Minimum Wage Effects under Endogenous Compliance: Evidence from Peru

Latin American labor markets feature large informal sectors. In practice, however, the simple duality formal-informal has many different shades: firms tend to comply more with certain legislation than with other. Recent evidence has suggested that minimum wages have significant effects on the informal sector (Bell (1997) for Mexico; Gindling and Terrell (2004) for Costa Rica; Lemos (2004) and Fajnzylver (2001) for Brazil; and Maloney and Nuñez (2004) for Colombia). Further, some of this evidence suggests effects throughout a large part of the wage distribution. This has been interpreted as evidence of ‘lighthouse’ or numeraire effects. We test this hypothesis using panel data from Peru to identify effects throughout the wage distribution. Although there are some effects on informal sector workers, overall results provide little support for numeraire or ‘lighthouse’ effects. Labor monthly earnings are affected only at the bottom of the distribution (0.25-0.60 of the minimum wage), made up mostly of informal workers, and for formal workers earning between the old the new minima. Negative effects on the probability of retaining employed status after a minimum wage shock are either weak or non significant for wage earners below the minimum wage, but significant for formal workers ‘trapped’ between minima, and for both formal and informal earning between 1.2 and 2 times the minimum wage. Independent workers earning below minimum suffer negative effects on both earnings and employment.