The Consequences of Doubling the Minimum Wage: The Case of Indonesia

Abstract

Results suggest that doubling Indonesia's minimum wage led to a 10 percent increase in average wages, a 2 percent decrease in wage employment, and a 5 percent decrease in investment. The disemployment effect appears to be considerable in small firms, but employment may actually increase in large firms. Minimum wages in Indonesia were tripled in nominal terms, and doubled in real terms, in the first half of the 1990s. Rama evaluates the effects of this hike on wage earnings, wage employment, and investment. After describing Indonesia's minimum wage policy and surveying the literature on the effects of minimum wages, Rama applies relatively simple statistical tools to individual and aggregate data. He visually inspects the wage distribution for full-time laborers and employees to assess the extent of compliance with minimum wages. He uses regression analysis involving minimalist specifications and data aggregated by province to estimate the elasticity of wage earnings, wage employment, and investment with respect to the minimum wage. A wide dispersion in the ratio of minimum wages to labor productivity across the 27 Indonesian provinces can be used to identify the effects of the minimum wage. The results suggest that minimum wages have a moderate effect on outcomes in Indonesia's labor market. Taken at face value, these results imply that doubling the minimum wage led to a 10 percent increase in average wages, a 2 percent decrease in wage employment, and a 5 percent decrease in investment. The disemployment effect appears to be considerable in small firms, but employment may actually increase in large firms. This paper - a product of the Poverty and Human Resources Division, Policy Research Department - was written as part of a broader labor study on Indonesia undertaken by East Asia and Pacific, Country Department III. The research was also supported by the Bank`s Research Support Budget under the research project The Impact of Labor Market Policies and Institutions on Economic Performance (RPO 680-96). The results of the research were presented at a joint Ministry of Manpower, Indonesia-World Bank workshop in Jakarta in April 1996. The author may be contacted at mrama@worldbank.org.