How Important are Labor Markets to the Welfare of Indonesia's Poor?
52 Pages Posted: 20 Apr 2016
Date Written: October 1996
Because poverty mainly afflicts agricultural and self-employed households in Indonesia, the most direct ways that policy can help to reduce poverty are through improving the operation of product, land, and capital markets, particularly where the regulatory environment now works to reduce farm profitability or inhibit entry to productive enterprises by the poor. Labor market policy can play an important role by facilitating, not impeding, labor mobility across sectors.
The majority of the poor in Indonesia come from agricultural and self-employed households. About 70 percent of the remaining poor came from rural agricultural households in 1993, and more than 72 percent lived in households that derived the bulk of their income from self-employed enterprises. Moreover, the largest single contribution to poverty reduction between 1990 and 1993 came from within-sector welfare gains to self-employed farm households.
Data show that the role of the labor market in reducing poverty has increased since the mid-1980s. Wage labor markets can be expected to play an increasingly important impact on the welfare of Indonesia's poor as the economy continues to undergo structural change, and as the workforce continues to move out of agriculture into manufacturing and services. Because poverty remains largely an agricultural and self-employed phenomenon, the most direct way for policy to contribute to reducing poverty is to focus on improving the operation of product, land, and capital markets - particularly where monopolies reduce farm profitability or viability (for example, cloves, oranges) or where excessive regulations raise costs or inhibit entry to productive enterprises by the poor. At the same time, labor market policy can play an important role in the Government of Indonesia's efforts to reduce poverty by helping to facilitate labor mobility across sectors - for example, from low productivity activities in agriculture to higher productivity activities in other sectors.
But if they reduce labor mobility, labor market policies can be counterproductive to Indonesia's poverty reduction efforts. Recent empirical evidence suggests that increases in the minimum wage may have hurt employment growth, particularly among small firms. As such, using minimum wage policy to ensure high wages to a limited number of (mostly nonpoor) workers will almost certainly diminish the poverty reducing potential of the labor market.
This paper - a joint product of the Poverty and Social Policy Department and the Country Operations Division, East Asia and Pacific, Country Department III - is part of a larger study of the labor market in Indonesia undertaken by East Asia and Pacific, Country Department III. It was presented at a joint Ministry of Manpower, Indonesia-World Bank workshop, Indonesian Workers in the 21st Century, Jakarta, April 24, 1996.
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