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Wage inequalities in Latin America

Latin America achieved something truly remarkable during the first decade of the 21st century: it sustained vigorous economic growth with declining inequality. Other regions in the world grew strongly during this period, but this growth was not shared equitably—in fact, inequality increased in most countries outside Latin America. In a period characterized by rising global inequality, Latin America demonstrated that an inclusive growth path is possible. This was an encouraging development not only for Latin America, but perhaps also for the rest of the world. The downward trend in inequality in Latin America in the 2000s was nothing short of a historic breakthrough for a region that, ever since the 19th-century writings of explorer Alexander von Humboldt, has been seen as the “land of inequalities”. In Latin America, labor earnings represent the lion’s share of most households’ total income, and thus they are the biggest determinant of overall trends in income inequality. Moreover, although inequality in households’ assets is important for distributional equity and economic efficiency, it is a more static factor: the large majority of Latin Americans rely on labor earnings as their main source of income, trading skills for income through labor markets. While the 1990s was a period of moderate increases in wage inequality in Latin America, the 2000s was characterized by a decline in wage inequality in the region—an important historical breakthrough. This happened as most developed countries faced a persistent rise in earnings inequality.

Inequality

See also: Economic Inequality

Inequality plays a mediating role in the relationship between economic growth and poverty reduction, partially explaining countries’ relative long-term performance in reducing poverty. Inequality also matters because it tends to be associated with social mobility. In other words, when the distance between steps in the income ladder increases, the ladder becomes more difficult to climb. Persistent inequality thus helps to explain why poverty persists over time and reduces the aspirations of groups at the bottom of the income distribution. As such, it becomes difficult to dissociate income inequality as an outcome from inequality of opportunity—whereby circumstances such as where you are born and who your parents are can define an individual’s lifelong earnings profile. Finally, inequality is also a source of social unrest, and excessive inequality is often perceived as a source of political turmoil. A dynamic labor market that provides opportunities to put individual skills into practice and rewards the effort exerted to acquire those skills is essential for social cohesion.

Key facts

These seven stylized facts show the extent to which wage inequality is multifaceted, and that, despite common trends, there is substantial heterogeneity across countries.

• Fact 1: Labor earnings (and household income) inequality in Latin America, after a decade of stagnation or moderate increase, decreased sharply in the first decade of the 2000s in 16 out of 17 countries.
• Fact 2: Earnings were relatively stable in the 1990s (when inequality was stagnant to increasing) and grew faster for unskilled workers than for skilled workers in the 2000s (when inequality decreased). Trends in the first decade of the 2000s were stronger in South America than in Central America and Mexico.
• Fact 3: The skilled labor supply has risen gradually since the late 1980s (when wage inequality was still increasing) and continued increasing through the 2000s.
• Fact 4: In both the 1990s and the first decade of the 2000s, individual worker characteristics (such as gender, education, experience, and whether the family lives in an urban or rural area) explain less than 50 percent of the total wage differential across workers. Similarly, changes in these characteristics explain less than half of the changes in the total wage differential across workers. Most of the decline in total wage inequality is explained by falling within-group wage inequality.
• Fact 5: The region’s labor market improved during the first decade of the 2000s, with unemployment falling and employment increasing. However, the employment rates of skilled and unskilled workers rose at a similar pace.
• Fact 6: Terms-of-trade movements differed across countries. During the first decade of the 2000s, these movements favored South America but were relatively stable in Central America and Mexico.
• Fact 7: In Argentina, Brazil, Mexico, and Peru, there was a sizable reduction of informal employment in the 2000s that contributed to reducing wage inequality, since most of those who became formal were low-wage workers.

Trends in overall inequality

High (income or consumption) household inequality is a persistent economic fact in Latin America, where for decades it has been nearly the highest in the world. In fact, Latin America, along with Sub-Saharan Africa, is the region with the greatest inequality in the world (figure 2.1). A growing body of literature suggests that, after a long period of growing or stagnant inequality, the trajectory of household income inequality in Latin America shows a visible kink around 2002—rising from the 1990s until about 2002, when it started to decline. This trend of decreasing inequality was particularly steep during the commodity-driven boom period of 2003–11, before flattening out during the post-2011 slowdown.

Putting numbers in a recent historical perspective, Latin America from the 1970s through the 1990s was nearly 10 Gini points more unequal than Asia, 17.5 points more unequal than the 30 countries in the Organisation for Economic Co-operation and Development (OECD), and 20.4 points more unequal than Eastern Europe. During the 2000s, however, the data clearly indicate an inequality convergence: while inequality was decreasing in Latin America, it was increasing in the world’s more-equal countries. By the end of the decade, Latin America was only 3.4 points more unequal than East Asia and the Pacific, 7.7 points more unequal than South Asia, and 11.9 points more unequal than Eastern Europe and Central Asia (figure 2.2).

