Strategic Formal Layoffs: Unemployment Insurance and Informal Labor Markets

Abstract

Exploiting an unemployment insurance (UI) reform in Brazil, we study incentive effects of UI in the presence of informal labor markets. We find that eligibility for UI benefits increases formal layoffs by twelve percent. Most of the additional formal layoffs are related to workers transitioning to informal employment. We further document formal layoff and recall patterns consistent with rent extraction from the UI system. Workers are laid off as they become eligible for UI benefits and recalled just when benefits cease. Salary patterns around the reform are consistent with firms and workers sharing rents through lower equilibrium salaries.

Keywords: unemployment insurance, informal labor markets, law and economics

JEL Classification: J21, J22, J46, J65, K31