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  • The Implications of Minimum Wage Policy on School Enrollment:

    An Empirical Analysis of Indonesia


    Prapon Wongsangaroonsri



    Bachelor of Arts, Honours in Economics



    April 2016

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    I. Abstract1

    This paper investigates the effect of minimum wage on school enrollment in Indonesia between

    1997 and 2007, exploiting a policy initiative which more than quadrupled the minimum wage

    rate. Using a fixed effect regression with difference-in-difference approach, this study finds that

    minimum wage policy had diverging implications on school enrollment for each demographic

    group. The result indicates a positive effect of minimum wage on school enrollment for

    individuals below the legal working age and a less-robust indication of negative effect on for

    individuals above the legal working age. In the context of developing countries, this study

    further argues that the more stringent household income constraints allows minimum wage to

    have positive effects on school enrollment in addition to the negative effects previously found in

    the literature.

    1 Acknowledgement: I am immensely grateful toward my thesis advisor, Professor Jamie

    McCasland, for her valuable insights and encouragement. Her advices had led many significant

    improvements of the model and specification used in this paper. I am also deeply indebted to

    Professor Nicole Fortin, who had generously provided assistance and feedbacks through the

    entire writing process. I would like to thank Professor David Green for his insightful comments

    regarding the economic model used in this paper. Special thanks to my family and friends, who

    had been a source of constant emotional supports and discussions.

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    II. Table of Content

    I. Abstract....ii

    II. Table of Content.......iii

    1. Introduction.................1

    2. Background.............3 2.1 Minimum Wage System in Indonesia....,3 2.2 Adjustments for Non-Homogeneous Labour Market.....5

    3. Literature Review. .............6

    4. Economic Framework..................12 4.1 Intergeneration Model of Education...,..12 4.2 Adjustments for Non-Homogeneous Labour Market....16

    5. Data............................18 5.1 Data Source and Description.18 5.2 Summary Statistics....21

    6. Estimation Strategy..........................24

    7. Results Presentation..........................31 7.1 Minimum Wage Effect by Age Group..33 7.2 Minimum Wage Effect by Gender Group.....37 7.3 Analysis of Results........39

    8. Conclusion.............................41


    Figures and Tables........................45

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    1. Introduction

    The controversy surrounding minimum wage policy is a subject of many debates in both

    the academics and political arenas. The policy is celebrated by its proponents as one of the

    means in alleviating income disparity and denounced by its opponent for the risk of displacing

    workers and choking firms competitiveness with labour cost. While there is little dissent

    regarding the positive effect of the policy on formal sector wage rate (albeit an unclear

    implication on distribution), the effect of the policy on the labour market is by far more

    controversial and hence a topic of extensive study. However, in addition to the much studied

    labour market effects, the policy may also results in household-side adjustments, which may

    amplify or weaken the intended policys effect. In contrast to the relatively numerous researches

    in the literature that focuses on the direct impact on income and employment, this paper argues

    that household spending particularly on educational investment is another channel which is

    affected by the policy. In turn, by affecting the level of human capital of the subsequent

    generations of workers, the effect on education investment also hold long-run implication over

    the economy through the quality of labour supplied in the labour market. A similar query into

    this dynamics is investigated in Neumark and Wascher (1995), which stresses the linkage

    between schooling, employment, and minimum wage for labour market analysis.

    This study is conducted to investigate the manner in which household adjustments to

    minimum wage policy may lead to unintended consequence on education and, in turn, hold long-

    run implications over labour market. As a result of the dynamics between education and labour

    market, any policy that affect education holds implication to the labour market structure and

    productivity. Due to the lag in which changes in education outcome manifests on the economy,

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    this linkage between minimum wage and education may not produce an apparent effect during

    the period in which minimum wage policy is evaluated and is not often included into policy

    evaluation. The assumption of relationship between minimum wage and educational investment

    implies that the use of the minimum wage without considering these additional effects may lead

    to sub-optimal outcome for the economy. This implication then posit the need for a more

    integrated outlook and robust criteria for evaluating policy impacts of minimum wages beyond

    the short-term outlooks of workers welfare and the economy.

    In order to investigate this linkage, this study focuses to Indonesia, which is a fertile

    ground for minimum wage research due to the countrys long-term reliance on the policy to

    achieve social and distributional outcomes. Within this setting, this paper aims to illustrate two

    specific ideas. First is that minimum wage policy has an indirect implication on the labour

    market over the long-run by influencing households decision to invest in education. Second,

    the households educational adjustments are not uniformed over different demographic groups,

    which in turn hold implications over the distribution human capital among the population in

    addition to level effect. Conditioned on demographic groups, this paper hypothesizes the

    minimum wage has two opposing effects on school enrollment in developing countries due to the

    more stringent income constraints on households toward investment in education. The net effect

    to be either positive or negative, depending on the effect that prevails for each demographic


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    2. Background

    2.1 Minimum Wage in Indonesia

    The first minimum wage legislation in Indonesia was implemented in the early 1970s, following

    the creation of the national wage council in 1969. However, the rate set by council was not

    binding, and the lack of enforcement and monitoring resulted in the legislation only achieving

    symbolic status (Hohberg & Lay 2015). The minimum rate wage only became binding

    following the reform to the legislation in 1989, whereupon the minimum wage is calculated

    based on a government-determined minimum consumption basket. Variations of the rate at the

    provincial level is allowed to account for differences in price-level of goods in the basket, local

    labor market conditions, and economic growth (Rama 2001). However, while the price of the

    consumption goods did not differ significantly across Indonesia, the considerations for local

    labour market still led to large variations of the minimum wage across provinces. Additionally,

    considerations are given for some variations at district levels from the provincial baseline.

    Another subsequent reform to the minimum wage system occurred in 2001, in which the tasks of

    determining each provinces minimum wage were relegated to the provincial government. The

    recommended rate of minimum wage in each province is chosen annually by regional wage

    council on an annual basis during the last three months of the previous year. Once approved, the

    new rate is announced by the provincial governor via a press release and is effective for the

    duration of the coming year. The minimum wage is set for monthly full time work but also

    affects the part-time wage, which is calculated as a by-day proportion of full-time work (Widarti

    2006). Another initiative in enforcing the policy came with the Indonesian Manpower Act in

    2003, which allows non-compliance with the policy to be subjected to criminal sanctions. The

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    Article (185) of the Act 13 of 2003 concerning Manpower stated that the punishment of paying

    wage lower than the minimum rate to involve a maximum of 4 years imprisonment and a fine of

    4 hundred million rupiah, a much harsher development in comparison to the punishment scheme

    in the 1990s, where non-complying firms were simply black-listed (Rama 2001).

    However, despite the efforts to achieve a universal minimum wage rate, the enforcement

    and monitoring of the policy is mostly limited to the occupations in the formal sector, whereas

    the informal sector may not be subjected to the same minimum constraint. In the context of

    developing countries, where the informal sector tends to be large relative to the economy, this

    implies that a large share of population may sti


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