This paper seeks to examine the effect of employment protection on income inequality. By employing the employment protection data developed by Botero et al. (2004) as well as well established measures of economic inequality for a sample of 83 countries, our analysis suggests that increased employment protection is negatively associated with income inequality. This relationship remains highly robust across several different specifications and estimation methods. In addition, our analysis places the spotlight on the role of the informal economy and investigates how the presence of informal sector may affect the above mentioned relationship. Our results suggest that in the presence of a large unofficial economy the negative impact of employment protection on inequality is crucially mitigated and in some extreme cases may also be reversed.
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