Employment Policy and Labour Markets in Indonesia

Chris ManningAustralian National University

Presentation at the ILO Workshop on Trade and

EmploymentJakarta June 12 2010

Contents of Presentation

Background Indonesian context International context

Employment protection legislation (EPL) focus on severance pay and contract

work/outsourcing Other labour policies: wage policy and

job creation Conclusions

I. Background a. The Indonesian context

Five issues Look briefly at each

1. Labour demand2. Labour supply3. Surplus labour4. Labour market structure5. Institutions

The Indonesian context

1. Labour demand: past decade Slower economic growth and less

employment friendly growth, by low income East Asian standards pre-crisis Indonesian historical standards

Employment suffer especially

formal sector internationally oriented, labour-intensive

manufacturing

Main challenge: more, higher productivity jobs

-2.00.02.04.06.08.0

10.0

Agric Manuf Trade Serv Other Total Non-Agric

Employment Growth, Indonesia 1990-1996, 2000-2006 (% p.a.)

1990-1996 2000/1-2005/6

Formal and Informal Sector Employment in Non-Agricultural Sectors, Indonesian 1986-2005

0

5000

10000

15000

20000

25000

30000

35000

1986 1990 1994 1998 2002

Empl

oym

ent (

000)

Formal Sector

Informal Sector

Employment in Major Sector of L&M Manufacturing, 1984-2003 (000)

0

200

400

600

800

1000

1200

1400

1600

Food

Text

Chem

Metal+Mach

Other

Employment Elasticities, 1990-96 and 2000-06

0.00

0.40

0.80

1.20

1.60

Manuf Trade Serv Other Non-Agric

Total(incl.agric)

1990-1996

2000/1-2005/6

The Indonesian context

2. Labour supply Labour supply still high (+/- 2%

p.a.) but Indonesia opportunity to take advantage of demographic dividend

though not for long Education expansion impressive

but questions on quality despite some very impressive

developments

Main challenge: raising the level of skills

The Indonesian context

3. Surplus Labour Unemployment intermediate by LDC

standards Trending down in recent years, even despite

WFC Heavily concentrated among HS educated

youth (15-24) Under-employment moderately high

a function of labour market structure -15-30% depending on definition

Main challenge: absorbing young school graduates into better jobs

0.0

5.0

10.0

15.0

Urban Rural Female Male Total

Unemployment Rates in Indonesia, 2001-2006

Aug-01 2002 2003 2004 Feb-05 Nov--05 Aug--06

The Indonesian context

4. Labour market structure Broadly dualistic for unskilled-semi-

skilled workers Low productivity: Agriculture, low

productivity IFS and casual wage labour about 75% of total employment about 40% of urban employment

Higher wages in large, foreign and resource intensive firms

Why a problem: contributes to surplus labour, stifles skill development

Too many people locked into low productivity jobs

Main Challenge: reduce the gap – create more high productivity jobs and raise productivity in low wages sectors

The Indonesian context

5. Institutions Economic policy decisions through

political bargaining in a democratic framework

Hard to get China/Vietnam growth? Under-developed IR after 30 years

of tight political controls Lack of confidence/suspicious of

markets and collective bargaining Compare with China and Vietnam Paternalism?

Main Challenge: Develop collective bargaining

Backgroundb. The international context Living with China: an international

environment dominated by China More competitive environment: domestic

and international If Indonesia wants to create a better jobs

environment, export growth in manufacturing is critical

Global production networks demand flexible responses to changing product demand Fewer stable, regular jobs in manufacturing

At same time lesson from the GFC: services play a bigger role at home and abroad

II. Employment Protection Legislation

Key purposes of EPL: Provide job and income security for workers Provide temporary financial security to workers

while unemployed Policy and political economy challenges

Assess how EPL effects employment (mainly outsiders) versus setting standards for those in jobs (insiders)

Getting the balance right between national standards, and industry and mainly firm-level standards set through collective bargaining

EPL: General

Like many countries with a civil law tradition, extensive legislation of labour standards (Revised Law 13, 2003) Most standards similar to many other

countries: hours of work, child and female employment, health and safety

Legislated by Central Government Two outliers in the Indonesian case and

two other controversial areas Severance pay and contract employment Foreign workers and regional restrictions

EPL: Severance Pay

Many countries have severance regulations Some countries leave severance pay

conditions up to parties to determine within their CLAs

Most countries set low to moderate severance rates

Entitlement generally limited to redundancies/layoffs

Complemented with legal recourse for unfair dismissal claims

EPL: Severance Pay

Indonesian severance strict by international standards (Law 13,2003): High rates of severance Includes voluntary quits as well as

dismissals In combination with extensive minimum

wages, a burden for some firms (especially small scale, competitive?)

