Higher minimum wages won't help the country's poor, because labor laws
shut them out of jobs.
Labor activists demanding
minimum-wage hikes have led protests that brought Indonesian cities to a
standstill in recent months. But for all the sound and fury, this preoccupation
with wages remains misguided. If politicians are serious about improving the
lot of Indonesia's poor, they should focus on reforming labor laws that protect
formal sector jobs at the expense of nine out of 10 Indonesians who are
employed informally.
These latter workers get lost in
the din when thousands of union members flood Jakarta's streets and threaten to
halt traffic, as occurred last November in the latest round of wage demonstrations.
Now an annual feature, such disturbances have spurred local governments to
implement unusually high minimum-wage increases.
Minimum wages have increased
across Indonesia by an average of 10% per year over the past four years. For
2013, some 25 provinces, regencies and cities agreed to raise the minimum wage
by an average of 30%, with a few as high as 50%. Greater Jakarta, which
accounts for the bulk of Indonesia's manufacturing and services, agreed to 44%,
bringing the minimum wage there to 2.2 million rupiah ($225) a month. Unions
are encouraged, and their demonstrations are likely to grow in size and
assertiveness in the years ahead.
These increases are great for
union members employed in factories and offices, but not for the 90% employed
informally—in small, make-shift businesses such as road-side tea stalls, or in
factories or other businesses where managers conveniently forget about
record-keeping (and government officials conveniently forget to check on it).
These Indonesians work without
the high wages or job security their formal counterparts command. The policy
goal should be to allow them to transition to formal work. But the minimum-wage
hikes raise the barrier to such a transition.
The problem is the 2003 Manpower
Act. This places tight constraints on dismissing workers by requiring one of
the world's highest severance payments: 32 months' worth of wages.
Each time the minimum wage rises,
so do legally mandated severance payments. The increases in the minimum wage
therefore make layoffs so costly that there is no incentive to hire an informal
worker at the margin. Employment is virtually guaranteed for those who already
have a formal job.
Such job protection does not help
productivity. Nor does it improve Indonesia's overall employment picture. A
2010 World Bank study shows that a 10% increase in Indonesia's minimum wage
reduces formal employment by 1%. Formal employment in Indonesia is around 44
million today, so a 30% average rise in the minimum wage could reduce formal
employment by more than 1.3 million workers.
These labor regulations are so
expensive that a large proportion of firms skirt around the law. They don't pay
the minimum wage at all. Those who try to stay within the letter of the law can
circumvent its requirements by employing "temporary" workers, without
a contract.
The strategy is a less-than-ideal
work-around, for one thing because "temporary" workers can't climb up
the wage and skill ladder. Jakarta's 2011 average wage in manufacturing was
about the same as the minimum wage. But laborers nevertheless obtain legal
employment that wouldn't otherwise be available.
This practice is about to end,
though. A new government regulation on "temporary" workers restricts
their employment to a few occupations. The intention of the new regulation is
commendable: to encourage firms to hire workers on long-term contracts at the
minimum wage or higher.
The outcome, however, is likely
to be the opposite. In concert with existing laws and labor politics, the new
restriction on temporary workers will further discourage formal employment. It
will drive a bigger wedge between wages in the formal and informal sectors,
discourage labor-intensive businesses and impede structural change toward
globally competitive industries.
Indonesia has time to ensure
these scenarios don't become reality. To begin with, it should bring its
policies on severance payments more in line with international standards.
Next, minimum wages should be
automatically adjusted each year to take local inflation into account. The 2003
labor law also stipulates annual wage negotiations among unions, employers and
local governments. These should be discontinued because they usually involve
two parties, the union and the politician, ganging up on the businessman.
Jakarta is enjoying an economic
boom, so leaders may not see the urgency of correcting labor policies. Foreign
investment in manufacturing is flowing in, while economic growth is among the
fastest in Asia. These good times conceal a multitude of sins.
But over time, labor market
policies that favor the few over the many will exert a drag on growth. As
worrying, these policies could lead to social instability. The rise in income
inequality in Indonesia has been among the fastest in the world. Instead of the
10% who are unionized and protesting today, it may be the 90% shut out of
formal jobs take the streets in the future.
VIKRAM NEHRU
Mr. Nehru is a senior associate and Bakrie Chair in Southeast Asian
Studies at the Carnegie Endowment for International Peace.
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