br Introduction In the present paper

Introduction In the present paper the dynamics of the labour market is studied by using an evolutionary game theory approach. The starting point is the model developed by Araujo and Souza (2010) who departing from a microeconomic point of view of agents’ choice making and going through a macroeconomic assessment of formal and informal sectors behaviours delineate optimal policies that foresee the trade-off between tax collecting and incentive creation to workers and firms to operate in the formal sector. In fact there are a number of papers acknowledging a correspondence between the labour market and the stage of economic development (see Acemoglu (1998, 2002)). Greenwood and Yorukoglu (1997), for instance, maintain that the adoption of technical change requires equally specific human capital in addition to physical capital, and an increase in labour skills facilitates the adoption of new technologies. Hendicks (2000) models growth through technology adoption focusing on the complementariness between technologies and skills. Workers’ skills and technological profile of firms are therefore complementary: the level of the former limits the profile of technologies that firms can use, while this latter determines the rate of learning. Benhabib and Spiegel (1994), focusing on the role of human capital in economic development suggest that the role of the former is to facilitate the adoption of technology from abroad and at the same time, to create a domestic technology. Hence, there exists a consensus that the presence of skilled workers implies a better environment for skill-complementary technologies, and it encourages further upgrading of productivity of skilled workers. On one hand, firms operating in a labour market thickly populated by high skilled workers may choose a better technological profile to match those skills. On the other hand, workers in an environment in which firms demand high skilled workers, find incentives to improve their skills. This view is supported by a number of authors. Snower (1994), for instance, shows how a country can fall into a “low-skill, bad-job trap,” characterized by a vicious BTL105 of low productivity, deficient training, and low-skilled jobs, preventing the economy from competing effectively in the markets for skill-intensive products. Redding (1996) also points to the existence of a low growth trap in which a large proportion of the workforce is unskilled, firms have little incentive to provide good jobs (requiring high skills and providing high wages), and if few good jobs are available, workers have little incentive to acquire skills. Following this rationale, Lavezzi (2006) has emphasized the role of skill resources as a crucial constraint on the selection of the technological profile to be implemented in developing economies. This author focuses on the dynamics of human capital accumulation – framed by a Markov chain – where human capital accumulation and technology adoption are interrelated processes. For workers the crucial issue is the type of firms they interact with, and likewise for firms, it is the type of workers they hire. In high-skill equilibrium, for example, workers expect firms to invest in technology and then invest in human capital. Thus, firms find it optimal to invest, and therefore expectations are fulfilled in equilibrium. The connection between skills and formality, which is one of assumptions of the present paper, was addressed by Rausch (1991) in a model in which agents with highest ability become formal managers. Managers with more ability would naturally run larger firms and employ more capital; for this reason they choose to join the formal sector, where they face a lower cost of capital and do not face limits on capital deployment. Hence in this model limited access to capital goods is not the only constraint that firms and workers face when they decide for the informal sector. In this paper we intend to provide a characterization of the dynamics of the labour market by studying the stability of an evolutionary game theory model of the labour market presented by Araujo and Souza (2010) by using the Lyapunov method. Following this approach our study consider that workers and firms’ decision to engage in the formal or informal sector as the outcome of rational decisions based not only on the expected pay-offs in each of the sectors but also on the interaction with other agents. In this vein our framework is similar to the search and matching models but with the advantage of endogenizing the probabilities of matching between firms and workers.