with GDP per capita (both over the business cycle and across countries).\n  - The Okun's coefficient falls with the level of labor informality.\n- Quantitative result highlighted:\n  - Higher productivity in the formal sector is key to explaining the gap between Colombia and countries with significantly lower informality."
    },
    {
      "heading": "Role of informality in business cycles and shocks",
      "content": "- How informality mediates cyclical response:\n  - Labor informality and labor market frictions affect the cyclical response of the economy to shocks.\n  - Commodity price shocks (especially relevant in Latin America) are studied with the model.\n- Informality's functional role:\n  - Informality serves as a shock absorber.\n  - The informal–formal margin limits movements in the employed–unemployed margin."
    },
    {
      "heading": "Policy implications and cautions",
      "content": "- Policies affecting informality:\n  - Labor market reforms and tax reforms can materially change the informality rate.\n- Caution:\n  - Reforms alone may have limited effects when GDP per capita is low because insufficient demand for formal goods sustains high informality.\n- Diagnostic emphasis:\n  - Policies that raise productivity in the formal sector can be particularly effective in reducing informality relative to peers."
    },
    {
      "heading": "Publication and metadata",
      "content": "- Authors: Frederic Lambert, Andrea Pescatori, Frederik G Toscani\n- Date: November 20, 2020\n- Series: Working Paper No. 2020/256\n- Volume: 2020\n- Issue: 256\n- Pages: 42\n- DOI: https://doi.org/10.5089/9781513561288.001\n- Stock No: WPIEA2020256\n- ISBN: 9781513561288\n- ISSN: 1018-5941\n- Subjects: Business cycles, Economic growth, Labor, Labor markets, Production, Total factor productivity, Unemployment\n- Keywords: business cycle, business cycle model, Business cycles, commodity price shock, frictions affect labor market dynamics, GDP growth, informality, labor market, labor market frictions affect labor market dynamics, labor market informality, Labor markets, sector TFP, TFP parameter, TFP shock, Total factor productivity, Unemployment, WP\n\nSource: Labor Market Informality and the Business Cycle, Frederic Lambert, Andrea Pescatori, Frederik G Toscani; IMF Working Paper No. 2020/256 (November 20, 2020).\n\n---\n\n Content in this bundle\n\n- Working Paper\n  - Working Paper (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2020/11/20/labor-market-informality-and-the-business-cycle-49892"
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    "Authors: Frederic Lambert, Andrea Pescatori, Frederik G Toscani",
    "Published: November 20, 2020",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9781513561288.001",
    "Labor market informality is a pervasive feature of most developing economies.",
    "Empirical regularities motivating the work:",
    "The authors build a small open-economy dynamic stochastic general equilibrium model with two sectors, formal and informal, calibrated to Colombia.",
    "Main high-level conclusions:",
    "Model type:",
    "Calibration:",
    "The model replicates the following stylized facts described in the paper:",
    "Quantitative result highlighted:",
    "How informality mediates cyclical response:",
    "Informality's functional role:",
    "Policies affecting informality:",
    "Caution:",
    "Diagnostic emphasis:",
    "Authors: Frederic Lambert, Andrea Pescatori, Frederik G Toscani",
    "Date: November 20, 2020",
    "Series: Working Paper No. 2020/256",
    "Volume: 2020",
    "Issue: 256",
    "Pages: 42",
    "DOI: https://doi.org/10.5089/9781513561288.001",
    "Stock No: WPIEA2020256",
    "ISBN: 9781513561288",
    "ISSN: 1018-5941",
    "Subjects: Business cycles, Economic growth, Labor, Labor markets, Production, Total factor productivity, Unemployment",
    "Keywords: business cycle, business cycle model, Business cycles, commodity price shock, frictions affect labor market dynamics, GDP growth, informality, labor market, labor market frictions affect labor market dynamics, labor market informality, Labor markets, sector TFP, TFP parameter, TFP shock, Total factor productivity, Unemployment, WP",
    "**Working Paper**"
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