Rafael Dix-Carneiro (Duke University)

Trade and Informality in the Presence of Labor Market Frictions and Regulations

Abstract. We build an equilibrium model of a small open economy with labor market frictions andimperfectly enforced regulations. Heterogeneous firms sort into the formal or informal sector.We estimate the model using data from Brazil, and use counterfactual simulations to understandhow trade affects economic outcomes in the presence of informality. We show that: (1) Tradeopenness unambiguously decreases informality in the tradable sector, but has ambiguous effectson aggregate informality. (2) The productivity gains from trade are understated when the infor-mal sector is omitted. (3) Trade openness results in large welfare gains even when informality isrepressed. (4) Repressing informality increases productivity, but at the expense of employmentand welfare. (5) The effects of trade on wage inequality are reversed when the informal sectoris incorporated in the analysis. (6) The informal sector works as an “unemployment,” but nota “welfare buffer” in the event of negative economic shocks.

Joint with Pinelopi Goldberg (Yale University), Costas Meghir (Yale University) and Gabriel Ulyssea (University College London)