Until the Card and Krueger (1994, 1995) publications, there was near unanimity among economists that increases in the minimum wage have a small negative effect on the employment of low wage workers covered by minimum wage law. However, Card and Krueger’s contrary evidence with US data, as well as evidence from Britain (Machin and Manning, 1994; Dickens, Machin and Manning, 1999), have challenged this view, based on the traditional competitive model. Economists are now taking more seriously other models, such as the equilibrium wage dispersion models (e.g., Burdett and Mortenson, 1989; Burdett and Wright, 1994; Dickens, Machin and Manning, 1999; Manning, 1993), which can accommodate non-negative employment effects in the covered sector.
While this debate moves forward, we note that we have even less of an understanding of the employment and wage effects of the minimum wage on the sector not covered by minimum wage law (uncovered sector). Aside from this paper’s predecessors (El-Hamidi and Terrell, 2001; Gindling and Terrell, 1995), there are only a handful of empirical studies examining the impact on the uncovered sector, e.g., Tauchen (1981) studies the uncovered agricultural sector in the US and more recently Fajnzylber (2001) studies the impact on the informal sector in Brazil.
This gap in our knowledge may not be surprising given that the empirical work on minimum wage policy has been carried out almost entirely in the US, where the uncovered sector is small (considered to be 10% of the labor force today). A search of articles in the leading US and European journals from 1985-2000 shows only 22 articles published on the impact of minimum wages outside of the US, compared to over 150 articles on the US. The fact that so little research exits with non-US data is striking given that minimum wage legislation exists in almost all countries of the world. As Hamermesh (2002) argues, labor economists can learn a great deal about the impact of policies on the labor market from studying countries other than the US, since there is generally more variation in these markets, policies and hence, variables of interest.
Moreover, in the case of minimum wage policy, studying other countries opens the possibility for testing its impact on the uncovered sector since it is generally a large segment of the labor force. Measuring this impact is all the more necessary given the concern expressed in some international policy circles (e.g., the Inter-American Bank and the World Bank) that minimum wages may be negatively impacting wages in the uncovered sector as it restricts employment in the covered sector.
Our paper examines the effects of changes in the minimum wage on the level of employment and wages in Costa Rica’s covered and uncovered sectors over the 1980-1996 period. We will use the terms “formal” and “covered” sector interchangeably, as well as “uncovered” and “informal,” since one definition of formality in the labor market is determined by whether or not the sector is covered by labor legislation.
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