April 25, 2005 PREM Learning Week Wendy Cunningham (LCSHS)

1. Are minimum wages a free lunch in LAC? April 25, 2005 PREM Learning Week Wendy Cunningham (LCSHS) * This presentation is based on the book “Minimum Wages and Social Policy: Lessons from Developing Countries” (forthcoming). Unless otherwise stated, all the citations in this presentation are from this source.

2. Motivation for the issue & the book • LAC in the 1990s: wage stagnation, increased unemployment, and informal sector growth (in some countries) • Increasing Poverty and inequality What tools can be used to slow down/reverse these trends without interfering with market forces that allows for global competitiveness? Minimum wage was conceived of as a social justice tool, but can it be used to reduce poverty? Decrease national inequality? Aid certain groups? A lot of OECD literature to learn from but LAC lessons may be different due to: • A large informal sector in LAC • Little enforcement of mw • Low-wage earners include household heads • Weak social protection systems in LAC introduction overview individuals households conclusions policy

3. What does the literature tell us? introduction overview individuals households conclusions policy

4. Main questions for the presentation • Are minimum wages a free lunch? What are the intended and unintended impact of the mw on worker and household well-being? • Are certain groups disproportionately affected by the mw? introduction overview individuals households conclusions policy

5. Overview Who are mw earners? Mw institutions

6. Up to 20% of the LF in LAC countries earn the mw Up to 45% of the LF in LAC earns a sub-mw How big is the mw population in LAC? introduction overview individuals households conclusions policy

7. Women are over-represented among mw earners, especially in countries with a low (relative) mw Derived from Kristensen and Cunningham (2007) introduction overview individuals households conclusions policy

8. Youth are over-represented among all mw earners, but less so in (relative) high mw countries Derived from Kristensen and Cunningham (2007) introduction overview individuals households conclusions policy

9. Sub-minimum wage Young (16-19) Low skilled Informal employees Self-employed Minimum wage Young (16-19) Low skilled Informal employees Women (slightly) In conclusion, who earns the mw? Women, unskilled, youth, and older workers are over-represented in countries where the mw is relatively low while men, prime-aged workers, formal sector are more represented in countries were mw is relatively high introduction overview individuals households conclusions policy

10. Proportion of labor force earning at or below the minimum wage, by demographic characteristic Over-representation does not necessarily mean that population is mostly earning mw introduction overview individuals households conclusions policy

11. Distributional impact of mw on individuals Wages Employment Special groups

12. Mw can affect the wage distribution… for example mw introduction overview individuals households conclusions policy

13. Kernel density plots show us that • Mw affects: • Formal sector wage distribution: Brazil, Colombia, Chile, Peru, Ecuador, Paraguay, Panama, Nicaragua, Venezuela • Informal sector wage distribution: all the formal sector countries + El Salvador, Mexico • “fairness” in wages by occupation • Spillover from formal sector (“efficiency wage”) • Benchmark for wages in a particular occupation/region/group • Lower equilibrium wages, so more chances for bite • Numeraire effects in: Jamaica, Mexico, Brazil, Colombia introduction overview individuals households conclusions policy

14. Panel/Time series data regression analysis shows us that • An increase in the minimum wage has a positive (or neutral) effect on average wages … a 10% increase in the mw leads to a 3-6% increase in average wages • Lighthouse effect & numeraire effects • An increase in the minimum wage generally reduces wage inequality by increasing the wages more of low earning workers… introduction overview individuals households conclusions policy

15. For example, in Mexico: % change in the wage if mw increases by 10%, by wage at t Solid bar indicates that the estimate is significant at the 5% level introduction overview individuals households conclusions policy

16. The wage effects are larger for men than women Percent change in the average wage if the mw increases 10%, by the wage at time t * The percent increase for men is given in the left bar and for women in the right bar. A solid bar indicates the coefficient is statistically significant at the 5% level, a white bar indicates that it is not. Source: Cunningham and Siga (forthcoming). introduction overview individuals households conclusions policy

17. Mw affect unemployment rates • An increase in the mw by 10% increases average unemployment probability by 0-2.5%, particularly in the formal sector. • This is experienced across the income distribution, but is more consistent for poorer workers. introduction overview individuals households conclusions policy

18. Women’s unemployment rises more than men’s when the mw increases Probability of job loss due to a 10% increase in the mw, by the mw range in time t (Brazil) * The solid bars indicate that the observed value is significantly different than 0 at the 5% level. The striped and spotted bars are not statistically different from 0 . Source: Cunningham and Siga (forthcoming). introduction overview individuals households conclusions policy

19. Thus, the mw disproportionately affects certain groups • Women’s and young people’s wages benefit from mw increases, but men’s and older workers’ wages increase more • More unemployment among females, young, low skilled when the mw increases, as compared to men, older, and highly skilled workers.  Income of “vulnerable groups” is redistributed to less vulnerable segments of the labor force when the minimum wage increases. introduction overview individuals households conclusions policy

20. Mw and the distribution of household income Household income inequality

21. The mw is not high enough to make a big impact on poverty poverty The mw is sufficient to bring a family of 1 over the poverty line 11 countries For a family with one dependent, it is sufficient for 7 of the 17 sampled countries For a family with 3 dependents, it is sufficient for only 3 introduction overview individuals households conclusions policy

22. The effect of the mw on average household inequality depends on: • How the poor’s incomes respond to an increase in the mw, relative to the income of the non-poor • How the poor’s labor responds to an increase in the mw, relative to the labor of the non-poor • How quickly employment adjusts to a higher mw, relative to wage increases Which are all a function of the size of the mw 3 data points… introduction overview individuals households conclusions policy

23. Mexico inequality decreases – poor benefit % change in household income, 10% increase in mw No unemployment effects introduction overview individuals households conclusions policy

24. Brazil inequality decreases in the SR, increases in the LR – poor are hurt, non-poor no effect Lagged unemployment effects of the poor introduction overview individuals households conclusions policy

25. Colombiainequality increases - poorest hurt, non-poor gain Poor are the unemployed introduction overview individuals households conclusions policy

26. Conclusions

27. 4 main lessons • Mw increase wages, but benefits the poorest only when the mw is near their market wages • A higher relative mw increases unemployment, a low mw does not • Mw redistributes income from more-vulnerable to less-vulnerable groups • Mw is not an effective tool to decrease household inequality – too dependent on intermediate impacts introduction overview individuals households conclusions policy

28. Policy Directions

29. Policy Directions. . . • A direct transfer scheme, rather than the mw, is a more efficient tool for income redistribution BUT If the mw is being used for redistribution, it should be accompanied by a safety net for those who compensate those who pay the cost (those who lose their jobs) & the safety net needs to be targeted to certain populations, including women and youth THEN The combination of mw + safety net can be superior to direct transfer schemes introduction overview individuals households conclusions policy

30. Sources • Cunningham, Wendy (forthcoming) Minimum Wages and Social Policy: Lessons from Developing Countries. World Bank Press. • Kristensen, Nicolai and Wendy Cunningham (2007) Do Minimum Wages in Latin America and the Caribbean Matter? PRWP #3870 • Cunningham, Wendy and Lucas Siga (in process) “Wage and Employment Effects of Minimum Wages on Vulnerable Groups in the Labor Market: Brazil and Mexico,” World Bank/LCSHS mimeo