Labour Market Policies and the Informal Sector: A Segmented Labour Markets Analysis

In this paper we develop a dynamic model of a multi-sector economy with an informal sector and segmented labour markets first to demonstrate how informal production and employment decline in transition towards the steady state, and second to analyse the impact of various labour market policies at the steady state. Our results primarily indicate that informal employment share increases with minimum wage, and decreases with reductions in the payroll taxes, moreover, reducing the tax imposed on employer is more effective in reducing the informal employment share, while reducing the tax imposed on employee is more effective in increasing consumer felicity.