The Effect of Increasing the Minimum Wage on Employment in Indonesia An Analysis of Manufacturing Firms in West Java from 1994 to 2015

After Indonesia introduced its sweeping decentralization reforms in 2001, basic government functions—including the authority to set minimum wages—were devolved to local governments. We study the effect of increases in the minimum wage on employment by examining plant-level panel data from 1994 to 2015. We focus on five neighbouring local government areas in West Java province, which used to have the same minimum wage before the 2001 reforms and which have since established different minimum levels of mandatory remuneration. According to our baseline analysis, a 1 per cent increase in the minimum wage in real terms reduced the number of workers employed by manufacturing plants in that area the following year by 0.35 to 0.51 per cent. This suggests that, after 2001, the number of employees in manufacturing firms operating in the local government with the highest average minimum wage (Bekasi municipality) decreased by 3.7 to 5.4 per cent compared to the municipality with the lowest average minimum wage (Bogor municipality). We also find that the negative effects were mainly observed in large plants with more than 100 employees as of 1994. We check the robustness of our baseline analysis by changing the definition of factory size, including plants that had exited the labour market or moved out to other locations, and by changing the specification of time trends by local government.