The impact of minimum wages on informal labor markets in a small open economy: The case of Costa Rica

In this paper I examine the impact of minimum wages on informality in a small open economy. First, I use a theoretical model that is a version of the model from Bernard et al. (2007), which includes labor market imperfections and asymmetric countries. Second, I confirm some of the main findings from the model using an empirical strategy. I estimate a 10% increase in the minimum wage-to-wage ratio is associated with an overall increase of 1.8% in informal employment. The impact also differs by skill level, with a lower impact for high skilled workers and a higher impact for low skilled workers. Import tariffs are also associated with lower informal employment. I also find minimum wages have an effect on wages for workers in the formal and informal sector. The estimates by skill level indicate an increase in minimum wages is associated with a higher increase in the wages of high skilled workers than of low skilled workers.