Can Minimum Wages Fight Poverty? Lessons from Indonesia’s Economic Policies

The study finds that while minimum wage increases benefit low-wage workers in Indonesia, they have no significant impact on poverty reduction due to limited reach among nonwage workers and poor households. Alternative policies like direct cash transfers and social programs may be more effective in addressing poverty.

A study by Nurina Merdikawati and Ridho Al Izzati, published in The World Bank Economic Review, investigates whether minimum wage increases have helped reduce poverty in Java, Indonesia, between 2002 and 2014. Conducted by researchers from the Australian National University and the SMERU Research Institute, the study uses an innovative approach comparing geographically proximate districts with different minimum wage levels. Despite a 67 percent real increase in minimum wages over the study period, the research finds that while wage workers benefit from higher pay, the overall impact on poverty remains minimal.

A Decentralized Wage Policy with Limited Reach

Minimum wages have been a key policy tool for improving wages and working conditions, particularly in developing economies. In Indonesia, the minimum wage system was initially set at the provincial level, but following decentralization in the early 2000s, district governments were given greater autonomy in setting their own wage floors. The logic behind increasing minimum wages is that it boosts the earnings of low-wage workers, potentially lifting them and their families out of poverty. However, economic debates persist on whether these policies work as intended. Proponents argue that wage increases improve the financial well-being of low-income workers without significantly affecting employment, while critics fear that rising labor costs could lead to job losses, especially among unskilled workers.

To analyze the effects of district-level minimum wages, the study utilizes cross-sectional data from Indonesia’s National Socioeconomic Survey (Susenas), focusing on Java Island. The researchers exploit variations in minimum wages across neighboring districts, assuming that adjacent areas share similar economic conditions. This method helps isolate the impact of minimum wage increases from broader economic factors. During the study period, the poverty rate in Java declined from 17 percent to 10 percent, but the study investigates whether these reductions were actually driven by rising minimum wages.

Wage Gains Without Household Prosperity

The research finds that district minimum wages positively affect wage workers earning near or below the 20th percentile of the wage distribution. A 10 percent increase in district minimum wages leads to a 2 percent wage increase, with the largest wage gains (3 to 4 percent) occurring among workers in the 15th to 30th percentile. However, the study finds no significant impact on earnings for nonwage workers, including the self-employed, casual laborers, and unpaid family workers. This suggests that minimum wages primarily benefit formal wage workers but have little effect on those outside formal employment.

Employment effects are also minimal. Overall, there is no significant job loss associated with minimum wage increases, but for individuals from poor households, the probability of being employed declines slightly (by 0.06 percentage points) following a 1 percent increase in the minimum wage. While this is not a dramatic reduction, it highlights potential vulnerabilities among low-income workers when minimum wages rise.

When analyzing household per capita expenditure, which is the primary indicator of poverty status in Indonesia, the study finds no meaningful effect. Even among households in the bottom 20 percent of the expenditure distribution, the impact is statistically insignificant. This suggests that while some individuals may experience wage gains, the overall financial improvement is not strong enough to raise household spending to levels that would lift families out of poverty.

Why Minimum Wage Fails as a Poverty Reduction Tool

The study finds no direct relationship between higher minimum wages and poverty reduction, despite wage increases for some workers. Several factors contribute to this outcome. First, many workers in poor households are nonwage earners, meaning they are not directly affected by higher statutory wages. Second, compliance with minimum wage laws is imperfect, with many workers still earning below the mandated wage. Third, many minimum-wage earners belong to nonpoor households, where additional earnings do not significantly influence poverty measures.

Another key limitation is that Indonesia’s minimum wage is designed based on the needs of a single worker, rather than a family. Meanwhile, the official poverty measurement is based on household per capita expenditure. This means that even when an individual sees an increase in wages, it does not necessarily translate into a household-wide improvement in economic well-being.

The study also accounts for various factors that could affect its findings, including political influences on minimum wage setting, local economic conditions, and migration effects. The results remain consistent across different scenarios, further reinforcing the conclusion that minimum wage increases alone do not significantly reduce poverty.

Rethinking Policy Approaches to Address Poverty

Despite the limited effectiveness of minimum wage policies in reducing poverty, they remain a central labor market regulation tool in Indonesia. In recent years, the government has introduced reforms to create more predictable minimum wage increases by linking them to economic growth and inflation. The 2020 Job Creation Law introduced further changes, including exemptions for small businesses. These reforms raise important questions about the future role of minimum wages in Indonesia’s labor market and their impact on both employment and poverty.

The study suggests that while minimum wage policies can help increase earnings for some workers, they are not a sufficient tool for poverty alleviation. Alternative or complementary policies, such as direct cash transfers, targeted social assistance programs, and initiatives to improve informal sector earnings, may be more effective. Policymakers should also consider a broader set of labor market interventions, including vocational training programs, wage subsidies, and policies aimed at improving the productivity of low-income workers.

As Indonesia continues refining its labor market policies, understanding the limitations and potential of minimum wages will be crucial in designing more effective poverty reduction strategies. The research provides valuable insights into the role of wage policies in developing economies, reinforcing the need for multi-dimensional approaches to tackling poverty. Instead of relying solely on minimum wages, a combination of social protection measures, education, and economic policies is needed to ensure that poverty reduction efforts reach those who need them most.