Bosnia and Herzegovina is the poorest country in Europe. Its GDP is 72% lower than the EU average, which puts it behind all other countries from the Western Balkans. The constantly increasing economic deprivation and poverty is a direct consequence of rising unemployment. In September 2013, 555.087 persons registered as unemployed, which accounts to 44,8% of the labor active population. Out this number, around 200.000 people work on the black market. The high unemployment has led to a degradation of workers` rights and massive violations of these rights by employers. Many union activists describe the state of the labor market in BiH not as a struggle to earn more or have better working conditions, but simply as a struggle to save jobs they already have. As employers can easily find new workers, they blackmail their workers with firing them so they are forced to put up with miserable working conditions. Workers are not paid regular wages, some wait months and years to get any kind of compensation. Although various labor market liberalization policies have been adopted, they did not result in increased employment or improved economic situation. The case of Bosnia and Herzegovina is not an isolated one. Similar problem has been noted across the developing world: labor policies are difficult to implement or even when implemented, they fail or do not generate desired outcomes. In an attempt to provide answers to the question why attempts to reform the labor market constantly fail in developing countries, by using the case study of Bosnia-Herzegovina, this study moves beyond the usual focus on formal labor institutions. Based on empirical research, this case study demonstrates that behind the formal institutions (i.e. policies, taxes, organizations, etc.) an extensive informal framework of rules exists, which shapes the labor market. Using the mixed-method approach, it investigates incentives the formal- informal framework produces on labor relations. In particular, the study attempts to examine the functional interrelation between the formal and informal institutions and develops an institutional design for the demand, supply, quality, mobility and social position of the labor force. The study finds that the formal labor market institutions in Bosnia and Herzegovina are a product of informal rules based on bribery, patronage and nepotism, which have created “an economy of influence” that has inverted the purpose of formal institutions to provide social protection, instigate development and redistribute wealth. In the long run, institutional corruption in the labor sector has created significant economic inequalities between a small elite and the rest of the country’s population. Using the case of a national labor market, the paper displays the complex relationship between institutional corruption and social justice.