Changes in wage inequality

The structure of wages changed markedly in Latin America during the past two decades. Remuneration for observable skill-related characteristics, particularly education and experience, moved hand-in-hand with the inequality dynamics. In particular, the returns to education and experience declined during the 2000s, when earnings inequality was also in decline. Other gaps—including differences between urban and rural earnings and the differences in pay between men and women and between the majority of the population and ethnic minorities—declined as well. Behind all of these closing gaps was a sharp increase of the wages at the bottom of the wage distribution.

Labor supply and education

Much of the discussion on changes in wage inequality focuses on returns to skills and education—that is, the pay differential among skilled and unskilled workers. Because education is the most important predictor of labor earnings that can be consistently measured over time, changes in returns to schooling have important implications for the evolution of income inequality.

Skilled workers have a higher employment rate than unskilled workers in most Latin American countries. Similarly, college graduates tend to have a higher employment rate than unskilled individuals (figure 2.16). These stylized facts are common across both South America and Central America and Mexico. However, there are important differences in the evolution of the employment and unemployment rates across groups and geographical areas.

[L]abor supply trends evolve differently across levels of schooling. The share of the workforce that had completed high school increased steadily during the past two decades, while the share of potential workers with only basic skills, as proxied by primary education or less, declined. Expanded access to education across Latin America increased the skilled (highly educated) labor supply, which in turn exerted downward pressure on wage inequality by decreasing the earnings premium for skill.

In South American countries, real earnings of both college-educated workers and those with a primary school education or less increased, but earnings of unskilled workers grew faster than those of skilled workers, matching the overall regional pattern. In contrast, in Central America and Mexico, real earnings of college-educated workers declined, while those of workers with a primary education or less modestly increased (figure 2.8, panel b). In Mexico, for example, average hourly earnings of workers who had completed either college or high school declined during the 2000s; meanwhile, the wages of the rest of the workers rose until the 2008 global financial crisis and subsequently declined, albeit more slowly than the wages of college-educated workers, as shown in figure 2.8, panel c.

At least since the 1990s, the region has experienced a rapid increase in the supply of more-educated workers. In all Latin American countries, educational attainment increased and the population aged, raising the skill levels of the workforce. The average years of schooling of individuals ages 18 and older increased from 5.8 in 1990 to 8.26 in 2010. The proportion of the labor force that had at least completed high school rose from 21 to 36 percent during the same period. The unweighted average share of the working-age population that completed secondary education in the 15 countries for which data are available rose from 14 percent in 1990 to 20 percent in 2013. This rise is all the more remarkable if we consider the weighted (by population) average, which rose from 11 to 23 percent in the same period.

The expansion of tertiary education was equally important to the expansion of secondary education, and therefore the ratio of workers with tertiary to secondary education increased only slightly in the 2000s (figure 2.12, panel a). Led by Argentina, Chile, Honduras, and Panama, the weighted average share of workers who had completed college more than doubled, rising from 6 percent in 1990 to 14 percent in 2010 (or from 7 to 14 percent if we consider the unweighted average). The share of people between 15 and 24 years old attending higher education institutions also doubled during that period, from 10 to 20 percent. In Brazil and El Salvador, the ranks of working-age individuals who had completed secondary and tertiary education more than doubled as well. In a third group of countries (Bolivia, Colombia, Costa Rica, the Dominican Republic, Paraguay, and Peru), the improvements in educational attainment were significant but more modest. These broad patterns of large shifts in workforce education in Latin America hide substantial country-specific differences in the educational attainment of the labor force during the 1990s and 2000s. Some countries (Colombia, Costa Rica, and Paraguay) achieved gains in years of schooling only during the 2000s, after a decade of stagnation or, in the case of Paraguay, after a severe deterioration of educational attainment. Others (Brazil and Ecuador) rapidly expanded secondary education in the 1990s, followed by a more intense expansion of tertiary education in the 2000s. But in contrast to the reductions in inequality, which were mostly concentrated during the 2000s, several Latin American countries (notably El Salvador and Uruguay) expanded education more rapidly in the 1990s than in the 2000s.

Although education has expanded, there is no evidence of a regime shift since the 1990s, which stands in contrast to the case of wage inequality (figure 2.12). Specifically, there is no evidence of a strong acceleration in the supply of highly educated workers in the 2000s. In fact, the expansion of the supply of highly educated labor appears to be a secular, long-term phenomenon. Figure 2.12, panel b, presents the mean years of schooling at age 30 by birth cohort for Argentina, Brazil, Chile, and Mexico (the four Latin American countries where comparable data since the 1980s were available).

