Cheaper AI, More Informality? A Dual Labor Market Model for Developing Economies

2026-07-16

AI Summary

This study investigates the impact of declining AI costs on labor market structure in developing countries, with a focus on their differential effects on formal and informal employment. It innovatively incorporates AI capital into a small open-economy DSGE model characterized by high informality, featuring dual labor markets, country risk, and substitution/complementarity between AI and formal labor. Through model calibration and numerical simulations, the analysis reveals that if AI substitutes for formal labor, it suppresses formal employment and expands the informal sector; conversely, if AI and formal labor are complementary, formal employment, output, wages, and capital accumulation all rise significantly. This work is the first to uncover the bidirectional mechanism through which AI price changes affect employment structure within a DSGE framework tailored to developing economies.

Abstract

This paper studies what happens when AI gets cheaper, with emphasis on the labor market outcomes, whether it creates formal jobs or whether it pushes workers into informality. We argue that the answer depends on the elasticity of substitution between imported AI capital and formal labor. We build a small open economy DSGE model with a dual labor market, imported AI capital, and country risk, calibrated to an economy where informality is pervasive. The same decline in AI prices produces sharply different labor-market outcomes depending on whether AI substitutes or complements formal workers. Under substitution, cheaper AI weakens formal labor demand and increases the role of the informal sector as an employment buffer. Under complementarity, it expands formal employment and amplifies output, wages, investment, and capital accumulation. The model therefore shows that AI can become either a source of displacement pressure or a driver of formal-sector expansion, depending on how it interacts with human labor.

Problem

• AI cost
• labor market
• informality
• formal employment
• developing economies

Innovation

• dual labor market
• AI capital
• elasticity of substitution
• informality
• DSGE model