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

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 demand 2. Labour supply 3. Surplus labour 4. Labour market structure 5. 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

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 % depending on definition Main challenge: absorbing young school graduates into better jobs

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

Background b. 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 Countries Severance pay for a worker with 4 years service at the firm and dismissed for no-fault. OECD (2004)

Severance Regulations in Asia IndiaMalaysiaPhilippinesSingaporeThailandIndonesia 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)

Indonesias Hiring Tax is very High Among Developing Economies (Hiring tax in number of months wages)

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

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 Indonesias 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 m ainly 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, 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) EPL index Employment rate US Tur Por Can/UK Aus Kor Aut Bel Gre Spa Pol Hun Slo Ire Ita NZL Jap Cze Ger Fra Mex Ned Den Swi Nor Swe

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

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