Legal Minimum Wages and the Wages of
Formal and Informal Sector Workers in Costa Rica
January 2004
Abstract
The classic dual economy models of developing countries hold minimum wages (among other
institutions) accountable for persistent dualism. They note that applying or enforcing minimum wage
laws in only one sector of the economy will create wage differentials which will not be eroded with labor
mobility to the high wage sector. In this paper we use 12 years of micro data on thousands workers living
in Costa Rica to test whether legal minimum wages have a differential impact on the wages of workers in
the formal sector vs. informal sector, defined in various ways in accordance with the dual development
models. The evidence from Costa Rica is contrary to the assumptions of these models. We find that
increases in minimum wages not only raise the wages of workers in the urban formal sector (large urban
enterprises) who are covered by minimum wage law, but they also increase the wages of all other workers
covered by minimum wage legislation in what are traditionally regarded as informal sectors and where
the legislation is often considered not to be enforced. Specifically, we provide evidence that minimum
wages increase the wages of workers in small urban enterprises, large rural enterprises and small rural
enterprises. Further, our results suggest that higher legal minimum wages raise the average wage of
workers in these “informal” sectors more than in the urban formal sector. We concluded that in Costa
Rica minimum wages are being enforced in the rural and small scale sectors and may actually work to
reduce average wage differentials between these sectors and the urban formal sector. On the other hand,
minimum wages have no significant impact on the wages of workers in another sector that is regarded as
informal but which is not covered by minimum wage legislation: the self-employed workers (both urban
and rural). Thus, one could argue that minimum wages may contribute to dualism between the formal
and informal, defined as self-employed vs. salaried workers. However, we find no evidence of the
bleaker scenario, that self-employed earnings are being lowered by minimum wages.
JEL Classification: J23, J31, J38
Keywords: dual economy, informal sector, minimum wages, wages, Costa Rica, Latin America
Acknowledgements: We would like to thank Rebecca Blank, Charlie Brown, John DiNardo, Francisco Ferreira,
Gustavo Gonzaga, Daniel Hamermesh, John Kennan, Janos Kollo, Sara Lemos, Martin Ravallion, Brad Humphreys,
Pablo Sauma, Juan Diego Trejos and Juan Rafael Vargas for helpful suggestions on earlier versions of this paper.
Staff members at the Costa Rican Central Bank and Ministry of Labor and Social Security were very helpful in
providing us with data and important information on minimum wages. We are especially grateful to José Pablo
Carvajal, Orlando Garcia and Yabera Alvarado of the Ministry of Labor. We benefited from comments of seminar
participants at the Costa Rican Central Bank (June 5, 2002), the Network for Inequality and Poverty Meetings in
Madrid (Nov. 10, 2002), the World Bank Applied Microeconomics seminar (Dec. 6, 2002) and the University of
Maryland Baltimore County (Oct. 15, 2003.) Justine Wagner provided invaluable research assistance.