Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/36956 
Year of Publication: 
2010
Series/Report no.: 
IZA Discussion Papers No. 4890
Publisher: 
Institute for the Study of Labor (IZA), Bonn
Abstract: 
A large body of empirical literature indicates that, contrary to predictions from economic theory, wages in the informal sector increase after any minimum wage hike. This phenomenon was so far explained as a byproduct of a signal conveyed by statutory minimum wages to wage setting in the informal sector, as if workers in the latter had significant bargaining power. A simple matching model shows that the lighthouse effect may be induced by significant sorting and composition effects between the formal and shadow sectors in the aftermath of the increase in the minimum wage. Using data on Brazil, we test this alternative explanation of the lighthouse effect, associated with the endogenous sorting of workers by skill in the formal and informal sectors. We find that sorting accounts for at least one third of the increase in average wages in the informal sector after the minimum wage hike. This contribution of sorting to wage dynamics in the informal sector is also increasing over time.
Subjects: 
Minimum wage
lighthouse effect
sorting
JEL: 
J30
Document Type: 
Working Paper

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