Do workers in the informal sector benefit from cuts in the minimum wage

This paper analyzes the effect of a change in the minimum wage on the earnings of workers in the informal sector, who supposedly are not covered by minimum wage legislation. The standard view of the matter is that a reduction of the minimum wage, which increases employment in the formal sector, reduces the effective supply of labor to the informal sector increasing the wage at which the latter clears. Strong policy conclusions can be - and have been - derived from the standard view. Given that workers in the informal sector earn less than those in the formal sector, a reduction in the minimum wage should reduce income inequality between workers in the two sectors. Also, to the extent that most of the urban poor work in the informal sector, reducing the minimum wage could be an effective anti-poverty policy. This paper explores the possibility of a non-standard result following a different avenue. It discusses the role of labor reallocation and demand factors in determining the relationship between minimum wages and informal sector earnings.