The minimum wage in Ecuador

Its impact on poverty, inequality and labour

market structure

Susana Herrero Olarte

Susana Herrero Olarte is Coordinator of the Center for

Economic and Business Research (CIEE) at the Universidad
de Las Américas (UDLA) in Quito, Ecuador.

ABSTRACT
This article aims to present an overview of the impact of the minimum wage
(MW) on the labour market in Ecuador. This Andean country is taken as a
sample of all the countries in the region, with similar structural limitations in
their labour markets. In Ecuador, the MW is positioned in the intermediate
deciles. In the lower deciles, most of the workforce is informal or self-
employed. The ‘lighthouse effect’ of the MW on the rest of the employed and
self-employed workers is presumed to be the main force in reducing poverty
and inequality. The lack of compliance with the labour regulation is, in part,
explained by low levels of demand and productivity. These factors would
limit firms’ ability to hold a wage increase and unemployment would rise. As
savings are low and the welfare state does not offer a safety net to guarantee
subsistence without a job, unemployed workers quickly transition into
informality and self-employment. We use a two-way fixed effects regression to
test this hypothesis. Results show that they cannot be rejected, suggesting the
need for new labour policies to reduce poverty and inequality, according to the
economic reality of the region.

KEY WORDS
inequality, poverty, minimum wage, labour market, Ecuador

Introduction
The import of economic policy tools from OECD countries, aimed at improving the
quality of life of citizens, is a common practice in South America. We question here
the validity of the minimum wage (MW) policy in South America (SA) as a tool to

Work organisation, labour & globalisation Volume 17, Number 2, 2023 105

DOI:10.13169/workorgalaboglob.17.2.0105
reduce poverty and inequality considering the limited consensus of empirical
literature in the region.
As a tool to improve the quality of life of the most vulnerable groups, the increase
in the MW is perverted because it is not located in the lower deciles of income
distribution, but in the intermediate ones. By 2015, 47% of the workers in SA were not
covered by the law, with 20% being informal workers and 27% self-employed (ILO,
2017). These labour groups will not be affected directly by increases in the MW.
However, the MW remains a benchmark for the living minimum income. Even in an
informal employment relationship, employees pressure their firms, and the self-
employed will improve their productivity to achieve it; this is the so-called ‘lighthouse
effect’. The ‘lighthouse effect’, of limited scope, is the main effect on the income of the
lower deciles.
The lack of compliance with labour legislation is traditionally explained by low
demand and productivity, which limits companies from paying better wages. The
economic structures in SA, unlike in most OECD countries, do not have the capability
to canalise the MW increase through efficiency improvements and price increases.
Therefore, raising the MW increases unemployment.
This increase in unemployment is not sustained over time. Unemployment is no
longer an option as it cannot maintain a decent standard of living without work because
there is no alternative source of permanent income for survival (e.g. unemployment
insurance, savings, capital revenue, monetary transfers). The state does not have a
system of protection against unemployment capable of supporting the citizenry
between jobs. Nor can the savings available, in the lowest deciles, generate sufficient
resources to allow them to remain unemployed. As a result, unemployment is
immediately transformed into informality and self-employment. The demand for
formal work is reduced and unemployed people have no choice but to accept it. The
demand for formal labour is reduced either because productivity levels do not support
the recruitment of formal workers, or because employers prefer to maintain or increase
their profit margin.
The movement from unemployment to informality/self-employment is possible
because of the weak enforcement of Ecuadorian labour law regarding the registration of
companies in order to operate. The informality of firms is implicitly accepted in the
modern economy (sometimes as a merciful act) to allow the subsistence of those who
have no place in the labour market in traditional sectors.
The aim of this research is to study whether the phenomena described above occur
in Ecuador and the intensity with which they occur. Despite the fact that the literature
on the impact of the MW in Ecuador is very limited, it continues to occupy huge
amounts of the public–private labour market dialogue space. Although it is notorious
that the impact it might have is significantly less than it might have in traditionally
industrialised countries, it remains, for both employers and trade unions, an important
element of dispute.
This research aims to contribute to delineating the dimensions of the MW in the
space of social dialogue in terms of its capacity to generate changes in the labour
market. For this reason, a general analysis is carried out, encompassing several related

106 Work organisation, labour & globalisation Volume 17, Number 2, 2023
fundamental spaces. In each case, the aim is to consider not only the impact of MW
changes, but the dimension of each of these impacts, if any.
To understand the global impact of MW increases, seven hypotheses are proposed
to be tested in Ecuador, using annual data ranging from 2007 to 2017. The hypotheses
correspond to responses of various labour market indicators when faced with an
increase in the MW and are as follows.
(H1 and H2): an increase in the MW will result in an increase in wages for the
informal and self-employed workers in the lower deciles (LD);
(H3 and H4): an increase in the MW will result in a low reduction in poverty and
inequality reduction; and
(H5, H6 and H7): an increase in the MW will not lead to an increase in
employment, but to an increase in informality and self-employment in the LD.

