Enforcing Labor Regulation - Monitoring and Punishment

While the literature focuses on determining whether stricter enforcement of labor regulations reduces labor informality but at the cost of adverse effects on labor markets, this study investigates the implications of the enforcement policy instrument itself. I develop a firm dynamics model with occupational choice and capital accumulation featuring informal labor employment and unemployment. Additionally, the model assumes a government conducting costly labor inspections and imposing penalty fines on firms employing informal workers. 
The model is calibrated using Brazilian data and examines the impact of two policy instruments: increased labor inspections and higher penalties. I find that both instruments reduce informality rates but have different economic outcomes. Higher penalties generate a positive government budget net, increase the TFP, wages, and welfare, and have mixed effects on unemployment. Increasing inspections reduces unemployment but decreases TFP and lowers overall welfare. The results highlight that the choice of enforcement instrument significantly affects economic outcomes, underscoring the importance of considering these impacts in policy design.