Behind the Lighthouse Effect

30 Pages Posted: 26 Apr 2010

See all articles by Tito Boeri

Tito Boeri

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Pietro Garibaldi

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Marta Ribeiro

affiliation not provided to SSRN

Abstract

A large body of empirical literature indicates that, contrary to predictions from economic theory, wages in the informal sector increase after any minimum wage hike. This phenomenon was so far explained as a byproduct of a signal conveyed by statutory minimum wages to wage setting in the informal sector, as if workers in the latter had significant bargaining power. A simple matching model shows that the lighthouse effect may be induced by significant sorting and composition effects between the formal and shadow sectors in the aftermath of the increase in the minimum wage. Using data on Brazil, we test this alternative explanation of the lighthouse effect, associated with the endogenous sorting of workers by skill in the formal and informal sectors. We find that sorting accounts for at least one third of the increase in average wages in the informal sector after the minimum wage hike. This contribution of sorting to wage dynamics in the informal sector is also increasing over time.

Keywords: minimum wage, lighthouse effect, sorting

JEL Classification: J30

Suggested Citation

Boeri, Tito and Garibaldi, Pietro and Ribeiro, Marta, Behind the Lighthouse Effect. IZA Discussion Paper No. 4890, Available at SSRN: https://ssrn.com/abstract=1595531 or http://dx.doi.org/10.2139/ssrn.1595531

Tito Boeri (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Pietro Garibaldi

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy
+39 02 5836 5422 (Phone)
+39 02 5836 5343 (Fax)

HOME PAGE: http://www.frdb.org/~pietrogaribaldi/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Marta Ribeiro

affiliation not provided to SSRN

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