18, February, 2015

Minimum Wage and Informality in Ecuador

This paper studies the relationship between minimum wage and employment in Ecuador. In particular it investigates whether or not, and if so, to what extent changes in the minimum wage influence changes on the formality and informality rates, and the level of wages.

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Minimum wages are intended to lead workers out of poverty, reduce inequality and exploitation. Whether they are an effective instrument to achieve these goals has for long been debated, but a common consensus has not been found.

On the one hand, neoclassical theory predicts negative effects on employment and an increase in average wages as direct consequences of rising the minimum wage. The standard two-sector model, one covered and one uncovered, dictates that raising the minimum wage reduces employment in the covered sector, creates unemployment, and eventually pushes workers to find employment in the uncovered sector which in turn has a negative effect on the lower tail of the wage distribution.

On the other hand, empirical findings are ambiguous. While the results from the first wave of studies of the minimum wage go in line with what is expected from traditional theory, most recent literature has found small disemployment effects and positive wage effects.

Evidence from Latin America is limited, even though the diversity of minimum wages and legislations in the region provide a good environment to study its effects on the labor market. Moreover, the significant size of the informal (uncovered) sector, 60-80 per cent of the working population, highlights the importance of research focused on this sector of the labor market, and the need of new policies and institutions concerned with the enforcement of labor regulations, and the design of social security systems and laws that protect informal workers.

The case of Ecuador is particularly interesting in terms of economic policy. During 1998/99 Ecuador went through an important macroeconomic and financial crisis that had dramatic effects especially in rural areas in the Coast Region hurt by El Niño, and among middle-class households. The crisis and its negative effects on GDP and inflation resulted in the adoption of the US dollar in September 2000. Inequality is high, the Gini coefficient is 0.49, and poverty is widespread. Around 15 per cent of the population lives under the official extreme poverty line, and around 30 per cent under the official poverty line. The Ecuadorian labor market is characterized by widespread informality that attains almost 80 per cent of the working population. Moreover, despite several increases of the legal minimum wage during the last decade, the proportions of formal and informal workers in the labor market seem to remain constant.

Author: Carla Canelas
Orginal publication date: January, 2014
Publisher:  World Institute for Development Economics Research (WIDER)

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