An interesting pattern is that those countries with the largest decline in labor income inequality appear to be those with the highest growth rate of the relative supply in the college to primary labor force (Bolivia, Nicaragua, and Russia). This finding provides some evidence in favor of relative labor supply trends as one of the plausible mechanisms that may be behind the trend reversal in labor income inequality. Also, it is interesting to observe that in the United States—the only country for which we observe a decline in the relative supply of both the college to primary labor force and the high school to primary labor force—labor income inequality has been increasing.

In summary, while the change in pay differentials among workers with similar skills and education (between-group inequality) accounts for a large share of the change in overall inequality, more than half of overall wage inequality occurs among workers with similar education, labor market experience, gender, location, and working in the same sector (within-group inequality).

Reduction of wage inequalities

Changes in the structure of wages can be linked to

1. changes in the distribution of the observable characteristics of workers (such as age, years of schooling, race, gender, working in formal or informal markets, earnings above or below minimum wages, and geographic location); and
2. changes in returns to those characteristics.

An important finding of existing studies is that changes in the distribution in education, keeping constant the returns to schooling, have tended to be unequalizing. This is the case in spite of the fact that the distribution of educational attainment has become more equal. This means that, had the pay structure by education level remained unchanged, the more-equal distribution of the education endowment would have resulted in an increase in labor income inequality. Because this sounds counter-intuitive, this finding is known as the “paradox of progress,” which is, essentially, a by-product of the convexity of returns: when returns to education are convex, there can be an inverse relationship between inequality of education and income inequality. Eventually, as the dispersion of years of schooling becomes smaller and smaller, this paradoxical result will disappear.

The role of minimum wage

The minimum wage and its effects on wage inequality have been among the most-studied subjects in labor economics. Results are mixed concerning both the magnitude and the direction of such effects. The level of the minimum wage matters. For example, the minimum wage’s effects are potentially much larger in Latin America than in the United States because the minimum wage in the former is often much higher (relative to the median wage) and rapidly increasing. However, minimum wage effects are potentially smaller in Latin America than in Europe, where the minimum wage is also high but the enforcement of legislation is much stricter than in Latin America. Similarly, macroeconomic conditions are likely to be important. A rising minimum wage in a rapidly growing economy may help to distribute the fruits of growth more evenly across workers by lifting the earnings of unskilled workers without sizable employment losses. On the other hand, a rising minimum wage in a context of low growth may backfire, because employment losses among unskilled workers may outweigh wage gains.

In Latin America, minimum wages doubled or tripled over roughly a decade in many countries—a noticeable exception being Mexico. In Brazil, the real minimum wage increased by 130 percent from 1995 to 2014, in Chile it doubled over the same period, in Peru it doubled from 1996 to 2013, and in Uruguay it doubled during the 2000s (as shown in figure 5.1). Moreover, although there is some variation among the region’s countries, high real rates of minimum wage growth really began to take off around 2002.

Compliance with minimum wage laws is also quite varied throughout the region. Although the percentage of formal workers making less than one minimum wage is small in almost all of Latin America, the existence of an informal sector makes all minimum wage analysis more complex and dependent on the cross-wage elasticity showing how informal sector employment reacts to formal sector wages. In a nutshell, the interplay between the formal and informal sectors as well as imperfect enforcement makes the analysis of the effects of the minimum wage on wage inequality different from that in developed countries. The effect of these trends on wage inequality depends on whether the new minimum wage level is binding (an indicator of which is the ratio of the minimum wage to the median wage). Minimum wage levels vary considerably by country.

This heterogeneity implies differences in the relevance of minimum wage policy that likely affect the impact of the minimum wage on wage inequality. In countries where the minimum wage bite is high, there is a larger risk that further minimum wage increases will either adversely affect employment rates or push vulnerable workers (such as unskilled workers, young people, and women) either into informal-sector jobs or out of the labor force entirely.

In the literature, the general conclusion is that an increasing minimum wage, despite pervasive incomplete compliance and ever-present but small employment losses, still has a wage-equalizing effect. This effect, however, depends largely upon the level of the minimum wage with respect to the country-specific wage distribution. In much of Latin America, before the large increases of the 21st century, the minimum wage was too low to be binding in the formal sector, and most of the adjustment occurred among informal workers to whom, in principle, the legislation did not apply. The minimum wage also appeared to create numeraire effects that echo higher up the wage distribution. Measured unemployment effects are, for the most part, modest. A recent study shows that the effects on informality instead may be important.

 This article incorporates text from a free content work. Licensed under CC BY 3.0 IGO (license statement/permission). Text taken from Wage Inequalities in Latin America: Understanding the Past to Prepare for the Future​, 2, Messina, Júlian & Silva, Joana, World Bank. World Bank.