Understanding the impact of economic
            shocks on labor market outcomes in developing countries : an
            application to Indonesia and Mexico
In this paper the authors use a search
            and matching model of multi-sector labor markets, to
            understand the channels through which economic shocks affect
            labor market outcomes in developing countries. In the model
            workers can be employed in agriculture, formal or informal
            urban jobs, or unemployed. Economic shocks are manifested as
            either increased turbulence in the formal/informal sectors
            or a decrease in overall sectoral productivity. By
            calibrating the model to Indonesia and Mexico, the authors
            are able to understand how the 1998 Indonesian crisis and
            the 2001 Mexican recession translated into labor market
            outcomes. They then venture to simulate how the current
            financial crisis might affect the allocation of labor and
            earnings across sectors, in these countries. The results
            suggest that in both countries past crises have increased
            the degree of turbulence of the formal sector, increasing
            job destruction. However, while in Indonesia the crisis
            affected the overall formal sector productivity, this was
            not the case in Mexico. This explains the larger blow to
            formal wages -- relative to the size of the shock- witnessed
            by Indonesian workers. The response of the informal sector
            was also different: In both countries the informal sector
            was able to act as a buffer, as relative earnings increased.
            However, while in Mexico it became much harder to find
            informal sector opportunities and easier to keep the job
            once found; in Indonesia turbulence in the informal sector
            increased substantially increasing the job destruction rate
            of informal jobs and limiting the cushioning role that the
            informal sector might have played. The agricultural sector
            was spared from the shock in both countries. In Indonesia,
            it actually benefited from an unusual exogenous increase in
            the price of rise. The simulations show that if either the
            informal or agricultural sectors are spared from the shocks,
            large reallocations of labor might occur, and the overall
            effect of the shock is smaller. Instead, if these sectors
            cant buffer the shock, the reallocation of labor is much
            smaller, but earnings in the formal sector drop
            substantially. The authors also explore the impact of
            alternative policies. They find that in relatively flexible
            markets where informality can be seen more as a choice
            rather than as queuing, unemployment benefits and informal
            employment subsidies may have paradoxical effects, by
            discouraging formal search. Instead, policies targeted at
            creating informal employment and boosting formal TFP growth
            have the desired effects.