Minimum‐Wage Effects, Compliance, and Firm Size in a Developing Economy: Evidence from Colombia

Minimum‐wage legislation is a standard policy in most developing countries. Nonetheless, the consequences of increases in the minimum‐wage are not conclusive. This paper examines the heterogeneous effects of minimum‐wage, considering the imperfect enforcement of minimum‐wage policy and different compliance levels across the firm sizes and types of workers, analyzing the Colombian case. Our identification strategy uses policy circumstances to set the minimum‐wage associated with arbitrary decisions not explained by the fundamentals determining the minimum‐wage. Using instrumental variable techniques, we show that a 10% increase in the minimum‐wage reduces the employment rate by 1.27 percentage points and 0.70 percentage points in the proportion of hours worked. Consistent with a theoretical model of minimum‐wage policy with imperfect competition and enforcement, the negative minimum‐wage effect is larger in firms with higher levels of compliance—that is, medium‐ and large‐sized firms, and within these, the unskilled workers are the most affected.