Principal investigator: Viviane Pires Ribeiro
Article title: Informality in the Labor Market and the Impact of Institutions: An Analysis from the Perspective of Game Theory
Article authors: Fernando B. Meneguin and Maurício S. Bugarin
Location of the intervention: Brazil
Sample size: Brazilian population
Sector: Job market
Type of InterventionAn analysis of informality from the perspective of game theory.
Primary variable of interest: Informality
Evaluation method: Others Game Theory
Evaluation Context
The labor market has imperfections that are increasingly occupying space in national debates. These issues are related to high levels of unemployment, a high rate of informality, the frequency of litigation in labor courts, high income inequality, the limited reach of labor laws, and government interventions to provide assistance to workers.
Regarding informality, between 1991 and 2002, the Monthly Employment Survey (PME) of the Brazilian Institute of Geography and Statistics (IBGE) identified an average growth of almost ten percentage points in informal labor relations in metropolitan regions. Informal labor relations encompass salaried workers without formal employment contracts and those who are self-employed.
Some authors share the view that the informal sector is one of the segments that contributes most to Brazilian poverty, even more than metropolitan unemployment, because informal workers are those who do not have a formal employment contract and therefore lack labor rights such as maternity leave, unemployment insurance, and social security contributions.
Intervention Details
Meneguin and Bugarin (2008) conduct an analysis with a differentiated approach to informal labor relations, using Game Theory, seeking to understand the behavior of the agents involved – workers and employers – and the effect of institutions on the functioning of the labor market. More specifically, the authors emphasize the interaction between informality and Labor Justice. To this end, data from the Brazilian Institute of Geography and Statistics, the World Bank, and IPEA were used.
Methodology Details
In order to understand the relationships between agents in the labor market, Meneguin and Bugarin (2008) constructed a dynamic and infinite game of complete information with two players: workers and employers. In the model, the worker initially has two options: either they choose to be self-employed and, in that situation, earn income Y, or they prefer to be employed by company E. If they choose to be salaried, then the company makes the decision. It can register the employee, signing the work card, and pay, in addition to the remuneration, all the labor charges that correspond to the benefits due to the worker plus the employer contributions that the company collects for the government. Or, the firm can decide not to register the employee and keep them in the informal sector, paying only the remuneration r.
If the company registers the worker, the employment becomes formal and remains so, without any opportunity for future strategic behavior. On the other hand, if the worker remains in the informal sector, they may become complacent, receiving only their remuneration, or they may report the company to the Labor Court. If they do so, they will receive their remuneration plus a percentage of the labor benefits they would be entitled to. In this model, for simplicity, it is assumed that the employee reports the company and is dismissed simultaneously. Furthermore, if dismissed, they will remain self-employed.
If an employee is dismissed, the company will still have the option of hiring a new worker to fill the vacancy, provided there is a demand for labor. Therefore, the company's decision is limited to maintaining the informal worker, at the minimum cost of their salary, or formalizing their employment, adding the associated costs. The worker, in turn, besides deciding whether to become self-employed or seek employment, if they seek employment and are hired informally, decides whether to report the company to the courts and be dismissed, or remain silent about the informality, keeping their job.
In this model, the Labor Court is represented by a parameter that increases or decreases employers' costs in terms of labor charges when a dispute arises and the court is called upon. The aim is to explain, using Nash equilibria as a metaphor for the game, how the length of informal employment to which a worker is subjected is determined, as well as a possible cause for high labor turnover.
Results
The results found by Meneguin and Bugarin (2008) show that there is an equilibrium in which the employee is hired informally and, after a certain period, has their work permit signed. Thus, the solution of the model used by the authors allows us to conclude that the more efficient the institutional framework, that is, the more the Labor Courts compel employers to pay the full benefits to which employees would be entitled, the faster the formalization of the employment contract will occur in this equilibrium where the employer formalizes the work after an initial period without a signed work permit.
The model confirms what appears to be the reality in certain labor markets where, under certain conditions, employers prefer to keep employees in the informal sector, even knowing that this will lead to labor court costs. That is, firms adopt the practice of hiring informally and frequently firing, contributing to high labor turnover. This highlights a sad convergence of the labor market towards a situation of stable informality at high levels. Despite the negative result, the study points out that the balance without registration does not exist if the courts can guarantee the worker a high percentage of recovery of benefits not paid by the firm during the period of informality. In this case, the firm prefers to register the worker before he denounces it in court.
Therefore, the main message from the balances found is that the more agile the courts are in judging labor lawsuits, the less time a worker will remain in an informal situation before being formally hired by a company. The second important message is that the slower the courts are in judging labor lawsuits, the greater the turnover of workers in jobs that are not formalized. On the other hand, the more agile the Labor Courts are, the lower the probability of an equilibrium existing in which employees never have their employment contracts signed.
Lessons in Public Policy
To combat informality, the analysis conducted by Meneguin and Bugarin (2008) suggests adopting public policies such as reforming the Labor Courts, making them more agile, with judgments that reflect the real rights of workers, or perhaps creating other instances of conciliation between employees and employers not linked to the Judiciary, which guarantee speed and justice in labor disputes. According to this analysis, this reform has two important effects. First, it makes firms register employees more quickly, in the case of a balance with delayed registration, reducing the time of informality in the economy. Second, it can end the harmful balance in which the firm never registers the worker, replacing them with another informal worker when the latter takes legal action.
References
MENEGUIN, Fernando B.; BUGARIN, Maurício S. Informality in the labor market and the impact of institutions: an analysis from the perspective of game theory. Applied Economics, v. 12, n. 3, p. 341-363, 2008.