The research presented here tests these hypotheses in Ecuador using a two-way fixed
effect regression. This estimator allows us to adjust for unobserved unit- and time-
specific variables. Given that the MW is set nationwide, we use the ‘bite’ of the MW to
capture variation within provinces and years. A series of outcome variables are
evaluated at different deciles for the income distribution.
The panel was built at a province level from household surveys carried out between
2007 and 2019.
The application of the above methodology makes it possible not to reject the
assumptions made.
The rest of this article is organised as follows. The next section presents a review of
relevant related theoretical literature and presents the hypotheses. The following section
describes the data and the methodology applied to test them. This is followed by a
section in which the results are presented. The final section discusses these results and
draws conclusions from them.

Literature review
The stated purpose of a statutory MW is to reduce poverty and inequality (Sobel, 1999).
In the OECD countries, there is a general consensus that the introduction of the MW
increases the likelihood of reaching these objectives (Belman & Wolfson, 2014;
Guichard & Pinel, 2018; ILO, 2012). As a consequence, the OECD (2015) countries, the
European Union (McKnight et al., 2016) and the G20 countries (IMF, 2014) all claim
that the MW is a useful mechanism for stopping and reducing the systematic growth in
poverty and inequality that have been registered in recent decades (OECD, 2018).
In developing countries, the impact of raising the MW is not so positive. In general
terms, the effect on reducing poverty is modest, if it exists, because it is in practice
related to the workers in the medium-low deciles, but not to the lowest ones (Saget,
2001). In relation to inequality, the MW variations contribute to reducing it, but the
effect is smaller, sometimes only symbolic (Gindling, 2014).
In Latin America (LA), where the countries are in different categories of income,
there is no consensus about the effects on poverty of increasing the MW. Even when

Work organisation, labour & globalisation Volume 17, Number 2, 2023 107
similar regression methodologies are used, results regarding the income of the poorest
decile can have either a positive or negative result depending on the country and time
period analysed.
There is evidence of a positive impact of variations of MW on poverty reduction in
Nicaragua (Alaniz, Gindling & Terrell, 2011), Argentina (Grimshaw & Miozzo, 2003)
and Perú (Jaramillo, 2004), and a negative influence in Brazil (Neumark, Cunningham
& Siga, 2006) and Honduras (Gindling & Terrell, 2009). In Brazil, Paes De Barros,
Henriques & Mendonça (2001) and Colombia (Arango & Pachón, 2004) did not find
any evidence of a relationship between MW variations and poverty reduction.
As for the effect on inequality, the relevant literature agrees that increasing the MW
would also be ambiguous in its direction, and, in any case, limited in its impact.
Maurizio and Vázquez (2016) in Argentina, Brazil, Chile and Uruguay, Soares (2018)
and Firpo and Portella (2019) in Brazil, Alves et al. (2012) in Uruguay and Maloney and
Mendez (2003) in Colombia, found evidence of a positive impact of MW increase on
inequality. Ferreira, Firpo and Messina (2017) found in Brazil that the impact of MW
increase on inequality was ambiguous. Rani et al. (2013) found a compression in the
income distribution in Brazil and Costa Rica, an ambiguous effect in Perú, and no
effect in Mexico.
The lack of consensus about the impact of MW increases on poverty and inequality
is related to the small number of people affected by it, especially in the lowest deciles
(Belman & Wolfson, 2014). People who are not covered by the MW are in informal or
self-employment sectors.
The informal sector (also studied in the context of the lack of compliance with the
labour law) covers employees whose activities are not registered and who, consequently,
are not recognised or protected by the law. According to the ILO (2019), globally, 40% of
all waged workers are in informal employment. In SA, this rises to 54% of all waged
workers. As informality is a matter especially related to the poorest groups (Herrero
Olarte, 2021), the lowest deciles are therefore characterised by the people in informal
conditions. According to a study of data from Perú and Brazil, the lack of compliance
affects the least qualified workers and women (Rani et al., 2013). In Chile, indigenous
and agricultural regions and foreign-born groups present the highest level of informality
(Kanbur, Ronconi & Wedenoja, 2013). Informality is also more persistent in the lowest
deciles. In the 2000s informality decreased in the middle and upper deciles in Argentina,
Brazil, Ecuador, Paraguay and Perú, but in the lowest deciles the decrease was minimal
(Beccaria & Maurizio, 2020).
There are two approaches that try to explain the amount and length of
informality in the region: structuralism and institutionalism. According to the
structuralist approach, informality is the result of the LA productive model. It is
defined by the coexistence of a modern sector, characterised by high productivity
and large-scale economies, and a traditional sector, defined by inefficient
production processes and low added value (Lewis, 1954). As the modern sector
has insufficient jobs, generally restricted to skilled employees, the unskilled
workers are relegated to the informality of the traditional sector. Informality is
therefore understood as a choice to subsist in the traditional sector among the
unskilled workers, faced with the impossibility of finding a job in the modern

