Unemployment Persistence and The Informal Sector

This paper argues that unemployment persistence in countries like Tunisia is not caused only by labor market rigidities and by population growth. The size of the informal sector and the low level of investment within the formal sector and in public infrastructure and services are other important factors. The main purpose of this paper is to show that the larger the size of the informal sector the more persistent unemployment will be, and that the larger the share of investment allocated to the formal sector the lower and least persistent unemployment will be. We also show that an exogenous increase of the wage rate paid by the informal sector, for instance as a result of the enforcement of some labor regulations within the informal sector, will (paradoxically) reduce unemployment. The reason is that it reduces the gap between work conditions in the formal and the informal sectors and slows down the migration process to the formal sector. The link between unemployment, the size of the informal sector and capital formation is based on many channels and assumptions built in the dynamic theoretical framework of this paper. Although the most crucial of these assumptions are tested empirically using data from a survey of firms conducted in Tunisia, the main results obtained in this paper are confirmed mainly by simulation under various scenarios.