Cecilia Machado: Minimum wage is not a silver bullet to reduce inequalities

The appreciation of the minimum wage –with readjustments above inflation– was an important policy practiced in Brazil in the last two decades. Between 1996 and 2018, the purchasing power of the minimum wage increased by 128%, and this appreciation was accompanied by a reduction in informality and a decrease in inequality in the period.

Explicitly defended by Lula, the policy also gained support from Bolsonaro, after a huge offensive suffered by the current government in the face of the news that Minister Paulo Guedes was behind a proposal to deindex the minimum wage from the inflation of the previous year, which it could, on the contrary, reduce the purchasing power of workers.

Would it, therefore, be so obvious that the appreciation of the minimum wage was associated with unequivocal gains for workers and society, being able to bring convergence in the economic plans of the two candidates?

Economic theory gives us arguments in both directions. On the one hand, the increase in the minimum wage opposes the market power of firms in some segments, making them distribute to workers a greater part of the surplus that is generated in a labor relationship.

On the other hand, excessively high increases in the minimum, with real readjustments that do not accompany the gains in labor productivity, go in the opposite direction, since a heavily regulated labor market, such as the Brazilian one, has informality as an escape valve, where the minimum value need not be respected.

But the simple association of the appreciation of the minimum to the reduction of informality or the drop in inequality observed in the data ignores that our economy has undergone so many transformations over the last 20 years.

Among them: the increase in the supply of qualified workers resulting from the population’s higher level of education (supply); changes in demand in specific segments, resulting from the growth brought about by the commodity boom, trade liberalization and the adoption of technologies (demand); and changes in labor institutions, such as payroll tax exemptions, but also the policy of valuing the minimum (institutions).

Together, these changes alter the supply and demand for labor in the economy, with concomitant effects on wages and employment, which undermines the direct association between the appreciation of the minimum, informality and inequality.

A careful assessment of the cause-and-effect relationship of the policy of valuing the minimum wage on economic indicators shows that part of the adjustment actually manifests itself in the increase in informality, although the effects on employment are null or close to zero (Foguel, Ramos and Carneiro , 2001; Lemos, 2009).

Considering the effects of supply, demand and institutions in isolation, the change in the composition of the workforce, which has become more educated over time, appears as the main factor behind the reduction of informality (Haanwinckel and Soares, 2022). . Without the improvement in the qualification of the workforce, the valorization of the minimum would have increased, not reduced, informality.

Regarding the reduction of inequality in the period, this is also largely explained by supply factors, which reduces the wage premium of workers with higher education and the wage gap between more and less qualified workers. The decrease in returns to schooling and experience has been consistently identified as an important driver in reducing wage inequality (Firpo and Portella, 2009).

This evidence in no way suggests that the minimum wage is irrelevant to population welfare gains. On the contrary, the minimum wage also contributes to the reduction of inequalities by compressing wages in the lower tail of the distribution, in addition to acting together and enhancing the other changes that have been taking place in the labor market.

But the existence of an informal sector that absorbs workers in more precarious contracts, of an educational system that has not been able to prepare workers for the labor market, and of a minimum wage that is already the norm for a substantial contingent of workers – around 40% of workers earn up to the minimum wage – show that there are limits to real wage gains without any counterpart.

The appreciation of the minimum wage is not a silver bullet decided by mere political will, and needs to be minimally accompanied by gains in labor productivity, something that only a quality educational policy will be able to guarantee.