The impact of minimum wages on informal and formal labor market outcomes: evidence from Indonesia

Maike Hohberg,Jann Lay

doi:10.1186/s40175-015-0036-4

Maike Hohberg, Jann Lay

Open Access

https://doi.org/10.1186/s40175-015-0036-4

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Abstract

This paper studies the effects of minimum wages on informal and formal sector wages and employment in Indonesia between 1997 and 2007. Applying fixed-effects methods, the estimates suggest that minimum wages have a significant positive effect on formal sector wages, while there are no spillover effects on informal workers. Regarding employment, we find no statistically significant negative effects of minimum wages on the probability of being formally employed. These findings suggest that employers use adjustment channels other than employment or that effects such as a demand stimulus on a local level outweigh the possible negative employment effects. Jel codes: J08, J46

Highlights

Due to limited fiscal resources, minimum wages in developing countries are a possible instrument to allow workers a decent standard of living
In the remaining tables we distinguish between the formal and the informal sector, i.e., considering only workers who have not changed their formal/informal status in two adjacent survey waves. This procedure seeks to capture the “pure” wage effects in the respective sector that should not be distorted by individuals changing sectors and thereby experiencing a change in wages. For both formal and informal workers we present the results for a subsample of individuals who earn below the minimum wage in their first year of appearance in the survey
The case of Indonesia is interesting as minimum wages are annually adjusted, considered as relatively high and do not cover a large informal sector

Summary

Introduction

Due to limited fiscal resources, minimum wages in developing countries are a possible instrument to allow workers a decent standard of living. Del Carpio et al (2012) argue that using provincial data might lead to an endogeneity bias since the local governments participating in the minimum wage setting process take the labor market conditions in their provinces into consideration They use a firm-level dataset Survei Industri (SI) to analyze the formal manufacturing sector and report negative employment effects for small but not for large firms with a negative overall impact. Chun & Khor (2010) use the IFLS and apply an estimation strategy developed by Neumark et al (2004) which includes dummies in order to indicate an individual’s wage distribution position While they find positive wage and negative employment effects for individuals at the lower end of the wage distribution in the formal sector, they do not observe such effects in the informal sector. Indonesian minimum wages are considered to be sufficiently high to provoke significant impacts on the labor market

Data and descriptive analysis

Empirical strategy

Results

Employment effects

Conclusion