Labor market informality, risk, and public insurance

A large proportion of workers in developing countries are informal and are not covered by social insurance programs, including pensions and unemployment insurance (UI), depriving them of a key mechanism for mitigating risks. To address this important social issue, governments offer noncontributory benefits, such as minimum pensions. The design of these programs has implications for employment choices and savings, which can be used for self-insurance. To understand how policy can affect these life cycle choices, I develop a life cycle model of formal and informal employment as well as savings and self-employment (which requires self-funded irreversible investment). Formal employment gives access to a bundle of public insurance programs, while informal workers are covered by basic pension guarantees. I estimate the parameters of the model using longitudinal survey data linked with administrative data from Chile and exploiting policy reforms to the pension system. The estimates suggest that the role of savings as self-insurance, the presence of borrowing constraints, and job amenities are important drivers of employment decisions. I also show evidence of complementarities between pensions and UI: when individuals have access to UI to insure themselves in the short run, they are more likely to invest in pensions. In counterfactual simulations, I show how the pension design affects formality decisions.