Informal and Formal Wage Differences Based on Cohorts in Indonesia

Abstract

Labor market dualism has caused a persistent wage gap between formal and informal workers in Indonesia. This study aimed to decompose the wage difference between formal and informal workers based on cohorts in Indonesia and further analyze the factors that influence this gap. This allowed us to identify the structure of the labor market and whether it tends to be segmented or competitive. By controlling the cohort, the estimation result was compatible with the human capital accumulation argument. The data sourced from the 2010 and 2019 National Labor Surveys comprised 581,312 and 503,313 workers, respectively. This study used the threefold Heckman selection-biased corrected Blinder–Oaxaca decomposition technique. The results showed that the wage gap between formal and informal workers is decreasing, especially among the younger cohort. Among this cohort, the labor market is still segmented, although the degree of segmentation is lower. In contrast, the older cohort labor market is more competitive but at a decreasing rate. A further decomposition showed that education has affected the wage gap between young and old cohorts. However, this effect is diminishing. In addition, differences in institutional labor market settings such as the wage system and occupational health and safety systems have increased the wage gap. The findings imply that equitable access to education for the younger cohort and the improvement of labor market institutions can reduce the gap between formal and informal wages.