Shadow Sorting

No 10, Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: This paper investigates the border between formal employment, shadow employment, and unemployment in an equilibrium model of the labor market with market frictions. From the labor demand side, firms optimally create legal or shadow employment through a mechanism that is akin to tax evasion. From the labor supply side, heterogeneous workers sort across the two sectors, with high productivity workers entering the legal sector. Such worker sorting appears fully consistent with most empirical evidence on shadow employment. The model sheds also light on the "shadow puzzle", the increasing size of the shadow economy in OECD countries in spite of improvements in technologies detecting tax and social security evasion. Shadow employment is correlated with unemployment, and it is tolerated because the repression of shadow activity increases unemployment. The model implies that shadow wage gaps should be lower in depressed labor markets and that deregulation of labor markets is accompanied by a decline in the average skills of the workforce in both legal and shadow sectors. Based on micro data on two countries with a sizeable shadow economy, Italy and Braziil, we find empirical support to these implications of the model. The paper suggests also that policies aimed at reducing the shadow economy are likely to increase unemployment.

Keywords: Unemployment; Matching; Shadow Activity. (search for similar items in EconPapers)
JEL-codes: J30 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2006
New Economics Papers: this item is included in nep-dge and nep-lab
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (21)

Forthcoming in NBER Macroeconomic Annual-ISOM Conference

Downloads: (external link)
https://www.carloalberto.org/wp-content/uploads/2018/11/no.10.pdf (application/pdf)

Related works:
Working Paper: Shadow Sorting (2006)
Chapter: Shadow Sorting (2005)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cca:wpaper:10

Access Statistics for this paper

More papers in Carlo Alberto Notebooks from Collegio Carlo Alberto Contact information at EDIRC.
Bibliographic data for series maintained by Giovanni Bert ().