Peru | Minimum wage: between policy and evidence

Minimum wage: between politics and evidence

At the end of September, the government announced a new increase in the Minimum Living Wage (RMV), reopening the debate on its effects on employment and formality. Beyond ideological positions, it is worth reviewing what economic theory proposes and what the evidence shows.

Economics offers, in general terms, two approaches. The first starts from a competitive labor market, where the equilibrium wage arises from the interaction between labor supply and demand. Under this perspective, a minimum wage set above that level acts as a price control: it raises the cost of hiring, reduces the demand for workers, and can generate unemployment or informality. The impact would be greater among those with less experience or training, such as young people, whose wages are usually lower.

The second approach argues that the labor market is not always competitive. Companies may have the power to set wages, for example, when workers face difficulties in changing jobs due to lack of information, transport costs, or search frictions. In such circumstances, it is argued that there is room for public intervention through a moderate increase in the minimum wage, which could be absorbed by companies through lower margins, without necessarily translating into lower employment. Its proponents add that this policy can contribute to reducing inequality and poverty, although they admit that there could be costs in terms of employment or informality.

One of the most cited studies in support of this second view is that of David Card and Alan Krueger, published in 1994. In analyzing the increase in the New Jersey minimum wage in 1992, the authors found no negative effect on employment in fast-food restaurants. However, their conclusions do not imply that any increase in the minimum wage is harmless. Card and Krueger pointed out that their results depended on specific circumstances, such as the magnitude of the increase, the characteristics of each market, and the possible existence of monopsonistic power. Their contribution did not eliminate the logic of supply and demand, but rather showed that low-wage labor markets can be more complex and tolerant of income increases than previously assumed.

Beyond the interest and media coverage that works like Card and Krueger's receive, the evidence continues to strongly support that minimum wage increases misaligned with worker productivity do generate unemployment. In 2021, David Neumark and Peter Shirley reviewed the extensive literature on the minimum wage in the United States since the early 1990s. These authors found that an overwhelming majority of the research reviewed finds negative effects on employment, especially among young workers and those with lower educational levels.

In Peru, the work of Nikita Céspedes (BCRP) and Miguel Jaramillo (GRADE) also finds a negative relationship between minimum wage increases, employment, and informality. Renzo Castellares (BCRP), for his part, documents that a high minimum wage in relation to the average labor income is associated with higher levels of informality in different economic sectors.

This point is especially relevant for Peru, an economy characterized by low productivity and high informality. Under these conditions, increases in the RMV can harm precisely the most vulnerable groups: young people, low-skilled workers, informal workers, and employees of micro and small businesses. Therefore, minimum wage adjustments should respond to technical criteria and carefully consider their costs, rather than becoming solely a response to political pressure.

If the goal is to achieve higher wages in a sustainable way, the priority must be to attack the root of the problem. Rather than raising the price of labor by decree, the challenge is to increase worker productivity and reduce the transaction costs that hinder the creation of formal employment. Only then will it be possible to improve incomes without closing off job opportunities to those who need them most.