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03 Mar 2016

Minimum Wages and Labour Market Outcomes in Decentralized Indonesia: A Case Study from Java

Raden Muhamad Purnagunawan, January 2011
The Australian National University

Abstract
Using the data at the district and individual level, this thesis analyses three core interrelated sets of issues related to minimum wages impact on employment and hours of worked, commuting and returns to commuting, and the gender earnings gap. These issues are discussed in the context of economic and labour market changes 2001 – 2007 in Indonesia.

In 2001, Indonesia experienced decentralization that was accompanied by variation of minimum wages at district level and a rapid increase in minimum wages by the mid 2000s. This condition created an opportunity to re-assess the impact of minimum wages across regions.

In regard to the first set of issues addressed in Chapter 3, it was found that compression of the wage distribution near the minimum wages level was evident in both the formal and informal sectors. However, minimum wages did not strongly affect the total employment in either sector. The regression analysis only found that the employment effect was channelled through a decrease in working hours for workers in the formal sector in urban areas. This suggests that firms and employers in the formal sector in urban areas are more likely to choose to adjust working hours rather than dismissing workers in response to minimum wage increases. Another possible effect was found through the spillover employment effect of minimum wages across districts. This probably played a role in dampening the disemployment effect of the increase in minimum wages.

Chapter 4 focused on commuting between districts among male workers. The analysis revealed that minimum wages has a significant pull and push effect in attracting and deterring the number of commuters between districts. The effect is found to be significantly larger for workers in the informal sector than in the formal sector that might due to a strong derived demand for workers in the informal sector or a lighthouse affect that tends to boost expected incomes. Nevertheless, further analysis using individual level data revealed that the returns to commuting of informal workers were still lower than the wage premium earned by formal workers. Workers in the informal sector generally travel longer distances and have a lower education level.

Chapter 5 deals with earning differential between male and female workers. The gap was expected to narrow as a result of the implementation of minimum wage regulation. However, there is no significant evidence of a convergence effect related to minimum wages during the period of analysis. The lack of a significant effect of minimum wages in the formal sector is likely to be due to the fact that wages are more likely to be based on observable productivity-related characteristics, such as human capital, job, location and other individual characteristics. This was reflected in the relatively large contribution of the differences in endowments to the gender earnings gap.

The general conclusion of this study is that the impacts of minimum wages are not as large as expected. Mobility of labour across districts and low levels of compliance in general might have dampened the disemployment effect of the minimum wages.

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