This paper evaluates the impact of market-oriented structural reforms, in particular labor
market policies, social assistance programs, and trade liberalization upon long run unemployment,
wage inequality and the distribution of employment across sectors in a small open economy with
search frictions and idiosyncratic productivity shocks. I build a search and matching model of a
labor market with a large informal sector and estimate the model using Colombian household-level
data. Changes in labor taxes may have sizable aggregate, compositional and distributional effects
if workers associate high payroll taxes with more valuable and efficient social security services. The
higher the valuation of the services, the higher the reduction in the log-wage gap. An expansion of
public health insurance to informal sector workers has minor aggregate and distributional effects.
Changes in relative prices that negatively affect the relative profitability of the formal sector
have quite sizable aggregate effects, producing more long run unemployment and informality, and
increasing unemployment duration.