Product Market Regulation, Firm Size, Unemployment and Informality in Developing Economies

45 Pages Posted: 21 Feb 2011

See all articles by Olivier Charlot

Olivier Charlot

University of Cergy-Pontoise

Franck Malherbet

University of Cergy-Pontoise - THEMA; IZA Institute of Labor Economics

Cristina Terra

ESSEC Business School; University of Cergy-Pontoise - THEMA

Date Written: February 1, 2011

Abstract

This paper studies the impact of product and labor market regulations on informality and unemployment in a general framework where formal and informal firms are subject to the same externalities, differing only with respect to some parameter values. Both formal and informal firms have monopoly power in the goods market, they are subject to matching friction in the labor market, and wages are determined through bargaining between large firms and their workers. The informal sector is found to be endogenously more competitive than the formal one. We find that lower strictness of product or labor market regulations lead to a simultaneous reduction in informality and unemployment. The difference between these two policy options lies on their effect on wages. Lessening product market strictness increases wages in both sector but also increases the formal sector wage premium. The opposite is true for labor market regulation. Finally, we show that the so-called overhiring externality due to wage bargaining translates into a smaller relative size of the informal sector.

Keywords: informality, product and labor market imperfections, firm size

JEL Classification: E24, E26, J60, L16, O1

Suggested Citation

Charlot, Olivier and Malherbet, Franck and Terra, Cristina, Product Market Regulation, Firm Size, Unemployment and Informality in Developing Economies (February 1, 2011). IZA Discussion Paper No. 5519, Available at SSRN: https://ssrn.com/abstract=1765685 or http://dx.doi.org/10.2139/ssrn.1765685

Olivier Charlot (Contact Author)

University of Cergy-Pontoise ( email )

33 Boulevard du Port
Cergy-Pontoise Cedex, Cedex 95011
France

Franck Malherbet

University of Cergy-Pontoise - THEMA ( email )

33 boulevard du port
F-95011 Cergy-Pontoise Cedex, 95011
France

IZA Institute of Labor Economics

Schaumburg-Lippe-Str. 7 / 9
Bonn, D-53072
Germany

Cristina Terra

ESSEC Business School ( email )

95021 Cergy-Pontoise Cedex
France

University of Cergy-Pontoise - THEMA ( email )

33 boulevard du port
F-95011 Cergy-Pontoise Cedex, 95011
France

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