Dual Labor Markets: How Minimum Wage Policies Reshape Indonesia's Employment Landscape

Abstract

Indonesia's minimum wage policy has been a contentious issue in employment discourse, particularly regarding its impact on the dual labor market structure consisting of formal and informal sectors. The segmented nature of Indonesia's labor market, where minimum wage regulations primarily apply to the formal sector while leaving the informal sector largely uncovered, creates complex spillover effects that differ from those observed in developed countries. This study aims to examine the comprehensive impact of minimum wage policies on employment across Indonesia's formal sector, informal sector, and unemployment rates, addressing the interdependence between these sectors that previous research has largely overlooked. Using panel data from 34 provinces across Indonesia for the period 2017-2021, this study employs Ordinary Least Squares (OLS) regression analysis to estimate three separate models examining the relationship between minimum wage and employment outcomes in formal, informal, and unemployment sectors. Control variables include productive age population, education levels, and Gross Domestic Product (GDP). The findings reveal that minimum wage increases significantly reduce formal sector employment while simultaneously increasing informal sector employment and unemployment rates. These results support the dual labor market theory, demonstrating that workers displaced from the formal sector migrate to the informal sector or become unemployed rather than exiting the labor force entirely.The study provides crucial insights for policymakers regarding the unintended consequences of minimum wage policies in developing countries with segmented labor markets. The results suggest that while minimum wage policies aim to improve worker welfare, they may inadvertently increase informal employment and unemployment, potentially undermining the policy's redistributive objectives. These findings emphasize the need for comprehensive labor market policies that consider the interconnected nature of formal and informal sectors in developing economies.