Munich Personal RePEc Archive
Employment Targeting in a Frictional
Labor Market
Ghate, Chetan and Mazumder, Debojyoti
Indian Statistical Institute, Delhi Center, Indian Institute of
Management, Indore
29 May 2018
Online at https://mpra.ub.uni-muenchen.de/87065/
MPRA Paper No. 87065, posted 12 Jun 2018 14:03 UTC
Employment Targeting in a Frictional Labor Market
Chetan Ghate
y
Debojyoti Mazumder
z
May 28, 2018
Abstract
Governments in both developing and developed economies play an active role in
labor markets in the form of providing both formal public sector jobs and employment
through public workfare programs. We refer to this as employment targeting. In the
context of a simple search and matching friction model, we show that the propensity
for the public sector to target more employment can increase the unemployment rate
in the economy and lead to an increase in the size of the informal sector. Employment
targeting can therefore have perverse e¤ects on labor market outcomes.
Keywords : Search and Matching Frictions, Labor Markets, Employment, Informal
Sector, Public Sector.
JEL Codes : J46, D83, O17, O20
We thank Monisankar Bishnu and workshop participants at the World Bank-ISI workshop on Jobless
Growth in South Asia (March 8, 2018) for excellent comments. The usual disclaimer applies.
y
Economics and Planning Unit, Indian Statistical Institute, New Delhi – 110016, India. Tel: 91-11-4149-
3938. E-mail: cghate@isid.ac.in.
z
Corresponding Author: Economics Area, Indian Institute of Management, Indore. Prabandh Shikhar,
Rau-Pithampur Road Indore - 453556, Madhya Pradesh. Tel: +91-731 243 9491. E-mail: debojy-
oti.eco@gmail.com, debojyotim@iimidr.ac.in.
1
1 Introduction
Governments in both developed and developing economies play an active role in labor mar-
kets to meet their growth and development objectives. In the case of India, the twin phenom-
enon of jobless growth and the growing casualization of the work-force has led to a vibrant
debate about the role of government policy in stimulating employment (see Kapoor (2017)
and Abraham (2017)). One particular intervention takes the form of the public sector being
the provider of jobs. We refer to this as employment targeting. For instance, public work-
fare programs are amongst the most common forms of anti-poverty programs in developing
countries. NREGS, the ‡agship workfare government scheme in India employs several hun-
dred million people. In the US, the Works Projects Administration (WPA) started in 1935
was initiated in response to the Great Depression, and hired unemployed workers directly.
Large scale poverty reduction is a central policy objective of developing countries in Latin
America, Africa, and Asia, where employment guaranteed schemes have been at the centre
of an employment oriented approach to anti-poverty policy-making (Basu et al, 2009). More
recently, the aggressive response of …scal policy in the …nancial crisis of 2008 by developed
economies has sparked a burgeoning literature on the merits of counter-cyclical government
spending (see Rendahl (2016)).
In each of these cases, the general equilibrium e¤ects of policies that target employment
on overall unemployment remains a key research question. In the context of employment
guarantee schemes, like NREGS, a question that arises is that by leading to an increase
in wages, do employment guarantee schemes crowd out private sector employment ? In
a recent paper, Muralidharan, Niehaus, and Sukhtankar (2018) study the policy-relevant
general-equilibrium estimates of the total e¤ect on wages, employment, income, and assets of
increasing the e¤ective presence of NREGS. They show that a public employment guarantee,
by improving the outside option for workers, puts upward pressure on labor markets that
drives up wages and earnings. Basu et. al (2009) develop a formal model of an employment
guarantee scheme and show that such schemes introduce contestability in labor hiring, and
raise the reservation wage. Gomes (2015) characterizes a government’s acyclical wage policy
that protects workers from business cycle ‡uctuations. He argues that very high public sector
wages can create disincentives to private players for posting vacancies and can reduce overall
employment. In this context, he proposes an optimum level of the public sector wage which
maximizes welfare.
What is less understood in the literature however, is the impact of employment targeting
on the size of the informal sector in developing economies. We …ll this gap in the literature.
