The issue of unemployment was – and probably still is – among the myriad of problems plaguing the economy when President Joko “Jokowi” Widodo took over the presidency in late October 2014. At the time, the Indonesian economy was running on a huge fuel subsidy amidst falling energy prices; a trade balance deficit as a result of decline in exports and an overall global economy slowdown; and rampant unemployment, whereby twenty million surplus workers were facing a shortage of jobs in the formal sector.
A research done by the Center for Public Policy Transformation (Transformasi) in 2014 found that a labor-intensive, export-oriented manufacturing strategy is the ideal development model, given its ability to take advantage of the demographic bonus, create more jobs in the formal sector, protect low-income workers through a social protection program, and increase the competitiveness of the Indonesian workforce.
In a bid to increase investments in the manufacturing sector, most of the economic policy packages launched since September 2015 have tackled contentious issues such as the deregulation of licensing requirements, minimum wage increases, and the provision of tax incentives for labor-intensive industries.
These industries, such as textile and footwear, are widely accepted as one of the best tools for employment generation, particularly in countries with a scarcity of capital but an abundant supply of low-skilled labor.
In Asia, labor-intensive strategy was aggressively pursued by China starting in the early 1980s, and by Vietnam in the 2000s as the former gradually moved up the global value chain. Other Asian countries, such as Bangladesh and India, also enjoyed productive employment as a result of investment in labor-intensive industries.
Nevertheless, the domestic labor market poses some of the biggest challenges facing labor-intensive industries in Indonesia, primarily due to unresolved issues related to lack of competitiveness in wage levels, workers’ productivity, and tight labor regulations.
Indonesia’s minimum wage levels are not the most competitive for labor-intensive industries. In 2015, Indonesia’s monthly average minimum wage stood at US$123, higher than its competitors in labor-intensive manufacturing such as Vietnam (US$118), Bangladesh (US$68) and India (US$77).
The new minimum wage policy, which calculates annual wage hikes based on inflation rate and economic growth, guarantees that workers’ wages will increase every year. Indonesia’s competitiveness in labor-intensive industries therefore becomes even more questionable when productivity stagnates and the discrepancy between wage and skill levels widens over time.
Another challenge facing the labor market in Indonesia is workers’ productivity, whichj has been cited by businesses as one of the key determinants when selecting a location to invest in. Vietnam, Indonesia’s main competitor in the region for investment in labor-intensive industries, attributes 38 percent of its GDP growth between 1990 and 2013 to labor productivity growth, vis-à-vis labor input contribution. Indonesia, on the other hand, attributes slightly less – 36 percent to labor productivity growth – for the same period.
Tight labor regulations also mean that it is relatively more difficult to ‘hire and fire’ in Indonesia compared to other developing countries. The Law No. 13 of 2003, which is also known as the Labor Law, is considered as strict by international standards and sets high rates of severance. Permanent workers, upon dismissal, are to receive more than 20 percent of the annual wage for every year worked. As a result, firms tend to either stay small, or use contract labor to reduce the costs of severance.
Focus group discussions among stakeholders revealed that the rate of severance payment is considered by many companies in Indonesia as demoralizing for the working environment. There have been past cases whereby workers refused to participate in peaceful wage negotiations, and instead demanded to be fired so that they would be eligible to receive severance payments.
As such, there are several aspects of the labor market that the government may wish to re-evaluate in order to make labor-intensive industries more competitive and attractive:
First, productivity should be considered as an additional criteria when companies are in the process of hiring workers. Productivity in this sense is measured in output per labor hour, therefore assigning a monetary value to the time spent on each of the product.
Some concrete measures will need to be taken in order to increase workers’ productivity, which include the provision of basic education for workers, and industry-provided training for jobs that require more specific skills. Applying the concept of agglomeration, in which firms are located in the same sector cluster, will also assist both the government and the private sector in designing a comprehensive training program for a particular sector.
Second, preferential labor policies may be applied in a selected special economic zone (SEZ) or industrial estate, as well as in a specific industry or firm. Establishing pilot projects is a good way to test out preferential policies, since the impact would be minimized in the case of failure.
Having the right to start and terminate employment contracts more easily would also give companies a powerful incentive to locate to these development zones, especially those situated in regions that are located further away from the capital.
Another pilot strategy that Transformasi’s research recommended is to reduce the burden of severance pay on the manufacturing sector by having a large firm, a group of firms or a whole industry voluntarily shift from the current severance pay rules to a flexible unemployment insurance scheme.
Under this scheme, employers would pay a smaller percent of their wage bill into the insurance fund at an amount agreed to by workers, unions and employers, while the government offers an initial subsidy to build up the fund. This will eventually lead to a more stable labor force in the long-run, since there will no longer be any advantage to using contract labor as opposed to permanent workers.
Finally, it is important to note that the issues surrounding labor-intensive industries in Indonesia are not limited to the labor market. Other factors such as complicated bureaucracy, infrastructure and transportation costs also play a large role, and will need to continuously be addressed by the current administration.
Indonesia would also do well to remember that it does not exist in a vacuum. Decades of trade liberalization in other manufacturing hubs mean that investors have the luxury of choosing the most favorable conditions for their businesses, leaving Indonesia to face stiff competition in attracting investment.
The writer is a Senior Researcher at the Center for Public Policy Transformation, Jakarta.