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

employment in the US, monopsony was not a very popular model of the labour market. Dickens
et al. (1999, p.2) argue that monopsony may be more common than we have traditionally
believed from the one-company town examples: “For example, in most labour markets
employers that cut wages do not instantaneously lose all their workers, so the supply of labour to
a firm is not perfectly elastic, and firms therefore posses some monopsony power... in the short
and long run.”

Our paper examines the effects of changes in the minimum wage on earnings inequality
and aggregate level of employment in Costa Rica’s covered and uncovered sectors over the
1980-92 period. We also examine whether changes in the minimum wage lead to a reallocation
of labour between the covered and uncovered sector.

There are a number of features about Costa Rica that make it an interesting country for
the analysis of minimum wages and inequality in the two sectors. For one there is a significant
group, approximately one-fifth of the employed, who are not covered by minimum wages. These
are self-employed (“informal sector”) workers.³ Second, unlike most countries, Costa Rica has
multiple minimum wages, set for various occupations and industries. In the 1970s and early
1980s there were approximately 350 minimum wages and in 1990 the number was reduced to
about 80. Setting the minimum at different levels by occupation and industry could but need not
be more a more effective instrument for raising the wage floor and reducing wage inequality than
one minimum wage. However, the Costa Rican National Salary Council has taken an additional
step of systematically raising the lowest minimum wages by a greater percentage than it raised
the higher minimum wages over the 1980’s and 1990’s. Moreover, the Council did not allow
minimum wages to erode over the 1980s as was the case in most Latin American countries
(especially Ecuador, Mexico, and Peru). As seen in Figure 1, the plot of the lowest minimum

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