108 Work organisation, labour & globalisation Volume 17, Number 2, 2023
sector (Tokman, 2001b). This dual productive structure is the result of an
incomplete industrialisation in an open economy (Prebisch & Cabañas, 1957).
In the institutionalist approach, informality is the result of political decisions.
Labour law enforcement is extremely complex and costly (Piore & Schrank, 2008),
which is related to the worst compliance rates (Rani et al., 2013). Firms break the law to
avoid regulations and obligations, and be able to offer a higher wage to their workers
(Tokman, 2001a). Workers prefer to save the taxes they would have to pay in order to
formalise and thus have a higher income (Tenjo, 2012). This is because wages are very
low, and there is a lack of benefits related to becoming formal due to the low quality of
public services (The World Bank, 2012). According to this approach, formalisation is a
choice for the firms and the workers because the state allows it (Ghosheh, 2013).
Informality is understood as a part of the culture and a means of subsistence. It is
considered as a fundamental tool of economic performance, as a licence provided by
the system to compensate for low productivity and high poverty rates.
Although the structure of the labour market in the lower deciles limits the impact
of any MW increase, its value could nevertheless act as a reference for the economy in
general, and for the income to be expected from employment and informal work. This
is what is known as the theory of the ‘lighthouse effect’ which defines the MW in
developing countries not as a decisive variable, but as a reference point (Souza & Baltar,
1979). Beyond its direct effect on formal employment, according to this theory,
informal workers will seek to match their incomes with those in the formal sector.
Conscious that prices will probably increase, informal workers will put pressure on
their employers to raise wages to maintain their quality of life.
The majority of research on this topic has concluded that MW growth affects
workers whose earnings are close to that value, regardless of whether they are formally
or informally employed, reinforcing the idea that the ‘lighthouse effect’ exists. In
Bolivia, Nogales, Córdova and Urquidi (2019) calibrated this by means of a job search
comparison. In Brazil, Lemos (2009a) carried out a panel study. Kristensen and
Cunningham (2006), using estimates for 19 Latin America countries, found that the
MW has effects on both the formal and informal sectors, showing compressions in
wage distributions around the MW. However, the significance and effect on the formal
and informal sectors differ between countries, with no uniform effect across countries.
Focusing on the group most affected by MW increases, Pérez Pérez (2020) found that
increases were present in both the informal and formal sectors and were larger in the
formal ones in Colombia. He combined unconditional quantile regressions with a
differences-in-differences design. In Argentina, using quasi-experiments of MW bite
changes, Khamis (2013) found that the impact on the informal sector in the case of the
MW was stronger than in the formal sector.
However, some literature suggests that the ‘lighthouse effect’ does not exist.
Arcidiácono (2015) arrived at this conclusion in Argentina, calculating the distributive
effect of the MW on the gap between the MW and the income of a reference percentile
on wage dispersion. Grau, Miranda and Puentes (2018) reached the same conclusion in
Chile using a panel. In addition to informality, the weight of the self-employment sector
in LA is another factor that limits the impact of MW increases on poverty and
inequality. The self-employed are defined as individuals working on their own account,

Work organisation, labour & globalisation Volume 17, Number 2, 2023 109
without a relationship of dependence. This definition is perfectly applicable to both
developed and developing countries; however, the reasons for becoming self-employed
are very different.
Two theories try to explain the motivation of an individual to take up
self-employment.
The ‘Pull’ theory explains that entrepreneurship and self-employment thrive in
times of economic growth because such a condition establishes opportunities to create
new businesses. In this scenario, self-employment represents an opportunity for
individuals to improve their working conditions (Thurik et al., 2011). On the other
hand, the ‘Push’ theory argues that, given a deterioration of the formal labour market,
unemployment increases. To maintain a living income, previously employed individuals
jump to the self-employed jobs, usually informal. These jobs tend to have worse
working conditions than the ones in the formal sector.
The ‘Push’ theory explains the evolution of the self-employment sector in SA.
Indeed, more than three-quarters of companies arise from self-employment among the
most vulnerable groups as a mechanism to survive (Boeri & Ours, 2008). Consequently,
self-employment is highly correlated with poverty, extreme poverty and premature
death (Caceres & Caceres, 2017).
As a consequence of the two contrasting approaches to self-employment, the data
diverge significantly between countries. While in high-income countries self-employed
workers account for 12% of the total labour market, in low-income countries more than
80% are own-account workers (The World Bank, 2020).
In LA, 37.5% of the workforce is self-employed compared with 16.6% in OECD
member countries.
The ‘lighthouse effect’ is as relevant to the self-employment scenario as it is to
informal employment, and this too has been researched. Maloney and Mendez (2003)
in Colombia, and Fajnzylber (2005) in Brazil found that an increase in the MW was
linked to an increase in the incomes of the self-employed to a level around the MW.
The impact of raising the MW on poverty and inequality is also conditioned by its
influence on the quantity and quality of formal work. In the OECD countries, the
channels of adjustment for the MW increase would be, above all, improvements in
efficiency and small price increases (Schmitt, 2013). The employment consequences of
the MW increase are minimal (Doucouliagos & Stanley, 2009; Wolfson & Belman,
2019). In fact, MW increases could even have a positive impact on employment
(Belman & Wolfson, 2014). The limited and even positive impact of MW increases on
employment, according to Kaufman (2010), is due to the expansion in demand and the
multiplier effect.
In LA, efficiency improvements and price increases are more difficult to achieve as
a means to channel the impacts of MW increases because of low levels of productivity
and demand. Indeed, low productivity growth is regarded as the root cause of the
region’s poor economic performance in the last four decades (Daude, Fernández-Arias
& Pezzini, 2010). Productivity is linked to innovation (Hall & Jones, 2005) and
innovation is very limited in LA, where is largely confined to imitation and technology
transfer (Katz, 1986), with little or no impact on international markets. The poor
behaviour of innovation is because investment is relatively very expensive, in the