1
1
There are only a handful of papers that use search and matching frameworks to study informal labor
2
We build a simple model of a developing country labor markets characterized by search and
matching frictions. We show that public sector intervention in the labor market can lead to
an increase in the size of the informal sector. Because the informal sector is characterized by a
high …ring rate and lower unemployment bene…ts, employment targeting leads to an perverse
e¤ects on labor market outcomes. This is our main result. We also show that, under certain
parametric restrictions, an increase in the public sector hiring rate can increase employment
unambiguously. In particular, we …nd it is possible that the private sector wage falls as a
result of an increase in the public sector hiring rate which leads to more job creation in the
private sector. This reverses the consensus …ndings in the search and matching literature
which shows that an increase in public sector employment disincentivizes private sector
vacancy postings, as in the paper by Gomes (2015).
2 The Model
The economy is comprised of three in…nitely lived agents: …rms, agents or workers, and
the government. Heterogeneous individuals are uniformly distributed according to their
abilities. Each individual’s ability is indexed as i 2 ( 0 ; 1) where 0 is the lowest ability and
1 is the highest ability. Since agents do not have any other distinguishing features, they are
indexed as i. Firms present in the economy produce a single …nal good which is consumed
by agents. We call a private …rm’s production unit as the "private sector", denoted by P .
The government’s production unit is termed as "public sector", denoted by G. Unemployed
agents are denoted by U: Agents are risk neutral and their utility comes only from consuming
the …nal good.
Each agent has one unit of labour endowment, which he supplies inelastically in each
point of time. However, the labour market is characterized by frictions. Private sector
…rms and agents face search and matching friction before commencing production activity.
Unemployed agents search for jobs irrespective of their abilities and can search for both
private sector and public sector jobs. Vacant …rms looking for workers post a vacancy by
paying a vacancy posting cost, d > 0. Private sector …rms and job seekers are matched
according to a Pissarides style matching function: m = m(u; v), where u is the number
of unemployed, and v is the number of vacant …rms (Pissarides 2000). The function, m,
is homogeneous of degree one, concave, and increasing in each of its arguments. Hence,
m=u = m(1; );where v=u, denotes the job …nding rate, while m=v = m(
1
; 1) is the
markets. See Albrecht et. al. (2009), Castillo and Montoro (2010), Maarek (2012), and Charlot et. al.
(2013). None of these papers however focus on the e¤ects on employment targeting.
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vacancy matching rate.
2
Production starts in the private sector once a …rm and a worker are
matched. Production follows a constant returns to scale (CRS) technology in the economy:
i.e., the i
th
ability agent produces i units of output. Firms get to know about their workers’
ability once they are matched.
Unemployed agents get an amount, b > 0; which is an unemployment bene…t from the
government. Workers who are employed in the private sector get a per period wage, w
i
,
according to their ability. The …ring rate in the private sector is given by > 0. The rate at
which an unemployed agent …nding a public sector job is given by > 0. The parameter
can be considered as the hiring rate of public sector. We assume that the government pays
a …xed wage to its employees, w; irrespective of their ability. The …ring rate in the public
sector is given by,
~
. Therefore, in a small time span, t, an unemployed agent can get a
public sector job with a probability, t, while a public sector worker can be …red with
the probability,
~
t. Similarly, a private sector job match can break with probability,
t; within t. r is the discount rate in the economy. Finally, we assume that a job seeker
cannot get a net surplus from a public sector job and a private sector job simultaneously.
All the public/private job creation and job destruction rates follow a Poission process as in
Pissarides (2000).
We formalize the public sector’s employment policy by the policy-tuple, { w; b; } and
call this the employment targeting policy of the government. Our main focus in this paper,
however, is on the parameter, ; and its e¤ect on unemployment and informalization.
2.1 Steady state
In this paper, we focus on characterizing the steady state. Let V
i
j
denote the in…nite income
stream of the i
th
worker, where the state j = P; G; U: This implies that
rV
i
P
= w
i
(V
i
P
V
i
U
) (1)
This implies that the ‡ow value of a private sector job (or a …lled vacancy), rV
i
P
, equals the
wage from the private sector job (w
i
) plus the expected net surplus from being unemployed
if the private sector job is destroyed ((V
i
U
V
i
P
)) : Analogously, the ‡ow value of being
employed in the public sector is given by
rV
i
G
= w
~
(V
i
G
V
i
U
); (2)
2
m(1; ) t and m(
1
; 1) t are the transition probabilities from being unemployed to employed and
vacant to a …lled post, respectively, in the private sector, at a very small time interval t.
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