Illegal Work and the Minimum Wage

Last Saturday my advisor informed me that he never wanted to read my dissertation again, which was his way of saying he was ready to sign off. So I thought I would amuse everyone (well, me anyway) with a very brief recap of my findings. Let me assure you that there is no Mormon angle to this work, so if you are offended by the secular, feel free to move on.

I looked at the formal and informal (i.e., noncompliant) labor markets in Brazil. I was interested in how much it cost people, wage and benefits wise, to be illegal. I was also interested in the extent to which different kinds of illegal behavior go together. So if you are insufficiently productive to work for more than the minimum wage, how much more likely are you to evade payroll taxes? Fortunately, Brazil has extensive survey data with people very willing to talk about their illegal behavior. The workers, after all, are not directly punished, only the firm. All the results are for men between the age of 15 and 55.

I should mention that in the U.S., the textbook model is higher minimum wage = lower employment. But it is rather hard to get far in the U.S. data because illegal workers are difficult to survey and the minimum wage is comparatively low. In the Northeast part of Brazil, there are some groups where half or more of the workers are working for less than the minimum wage! This lets one estimate models that may apply to the U.S., but could never be estimated on U.S. data.

What I found was that the labor laws that created an informal market cause the informal workers to average about 25% less than they would earn if they were not breaking a law. Thus the “informality tax” is, on average, about a quarter of illegal’s salary. This is the cost of evading the law. Raising the minimum wage 10% increases the violations of the payroll tax law by about 2%, but in some groups as much as 8-9%. This suggests that raising the minimum wage can substantially increase the relative number of illegal workers. Also, there is no noticeable employment loss, those that would be unemployed just shift into illegal work.

Of course, all of this is based on a set of modeling assumptions and imperfect sample data, so there’s certainly room for error

5 comments for “Illegal Work and the Minimum Wage

  1. Contgratulations, Frank! I’m sure you’re as happy to be done dealing with Tom as I was.

  2. Congratulations.

    What I found was that the labor laws that created an informal market cause the informal workers to average about 25% less than they would earn if they were not breaking a law.

    I’m interested in two points about this sentence, that I’ve highlighted: the idea of minimum wage laws causing lower earnings for certain groups and the idea that were informal workers not breaking the law, they’d be making more money.

    Can you elaborate?

  3. The way to think about it is as if the firm is buying an input that has varying quality, just like if you buy a car you can get ones of verying quality. Paying a high wage will buy you a great car (worker); paying a low wage will get you an fairly unproductive worker or a junky car.

    The minimum wage is akin to a law making it illegal to buy junky cars– or you can buy them, but you have to pay as much as you’d pay for a decent car, so why bother?

    But the guy with the junky car still wants to sell it, just like the low productivity worker still wants a job. So the seller goes to the illegal market to sell the car or get work. The only difference is that now the buyer of the car or the worker’s employer is breaking the law, and so they have to be compensated for that risk of getting caught. So firms hire the illegal worker, but for less than if the worker were the same but legal. The result being that, in Brazil, an illegal worker ‘spends’ about 25% of their productivity in order to compensate the firm for the risk of getting fined by the government. Thus they earn 25% less than they would in a world without the regulation.

    So the minimum wage law causes lower wages for those that are very low productivity. Other, more productive, workers may see their wages go up, but this is only if they manage to drive the low productivity (and hence poor) workers out of the labor force. This, of course, is one of the reasons why minimum wage laws can be a very bad idea.

    There are situations where minimm wage laws can be a good idea, the most well-known being if there is only one firm in the market buying labor. In that case a properly set minimum wage can make all workers better off. This would be the example of a “company town”. It is probably not a very good characterization of the labor market in most countries or cities.

  4. Did you serve your mission in Brazil? If so there is a Mormon angle in that missions might cause Mormons to focus their academic studies based on their missions.

  5. No and Yes. I served in Portugal, so the language thing was a big help. Anecdotally, I’d say that more than half of the economists here at BYU became interested in economics because of their mission experiences. Very few of them do development work now, but it does have an impact.

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