110 Work organisation, labour & globalisation Volume 17, Number 2, 2023
context of limited capital availability, the long time it takes to recover the investment
(Pagés, 2010) and the low incentives to invest in innovation when there is a large
distance between the LA firms and the technological frontier (Acemoglu, Aghion &
Zilibotti, 2006). On the other hand, the small percentage of the population with
incomes higher than the subsistence level, makes it impossible for companies to
increase their prices. If they increase them, the loss of demand could endanger the
company. Demand in LA cannot absorb the price increases that, in OECD countries,
would result from increasing the MW.
Therefore, MW rises in LA would be related to an increase in unemployment and,
consequently, to the rise in informality and self-employment. This effect is especially
relevant for Latin American countries since it is one of the regions with the highest
unemployment worldwide. In 2017, LA countries registered an unemployment rate of
8.1% compared to 5.6% worldwide and 5.9% in OECD countries.
Unemployment in Latin America is not only high; it also disproportionately affects
the poorest. In the lowest income quintile, 12.5% of people are unemployed. For the
highest income quintile, this drops to 2.7%. Even though in the last 20 years the region
has seen a substantial reduction in average unemployment, the gap between the richest
and the poorest has grown wider. This effect has been especially noticeable since 2013,
when the price of commodities, on which the Latin American region is heavily
dependent, began to fall (Ocampo, 2017).
The literature on these topics often reports ambiguous results concerning
employment (Bell, 1997). MW increases have been found not to be related to an
increase in unemployment in Argentina (Groisman, 2012), Brazil (Lemos, 2009b,
2009a) or Mexico (Bouchot, 2018). On the other hand, MW increases and
unemployment were found to be related in Colombia (Mora & Muro, 2017; Messina &
Silva, 2018) and Bolivia (Nogales, Córdova & Urquidi, 2019).
Regarding informality, MW increases are related to a growth in informality in
Bolivia (Nogales, Córdova & Urquidi, 2019) and Colombia (Mora & Muro, 2017) and
to an increase in self-employment in Costa Rica (Terrell & El Hamidi, 2005).
The research reported here aimed to understand the impact of the MW on
various variables related to the labour market in Ecuador. The work was carried out
in Ecuador because the topic of the MW is a fundamental element of the dialogue
between trade unions and employers and a key element of the programmes of the
different political parties. Despite this, general and accurate information on the
subject is very limited.
In the literature that exists in Ecuador, Canelas (2014) used a fixed effects panel to
analyse the effect of the MW on the formal and informal income of the total labour
force. To define informal workers, he identified three categories: self-employed workers;
workers in small firms with fewer than ten employees; and workers who were not
affiliated with the social security system. In relation to these three categories, the
research concluded that the raising of the MW has had a positive effect on all labour
income, but was particularly high for the group of informal workers. In addition, no
positive effect on the level of employment similar to that of a monopsony market (see
Card & Krueger, 1993) was found, which, according to the author, is due to the high
levels of non-compliance with labour legislation in Ecuador.

Work organisation, labour & globalisation Volume 17, Number 2, 2023 111
 In line with these results, Guzman (2018) found that, for salaried employees (excluding
employers and self-employed workers), campaigns to improve labour law enforcement and
a significant increase in the MW in real terms have resulted in a compression of the wage
income distribution at the national level. This compression occurs because wage increases
in the bottom half of the distribution are especially large and significant. Finally, this
author suggests that, as MW policy enforcement has improved with stricter laws,
awareness campaigns and better labour inspection, some of the low-wage earners may
have moved into informal employment, underemployment or unemployment.
Finally, Wong (2019) employed a quasi-experimental difference-in-difference
design. To do so, he took advantage of the 2012 annual increase in the Universal Basic
Subsistence level (UBS) to define the pre- and post-treatment periods. For this analysis,
he focused on individuals who earned below the MW and who were covered by labour
legislation (private employees). The control group was composed of workers who
earned above the UBS or were outside the influence of labour legislation (self-
employed, government employees and employers). The results suggested that a 1%
increase in the UBS would generate a 0.45% increase in the income of this group
compared to the control group. However, this increase is heterogeneous across gender,
age groups and industries.

Hypotheses used in this research

Building on the literature review, various hypotheses were developed for this research,
to be applied in Ecuador.
If MW increases, workers will be displaced from the formal to the informal or
self-employed sectors (H1 and H2). Because of the ‘lighthouse effect’, informal and
self-employment wages will increase (H3 and H4). The rapid movement to the formal
and self-employment sectors will mean that unemployment remains unaffected (H5).
Finally, the lighthouse effect will provide better income for the lower deciles, compressing
the income distribution and reducing inequality (H6 and H7). The following seven
hypotheses were developed to be tested in this research.
H1. MW increases have a positive effect on the informality rate in LD.
H2. MW increases have a positive effect on the self-employment rate in LD.
H3. MW increases suppose an increase in informal workers’ wages in LD.
H4. MW increases suppose an increase of self-employment income in LD.
H5. MW increases have no effect on unemployment in LD.
H6. MW increases suppose a reduction in poverty (measured by income)
H7. MW increases suppose an inequality reduction.

