VoxEU Column Labour Markets Welfare state and social Europe

Dual (sometimes threefold) labour markets in Europe

Workers across Europe are suffering from what economists are calling a dual labour market. One side with permanent jobs, sheltered from risk, leaving the other side – the temporary workers – exposed to the vagaries of the market. This column argues that policymakers need to consider a third dimension – the shadow labour market. If they do not, the column warns that policymakers could make things far worse.

Recent articles on this site have been focusing on the importance of labour market reforms to be able to solve problems without generating others. For instance, Bentolila et al. (2010) observe that while European “reforms of the 1980s increased flexibility, they also led to a two-tier system with ultra-secure permanent workers and vulnerable temporary workers”. There is a third tier that warrants further exploration: the shadow or informal labour market.

In recent research, I make use of official data from the Italian National Institute of Statistics, Istat, on the Italian irregular labour market stretching from 1980 to 2009. My motivation was to examine whether the above-mentioned reforms could have narrowed the number of workers operating irregularly, a point worth considering when assessing the overall effectiveness of these policies.

So, what are the relationships between vulnerable temporary (dual) and shadow workers? One possible reason for the presence of shadow employment, that is by its definition flexible and frictionless, is the lack of these characteristics in the regular labour market. Given a sufficiently low expected penalty and a rigid regular market, the presence of hidden workers may help increase all kinds of labour flexibility – occupational (hiring-firing), contractual (part-time, fixed-term, etc.), and wage (e.g. via the tax wedge). As a result, across Europe several new flexible, fixed-term, contractual types have been suggested. These include proposals to “transform” irregular jobs into low-cost and highly-flexible regular jobs.

Another similarity between temporary and informal workers is in their relatively low productivity. Were they productive enough, so the argument goes, temporary and informal workers would be able to bargain for a permanent contract. A highly experienced worker, by contrast, is relatively rare and able to “pay back” even his gross wage. Unsurprisingly, both dual and irregular drudges are often first-time unskilled workers. Figure 1 plots results from my investigation into this perception. It collects the coordinate in the “labour (apparent) productivity; irregularity ratio” space for 34 sectors. Each of the 34 points is the 1980-2008 average of the corresponding sector. As expected, there is a negative correlation between productivity and irregularity ratio (-36%). The correlation does not disappear even after eliminating the two extreme values (-33%). This therefore offers a first empirical confirmation that both dual and underground are low-productive agents.

We might be tempted to think that shadow employment is the – perhaps unavoidable– first step of the suggestions outline in Bentolila et al. (2010). “A better strategy is to (…) promote entrance to the permanent labour market in stages, making job security provisions increase smoothly as workers acquire tenure.” Figures 2a and 2b tell a possibly different story, however.

At least in Italy and at an aggregate level, the labour market policies implemented throughout the last 30 years have created dualism without reducing the underground sector. The overall shadow employment has remained a relatively constant part of the Italian labour-mix (see Bovi 2005 for more in-depth analysis). Even the mass legalisation of 2002-2003, which has dramatically reduced the irregularity ratio in some sectors (especially personal services), has only had a temporary impact on the total irregularity ratio, which has now returned at its – perhaps natural – long-run level.


While labour market policies should avoid creating dualism, they should also address the issue of the underground sector. Recent developments show that these two apparently linked problems appear to be different in the sense that the costs of dualism exacerbate in bad times, whereas the shadow employment is less-cyclical. Hence today it seems we are in the strange situation where having a vulnerable and temporary regular job is even worse than having an underground one – on average, firms prefer to reduce temporary workers than shadow workers.

This calls for multifaceted, possibly new, approaches when addressing labour market reforms. In another recent Vox contribution, Bertola (2010), highlights the difficulties of introducing labour market reforms at time of public debt. Due to the obvious links between shadow employment and fiscal policies, perhaps policymakers could consider initiatives to bring the underground sector back into the regular economy.

If policymakers are serious about truly Pareto efficient interventions, they need to learn the lessons the evidence points to. If we don’t look into the shadows, it doesn’t mean they don’t exist.


Bentolila, Samuel, Tito Boeri, Pierre Cahuc (2010), “Ending the scourge of dual labour markets in Europe”, VoxEU.org, 12 July.

Bertola, Giuseppe (2010), “Fiscal Policy and Labour Markets at Times of Public Debt”, VoxEU.org, 4 October.

Bovi, M (2005), “The Dark, and Independent, Side of the Italian Labor Market”, Labour, 19, 4.

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