Minimum Wage, Informality and Economic Development

n this paper we study the impact of minimum wage increase on the employmentstatus. Toward that goal, we rst empirically show that informal sector economy shows hetero-geneity though, on average, its characteristics support dual perspective (La Porta and Shleifer2008, 2014), and that formal sector economy shows monopsonistic competition over laborers. Theinformation on the features of informal and formal sector economy, provides a theoretical supportfor the empirical nding: minimum wage hike (i) increase formal sector employment, (ii) increasethe average productivity of the employer by forcing out small rms with less productivity out ofbusiness, and (iii) increase in intensive form of informality. Building on the empirical ndings,we extend Burdett-Mortensen equilibrium wage-posting model with heterogeneity in individualability. The central feature of the model is to allow heterogeneous aspect of informality by indi-vidual ability and also incorporate extensive and intensive margins of informality that previousresearch developed (Ulyssea (2017)). By putting together these dierent aspect of informality andthe presence of monopsonistic behavior of formal sector economy, we oer theoretical mechanismthat oers an insight on individuals' response on minimum wage hike. The central feature of themodel is the presence of spillover eects of minimum wage on both higher and lower earning ranksdue to monopsonistic competition among rms for workers and also due to incomplete compliance.Overall our theoretical model suggests that increase in minimum wage, in the long-run, leads to thechange of characteristics of informal sector economic activity, from external informality to informalinformality, and average ability of remaining self-employed decreases and average productivity ofentrepreneurs increase