Data description and methodology

The goal of the research was to estimate the effects of changes in the minimum wage
(MW) on several outcome variables according to the hypotheses stated in the
previous section. The analysed dependent variables were: informal and

112 Work organisation, labour & globalisation Volume 17, Number 2, 2023
 High presence of H1. Informality H3. Increase of
informal increases in LD informal workers
workers in LD (*) wagein LD
H6. Income
increases for the
lowest deciles.
High presence of H2. Self- H4. Increase of
MW
self- employment self-employment
increase
employment in increases in LD income in LD

LD
Low demand H5. H7. Inequality
Unemployment reducon
Low producvity increases in LD

Figure 1: An overview of minimum wage in Ecuador: impact on

poverty, inequality and labour market structure.
(*) LD: low deciles

self-employed workers as a share of the total workforce population, monthly average

real earnings of both informal and self-employed workers by decile and
unemployment. For this, annual microdata from household surveys was used
(ENEMDU for its Spanish acronym). Surveys were conducted by the National
Institute of Statistics and Census (INEC for its Spanish acronym). All data
corresponds to surveys conducted in the month of December. The ENEMDU aims
to provide information on the economic activity and sources of income of the
population. This survey is designed to provide statistics on the levels, trends and
changes over time of various labour market indicators such as, among the most
important: the economically active population, economically inactive population,
those in adequate employment, underemployment and unemployment.
Given the purpose of the research, only the population between 15 and 70 years of
age was considered. Workers by province and year with income above the top or below
the bottom percentile were excluded from the sample (these extreme values were
considered likely to be associated with measurement error). Labour income, one of the
response variables, was defined as the sum of the individual’s (formal) wage, informal
income and self-employed income. Income derived from capital, retirement pensions,
gifts and donations, remittances from abroad, cash transfers (Bono de Desarrollo
Humano) as well as disability benefits was excluded. Labour income was deflated
through the Consumer Price Index (CPI). All the variables were considered by
province.
To construct the data panel, the province of Santa Elena was merged with Guayas,
and the province of Santo Domingo de los Tsachila was merged with Pichincha.
Galapagos and undelimited zones were removed from the sample. Finally, because the
sample size was small in the provinces from the Amazon region, they were unified into
a single group called Amazonia. The resulting data panel is perfectly balanced with 16
units (N) and 11 time periods (T), for a total of 176 observations (NxT).

Work organisation, labour & globalisation Volume 17, Number 2, 2023 113
 It is common knowledge that informality and necessity-based self-employment are a
major challenge in developing countries; Ecuador is no exception to this rule. For the purposes
of this research, Informal work was defined as jobs that are not subject to the country’s labour
legislation. In Ecuador, one of the most consistent ways of measuring informality is through
affiliation with social security. Figure 2 shows that informality (measured by social security) is
strongly correlated with labour income. For the poorest decile, the rate of informal working is
close to 80%, while for the highest income decile, informal work represents 25%. The same is
true for self-employment (Figure 3), and even though the precise magnitudes and trends are
different, both diminish as we move upward through the income distribution.
Concerning the real income of informal workers, Figure 4 shows a slight increase in
the first eight deciles since 2007. This trend is reversed for the top two deciles of
income. This dynamic suggests that the distribution of income of informal workers has
compressed over the last ten years. On the other hand, self-employment income (Figure
3) shows a marked decrease for all deciles starting in 2014, the period in which oil
prices plummeted. This indicates that the income of the self-employed is more sensitive
to macroeconomic conditions than the income of informal workers.
Regarding inequality and unemployment, Figure 6 shows the relationship between
poverty/extreme poverty and income inequality. Since 2007, both have shown a

100

90

80

70

60

50

40

30

20

10

0
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Figure 2: Percentage of informal workers by income decile

Source: INEC, 2019.

114 Work organisation, labour & globalisation Volume 17, Number 2, 2023
100

90

80

70

60

50

40

30

20

10

0
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Figure 3: Percentage of self-employed workers by income decile

Source: INEC, 2019.

1400

1200

1000

800

600

400

200

0
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Figure 4: Monthly real earnings of informal workers, by income

decile
Source: INEC, 2019.

