The Minimum Wage in Formal and Informal Sectors: Evidence from an Inflation Shock

Erratum: On page 10, section 4.2, third paragraph, the numbers should read “From these estimates, a 1 percent higher incidence implies 0.5 to 1 percent lower employment in this city-industry block. The elasticity to incidence ranges from -0.5 to -1.” Thanks to Luis Munguía for pointing this out.

Abstract: I estimate the effect of the minimum wage on formal wages, informal wages, and employment in Colombia. I exploit an unexpected increase in the real minimum wage during 1999. My analysis combines unconditional quantile regressions with a differences-in-differences design. I find evidence of wage responses for wages close to the minimum wage. The increases are present in both the informal and formal sectors, and are larger in the formal one. Wages around the minimum increase by around 3 percent in the formal sector for a 10 percentage points larger minimum wage incidence, and by around 1 percent in the informal sector. These increases are smaller than those implied by full compliance to minimum wage policy, but positive for some unaffected workers. This suggests employers partially comply with the minimum wage and use it as a reference. I find slight negative employment effects on the informal sector, but not on the formal sector. The effects in the informal sector are not driven by cross-sectoral effects. The results suggest the minimum wage has a direct impact on the informal labor market, although they may not apply to minimum wage changes in other countries or contexts, or to larger minimum wage increases.