Fighting Informality in Segmented Labor Markets. A General Equilibrium Analysis Applied to Uruguay

As in other Latin American countries, labor informality in Uruguay mainly affects less educated workers, who are also more vulnerable to poverty. We analyze the impact of some policies against informality in Uruguay, applying a general equilibrium model with a segmented labor market specification. We simulate two sets of policies: payroll tax cuts and increased enforcement in the informal sector. Both sets of policies are effective in reducing informality, but the effect on poverty is not straightforward. Poverty falls as informality is reduced; however, as enforcement policies increase hiring costs for informal firms, wages of low-skilled workers decline and poverty increases.