these labor market policies become. An expansion of subsidized health to informal sector workers has minor aggregate and distributional effects. Changes in relative prices that affect the profitability of the formal sector negatively have quite sizable aggregate effects, producing more long run unemployment and informality, and increasing unemployment duration.

The paper proceeds as follows. Section 2 introduces some stylized facts about the Colombian labor markets and a brief summary of the policy reforms. Sections 3 details the theoretical model. Section 4 describes the data and details the estimation procedure and results. Section 5 concludes.

# **2 Stylized Facts**

Some stylized facts about the Colombian urban labor markets in the last two decades include: increasing long-run unemployment and unemployment duration, a decreasing but persistently high informality rate, a modest rise in relative earnings favoring informal sector workers, and a decrease in overall wage inequality<sup>5</sup> driven by a reduction in within-sector inequality.

Figure 1 presents the evolution of the unemployment rate from the first quarter of 1984 to the third quarter of 2013. At the beginning of 1984, approximately 13.7 percent of the labor force was unemployed. A period of steadily declining unemployment started. In the fourth quarter of 1993 the unemployment rate had dropped to 7.8 percent. A long period of rising unemployment followed, reaching a peak of 20.5 percent in the third quarter of 2000. The decline of unemployment in the following quarters was slow, reaching a rate of 10.4 percent in the second quarter of 2013.

Notably, short-term unemployment did not fall near its average levels: 11.8 percent over the period 1984-1999 versus 13.9 percent over the period 2000-2013. Mean unemployment duration also increased from 31 weeks to 35 weeks, well above pre-recession norms (see Figure 2).

Figure 3 shows the evolution of the employment rate. The long run employment rate followed an upward trend, increasing from 52 percent in the period 1984-1999 to 55.8 percent in the period 2000-2013.

Informality has been a persistent phenomenon over the last two decades: regardless of the definition of informality used,<sup>6</sup> approximately one of every two workers are considered informal. Figure

> 5Labor market statistics are constructed using data from Colombian household surveys. These surveys are repeated cross-sections carried out by the Colombian Statistics Department (DANE) on employed and unemployed individuals, and include: Encuesta Nacional de Hogares (ENH) for the period 1984:QI to 2000:Q2, Encuesta Continua de Hogares (ECH) for the period 2000:M1 to 2006:M12, and Gran Encuesta Integrada de Hogares (GEIH) for the period 2007:M1-2013:M6. Informality statistics are constructed using the Informality module in the surveys, available every two years before 1996, and yearly afterwards. The statistics presented in this section are for all urban workers.

> 6 The following definitions will be used in the paper:

> **“Social Protection” (SP) Informality Definition** : A worker is considered informal if either of the following two conditions hold:

> _• Health Affiliation_ : Is not affiliated to a health plan, or if affiliated does not make any contributions to the system (either because is part of subsidized regime or beneficiary of the contributory regime)

> _• Pension Affiliation_ : Not affiliated to a pension fund

This variable is primarily a proxy for non-compliance to labor regulations in Colombia.

**“Firm Size and Occupation” (FSO) Informality Definition** : A worker is considered informal if the following two criteria hold:

4