In Brazil, education raised productivity and reduced informality, while minimum wage increases compressed inequality but risked lowering formal employment for low-skilled workers.
Editor's note: The author has made slides available here.
Policy debates in low- and middle-income countries rightly focus on improving the well-being of the poor. It is less obvious that we should also worry about wage inequality: if living standards at the bottom are rising, is it really a problem if highly skilled workers earn much more than the untrained?
The answer is yes: inequality matters. When income distributions become more unequal, the link between aggregate growth and poverty reduction weakens. Brazil’s ‘economic miracle’ in the late 1960s and 1970s is a classic example of this, where the poor benefited little from rapid growth due to rising inequality (Fox 1983). Very unequal societies also tend to adopt institutions and policies that concentrate political influence and access to land, schooling, and finance in the hands of a narrow elite, limiting broad-based participation in growth (Engerman and Sokoloff 2000).
Policymakers who care about long-run development should therefore be more aware of how income is distributed. But what, in practice, can they do?
Does education reduce inequality?
In standard supply-and-demand models, education is the textbook tool for countering inequality. If education expands the supply of skilled workers, the wage gap between the skilled and the less skilled should narrow, following a “diminishing returns to skill” logic (Katz and Murphy 1992).
Brazil’s recent experience seems, at first glance, to fit this story. After a long period of high inequality, wage dispersion started falling in the mid-1990s and continued declining into the 2010s, particularly in the formal sector, while schooling and college access expanded dramatically. It is tempting to conclude that education drove the fall in inequality.
But many other things were happening at the same time. For instance, Brazil saw a sequence of ‘labour demand’ shocks that changed employers’ incentives to hire different types of workers: trade liberalisation, a commodities boom, new digital technologies, and automation. The federal minimum wage also rose sharply from the mid-1990s onwards. With so many forces at work, simple before-and-after comparisons are uninformative.
In recent work (Haanwinckel 2025), I develop and estimate a structural model of Brazilian local labour markets that brings together changes in education, labour demand, and the minimum wage in a setting where firms have wage-setting power. The model is disciplined by regional data on wages, employment, and how binding the minimum wage is. I then use that model to disentangle the impacts of each change, and evaluate whether their consequences differ when they operate in isolation or jointly.
The most striking result of my analysis is that rising education explains none of the fall in wage inequality in the formal sector. The action comes instead from labour-demand shocks and minimum wage increases.
The explanation for this departure from the ‘diminishing returns’ story lies in combining employer market power with entrepreneurs’ firm-opening decisions. As more workers finish secondary school or college, it becomes more profitable to create skill-intensive, high-wage firms that benefit from that type of labour. These new firms absorb the more-skilled workers, while the less-skilled remain in low-wage firms. Thus, the difference in ‘firm wage premiums’ between skilled and unskilled workers rises, completely offsetting the narrowing of the skilled-unskilled wage gap that follows from the diminishing-returns channel.
Beyond the formal sector: Education and informality
So far, the discussion has focused on formal jobs. But in many developing and middle-income countries, a large share of workers is employed informally, without effective enforcement of labour regulations or access to social insurance. Does this change the link between education and inequality?
In joint work with Rodrigo Soares (Haanwinckel and Soares 2021), we develop a model in which firms decide whether to comply with labour regulations and offer formal jobs, or to operate informally in the shadow sector. We estimate this using Brazilian data from the 2000s.
We find that Brazil’s educational expansion was a key driver of the fall in labour informality. As the workforce became more educated, more workers moved into formal jobs. Even if wages were identical across sectors, this shift is valuable because formal employment brings unemployment insurance, disability benefits, and public pensions. In our simulations, higher formality rates also raise the pay of unskilled workers, even those who remain in the informal sector.
Once we account for the informal sector, education looks much more promising as a tool for reducing inequality. It may do little to compress wage gaps within the formal sector, but it improves outcomes at the bottom of the distribution by cutting informality and expanding access to social protection.
Minimum wages: Powerful but risky
As noted above, my research finds that labour-demand shocks explain most of the decline in formal-sector wage inequality, but the rising minimum wage is the second most important factor. From a policy perspective, that matters because commodity prices and technological changes are largely outside a government’s control, while the minimum wage is an explicit policy choice.
Minimum wages are attractive because they directly boost wages at the bottom and compress the lower tail of the distribution. In contexts with employer market power, they can also potentially raise wages and employment at the same time. However, there is a risk of destroying jobs for low-productivity workers, and in countries with large informal sectors there is an additional concern that firms and workers are pushed out of the regulated market.
What do carefully estimated economic models say about these trade-offs? My work in Haanwinckel (2025) predicts that a large increase in the Brazilian minimum wage, holding other factors constant, would reduce formal employment by around 6%. Engbom and Moser (2022), using a different framework, find a smaller but still negative effect of about 1%. This range of estimates primarily reflects different assumptions about how easily low-wage workers can move to new jobs. Specifically, I assume workers cannot move across regions to search for better jobs, while Engbom and Moser assume such mobility is costless.
Both models focus on the formal sector. To assess the implications of the minimum wage in the informal sector, we can return to Haanwinckel and Soares (2021), in which we find that minimum-wage hikes can significantly increase informality. When the minimum wage raises the cost of formal employment but informal firms can continue paying lower wages, some low-skilled workers lose formal jobs and reappear in informal ones, with lower pay and no social insurance – the opposite of what policymakers intend.
Lessons for policymakers
What does all this imply for governments that care about both poverty and inequality?
First, investing in education remains an effective tool for improving welfare. Even if it does not compress formal-sector wage gaps, it raises productivity, supports growth, and reduces informality. These changes disproportionately benefit poorer, less-skilled workers.
Second, minimum wages are a risky strategy to fight inequality. In the Brazilian case, they clearly contributed to compressing wage gaps in the formal sector. But they also pushed some of the most vulnerable workers into either informality or unemployment.
If governments choose to use minimum wages, the Brazilian experience suggests two practical guidelines. One is timing: the negative side effects on employment and informality are much smaller when minimum wage hikes coincide with rising education levels or favourable labour-demand shocks. Minimum wage policy and education policy should therefore be seen as complements, not substitutes.
The second guideline is targeting: a uniform national minimum can bite very hard in poorer areas while barely binding in richer ones. Allowing some regional differentiation – lower minimum wages in poorer or rural regions, higher ones in richer or urban areas – can reduce these risks, as illustrated by Mexico’s recent expansion of the minimum wage in municipalities along the US border (Inguanzo and Puggioni 2025).
References
Engerman, S, and K L Sokoloff (2000), “Institutions, factor endowments, and paths of development in the new world,” Journal of Economic Perspectives, 14(3): 217–232.
Fox, M L (1983), “Income distribution in post-1964 Brazil: New results,” Journal of Economic History, 43(1): 261–271.
Haanwinckel, D (2025), “Supply, demand, institutions, and firms: A theory of labor market sorting and the wage distribution,” American Economic Review, 115(12): 4137–4182.
Haanwinckel, D, and R R Soares (2021), “Workforce composition, productivity, and labour regulations in a compensating differentials theory of informality,” Review of Economic Studies, 88(6): 2970–3010.
Inguanzo, J A, and D Puggioni (2025), “The minimum wage and the shadow payroll: Evidence from Mexico’s 2019 policy,” Unpublished manuscript.
Katz, L F, and K M Murphy (1992), “Changes in relative wages, 1963–1987: Supply and demand factors,” Quarterly Journal of Economics, 107(1): 35–78.