Designing Unemployment Insurance for Developing Countries

Abstract

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.