## Minimum Wages and Earnings Inequality in Urban Mexico

** **Between the late 1980s and the mid 1990s, earnings inequality in Mexico increased markedly. In this piece we argue that one major force behind the observed trend in earnings inequality is the deterioration in the real minimum wage.

**Minimum Wage in Mexico **

Legislated daily minimum wages are a long standing feature of the Mexican labor market, dating back to the Federal Employment Code of 1931. Since 1986, each municipality has been assigned to one of three “minimum wage areas,” denoted by A, B and C, corresponding to increasingly lower levels of average and minimum wages. Similar to other Latin American countries, the Mexican minimum wage has traditionally acted as a nominal anchor to the economy: not only wages and legislated occupational minimum wages (which in Mexico coexist with the "general" minimum wage used in this study) but also social benefits, pensions, fellowships, and even fines have been typically expressed in multiples of the minimum wage.

**Evolution of Inequality and the Minimum Wage**

Before assessing the role of the minimum wage in explaining the trend in inequality in Mexico, in this section we present some descriptive evidence. Figure 1 uses micro data from Mexico’s national survey of urban employment or ENEU (Encuesta Nacional de Empleo Urbano) to describe the evolution of the earnings distribution in urban Mexico between 1989 and 2001. In practice, we plot the evolution of earnings among workers at different points of the distribution, those with very low (10th percentile), low (30th percentile), high (70th percentile) and very high earnings (90th percentile).

Similarly to what was found using other datasets and samples, the data show a clear fanning out of the distribution, with earnings inequality rising markedly both at the top and at the bottom of the distribution. The rise in inequality comes to a halt in the second half of the 1990s. Overall, between 1989 and 2001, the 50-10 and 90-50 percentile gaps rise respectively by 15 and 17 percentage points.

Alongside we also plot the “monthly minimum wage,” which is defined as thirty times the daily minimum wage. The monthly minimum wage declines by around 50 percentage points during this period in real terms. This deterioration is driven by high wage (and price) inflation in the face of slowly adjusting nominal minimum wages.

Because high minimum wages are thought to increase low wage workers’ earnings, and hence, in this way reduce inequality, there are reasons to suspect that the erosion in the real value of the minimum wage is responsible for the observed increase in inequality, especially at the bottom of the distribution.

Figure 1. Actual trends in earning inequality and the minimum wage: Mexico 1989-2001

Notes. The figure depicts the evolution of the gap between different deciles of the log earnings distribution and the median. An additional line (denoted by MW) reports the differential between the log minimum wage and the median. All series are standardized to their value in 1989. Source: ENEU.

The evidence in Figure 1 is further confirmed in Figure 2. Figure 2 reports the “smoothed” frequency distribution of (log) monthly earnings in area A in 1989 and 2001, respectively at the beginning and at the end of the period of observation. A vertical line denoted by MW corresponds to the real value of the monthly minimum wage. Figures for areas B and C (not reported) are very similar. Three observations are worth making.

First, consistent with the evidence in Figure 1, inequality increases over the period of observation. This is graphically represented by a “fattening” and “lowering” of the earnings distribution. As the tails of the distribution become “fatter”, this means that there are more workers making very low or very high earnings, i.e. that inequality has increased.

Second, and again consistent with Figure 1, the real value of the minimum wage declines considerably across all areas over the thirteen years of analysis, which is graphically represented by a left-ward shift of the vertical line in each panel.

Third, and more important, in the initial period of observation (1989) the minimum wage creates a clear support for the wage distribution. One can see that a large proportion of workers have earnings close to the minimum wage. This is graphically represented by a hump shape around the vertical line denoted by “MW 1989”.As of the last year of observation, though, the minimum wage has fallen and we fail to observe a mass of the earnings distribution around it. This is because the minimum wage is too low to affect earnings, even of very low paid workers. The distribution "fattens up" at the bottom tail while the bunching around the old minimum wage disappears.

Figure 2 provides further support to the hypothesis that a fall in the real value of the minimum wage is responsible for the increase in inequality.

Figure 2: Changes in earnings inequality and the minimum wage: Mexico 1989-2001 (area A)

Notes. Panels 1 to 3 report respectively Gaussian kernel density estimates of the log earnings distribution in each minimum wage area in 1989 and 2001. A vertical line corresponding to the minimum wage in each year. All series are standardized to the median in each area and year. See also notes to Figure 1.

**The decline of the minimum wage as the driver of inequality**

One possibility explaining the evidence in Figures 1 and 2 is that, perhaps, minimum wages just happened to fall at the same time as other forces were pushing inequality to increase. If this were the case, one could not legitimately conclude that the rise in inequality was due to a fall in the real value of the minimum wage.

