Trade and Informality in the Presence of Labor Market Frictions and Regulations

We build an equilibrium model of a small open economy with labor market frictions and imperfectly enforced regulations. Heterogeneous firms sort into the formal or informal sector. estimate using data from Brazil, use counterfactual simulations to understand how trade affects economic outcomes in presence informality. show that: (1) Trade openness unambiguously decreases informality tradable sector, but has ambiguous effects on aggregate (2) The productivity gains are understated when sector is omitted. (3) results large welfare even repressed. (4) Repressing increases productivity, at expense employment welfare. (5) wage inequality reversed incorporated analysis. (6) works as unemployment, not buffer event negative shocks.