Minimum-Wage Effects, Compliance, and Firm Size in a Developing Economy: Evidence from Colombia

Abstract

Minimum-wage legislation is a standard policy in most developing countries. Nonetheless, the consequences of increases in the minimum-wage are not conclusive. This paper examines the heterogeneous effects of minimum-wage, considering the imperfect enforcement of minimum-wage policy and different compliance levels across the firm sizes and types of workers, analyzing the Colombian case. Our identification strategy uses policy circumstances to set the minimum-wage associated with arbitrary decisions not explained by the fundamentals determining the minimum-wage. Using instrumental variable techniques, we show that a 10% increase in the minimum-wage reduces the employment rate by 1.27 percentage points and 0.70 percentage points in the proportion of hours worked. Consistent with a theoretical model of minimum-wage policy with imperfect competition and enforcement, the negative minimum-wage effect is larger in firms with higher levels of compliance—that is, medium- and large-sized firms, and within these, the unskilled workers are the most affected.