The Effects of Increased Enforcement of the National Minimum Wage Law in a Developing Country: The Case of Ecuador1 Wilson Guzmán2† Facultad de Ciencias Económicas y Administrativas, Centro de Investigaciones Económicas y Empresariales -CIEE- Universidad de Las Américas, Quito, Ecuador Abstract During the years 2010 and 2011, the Ecuadorian government campaigned to improve compliance with the national minimum wage (NMW) legislation. This paper analyses the impact of the Campaign period on wages, employment, and monetary poverty. I applied a difference-in-differences methodology. The results for male workers are in line with the prediction of the Two-sector Model: the campaign led to large real wage increases for men who remained employed in the covered sector, some covered workers lost their jobs and moved to the (uncovered) self-employment sector, and there was a decrease in the earnings of self- employed workers. For women, I found no evidence that the Campaign had an effect on wages or employment. The exception is the group of domestic workers, who experienced a significant increase in wages and for whom the government implemented a special campaign. The increase in wages among male covered workers significantly reduced the probability that a worker’s family was poor. In the case of self-employed workers, I did not find that the decrease in earnings, due to the Campaign, led to a higher incidence of poverty among this group of workers and their families. Keywords: Employment, Minimum wages, Labour code enforcement, Latin America, Ecuador. JEL codes: J3, J38, J42, K31, 054 †Contact: [email protected]. Mailing address: UDLA -Ecuador, Campus Granados: Av. Granados y Colimes, Facultad de Ciencias Económicas y Administrativas, Centro de Investigaciones Económicas y Empresariales -CIEE-. Phone: +593 (2) 3981000. I would like to thank Stephen Jenkins and Berkay O zcan for helpful discussions and their comments on previous versions of this manuscript. All the mistakes in the document are entirely mine. 1 1 Introduction The effects of minimum wages on the labour market have been and continue to be a topic of major debate. Economists and social scientists have been debating for a long time about the effectiveness of this policy as a protection and redistributive tool to favour low-paid workers. The conventional neoclassical model predicts that an increase in the minimum wage will increase wages of workers who remain employed but will also reduce employment of some workers. In practice, minimum wages benefit low-paid workers only if the law covers them, if the law is enforced, and if workers remain employed. The standard Welch-Gramlich-Mincer Two-sector Model (Welch 1974; Gramlich 1976; Mincer 1976) relaxes the assumption of complete coverage and consider the existence of a covered sector and an uncovered sector. Under this model, a minimum wage imposition (or increase) above the equilibrium wage will reduce employment in the covered sector, and the workers who lost their job in this sector will migrate to either the uncovered sector or to unemployment. Regarding the effect on wages, a minimum wage will increase wages of low- paid workers who keep their jobs in the covered sector, and the increase in the labour supply in the uncovered sector will pull down the earnings of uncovered workers. However, to generate these predictions, the Two-Sector Model assumes that there is perfect enforcement of the minimum wage legislation within the covered sector. Weak enforcement of labour regulations and, by implication, low compliance among covered workers are a serious problem for minimum wage policies in developing countries. In Latin America, for example, compliance rates, based on social security contributions at the beginning of the 2000s, range from a maximum of 70%-80%, as in Costa Rica, Chile, Uruguay and Panama, to a minimum of 25%-50%, as in Peru, Ecuador, Nicaragua, Bolivia and Paraguay (Marshall 2007). Despite the evidence of high noncompliance, most empirical studies have focused on measuring the employment and wage effects of changes in the legislated level of the minimum wage (see Cunningham 2007, and Neumark and Wascher 2007, for reviews of the literature for developing countries). There are few studies that analyse the effects of the intensity of enforcement of labour regulations, on labour market outcomes, in developing countries. See Gindling et al. (2015), for Costa Rica; Almeida and Carneiro (2009), and Almeida and Carneiro (2012), for Brazil; Ronconi (2010), for Argentina; Harrison and Scorse (2010), for Indonesia; and Soundararajan (2014), for India. Among them, only the studies for the cases of Costa Rica (Gindling et al. 2015) and Indonesia (Harrison and Scorse 2010) measure the effects of an exogenous increase in the intensity of enforcement, generated through a campaign, on wages and employment. 