Job creation in a multi-sector labor market model for developing economies

This paper proposes an overlapping generations multi‐sector model of the labor market for developing countries with three heterogeneities – heterogeneity within self‐employment, heterogeneity in ability, and heterogeneity in age. We revisit an iconic paradox in a class of multi‐sector labor market models in which the creation of high‐wage employment exacerbates unemployment. Our richer setting allows for generational differences in the motivations for job search to be reflected in two distinct inverted U‐shaped relationships between unemployment and high‐wage employment, one for youth and a different one for adults. In turn, the relationship between overall unemployment and high‐wage employment is shown to be non‐monotonic and multi‐peaked. The model also sheds light on the implications of increasing high‐wage employment on self‐employed workers, who make up most of the world's poor. Non‐monotonicity in unemployment notwithstanding, increasing high‐wage employment has an unambiguous positive impact on high‐paying self‐employment, and an unambiguous negative impact on free‐entry (low‐wage) self‐employment.