ILO Working paper 39
Welfare Effects of Unemployment Benefits when Informality is High
We analyze for the first time how the high incidence of informal employment affects the welfare effects of unemployment benefits (UBs) outside of developed economies, exploiting matched administrative and survey data from the UB scheme of Mauritius. We find positive and large welfare effects, because the consumption drop at layoff exceeds what studies find for high-income countries, while the efficiency costs are comparatively low. In addition, UB recipients appear to move into informal employment out of economic necessity, rather than as part of a strategic choice.
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We analyze for the first time the welfare effects of unemployment benefits (UBs) in a context of high informality, exploiting matched administrative and survey data with individual-level information on UB receipt, formal and informal employment, wages and consumption.
Using a difference-in-differences approach, we find that dismissal from a formal job causes a large drop in consumption, which is between three to six times larger than estimates for developed economies. This is generated by a permanent shift of UB recipients towards informal employment, where they earn substantially lower wages. We then exploit a kink in benefits and show that more generous UBs delay program exit through a substitution of formal with informal employment. However, the disincentive effects are small and short-lived.
Because of the high insurance value and the low efficiency costs, welfare effects from increasing UBs are positive for a range of values of the coefficient of relative risk aversion.
Using a difference-in-differences approach, we find that dismissal from a formal job causes a large drop in consumption, which is between three to six times larger than estimates for developed economies. This is generated by a permanent shift of UB recipients towards informal employment, where they earn substantially lower wages. We then exploit a kink in benefits and show that more generous UBs delay program exit through a substitution of formal with informal employment. However, the disincentive effects are small and short-lived.
Because of the high insurance value and the low efficiency costs, welfare effects from increasing UBs are positive for a range of values of the coefficient of relative risk aversion.