Work organisation, labour & globalisation Volume 17, Number 2, 2023 115
1400

1200

1000

800

600

400

200

0
D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Figure 5: Monthly real own-account earnings by income decile

Source: INEC, 2019.

consistent downward trend. When compared with the real MW, there would seem to
have been an inverse relationship since the latter has consistently increased. However,
while increases in the MW and improvements in the enforcement of the law have
achieved a compression of the distribution of income (Canelas, 2014; Guzman, 2018) a
causal relationship cannot be inferred from these trends. Unemployment, much like
self-employment, is strongly correlated with the economic cycle (Figure 7). Until 2014,
unemployment dropped dramatically in the poorest deciles. But from 2015 onwards,
the commodity crisis triggered a rise in unemployment to historically high levels.
To test Hypotheses 1 through 5 in the Ecuadorian labour market, a two-way fixed
effects panel data regression was applied. The panel was built from household surveys
conducted annually from 2007 to 2019. Only the economically active population (PEA)
was considered, and the panel dataset was constructed at a province level. The standard
fixed effects model is represented in the following equation:

Yitp  0  1ln  MWit   fpi  ftt  it

Where Yitp represents the outcome variable of interest in province i and year t. MWit
represents the MW for every unit and year, fpi and ftt are the province and time-
fixed effects respectively, and µit the error term.
Nevertheless, this method applied to Ecuador poses an important problem because
MW is set nationwide, that is, is the same for every industry, sector and region in the
country, therefore, no individual variance exists. To overcome this issue, the
independent variable must be replaced with a proxy that captures variations within
entity and time. The MW bite is commonly used for this purpose and is defined as the
ratio of the MW to a specific point in the income distribution (London Economics,
2016). In this case, it takes the following form:

116 Work organisation, labour & globalisation Volume 17, Number 2, 2023
 400 60
350
50
300
40
250

Percentage
USD

200 30
150
20
100
10
50

0 0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Monthly real MW (left) Extreme poverty (right)

Poverty (right) Gini Index (right)

Figure 6: Minimum wage, poverty and income inequality

Source: CEPALSTAT, 2019; CEDLAS, 2019; World Bank, 2019

15

13

11

–1 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Figure 7: Percentage of unemployed labour force by income decile

Source: CEPALSTAT, 2019; CEDLAS, 2019; World Bank, 2019

Work organisation, labour & globalisation Volume 17, Number 2, 2023 117
 
MWBiteit(70)  ln  MWt   ln Incomeit(70) 

Where ln  MWt  is the natural logarithm of the MW in period t and ln Incomeit(70) 
represents the percentile 70 of the income distribution in the same province and year.
Percentile 70 was chosen because the MW is situated close to the 40th percentile for
salaried income distribution and the 60th percentile for own-account income
distribution. Therefore the 70th percentile, being above both classes of workers, should
not be affected by any MW change made annually by the Ministry of Labour, creating a
good reference point throughout the analysed period.
To further improve the robustness of estimation, a matrix of control variables Xit
was included. This array consisted of: the percentage of women, self-identified
ethnicity, level of education, branch of activity (1-digit CIIU8 classification), and
occupation group (CIUO8 classification). The following equations correspond to each
of the stated hypotheses in order:

%informal _ employment itp  0  1 MWBiteit70   Xit  fpi  ft t  it (1)

%Self _ employment itp  0  1 MWBiteit70   Xit  fpi  ft t  it (2)

Informal _ incomeitp  0  1 MWBiteit70   Xit  fpi  ftt  it (3)

self _ employment _ incomeitp  0  1 MWBiteit70   Xit  fpi  ft t  it (4)

unemployment itp  0  1 MWBiteit70   Xit  fpi  ft t  it (5)

To test hypotheses 6 and 7, the specification of the explanatory variable was changed to
the ‘fraction at’. This measure is defined as the percentage of people whose income is
between ±10% of the MW (0.9 MW ≤ income ≤ 1.1 MW). It is widely used in the
economic literature to capture the impact of the MW within the income distribution.
By using this variable it is also possible to compare results to previous research (Lemos,
2009a; Canelos, 2014). Before estimation, the Levin-Lin-Chu test was used to
determine the existence of unit roots in all variables. To correct for non-stationary
variables, the first differences were applied. In addition, population weights provided by
the ENEMDU were used in each estimation. The equations are as follows:

Witp  0  1FrAtit   Xit  fpi  ft t  it (6)

p
Where Wit represents the real labour income for percentile p in province i for period t.
FrAtit is the treatment variable and represents the MW proxy: ‘fraction at’. The same
matrix of control variables Xit was also considered. Finally, unit and time-fixed effects
were included.
For Equation 6, two distinct samples were used, each of which was tested without
and with control variables. First, the sample was restricted only to salaried workers;
given that MW policy targets this specific group this measure represents the direct
impact of such policy. Second, the full sample was considered to test both the direct

118 Work organisation, labour & globalisation Volume 17, Number 2, 2023
and indirect effect of the MW among the whole income distribution. By considering
both of these samples, it was possible to establish a possible spillover effect on the
entire population.

