Employment Policy and Labour Markets in Indonesia

1. Employment Policy and Labour Markets in Indonesia Chris Manning Australian National University Presentation at the ILO Workshop on Trade and Employment Jakarta June 12 2010

2. 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

3. I. Background a. The Indonesian context • Five issues • Look briefly at each • Labour demand • Labour supply • Surplus labour • Labour market structure • Institutions

4. The Indonesian context • 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

9. The Indonesian context • 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

10. The Indonesian context • 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

12. The Indonesian context • 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

13. The Indonesian context • 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

14. 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

15. 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

16. 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

17. 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

18. 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

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

20. A worker with 4-years experience at the firm and dismissed for economic reasons Severance pay in no. of monthly wages 10 8 6 4 2 0 India Malaysia Philippines Singapore Thailand Indonesia Severance Regulations in Asia Source: GIAT-UNPAD (2004)

21. 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)

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

23. 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)

24. 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

25. EPL : Contract Work/Outsourcing OECD EXPERIENCE • 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

26. 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

27. Restrictions on Employment Contracts: East Asia

28. 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

29. 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)

30. 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

31. 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

32. Nor 80 Swi Den Swe NZL Ned 75 Can/UK Jap Cze Por Employment rate US Aus Ger 70 Fra Ire Kor Mex Aut 65 Bel Slo Spa Gre 60 Hun Ita 55 Pol 50 Tur 45 0 0.5 1 1.5 2 2.5 3 3.5 4 EPL index Strict EPL associated with Lower employment rate(Source: OECD 2004)

33. 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?

34. Institutional Framework For Minimum wages in East Asia

35. 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

36. 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