Can the minimum wage reduce poverty and inequality in the developing world? Evidence from Brazil

Abstract

• Increases in the minimum wage cause poverty and income inequality to decline in Brazil. • Within three months of a wage floor increase, the incidence of poverty falls by 2.8% and income inequality drops by up to 3.1%. • Effects on income distribution fade over time, particularly with respect to bottom-sensitive distribution measures. • Positive effects also diminish when the legal minimum is high relative to the median wage. • The elasticity of changes in the incidence of poverty with respect to changes in the minimum wage is approximately −0.1. Even though there is growing social support for higher minimum wages as anti-poverty policy tools, very little is known about their effectiveness in reducing poverty or inequality in the developing world. Latin America’s largest economy offers a fertile setting for shedding light on the issue, in being a large and data-rich country where frequent increases in the minimum wage can allow for direct estimation of influence on the distribution of income. Using a difference-in-difference estimator that takes advantage of substantial regional income variation and 21 increases in the Brazilian national wage floor, the study finds that within three months of these minimum wage hikes, poverty and inequality declined by 2.8% and 2.4%, respectively. Influence waned over time, particularly with respect to bottom-sensitive distribution measures, a development that is consistent with resulting job loses that fell more heavily among poorer households. The fact that the following annual hike in the minimum wage led to a renewed decline in poverty and inequality, suggests that potential unemployment costs were again overwhelmed by benefits in the form of higher wages among working individuals. However, evidence also establishes an inelastic relationship between wage floor hikes and changes in the incidence of poverty, as well as diminishing returns to the strategy when the legal minimum is high relative to median earnings.