Legal Minimum Wages and the Wages of Formal and Informal Sector Workers in Costa Rica



I. Introduction

The degree to which legal minimum wages in developing countries have a real impact on
the wages of workers in those countries is of substantial interest to policy analysts and policy
makers in both developing and developed countries. Legal minimum wages have the potential
to reduce the level of poverty within developing countries (Freeman, 1993; McLeod and Lustig,
1997). However, if minimum wages are enforced only in the relatively high-wage urban formal
sector, they are unlikely to help workers in the parts of the economy where most of the poor are
found (the rural and urban informal sectors). Compared to the developed economies, minimum
wages in developing economies tend to be set at higher levels relative to the average wages.
Some have worried that these high minimum wages may result in substantial disemployment
effects in the formal sector, pushing workers into lower-paid informal sectors and suppressing
wages further in that sector (World Bank, 1990, p.63). From the point of view of unions in the
developed economies, the low level of legal minimum wages in developing countries compared
to those in the developed economies constitutes an unfair advantage in international trade. This
has led these groups to push for including legal minimum wage targets in bilateral and
multilateral trade agreements (Harrison and Leamer, 1997). The degree to which all of these
points of view are good representations of reality depends, in part, on the degree to which legal
minimum wages have a real impact on the wages of workers, and on which sectors of the labor
market are likely to be affected by legal minimum wages.1 We address these issues in this paper.

The literature on legal minimum wages in developing economies generally assumes that
minimum wages are likely to be enforced only in larger firms and among unionized workers in
the urban formal sector, and enforced weakly or not at all in the rural or urban informal sectors.2
Indeed, this differential enforcement of legal minimum wages is often cited as a key reason for
the existence of dualistic or segmented labor markets in developing economies. The classic
articles on the dualistic nature of developing economies cite differential enforcement of
minimum wages as a reason for this dualism. For example, Lewis (1954) divides developing
economies into a rural informal sector and an urban formal sector. The structure of the labor

For example, Harrison and Leamer (1997) present a general equilibrium model of the impact of minimum wages
in developing economies which includes the possibility of non-compliance with minimum wages. In this model an
increase in minimum wages in developing economies may not improve the competitiveness of developed economy
industries if developing country firms can shift employment to uncovered sector (informal sector) workers.

2 See Watanabe, 1976 for an early discussion of this issue and Maloney and Nunez (2002) for a more recent paper
with the same assumption
.



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