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With the Indonesian government's proposal to increase the minimum wage by 6.5%, an unemployment gap is likely to occur/worsen with the decrease in labor demand as a result. As such, the market being unable to define an equilibrium leaves the economy to run inefficiently. The extremity of this issue will be dependent on the unknown elasticities of the supply and demand of labor. Furthermore, this elasticity also determines how the redistribution of wealth and use of social programs will be affected. The current predicted consequences could be economic instability, inflation, increased budget deficit, and more. Alternatively, we propose investments in infrastructure, driving tourism, and creation and support of a competitive business environment.

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Indonesia Minimum Wage to be Raised by 6.5% in 2025, Prabowo Says

-Date published: November 29th, 2024

-Authors: Chandra Asmara and Norman Harsono

-Source: Bloomberg

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Check out the original article!

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Indonesia Raises Minimum Wage By 6.5% in 2025, Prabowo Says (1)

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Indonesian President Prabowo Subianto announced an average 6.5% increase in minimum wages for next year as consumption falters in Southeast Asia’s largest economy.

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-Increase in minimum wage will result in a decrease in the demand for labor in this market.

-At this higher price point the supply of labor will increase in this market.

-The "equilibrium" price will be higher because of the minimum wage increase but the equilibrium quantity demanded and supplied will ultimately be lower.

-Gap between quantity of labor supplied and demanded in this market.

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-Results are dependent on elasticity of supply and demand.

-Labor supplied will change significantly when supply is elastic.

-Labor supplied won't change much when supply is inelastic.

-Labor demanded will change significantly when demand is elastic.

-Labor demanded won't change much when demand is inelastic.

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Check Out This Article On The Harmful Effects Of Raising Minimum Wage

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Check Out This Article On The Harmful Effects Of Raising Minimum Wage

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Another Study Reveals the Harmful Effects of Raising the Minimum Wage

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A new study was released proves once again just how harmful a $15 minimum wage can be. The study, conducted by the economic consulting group PFM, found that raising the minimum wage to…

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-Income tax funds many social programs in the U.S. and Indonesia.

-Both the U.S. and Indonesia have a progressive income tax structure.

-Higher income from the minimum wage increase will result in more money derived from taxes.

-Effects of taxation and redistribution are based on elasticity of supply and demand of labor.

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Check Out This Article About The Indonesian Tax Structure

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Check Out This Article About The Indonesian Tax Structure

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A company is subject to the tax obligations set by the Indonesian government if the company's domicile is in Indonesia. Similarly, a foreign company that has a (permanent) establishment in Indonesia - and carries out business activities through this local entity - falls under the Indonesian tax regime. If the foreign company does not have a permanent establishment in Indonesia but does generate income through business activities in Indonesia, then it needs to settle its tax liabilities through withholding of the tax by the Indonesian party paying the income.

In general, a corporate income tax rate of 25 percent applies in Indonesia. However, there are several exemptions:

Companies listed on the Indonesia Stock Exchange (IDX) that offer at least 40 percent of their total share capital to the public obtain a 5 percent tax cut (hence a tax rate of 20 percent applies for these public companies).

Small and medium-enterprises with an annual turnover below IDR 50 billion (approx. USD $3.8 million) obtain a 50 percent tax discount (imposed proportionally on taxable income of the part of gross turnover up to IDR 4.8 billion). In 2013, Indonesia's Finance Ministry issued a regulation that set a one percent income tax tariff on individual and institutional taxpayers with an annual gross turnover below IDR 4.8 billion (approx. USD $363,636).

* Companies with a gross turnover below IDR 4.8 billion

1%

Individual Income Tax
If an individual fulfills any of the following conditions, then he/she is regarded a tax resident in Indonesia (except if a tax treaty overrides these rules):

the individual lives in Indonesia;

the individual is in Indonesia for more than 183 days within a 12-month period;

the individual is in Indonesia during a fiscal year and intends to reside in Indonesia.

Meanwhile, non-resident individuals are subject to a 20 percent withholding tax on Indonesia-sourced income.

Nearly all income earned by individual taxpayers in Indonesia is subject to income tax. The following progressive rates are charged to taxable annual income:

A large part of individual income tax is collected through withholding by employers. Employers withhold income tax on a monthly basis from the salaries and other compensation paid to the employees. In case the employee is a resident taxpayer (living in Indonesia), the above-mentioned tax rates apply. If the individual is a non-resident taxpayer, the withholding tax is 20 percent of the gross amount (in case of a tax treaty the amount may vary).

Annual non-taxable income was originally set at IDR 36 million (approx. USD $2,727) in 2016. However, in April 2016 Finance Minister Bambang Brodjonegoro said the government plans to raise non-taxable income by 50 percent to IDR 54 million (approx. USD $4,090) in a bid to strengthen people's purchasing power and encourage household consumption.
Value-Added Tax (VAT)
Value Added Tax (VAT) involves the transfer of taxable goods or the provision of taxable services in Indonesia. Events/services that are taxable:

Deliveries of taxable goods in by an enterprise;

Import of taxable goods;

Deliveries of taxable services by an enterprise;

Use or consumption of taxable intangible goods/services originating from abroad;

Export of taxable goods (tangible and intangible) or services by a taxable enterprise.