2 The other studies identify the impact of enforcement by exploring variation in the number of labour inspectors, or inspections, across provinces or municipalities. Nevertheless, the main obstacle to this approach is that the number of inspectors is not distributed randomly across provinces. The authors use instrumental variables such as distance to the nearest enforcement office (Almeida and Carneiro 2009; 2012), election years (Ronconi 2010), and the number of inspectors in charge of safety and health regulations (Soundararajan 2014), to deal with this problem of endogeneity of the enforcement variable. In this article, I contribute to the literature by evaluating the impact of an enforcement programme implemented in Ecuador. I exploit the fact that in the years 2010 and 2011, the Campaign period, the Ecuadorian Ministry of Labour campaigned to increase compliance with the national minimum wage (NMW) legislation. It began in March 2010 with an awareness campaign targeting domestic workers and their employers. In January 2011, the Ministry extended the scope of the programme to include all private employees and launched the Decent Work Campaign. To push further the increased enforcement of the labour law, in May 2011 the government approved, by referendum, that employers can go to prison if they do not affiliate their employees to the Ecuador Social Security Institute (IESS is its Spanish acronym), which implies compliance with NMW. The Campaign period was not a reaction of the government to increases in noncompliance rates, rather it was a policy change that occurred because a new government recognized that labour violations were a serious issue in the country I evaluate the effects of the Campaign using a difference-in-difference identification strategy with two individual-level panel data sets of workers living in urban areas. The first panel was collected before the Campaign, in June 2008 (baseline survey) and in June 2009 (follow-up survey), and the second panel was collected during the Campaign, in June 2010 and in June 2011. With these data, I compare what happened, during the pre-Campaign and Campaign periods, to the wage growth and the employment change of private employees who were earning below the NMW -my treatment group- to that of private employees who were earning above the NMW –my control group. The Campaign targeted the non-affiliation of private employees, by their employers, to the IESS. In principle, the affiliation of an employee to the IESS means that he/she get paid at least the NMW. Hence, in the case of Ecuador, all private employees in the economy are covered by the NMW law, irrespectively of the sector where the employee works, e.g. formal sector or informal sector. Employees who work in a small establishment (with less than five or ten workers), regarded as informal enterprises by the definition of informality proposed by the 3 International Labour Organization (ILO 2002), are covered by the NMW legislation. Similarly, employees of unregistered employers, those who are not registered with the tax authority, are covered by the NMW legislation. I analysis the impact of the Campaign on all private employees as a group and I explore the effects dividing this group into four subgroups: salaried men, salaried women, labourers, and domestic workers. These groups represent, respectively, 50%, 28%, 14% and 8% of all private employees (in urban areas, see Table A3 in the Appendix). I do this division because these groups of private covered workers may be affected differently by the Campaign. Salaried workers have monthly wages and are more likely to have permanent jobs in comparison to Labourers (mostly men), who do a temporary or casual job mostly in the agriculture or construction industries in return for a wage paid on a daily or weekly basis. Domestic workers (mostly women) were the first group targeted by the Ministry of Labour and I expect that this group of workers will be the most affected by the Campaign. I also examine the indirect effects of the increased enforcement of the labour law on the group of uncovered self-employed workers. In developing countries, there is a significant fraction of workers that are uncovered by labour protective regulations. In Ecuador, for example, in June 2008 self-employed workers represent around 28% of the total labour force, 1.8 million self-employed workers out of 6.6 million workers (see Table A2 in the Appendix). This group of workers are uncovered by the NMW law because they cannot be forced to pay themselves the NMW, and they are not obligated to affiliate themselves to the IESS. Finally, I evaluate the impact of the Campaign on household income and poverty. If the Campaign generates an increase in wages of low-paid covered workers, it is natural to think that there will be a reduction in the incidence of poverty for this group of workers and their families. On the other hand, the predicted decrease in earnings in the uncovered sector may lead to an increase in the incidence of poverty among self-employed workers and their families.