The minimum wage policy that has historically been designed to protect low-income workers in Indonesia has produced a paradoxical side effect. In its latest report titled Reforms for a Formal and Prosperous Indonesia, the World Bank states that setting minimum wages outside their optimal range actually creates efficiency losses and significant distortions in the labor market. Instead of addressing imbalances in bargaining power, the policy has inadvertently pushed workers out of the formal sector.

The report also highlights an anomaly in Indonesia’s labor market compared with global standards. Based on the Kaitz Index, which measures the ratio of the minimum wage to the median market wage, Indonesia ranks among the countries with the highest minimum wage levels in the world. In 2022, Indonesia’s minimum wage ratio reached 124% of the median market wage—more than double the OECD average, which stands at around 55%.

Minimum wage increases considered too aggressive and exceeding productivity growth have significantly raised compliance costs for companies. As a rational response, firms tend to avoid hiring workers formally. Consequently, affected workers often end up absorbed into the informal sector, where employment conditions are generally more vulnerable.

The World Bank found that in the years following the implementation of district-level minimum wages that were higher than those of surrounding provinces, the proportion of workers earning at least the minimum wage declined by 3.4 percentage points. At the same time, unemployment increased by 2.7 percentage points, and the rate of full-time employment fell by 3.5 percentage points.

“Due to weak enforcement of regulations, most workers affected in those districts were absorbed into the informal sector rather than becoming unemployed,” the report led by senior economists William Seitz and Wael Mansour explained, as cited on Monday (March 9, 2026).

The impact of this minimum wage policy is also evident in historical data compiled by the World Bank. The share of workers who actually receive wages equal to or above the minimum wage dropped sharply from 53% in 2010 to less than 20% in 2023.

“As the minimum wage threshold increases, the proportion of workers earning at least the minimum wage declines rapidly,” the report stated.

Ironically, the groups most negatively affected and pushed out of the formal labor market by the policy are the most vulnerable segments of the workforce, including young workers, low-skilled laborers, and people with disabilities. The World Bank recorded that in 2010, about 45% of full-time workers with elementary school education or less earned at least the minimum wage. That figure declined to just 10% in 2023.

“Nevertheless, policymakers have consistently continued to push for aggressive minimum wage increases since then—resulting in a rise of more than 87% between 2010 and 2023 after accounting for inflation,” the report added.

Policy Reform Recommendations

To help Indonesia escape the trap of widespread informality, the World Bank recommends a fundamental shift in wage regulation. First, the government is advised to rebrand the current minimum wage policy. The World Bank suggests that the policy would be more appropriate if transformed into a “reference wage” or “benchmark wage” that is non-binding, aimed at facilitating wage negotiations in the formal sector without creating legal distortions or artificial compliance burdens.

Second, the Washington, DC–based institution recommends that the government adopt a new wage floor concept that truly functions as a safety net for low-paid workers. For this mechanism to remain sustainable, the lower wage boundary must be closely calibrated with productivity trends.

To ensure that wage policies do not distort labor markets in low-productivity regions, the proposed framework suggests using the Kaitz Index at the provincial level. Through this approach, wage thresholds can be adjusted to reflect local economic conditions, allowing wages to increase proportionally as productivity improves without reducing the availability of jobs.