General or Vocational Schooling: How Minimum Wage Affect the Choice of Senior Secondary School Type in Indonesia

Abstraksi

Most economic research on minimum wage has put its focus predominantly on employment effects. Although some attention has been devoted to the analysis of the effects of minimum wage on skill acquisition and education, there is no previous research analysing the effect of minimum wage on choice of senior secondary school type, despite greater discussion on the provision of vocational education, especially in developing countries. Therefore, to fill the gap in the literature, this paper investigates the relationship between minimum wage and human capital investment, that is choosing whether to enrol in a general or a vocational school, using three waves of the Indonesia Family Life Survey (IFLS) in 2000, 2007, and 2014. This paper can be viewed as an effort to further analyse whether the minimum wage policy supports or hinders recent government efforts to promote student enrolment in vocational schools. It is worth noting that the government may be unaware of the possible interaction between different policies, especially in a developing country where inter-sectoral policy coordination is very limited. Apart from the analysis based on the firm and labour market, households should be considered as an important channel for explaining the effect of minimum wage policy, as household behavioural adjustment (e.g. spending pattern and entry into labour market) can generate substantial changes in the economy. In particular, in the view that households act as the supplier of labour, a household decision on educational investment – affecting human capital, and thus the quality of labour supplied – is another essential channel. By the same token, a study by Neumark and Wascher (1994) finds that the effect of minimum wage on employment is sensitive to the introduction of schooling control, highlighting the importance of examining the linkage between minimum wage, employment, and enrolment. A simple two-period model of human capital investment is utilised to formalise the relationship between minimum wage and senior secondary school choice. This model is developed based on Acemoglu and Autor (2000) and Acemoglu and Pischke (2001), which are also inspired by Becker (1964) and Becker and Tomes (1986) theoretical model of investment in human capital. This paper hypothesises that the minimum wage has two opposing implications that channel to the choice of senior secondary school type. First, a higher level of minimum wage decreases the skill premium of sending a child to a general school, and therefore induces a household to send the child to a vocational school (substitution effect); and second, the increase in the household disposable income leads to an increase in educational investment, making it more likely that a child will enrol in a general school to increase the probability of entering university (income effect). Moreover, aside from the direct impact on wage, the indirect impact on the probability of employment also consists of two conflicting forces, depending on the labour market structure. Under a competitive labour market, the substitution of low-skilled for high-skilled worker will increase the net benefit of investing in human capital, and thus give rise to student enrolment in general schools. Meanwhile, in a monopsonistic labour market, the higher probability of getting a job reduces the incentive to invest further in education, and thus induce student enrolment in vocational schools. As the theoretical predictions on the school choice are ambiguous, empirical analysis is therefore necessary to untangle the complex theoretical relationship between minimum wage and school choice. Earlier research poses some limitations including the lack of variation in minimum wage and potential endogeneity bias due to the inability to control for some explanatory variables. Although later research has taken advantage of state-level variation in minimum wage, only a handful of studies use individual- or household-level data to examine the effect of minimum wage on school enrolment. To contribute to the current literature, this paper investigates the relationship between minimum wage and human capital investment at the individual level, and thus attempts to reveal some individual-level heterogeneity of the effect of minimum wage, which may not be detectable in previous state-level regressions. The use of household-level survey data also makes it possible to control for some important explanatory variables, such as household income, parents’ educational attainment, and the number of children in the household. Furthermore, most existing studies were conducted in developed countries, and only a few studies have been carried out in developing countries. As far as I am aware, there is no previous study investigating the impact of minimum wage legislation on the choice of senior secondary school type, particularly in the developing country context. This paper finds that minimum wage legislation only affects individuals whose household incomes are below the minimum wage. This is consistent with the intuition that individuals in households at the lower end of the income distribution are more sensitive to an increase in the minimum wage. In this paper, there is no evidence of a dominant negative substitution effect, contrary to most studies conducted in developed countries, such as Neumark and Wascher (1994), Landon (1997), Pacheco (2007), and Rice (2010), which suggests that the adjustment towards an increase in minimum wage policy is different between developed and developing countries. To a certain extent, in the context of a developing country, an increase in minimum wage induces investment in education by enrolling in a general school as a result of a less binding budget constraint. Furthermore, the results show that the effect of minimum wage is concentrated in a particular household subgroup in the income distribution. This reveals the limitation of previous studies using state- or provincial- level regression such as Neumark and Wascher (1995) and Colombé (2016), which are unable to capture the household-level heterogeneity.