Minimum Wages and the Informality Constraint

IMF Working Papers, June 19, 2026

Source details

Research question: How does informality shape the impact of minimum wage policy?
Empirical context: Mexico’s 145% real increase in the minimum wage since 2016.
Methodology: Combination of reduced-form empirical estimates and a calibrated general equilibrium model featuring endogenous informality and household heterogeneity.

Implemented minimum wage increases indicate limited effects on employment.
Implemented minimum wage increases indicate limited effects on formalization.
Observed modest wage gains at the bottom of the formal wage distribution that arguably reflect incomplete enforcement.

The calibrated model reproduces the empirical patterns under observed enforcement conditions.
Under full enforcement, higher wage floors generate nonlinear effects:
- The share of firms reallocating toward informality rises sharply.
- Reallocation toward informality lowers productivity.
- Aggregate welfare declines as a result of the shift toward informality.
Welfare losses fall disproportionately on low-skill households:
- Low-skill households bear the brunt of reductions in transfers caused by lower tax revenue.
- Low-skill households, as predominantly informal workers, gain little directly from the minimum wage increase.

The minimum wage’s effectiveness as a redistributive tool is limited.
Enforcement matters crucially: incomplete enforcement helps explain observed modest formal-wage gains, while full enforcement can trigger strong reallocations to informality with adverse productivity and welfare consequences.
Distributional impacts are adverse for low-skill households due to fiscal effects (lower tax revenue → reduced transfers) combined with limited direct gains for informal workers.

Employment, Labor, Labor supply, Minimum wages, Wages, endogenous informality, household heterogeneity, informality Constraint, labor markets, welfare

Source: Nils H. Lehr; Johanna Schauer; Hugo Tuesta. June 19, 2026.