Increases in Brazil’s national minimum wage between 2000 and 2009 moved the country from a regime of low minimum wage bite to one of high bite. This column exploits variation in the bite of the reform across states and industries to reveal immediate and substantial passthrough of the minimum wage for informal workers working in formal firms, and a smaller passthrough that takes several years to materialise for informal workers employed in informal firms. The findings show that minimum wage policy can positively affect living standards for workers thought beyond the reach of labour law, with limited reallocation effects towards the informal sector.

Standard, perfectly competitive models of dual-sector economies predict that wage floors should induce sizeable reallocation from formal to informal employment. ¹ At the same time, recent evidence suggests that strict segmentation is a poor characterisation of formal versus informal employment and that gradients of informality may be a more accurate description of labour markets (e.g. Meghir et al. 2015, Ulyssea 2018, 2020 and VoxDev Talk here, Haanwinckel and Soares 2021, Feinmann et al. 2024).

In our new research (Derenoncourt et al. 2025), we show that minimum wage policy can positively affect living standards for workers thought beyond the reach of labour law, with limited reallocation effects towards the informal sector.

We study large increases in the national minimum wage that occurred in Brazil between 2000 and 2009. These increases moved the country from a regime of low minimum wage bite (a minimum-to-median wage ratio of 0.34) to one of high bite (a minimum-to-median wage ratio of 0.58) in ten years. About 46% of all workers employed in the Brazilian private sector are informal. Within this group of workers, there is substantial heterogeneity in their type of employment: about half of informal workers work in formal firms (intensive margin of informality), while the other half are employed in informal firms (extensive margin of informality). These features of the Brazilian labour market, combined with the availability of rich data capturing formality status, make Brazil an ideal context for analysing the effects of minimum wages on informality.

The bite of the minimum wage among informal workers

We start by analysing the monthly earnings distributions for workers in all types of employment. Our sample of interest is comprised of prime-age workers (25 to 54 years old) working full-time. To follow informal workers’ margin of informality in years where this information is not observed, we combine data on industry and the margin of informality available in the labour force survey since 2011 and in the establishment survey (ECINF) conducted in 1997 and 2003. Specifically, we show that working in agriculture, domestic services, and construction is a strong proxy for working in the extensive margin of informality (working at an informal firm), while informal workers in other industries can be reasonably assigned to the intensive margin (working at a formal firm). Doing so allows us to construct a database of informal workers by their margin of informality from 1995 to 2015. We make this database, along with all our other data and programs, available on our websites.   

We first show that there was a large mass of workers paid at the minimum wage in 1999, before the minimum wage increases. Among informal employees in formal firms, 8.1% of them were paid exactly at the minimum wage, with 7.3% paid strictly below. Among informal employees in informal firms, these respective shares were 10.8% and 23.5%. For comparison, among formal workers, there was almost perfect compliance, with only 0.7% paid strictly below the minimum wage and 12.7% of workers at exactly the minimum wage.

Why was there such a large mass of informal workers at the minimum wage? First, it may have been due to the relatively high penalties associated with violating labour laws. In 1999, the penalty associated with paying below the minimum wage was larger than the penalty associated with not registering informal workers and evading social security contributions. Second, the minimum wage could serve as an important benchmark for ‘fair’ remuneration – a phenomenon that could also explain the spike at the minimum wage among informal employees in informal firms (Maloney and Mendez 2004). Third, competitive mechanisms might have been at play. This hypothesis is consistent with the fact that informal employees working in formal firms at the minimum wage resemble formal workers in terms of their observable characteristics.

Interestingly, we show that the monthly earnings distributions of formal workers and informal workers in formal firms strongly track the minimum wage throughout the period of large increases in the 2000s – therefore upending the notion that the formal and informal sectors operate in different, segmented labour markets.

Figure 1 Monthly earnings distributions in the informal sector before the minimum wage increases

a) Informal employees: Intensive margin

b) Informal employees: Extensive margin

The wage effects of the minimum wage

To quantify the magnitude of the wage effect among formal employees, we use a difference-in-differences design exploiting variation in the bite of the reform across states and industries. We measure the bite of the reform for the formal sector as the fraction of formal employees paid at or below the 2009 minimum wage in 1999, across 279 state and industry cells defined pre-reform. We find that a one standard deviation increase in the share of affected workers is associated with a 13.2 log point increase in average monthly wages (see Figure 2a).

Using a similar research design, we find large and immediate wage increases among informal employees working in formal firms (see Figure 2b). These effects are concentrated at the level of the minimum wage for formal and informal employees in formal firms, with no impacts higher in the wage distribution.

We find an immediate and substantial passthrough of the minimum wage of 0.88 for informal workers working in formal firms – meaning, for the same increase in the share of affected workers as in the formal sector, wages increase by 88% of the increase in the formal sector.

For informal workers employed in informal firms, the passthrough is smaller (59%), and takes several years to materialise. We do not find any evidence of passthrough to the self-employed.

Interestingly, because the magnitude of the wage effects are similar within ~280 state-by-industry cells and ~6,500+ microregion-by-industry cells, we conclude that this suggests that the spillover effects of the minimum wage to the informal sector happen within finer local labour markets.

Figure 2 Wage effects of the minimum wage in 2009

a) For formal employees

b) For informal employees in formal firms

The effects of the minimum wage on the allocation of employment

In a setting of a low- or middle-income country, the potential for minimum wages to benefit workers and reduce poverty hinges not only on the policy’s effect on wages, but also on its effects on formalisation, specifically the reallocation of employment away from the formal sector.

Using a linear probability model, we estimate an own-wage reallocation elasticity of -0.28 in 2009 – that is, for a 10% increase in average wages as a result of the policy, there is a 2.8 percent shift into other modes of employment out of the formal salaried sector. We think of this elasticity as ‘small’ – if we follow Dube’s (2019) benchmark used to make sense of the more extensively studied ‘own-wage employment elasticities’ in high-income countries.

Finally, we ask: what would have been the formal share in the economy in the absence of the 2000s minimum wage increases? Calculations based on simple assumptions motivated by our findings (no overall disemployment effects, shifts out of the formal labour force absorbed by informal salaried employment, and no general equilibrium effects of the minimum wage), we find that the formal share would have been 64.3% in 2009 instead of the actual share of 62.1% (see Figure 3). Absent the minimum wage increases, the formalisation process would have sped up by one year for the entire private workforce of salaried workers.

Figure 3 Evolution of the formal versus informal sector, and counterfactual shares

Conclusion

Our findings raise the possibility that the minimum wage may be an effective tool to improve living standards for workers in developing economies typically considered beyond the reach of labour law. They also shed light on the historical record of other countries such as the US, which experienced strong increases in its minimum wage in the 1950s and 1960s while formalising and whose GDP per capita then was comparable to that of Brazil in the 2000s. Our results also have implications for the study of non-compliance in high-income countries today (Clemens 2021, Clemens and Strain 2022, Stansbury 2024).

Source : VOXeu