The high incidence of informality in the labor markets of middle-income economies challenges the provision of unemployment protection. We show that, despite informational frictions, the introduction of an unemployment insurance savings account (UISA) system may provide substantial benefits. This system improves welfare by providing insurance to the unemployed and creating incentives to work in the formal sector. The optimal scheme generates a reduction in unemployment (from 4 to 3 percent), an increase in formality (from 68 to 72 percent) and a rise in total output (by 4 percent). Overall, individuals obtain welfare gains equivalent to a 2.4 percent increase in consumption in every period.

We thank David Baqaee and Steve Davis for helpful comments and the C.V. Starr Center at NYU for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

The high incidence of informality in the labor markets of middle-income economies challenges the provision of unemployment protection. We show that, despite informational frictions, the introduction of an unemployment insurance savings account (UISA) system may provide substantial benefits. This system improves welfare by providing insurance to the unemployed and creating incentives to work in the formal sector with government contribution to the individuals' accounts during formal employment. Thus, the optimal scheme generates a reduction in unemployment (from 4 to 3 percent), an increase in formality (from 68 to 72 percent), a rise in total output (by 4 percent). Overall, individuals obtain welfare gains equivalent to a 2.4 percent increase in consumption in every period.JEL classification: D82, H55, I38, J65.