Generally, the VAT rate is 10 percent in Indonesia. However, the exact rate may be increased or decreased to 15 percent or 5 percent according to government regulation. VAT on the export of taxable tangible and intangible goods as well as export of services is fixed at 0 percent. Certain limitations for the zero-rated VAT apply to exports of services.
Luxury-Goods Sales Tax
In addition to VAT, Indonesia has a so-called luxury-goods sales tax (LGST), a tax that was introduced in the Suharto era and meant to create a more just society. This tax implies that the deliveries or imports of certain manufactured taxable goods - for example luxury cars, apartments and houses - are subject to an extra tax. Currently, LGST rates are set between 10 - 125 percent (the law allows for a maximum LGST rate of 200 percent).
Customs & Excise
Although Indonesian law allows import duties to range between 0 and 150 percent (of the customs value of the imported good, the highest rate currently set is at 40 percent. Due to the globalizing economy, Indonesia has signed a number of free-trade agreements, effectively scrapping or significantly lowering import duty rates. However, for protectionist strategies the government still applies high rates for specific goods. There are also anti-dumping import duty rates applicable on certain products from certain countries.

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Tax System in Indonesia - Corporate & Individual Income Tax | Indonesia Investments

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A company is subject to the tax obligations set by the Indonesian government if the company's domicile is in Indonesia. Similarly, a foreign company that has a (permanent) establishment in Indonesia - and carries out business activities through this local entity - falls under the Indonesian tax regime.

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-Higher cost of labor based on increase in minimum wage.

-Potential employees hold private information about their quality of labor.

-Employers take on a higher level of risk based on this high cost.

-Decrease in estimated value of employees based on this presence of private knowledge.

-Potential for decrease in supply of high quality labor.

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Do you think it is economically plausible to raise minimum wage in Indonesia by 8-10%?

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-President's goal is to increase purchasing power of consumers and countries economic growth.

-The president has collaborated with the labor leaders to raise the minimum wage by 6.5% although he initially argued for a 6% increase.

-High unemployment in Indonesia after COVID-19.

-Workers were requesting an 8-10% minimum wage increase and are predicted to push back regarding the further decision of “sectoral minimum wage”.

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While raising minimum wage by 6.5% and providing free school meals may sound like two positive implementations, unintended consequences could present themselves in the future. Higher costs for labor could worsen the already trending string of factory closures across Indonesia, hence leading to worsened unemployment rates. Additionally, the implementation of free school meals would escalate the government's deficit by $30 million. Not only does this contradict the President's previous pledge to keep a modest budget, but an increase in the national deficit could lead to inflation, economic instability, reduced national savings, and more unintended consequences. Furthermore, market power of the factory industry could have unintended impacts, even if a new minimum wage increase of 6.5% does pass legislation. If the factory industry is highly concentrated it is possible that they will continue to simply employ workers at minimum wage, and push additional costs on consumers; hence, reducing the benefit of the wage increase on employees. While we cannot be certain of the precise consequences of an increase in minimum wage and free school meals, it is certainly possible that the aforementioned consequences may occur in tandem, independently, or not at all.

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How do you think employers can reduce the presence of private information in this situation?

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Do more throughout checks of employment history. 

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The 6.5% minimum wage increase sets a price floor at P2, above the initial equilibrium wage at P1, as shown in graph.

This disrupts the labor market, altering the supply and demand balance.

As a result:

Employers reduce the quantity of labor demanded.

More workers are attracted to the higher wage, increasing the quantity of labor supplied.

This creates a gap between the supply and demand at P2, leading to unemployment.

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Consumer Surplus (Employers): Shrinks because employers pay higher wages while hiring fewer workers.

Producer Surplus (Workers): Increases for workers who retain their jobs but decreases overall due to unemployment.

Deadweight Loss: The purple triangular areas represents inefficiencies caused by the policy.

These changes highlight the trade-offs between higher wages and reduced employment opportunities.

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Elasticity determines how much the labor market responds to the wage increase:

Elastic Demand: Sectors like manufacturing may see significant job cuts, widening the unemployment gap.

Inelastic Demand: Essential services like healthcare experience smaller reductions in employment.

Over time, businesses may adopt automation or other cost-saving measures, further reducing labor demand.

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Model Prediction's Alignment with Article Content

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Model Prediction's Alignment with Article Content

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The model’s predictions align well with the article's content.

Both highlight the trade-offs of minimum wage increases, such as higher wages versus increased unemployment and market inefficiencies.

The articles also underscore the importance of productivity and economic stability, which the model incorporates through elasticity and market dynamics.

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Comparative Analysis and Real-World Examples

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Comparative Analysis and Real-World Examples

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-In 2023, a similar wage increase of 3.38% caused mass protests and a labor strike of 50,000 workers.

-The minimum wage issue is still a struggle and has impacted many families this year as their buying power becomes less. This year's increase is set for 6.5%.

-Based on past results, the upcoming 6.5% increase is likely to frustrate citizens and not contribute to Indonesia's goal of 8% economic growth.

-The announcement of this year's increase has already created unrest; the country's Employer Association and other business groups are not in favor of bigger increases as it creates uncertainties for investors, disrupting the economy. However, most citizens are calling for change. According to the South China Morning Post, the middle class makes up over 65% of Indonesia and is likely to hurt the most from the small increase.

-Union President Said Iqbal initially wanted a much higher increase but settled for 6.5% as the government must balance between long term sustainability and short term relief for those that have still been struggling in the years after the pandemic. Indonesia's President values the minimum wage as the country's safety net, as middle class families make up a majority of the population.

Sources:

https://indonesiabusinesspost.com/insider/kspi-twelve-percent-vat-hike-low-wages-severely-burden-low-income-people/

https://www.scmp.com/week-asia/economics/article/3277786/indonesias-middle-class-struggle-could-hurt-economy-highly-likely-trigger-unrest-experts

https://www.thejakartapost.com/indonesia/2024/12/01/reluctance-as-govt-pledges-6-5-wage-hike-next-year.html