Results
Table 1 shows the results of the applied models.
The first two columns show the effect of a MW increase on the proportion of informal
and self-employed workers, respectively. Regarding the percentage of informal workers, the
effect is positive but only significant for the first two deciles at 5%. A 10% increase in the
MW would mean that the number of workers in decile 1 who work informally increases by
0.14 percentage points and in decile 2 by 0.28 percentage points. On the other hand, the
effect on self-employment is also positive but only significant for the fifth decile at 5%. In
this case, a 10% increase in the MW would mean that the number of workers in decile 5
who work for themselves increases by 11%. These results partially confirm hypotheses 1
and 2. However, the effect is very small and only affects specific deciles of the income
distribution.
Columns 3 and 4 show the effect of MW on the earnings of informal and self-
employed workers. Results from this model suggest that the MW policy is more likely
to benefit informal workers and be detrimental to those who are self-employed.
On one hand, a 10% increase in the MW would mean that the workers in decile 1 who
work informally increase their salary by $555.4 per year, in decile 2 by $461.7, in decile 3
by $329.7, in decile 4 by $266.9 in decile 5 by $239.9, in decile 6 by $222.8 and in decile 7
by $136.3. On the other hand, a 10% increase in the MW would mean that the workers in
decile 1 who work for themselves decrease their incomes by $102.4 per year, in decile 2 by
$138.2, in decile 3 by $71.9, in decile 4 by $67.8 in decile 5 by $88.6, in decile 6 by $86.8
and in decile 7 by $88.6. Finally, Table 2 shows the mean values of all income-dependent
variables by decile in order to facilitate the visualisation of this effect in percentage terms.
Such findings indicate that hypothesis 3 cannot be rejected and hypothesis 4 can be
rejected. Results also suggest that the so-called ‘lighthouse effect’ of the MW only
applies in the case of informal workers, that is workers who receive a salary from an
employer but are not affiliated with social security.
A plausible explanation for this behaviour could be that informal workers can use
the MW as a point of reference to bargain wages with firms. Those who are self-
employed, on the other hand, have no bargaining power over their wages as their
income comes purely from work related to their labour activity and the market demand
for their products and services.
As predicted by hypothesis 5, the rapid movement of displaced formal workers to
informal/self-employment means that unemployment is unaffected. There is no effect
on unemployment in any decile, suggesting that H5 cannot be rejected.
Estimates shown in the first two columns of Table 3 indicate that MW changes
have no significant effect on income above the fifth decile. For salaried workers on
the middle-level deciles (3 and 4), the effect is moderate and significant at a 10%
level. Because MW is located near the 40th percentile, this result suggests that
increases in the MW only affect the wages of workers earning close to the 40th
percentile, probably due to a small spillover effect. Finally, the effect of the MW on

Work organisation, labour & globalisation Volume 17, Number 2, 2023 119
Table 1: Results of the estimation by fixed effects

Equation (1) (2) (3) (4) (5)

H1 H2 H3 H4 H5
Dependent % Informal % Self- Informal Self-employed Unemployment
variable workers employed Income Income

P10 0.014 ** 0.016 5.554 *** –1.024 ** –0.016

(0.005) (0.082) (1.780) (0.460) (0.033)

P20 0.028 ** 0.001 4.617 *** –1.382 *** 0.018

(0.013) (0.084) (1.298) (0.314) (0.028)

P30 0.038 0.065 3.297 *** –0.712 ** –0.014

(0.074) (0.074) (1.258) (0.305) (0.025)

P40 0.012 0.050 2.669 ** –0.678 ** –0.003

(0.069) (0.090) (1.059) (0.317) (0.037)

P50 –0.029 0.110 ** 2.399 *** –0.886 *** 0.004

(0.061) (0.052) (0.849) (0.292) (0.039)

P60 0.054 0.020 2.228 *** –0.868 ** –0.001

(0.060) (0.046) (0.805) (0.333) (0.025)

P70 –0.029 0.080 1.363 ** –0.886 ** –0.011

(0.091) (0.074) (0.678) (0.349) (0.030)

P80 –0.149 –0.051 0.423 –0.512 –0.029

(0.095) (0.065) (0.677) (0.496) (0.030)

P90 0.014 –0.091 0.240 –0.722 0.006

(0.094) (0.081) (0.803) (0.481) (0.024)

Independent MW Bite (70th percentile)

variable

Source: Author’s elaboration.

Note: Significance levels at * p<0.1, ** p<0.05, *** p<0.01. Robust standard error in parentheses.

the poorest deciles (1 and 2) is largely attenuated by the prevalence of informality and
necessity-based self-employment.
The nationwide estimation, shown in the last two columns of Table 2, suggests that,
when considering the whole sample (formal, informal, self-employed), the MW policy has
a significant spillover effect. This effect can possibly be explained by a lighthouse effect of
the informal workers given that informal workers represent a significant proportion of the
workforce and previous estimates suggest (H3) a positive income effect on this group.
Finally, a summary of the hypotheses and their results is shown in Table 4

120 Work organisation, labour & globalisation Volume 17, Number 2, 2023
Table 2: Average income per decile for the informal sector
and self-employment

Informal Income (mean) Self-employed Income (mean)

Decile 1 94.6 83.8

Decile 2 165.7 143.6
Decile 3 199.3 175.0
Decile 4 224.2 206.2
Decile 5 249.6 238.0
Decile 6 275.9 279.4
Decile 7 311.1 330.7
Decile 8 361.5 404.1
Decile 9 473.7 555.2
Decile 10 800.7 954.8

