The Impact of Minimum Wages on Wage Inequality and Employment in the Formal and Informal Sector in Costa Rica

William Davidson Institute Working Paper 479

Abstract:

This paper tests the impact of the Costa Rican minimum wage policy on wage inequality and the
level of employment in the formal sector (covered by minimum wage legislation) and the
informal (uncovered) sector. We also examine the redistributive effects of the minimum wage,
between the covered sector and the uncovered sector. Regression analysis using micro data from
the Labour Force Surveys over 17 years reveals three important findings. At the median, a unit
increase in the minimum wage relative to the average wage is associated with:

a) a reduction in wage inequality in the covered sector of between 0.9 percent (using the
Gini) and 1.7 percent (using the Theil mean logarithmic deviation) and there is no
effect on earnings inequality among the self-employed (using all measures);

b) an increase in the level of covered sector employment by 0.56 percent, but no effect
on the number of self-employed over time;

c) an increase in the average number of hours worked per week by 0.14 percent in the
covered sector and 0.34 percent in the uncovered sector.

From a theoretical perspective, these finds are counter to the traditional competitive two-sector
models of the minimum wage. We interpret them as supporting the monopsonistic and
efficiency wage models of the labour market in those industries where the ratio of the minimum
wage to the average wage (“toughness”) is low but supports the traditional models in those
industries where toughness is high. Given that we found overall employment to have increased,
minimum wages could be seen as assisting the reallocation of labour from the traditional to the
more modern sectors.

Keywords: minimum wages, employment, wage inequality, monopsony, Costa Rica

<<   1   2   3   4   5   6   >>

More intriguing information