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Child Worker in Indonesia (Photo: pulitzercenter.org)

Is Raising the Minimum Wage Policy Effective?

Haryo Aswicahyono

High minimum wage supporters often argue that raising the minimum wage is an effective instrument for reducing poverty. With a high minimum wage, poor workers would be guaranteed of their purchasing power so that they will be able to meet the needs of decent living standards (kebutuhan hidup layak, KHL).

Providing the KHL in a short time for the labors is a noble goal. However, for any noble goal there is always a cost. The problem is that these costs are not only borne by the rich, but also by the poor people outside the formal sector, the sectors which are required to meet the minimum wage, such as farm workers, temporary construction workers, micro enterprises, diner, and so on. Therefore, the impact of the increase in the minimum wage needs to be analyzed carefully.

The Decrease of Labors Absorption

In a market where the businessmen are competing, corporate profits will constantly be under pressure. Intense competition makes the entire revenue of the business is only enough to pay for labor, capital cost and a little income for the businessmen in exchange for their willingness to take risks in the form of a reasonable profit.

In such a fierce competition, what do employers do when wage rises? Firstly, employers would do the efficiency and substitution actions. The least productive workers will be laid off. Secondly, employers begin to think, may be it is more efficient if one worker with undergraduate diploma is replacing two or three workers of high school graduate with higher productivity. Or they would purchase some machines, for automation in most production lines so it does not require that much labor. Efficiency and substitution efforts undertaken earlier by the employers, all in all, will give a quite large negative impact on employment numbers.

Asep Suryahadi’s research results titled “Wages and Employment: Impact of Minimum Wage Policy on Absorption of Labors in Urban Formal Sector” shows that the increase of minimum wage would decrease employment significantly. For every 10% increase in the net minimum wage will result in a reduction of employment in total of more than 1%. Finance and Economics even showed a greater impact. For each increase of minimum wage by 10% will reduce employment by 4%.

Further research from Asep Suryahadi showed that the ones whom are most benefited from the minimum wage policy is the white-collar workers. Minimum wage increase by 10% would lead to increased employment by 10% for white-collar workers. Instead the hardest part would the women workers, young workers, and part-time workers. For a minimum wage increase by 10% will decrease the employment of women workers by 3%, youth workers by 2%, and part-time workers by 4%. Therefore, Suharyadi research results would indicate that if the minimum wage is too high then it is not a pro-job policy.

Putting Pressure on the Informal Sector Wages

Empirical research results discussed above indicate that the minimum wage rise would encourage layoffs in the formal sector. The question is, where should the workers who lost their jobs in the formal sector be looking for work? Where should the new labor force looking for work, if the formal sectors have difficulty employing new workers? The answer is that they will find work in the informal sector. As a result, the informal sector will have an excess supply of labors. Excess supply of labors in the informal sector in turn will put pressure on wages in the informal sector.

Bird and Manning’s research results in 2004, titled “The Impact of Wage Policy on Employment in the Formal and Informal Sector” shows the increase of minimum wage does not increase, and even tends to decrease wages in some segments of the informal sector, such as the wages for housemaids. SMERU institute survey also showed that 28% of wages in the informal sector are below the minimum wage.

Blow to the Poor as the Price Rises

If employers cannot find substitutions or efficiency as described above and layoffs cannot be done, then the remaining option is to raise the selling price. Kelly Bird and Chris Manning in their article titled “Minimum Wages and Poverty in a Developing Country: Simulations from Indonesia’s Household Survey”, conducted simulations to look at this possibility.

By using the Input-Output table, they estimated the impact of rising labor costs on the prices of all commodities. Then, using the data from SUSENAS, Bird and Manning saw the impact of the rising selling prices on the poor. The analysis results showed that the minimum wage policy is not an effective policy to help the poor.

Only 17% of the minimum wage increases in 2003 were received by poor households, 34% received by households, which are slightly above the poverty line, half received by households that are not classified as poor. Furthermore, the analyst showed that only a quarter of poor households received an increase in revenue as a result of the minimum wage, while three-quarters of poor households increasingly suffered from rising prices.

All research results described above indicate that the increase of minimum wage can indeed be a savior for workers who are already settled in especially the white-collar workers. But at the same time, the policy to establish a high minimum wage could harm women workers, part-time workers, and vulnerable young workers from a threat of laid-off. A higher increase of minimum wage would also put pressure on the informal sector and poor households would be hit by rising prices. In other words, increasing the minimum wage too high is not a pro-poor instrument and in favor of the availability of jobs (pro-job).

Haryo Aswicahyono is an economist and a researcher at the Centre for Strategic and International Studies (CSIS) Jakarta. This article is originally published in Suarakebebasan.org.