Abstract
In this paper, we develop a search and matching model that allows for two important channels through which participation in the informal sector may benefit young less- educated workers: (i) human capital accumulation, and (ii) employer screening. We calibrate our model using the ENOE, a Mexican household survey on income and labor dynamics. Using our calibrated model, we shed light on many unobservable characteristics of the Mexican labor market for young less-educated workers, most notably the di↵ering hiring standards for informal and formal jobs. Specifically, hiring standards for these workers are found to be substantially higher for formal versus informal positions, making these workers naturally flow from unemployment to the informal sector where they can gain skills and reduce the uncertainty about their abilities. We also conduct counterfactual policy experiments to assess how labor market reforms designed to limit the employment share of the informal sector impact young less-educated workers. While our results favor reducing regulations in the formal sector due to the policy’s positive effect on aggregate employment, the policy is still found to impede the development of skills within this vulnerable segment of the labor market.