Conclusion
Traditionally, MW policy has been used as a tool to reduce poverty and inequality. In an
ideal scenario, companies obliged to comply with the legislation would compensate for the
increase in their workers’ wages with improvements in productivity. Increases in the income
of the lower deciles would stimulate demand, which would lead to a better performance of
the economy through the spillover effect. Alternatively, companies that could not support
the increase in the MW, would be forced to lay off workers or go out of business, displacing
some workers to unemployment who in turn would be able to collect unemployment
insurance until they could find a new job if they wanted to remain employed, or begin the
process of starting up a business (entrepreneurship self-employment).
In Ecuador, as in many other Latin American countries, labour law is not strictly
enforced. As a result, employers do not necessarily increase the wages of their workers
according to the MW. Another important factor that prevents the ideal scenario is that
productivity levels are very low, especially in the traditional sectors where most of the
low-income workforce is located. This implies that there is little room for productivity
improvements that would allow a firm to absorb the increase in the MW, suggesting
that firms would either lay off employees or break the law and pay lower wages.
Although the increase in the MW does not directly influence the incomes of the
salaried worker from the lowest deciles, it is in practice a reference point that allows
informal workers to negotiate for better wages, in what is known as the ‘lighthouse
effect’. Such an effect does not seem to apply to self-employed workers as their income
comes exclusively from the demand for their provided product/services.
Regarding the possibility of collecting unemployment insurance in the event of
dismissal due to MW increases, in Ecuador this is not a viable possibility because
the state does not provide any type of support to the unemployed. Workers who
have lost their jobs will occupy the jobs that are offered to them, mostly in informal
conditions. Those who have no place in the labour market as employees, even
under informal conditions, may start their own businesses out of necessity, giving

Work organisation, labour & globalisation Volume 17, Number 2, 2023 121
Table 3: Results of the estimation by fixed effects

Equation (6) (6) (6) (6)

H6/H7 H6/H7 H6/H7 H6/H7
Dependent variable Salary income Salary income Labour Labour
income income
P10 1.900 1.380 2.530 *** 3.240

(1.310) (1.440) (0.700) (0.770)

P20 1.540 0.790 1.810 *** 2.250

(1.050) (1.170) (0.570) (0.620)

P30 1.900 ** 1.540 * 1.280 *** 1.700

(0.810) (0.860) (0.440) (0.470)

P40 1.900 *** 1.460 * 1.110 ** 1.450

(0.710) (0.750) (0.390) (0.410)

P50 1.260 ** 0.800 0.570 * 0.860

(0.570) (0.620) (0.310) (0.340)

P60 0.550 0.070 0.073 0.280

(0.490) (0.540) (0.270) (0.290)

P70 0.280 –0.210 –0.120 0.180

(0.470) (0.510) (0.260) (0.270)

P80 0.140 –0.340 –0.200 0.075

(0.540) (0.570) (0.290) (0.310)

P90 0.035 –0.290 0.004 0.220

(0.550) (0.580) (0.300) (0.310)

Dependent variable Fraction-at

Sample Salaried workers Salaried workers Full sample Full sample
Controls No Yes No Yes

Source: Author’s elaboration.

Note: Significance levels at * p < 0.1, ** p < 0.05, *** p < 0.01. Robust standard error in parentheses.

rise to necessity-based self-employment. Ecuadorian legislation related to the

legalisation and registration of companies is very lax, so starting a business does
not involve any type of bureaucratic procedure, thus facilitating the creation of
informal businesses.
The context of the Ecuadorian labour market explains the results of this work. The
increase in the MW in Ecuador, between 2007 and 2017, was translated into a small
reduction in poverty and inequality. Increases in the incomes of the lowest deciles were

122 Work organisation, labour & globalisation Volume 17, Number 2, 2023
Table 4: Hypotheses and results

N° Hypothesis Criteria Result

1 Positive effect on Partially Positive effect, but only significant on
informality rate in LD confirmed first two deciles
2 Positive effect on self- Partially Positive effect, but only significant in
employment rate in LD confirmed decile 5
3 Low increase of informal Confirmed Positive and significant effect for the
workers’ wages in LD first 7 deciles. Possible ‘lighthouse’
effect
4 Low increase in self- Rejected Negative and significant effect for the
employment income in LD first 7 deciles
5 No effect on Confirmed Non-significant effect
unemployment in LD
6 Mild reduction in poverty Partially Mild compression in income
confirmed distribution, low deciles increase their
wages while upper deciles remain
7 Mild inequality reduction Partially unchanged. The direct effect of the
confirmed MW is only significant for deciles 3
and 4
Source: Author’s elaboration.

mainly responding to the ‘lighthouse effect’ of the MW on the incomes of informal

workers, who formed the majority in these groups. We also observe that the increase in
the MW did not translate into an increase in unemployment, but rather into an increase
in informal work and self-employment.
Considering the results obtained and considering the structure of Ecuador’s
economy in general, and its labour market in particular, it is worth reviewing the use of
the MW increase as an economic policy to reduce poverty and inequality.
As in the rest of the region, attention has continually been drawn to the capacity of
the MW to act as a tool when in reality it is of very limited importance. The MW
nevertheless continues to occupy a prominent position in the dialogue around poverty
and inequality in the region, although it is long overdue to be relegated to the more
traditional secondary role that it should in fact occupy.
This is due to the influence of social dialogue in the labour market framework in
high-income countries, where the MW does have a greater capacity to influence the
labour market. Nevertheless, MW data has been among the most developed in the
region, which has led to a remarkable number of research projects on this topic,
compared to other key areas in the labour market.
© Susana Herrero Olarte, 2023

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