No alternative options such as individual worker accounts

Severance Regulations in OECD CountriesSeverance pay for a worker with 4 years service at the firm and dismissed for no-fault. OECD (2004)

Severance Regulations in Asia

0

2

4

6

8

10

India Malaysia Philippines Singapore Thailand Indonesia

Severance pay in no. of monthly wages

A worker with 4-years experience at the firm and dismissed for economic reasons

Source: GIAT-UNPAD (2004)

EPL: Severance Pay

Severance regulations acts like an implicit ‘tax’ on hiring new permanent workers (UNPAD study,2004)

The tax hurts employment of new workers, if wage adjustments are not flexible, for example, due to a relatively high minimum wage Tax is high in Indonesia (UNPAD study)

Indonesia’s ‘Hiring Tax’ is very High Among Developing Economies(Hiring tax in number of months wages)

0 1 2 3 4 5 6 7

Bolivia

Ecuador

Honduras

El Salvador

Mexico

Costa Rica

Argentina

Trid.&Tob

Uruguay

Paraguay

Barbados

Jamaica

Guyana

Belize

Brazil

Dominican Rep

Chile

Indonesia

Venezuela

Nicaragua

Colombia

Peru

Panama

1999

1990

Average 1999

Average 1990

EPL : 2. Contract Work/Outsourcing

Common types of employment arrangements found in countries Permanent employment contracts Fixed term employment contracts Temporary workers hired through

temporary work agencies (outsourcing manpower)

EPL : Contract Work/Outsourcing

Many countries do regulate employment arrangements but ‘regulatory strictness’ varies across countries

In recent years many countries have begun relaxing restrictions on employment contracts

EPL : Contract Work/Outsourcing

OECD EXPERIENCE o Contract renewals: most countries

permit contract renewals more than 2 times (19 of 26 circa 2000)

Cumulative duration of contracts: most countries have no limit on contract duration (only 5 of 26 for 3 years or less)

Temp worker agreements: more countries have restrictions

EPL : Contract Work/Outsourcing

In Indonesia, contract employment outsourcing tightly controlled:

Regulations tightened in MP13/03 Eg: Shorter duration of contracts (2 years,

extendable once to max 3 years) versus 3 years extendable once

Out-sourcing only for non-core activities More restrictive than in other East Asian

countries

Restrictions on Employment Contracts: East Asia

Country Fixed term Contracts Temporary work through

TWAs Indonesia Strict Strict restrictions – non-

core activities Japan No restrictions Restricted to certain sectors Korea No restrictions Restricted to certain sectors Malaysia No restrictions -- Philippines Strict Temp work permitted but

considered direct hires Thailand No restrictions

EPL: 3. Foreign workers and regional restrictions Foreign workers:Indonesian regulations quite

restrictive: more like Philippines than Malaysia or Thailand Negative list, monthly charges, needs tests and

language requirements for foreign workers

Charges on the employment of non-local workers: Raise the cost of employing outsiders (Pekanbaru, South Sumatra, Bekasi, Maluku) One-off or monthly charges, mainly for

professional/skilled manpower Not a major cost, in most cases, but a nuisance and

a departure from Indonesia’s history of an open labor market

EPL: Conclusion

EPL can improve job security of ‘covered’ workers Reduces dismissals in the economy and

increases worker tenure at the firm Promotes productivity

Severance pay provides some financial security for workers dismissed

Increase job insecurity for workers unable to access ‘protected’ jobs (especially among young persons)

EPL: Conclusion

Strict severance pay and regulation of contract work appears to have reduced hiring activity for regular jobs in Indonesia in recent years (a research question) Appears to have mainly affected youths,

females, low educated workers Contributed to a more dualistic labor

market? Insider-Outsider problem Shift of jobs to self-employment

EPL: Conclusion

Increase in temporary employment. Eg:AKATIGA, 2008

“..a direct effect of the legislation has been the introduction of flexible industrial relations practices in the form of contract labour and third party labour recruitment practices on a very large scale.”

Cause or effect of tighter regulations and stricter compliance?

See OECD evidence on employment rates

Strict EPL associated with Lower employment rate (Source: OECD 2004)

45

50

55

60

65

70

75

80

0 0.5 1 1.5 2 2.5 3 3.5 4

EPL index

Em

plo

ymen

t ra

te

US

Tur

PorCan/UK

Aus

KorAut

Bel

GreSpa

Pol

Hun

Slo

Ire

Ita

NZLJap Cze

Ger FraMex

NedDen

Swi NorSwe

III. Other Labour Policies

Wages Minimum wages:

regional, based on needs criteria, annual adjustments and mainly bipartite

High relative to average wage (not just social safety net): high non-compliance?

Public sector wages: increasingly out of step with private sector at upper levels

Job Creation Rural poverty alleviations schemes

such as PNPM create many jobs?

Institutional Framework For Minimum wages in East Asia

Country Tripartite wage council

Jurisdiction Annual Adjustments

Major determinant of MW adjustments

Indonesia Yes Province/Local government

Yes KHM/KHL, inflation

Korea Yes – employers, unions, public interest

National Yes Cost of living survey, inflation

Nepal Yes National Every 2 years

Inflation

Philippines Yes Province/region No Inflation Singapore Yes – wage

adjustment guidelines

National No

Thailand Yes Province No Inflation

IV. Conclusions

Major problems for job creation have been on the demand side Slow growth and uncertain investment climate

Extensive regulations probably contribute to employment problems through: Discouraging new investors in labour intensive

industries a more dualistic labour market: push youth-

women into IFS Unemployment a secondary problem, but

important for educated youth

Conclusions

Reform/Research Issues Assess impact of tight regulations and

compliance How to promote collective bargaining as

the main mechanism for wage setting and conditions?

How to introduce more flexible regulations? Eg: deferred compensation schemes/individual

accounts for severance Relax restrictions on employment

arrangements Permitting contract renewals more than once