Fajnzylber argues that even though it is assumed that legal minimum wages are not applicable to
the informal sector, the positive wage effect represents a “lighthouse effect” whereby informal
sector workers set their wages by referring to the legal minimum wage. An alternative
explanation for the large wage effects in the formal and informal sector found by Maloney and
Nunez and Fajnzylber is that the changes in legal minimum wages and changes in wages over
time may both be driven by the same unmeasured phenomenon.
Strobl and Walsh (2003) use panel data to estimate whether the minimum wage affected
the probability that a worker initially earning below the minimum wage earned above the
minimum wage after the introduction of the national minimum wage in Trinidad and Tobago in
1998. They argue that the introduction of a national minimum wage in Trinidad and Tobago
was largely unanticipated, and “can be argued to be at least weakly exogenous” (p. 428). They
find that the minimum wage increased the probability that a low-wage worker earns at least the
minimum wage by about 20%. They also find this effect is bigger for workers in large firms (10
or more employees) compared to small firms.
We will argue below that changes in the structure of minimum wages in Costa Rica result
in variation in the minimum wages, over time and within occupations, that were exogenous to
changes in the labor market. Therefore, the results presented in our present paper do not suffer
from the potential endogeneity bias that may be driving the results in the Maloney and Nunez
and Fajnzylber and other papers in this literature.
III. Methodology
In this paper, we will examine the effect of changes in legal minimum wages on the
wages of workers in both the formal and several informal sectors in Costa Rica.
As we indicated earlier, the original development models of dual sectors of Lewis (1954)
and Harris and Todaro (1970) assumed that minimum wage laws were an important factor
contributing to the wage differentials in the formal and informal sector and the urban and rural
sectors. Following the literature on economic dualism in developing economies, we present
results for workers in the urban formal sector and for several different types of “informal”
sectors. The urban formal sector is defined as all employees in large urban firms plus all those
urban workers with a university education or who are classified as professional or technical
employees (no matter where they work). We classify all workers in rural areas as part of the