Examining the drivers of changes in mean earnings and earnings inequality in Indonesia

• Published date: 01 June 2024
• Author: Maria Monica Wihardja,Abror Tegar Pradana
• Date: 01 June 2024
• DOI: http://doi.org/10.1111/asej.12332

ORIGINAL ARTICLE

Examining the drivers of changes in mean earnings and

earnings inequality in Indonesia

Maria Monica Wihardja

1

| Abror Tegar Pradana

2

1

ISEAS—Yusof Ishak Institute, Indonesia Studies Programme, Regional Economic Studies and Media,

Technology & Society, Singapore, Singapore

2

Independent Researcher

Correspondence

Abror Tegar Pradana, Independent Researcher.

Email: abrortp@gmail.com

Abstract

This article examines the main drivers behind changes in mean earnings and earnings

inequality in Indonesia between 2001/2002 (data for 2001 and 2002 are combined) and

2018. During this period, there was an increase in workers’education level, average age,

job quality and mean earnings. More women participated in the labor market, but

women earn lower wages than men, therefore mean earnings fell. For the overall period,

a decline in educational returns at all levels of education contributed negatively to earn-

ings. Narrowing wage premia across provinces contributed to the increase in mean earn-

ings. Indonesia’s Gini index rose during this period, driven by the education distribution

effect and the spatial location (place of residence) premium effect. Although improve-

ment in education levels increased mean earnings, this was inequality-increasing due to

the “paradox of progress”(exponential wage returns to education). There is a need for

complementary policies to attenuate the inequality-increasing education and spatial loca-

tion effects as well as gender wage gap.

KEYWORDS

inequality, labor market

JEL CLASSIFICATION

J31, J38

1|INTRODUCTION

Cross-country studies show that labor income is the most important contributor

to reducing poverty in many countries (see, for example, Azevedo et al., 2013).

DOI: 10.1111/asej.12332

© 2024 East Asian Economic Association and John Wiley & Sons Australia, Ltd.

Received: 18 January 2024; Accepted: 2 June 2024

232 Asian Econ. J. 2024;38:232–255.

wileyonlinelibrary.com/journal/asej

Moreover, a good quality job is a key pathway to attaining middle-class status,

and this applies in Indonesia. In 2018, Indonesia’s poverty rate fell to single

digits for the first time in the country’s history. However, given that many

Indonesians (one in five) live in vulnerability and many (one in two)

1

aspire to

join the middle class but lack the economic security to do so Indonesia continues

to face a huge challenge to increase the standard of living and welfare of most of

its citizens—something that will be achieved mainly through better quality jobs.

In addition to this, during the commodity boom era of 2001–2011 and a prema-

ture deindustrialization when employment in medium and large manufacturing

firms was “hollowed out”, inequality, as measured by the Gini coefficient, rose

from 30 points (in 2000) to 37.8 points (in 2010). The Gini coefficient continued

to rise, hitting 41.4 points in 2014, its highest recorded level in Indonesia. This

increase in consumption inequality has been partly driven by earnings inequality

(Wihardja & Cunningham, 2021).

This paper investigates the main drivers behind changes in mean earnings

and earnings inequality in Indonesia, as these determine the pace of poverty

reduction, expansion of the middle class, and the quality of economic growth.

Low mean earnings and high earnings inequality can also potentially threaten

Indonesia’s political and social stability. The paper studies the drivers behind

the changes in mean earnings, which will help policymakers to identify and

focus on necessary.

Following the work conducted in Ferreira et al. (2022), we decompose

changes in mean earnings and earnings inequality into distribution

(or endowment) and premium (or structure) effects. Each consists of explana-

tory variables based on the characteristics of individual workers, namely educa-

tion, age, job status, gender, place of residence (urban/rural and province),

economic sector of employment, and occupation.

2

A wide body of literature shows that contributors to changes in mean earn-

ings and earnings inequality vary by country. Ferreira et al. (2022) show that an

increase in the mean earnings in Brazil is associated with changes in the returns

to sectoral employment. However, earnings inequality has been driven primarily

by changes in the educational level and distribution (the distribution effect of

education). The inequality-increasing distribution effect of education is also

found in India by Khanna et al. (2016). However, in this case, the

inequality-increasing distribution effect of education is offset by a decrease in

1

The poor are defined as those who live below the poverty line. The vulnerable are defined as those who have

more than 10 percent probability of falling into poverty. Their monthly household consumption is around 1–1.5

times the poverty line. The aspiring middle class are defined as those who have more than 10 percent probability

of falling into poverty and vulnerability. Their monthly household consumption is around 1.5–3.5 times the

poverty line. The middle class is defined as having less than 10 percent probability of falling into poverty and

vulnerability. Their monthly household consumption is around 3.5–17 times the poverty line. The upper class

consumes at more than 17 times the poverty line (World Bank, 2019).

2

We use the phrases “distribution effect”and “endowment effect”interchangeably. We also use the phrases

“structure effect”and “premium effect”interchangeably.

ASIAN ECONOMIC JOURNAL 233