To disprove any potential concern of this type, we compare municipalities with the same level of minimum wages but different average wages. Notice that in this case, the “effective” minimum wage - i.e. the ratio between the minimum wage and the average wage - is lower in high wage municipalities.

The basic intuition for our approach (that is borrowed from Lee, 1999) is that, for the minimum wage to “cause” lower inequality, one will expect inequality to be higher in municipalities where the average wage is higher and hence the effective minimum wage is lower. This is because one will expect fewer workers to be affected by the same nominal minimum wage in high wage municipalities .

This is indeed evident in Figure 3 where we plot on the vertical axis a measure the 10-70 percentile gap across municipalities. The higher this number, the lower is inequality, as low wage workers earn more relative to high wage workers. On the horizontal axis we plot the effective minimum wage (also expressed relative to the 70 percentile). Again, we plot this series at the beginning (1989) and at the end (2001) of the period. We superimpose to the data the predictions from two regressions that interpolate across the data .

Figure 3 indicates that those municipalities with a higher “effective minimum wage” (on the right of the graph) also display lower inequality (a higher value of the 10-70 percentile gap, in the top part of the graph). In line with our reasoning, this is evidence that the minimum wage causes lower inequality.

One can also see that the two curves for 1989 and 2001 almost overlap, although data points for 2001 lie to the left and the bottom relative to those for 1989. What this means is that there was substantial decline in the real value of the minimum wage (represented by the move left of the mass of the distribution) but not a substantial rise in inequality other than the one ascribable to the decline in the real value of the minimum wage (as the two lines are almost on top of each other).

Figure 3. Earnings inequality and the minimum wage by municipality: Mexico 1989-2001

Notes: The figure depicts the 10th percentile of the log earnings distribution by municipality and year over the log minimum wage . All series are standardized to the 70th percentile of the log earnings distribution by municipality and year. The solid lines are regression lines from the specification in Table 2, column 2 in Bosch and Manacorda (2010). The dashed line is a 45 degree line.

Using this empirical strategy, in our companion paper (Bosch and Manacorda, 2010) we show that the decline in the real value of the minimum wage played a crucial role in driving the observed increase in urban earnings inequality during the early 1990s. Figure 4 shows the estimated trends in “latent” earnings inequality, i.e. the inequality that we estimate one would have observed had the real value of the minimum wage remained unaltered between 1989 and 2001. One can clearly compare this figure with Figure 1 and infer that, had the real bite of minimum wage not fallen as it did, earnings inequality would have hardly changed.

Figure 4: Latent trends in inequality: Mexico 1989-2001

Note. The figure depicts the estimated trend in earnings inequality conditional on the minimum wage. Results refer to the regression in column 2 of Table 2 and columns 3 and 6 of Table 4 in Bosch and Manacorda (2010). See also notes to Figure 1.

**Final remarks**

The fact that the decline in the real value of the minimum wage explains a very significant share of the increase in inequality observed in Mexico between the late 1980s to early 2000s is consistent with what others argue happened in the U.S. DiNardo and Card (2002) and Lemieux (2006), building on the work of DiNardo, et al. (1996) and Lee (1999), suggest that the rise in U.S. inequality in the 1980s was largely an "episodic phenomenon ," and that most of the increase at the bottom of the earnings distribution is potentially linked to the erosion of the real value of the minimum wage. Our findings seem to suggest even in countries like Mexico, where compliance with labour regulations is typically low, the minimum wage has an ability to compress the earnings distribution .

**References**

Bosch M, and M. Manacorda (2010), “Minimum Wages and Earnings Inequality in Urban Mexico”,

American Economic Journal: Applied Economics, 2(4), 2010.

Di Nardo, J. and D. Card (2002), “Skill Biased Technological Change and Rising Wage Inequality: Some Problems and Puzzles”, Journal of Labor Economics, 20, 733-783 October

Di Nardo J., N. M. Fortin and T. Lemieux (1996), “Labor Market Institutions and the Distribution of Wages, 1973-1992: A Semiparametric Approach“, Econometrica, 64, 1001-1044.

Lee, D. (1999), “Wage Inequality in the United States during the 1980s: Rising Dispersion or Falling Minimum Wage?”, Quarterly Journal of Economics, 114(3), 977-1023.

Lemieux, T. (2006), “Increasing Residual Wage Inequality: Composition Effects, Noisy Data, or Rising Demand for Skill?”, American Economic Review, 1- 64.