Other models emphasize the voluntary aspects of informal behavior by by focusing
on the worker’s decision to be in the formal or in the informal sector Albrecht et al.
(2008). Similarly, a number of papers focus on the firm’s decision to open a formal or an
informal vacancy. Finally, Boeri and Garibaldi (2005) and Frankel and Pissarides (2006)
endogenize, both workers’ and firms’ decision to join either the formal or informal sector.
Table 4 summarizes the main characteristics of this literature. Below we review in more
detail the three types of models that dominate the search matching-model-based literature
on informal labour markets.
4.1 The intersectoral margin for workers and firms
Boeri and Garibaldi (2005) solve a deterministic search-matching model with heteroge-
neous workers and find that workers with different skill sort themselves between the two
sectors. The intuition is the following: because informal employment (shadow employment
in the paper) is associated with more labour turnover, it discourages high-skill workers.
The driving assumption is that unemployment benefits are small enough, but a similar
sorting can apply to a framework where the informal economy is characterized by lower
capital intensity and no training commitment. The authors choose a framework with two
labour markets with frictions and two matching functions. The marginal worker than is
indifferent between being unemployed in the formal or in the informal sector. Also Fugazza
and Jacques (2003) assume that there are important search frictions in both the formal
and the informal sector since working informally requires “special connections and the
access to the network is time consuming”. The model solves for two arbitrage condition,
one for the firms and one for the workers. More than one equilibrium can arise depending
on a parameter which summarizes the relative profitability of the regular and the irregu-
lar sectors. The analytical and numerical exercises of the paper reveal interesting policy
analysis which will be discussed in the following sections. Badaoui et al. (2006) adopt a
Burdett and Mortensen search framework (Burdett and Mortensen (1998)) in which large
firms pay a higher wage than small firms and concentrate in the formal sector. Small
firms, instead, tend to choose the informal sector. The key factor in the informality choice
is that small firms are less likely to receive a tax inspection respect to large firms. In
presence of search frictions, a wage premium in the formal sector arise since large firms
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