**3. IMPACTS OF THE MINIMUM WAGE ON INFORMAL EMPLOYMENT AND PRODUCTIVITY**

In developing economies characterized by a high proportion of informality in the labor market, the minimum wage plays an important role for this segment of workers as well as in the dynamics between the formal and informal sectors. Theoretically, in a context of duality in which one sector is regulated by law and the other is not, increases in the minimum wage are expected to lead to more employment in the informal sector. Therefore, when faced with labor cost increases in excess of the value of labor productivity, businesses in the formal sector have to downsize their workforce, especially their less productive workers. When this happens, the workers who lose their jobs in formal businesses are forced to find employment in the informal sector of the economy—unless they choose to remain unemployed or inactive while waiting for better opportunities. Businesses may also stop paying social benefits for workers. As a result of these measures, a large percentage of their employees can end up working without paid social benefits. One of the consequences of resorting to informal contractual arrangements is that employers have less incentive to invest in training, since there is no guarantee that the workers will stay and the cost could be wasted. This situation can jeopardize productivity in both individual companies and the sector in general.

Some of the empirical evidence on the relationship between the minimum wage and informal employment belies the predictions of the dual model, as we will see below. In the end, the conclusion derived from this analysis is that in countries where this phenomenon has been extensively studied the evidence is controversial.

In Brazil, Fajnzylber (2001) has suggested that minimum wage increases have a much more severe effect on employment in the informal sector than in the formal sector. A 10 percent increase in the minimum wage shrinks employment in the formal sector by 1 percent, but the contraction ranges between 2.5 and 3.5 percent in the informal sector. Thus it can be assumed that during 1982‐1997 the minimum wage policy reduced the number of informal workers, either because they found a better‐paid job in the formal sector or because they dropped out of the labor market entirely. It is also possible that workers who decided to leave the market may have done so because other household members obtained jobs that paid better.

Based on household survey data for 1982‐2000, Lemos (2004) found that the minimum wage had a long‐term adverse effect on employment in both sectors and that the contraction in employment was consistent with wage increases for both formal and informal workers. Although the impact was greater in the informal sector, in both cases the elasticities were lower than 1 percent. On the other hand, Carneiro (2001) found that minimum wage increases during 1982‐ 1999 reduced formal employment, with elasticities ranging between −0.001 and −0.024, and increased informal employment, which is more consistent with the predictions of the dual model.

A study by Terrell (2009) covering a more recent period (2002‐2008) in Costa Rica looked at the 15