Indonesia currently stands at an important crossroads in its decision to set the minimum wage for 2014, given its significant impact on foreign investor perceptions of the country's attractiveness as an FDI destination. Within this highly polarized debate, labour unions point to the huge growth in profits that have been enjoyed by Indonesian companies over the past decade which has not been reflected in employee compensation, while employers argue that worker productivity has remained static despite the minimum wage continuing to rise. The immediate need to shore up exports and attract FDI into the country coupled with inflation and the soaring cost of living is adding to the intensity of the issue for both sides. As the rhetoric serves to test investor sentiment to its limits, it is crucial that investors take a long term outlook that takes into account Indonesia’s productivity potential and the still comparatively low labour costs relative to operational expenses that the country has to offer.

Context

The Indonesian government set a controversial precedent when it gave the green light to increase the minimum wage for Jakarta by 44% for 2013. They find themselves under pressure from labour unions once again, spurred by reports that the cost of living in Jakarta has jumped to 4 million RP per month which has led to demands that the minimum monthly wage should be set between 3.3 and 3.7 million RP; an increase of up to 50%.

Jakarta based manufacturing firms such as those from the textile industry argue that another substantial increase in the minimum wage would result in further mass layoffs to maintain profitability; an undesirable outcome in the lead up to an election. For employers the issue is rooted in worker productivity as the country’s per capita worker productivity has lagged behind the ASEAN average of $10,700, at $9,500 and increased by only 3.4% between 2000 and 2011 while wages rose by 5.5% (CSIS). Within the ASEAN, Indonesia ranked 6th in terms of labour productivity out of the 10 member countries (ASEAN Productivity Organisation) highlighting the need for drastic improvement in the lead up to the ASEAN One Market in 2015.

Indonesia’s trailing worker productivity is testament to the short term approach that has been adopted by Indonesian companies by relying on cheap labour over capital investment. This has been in support of the government’s populist minded approach to stimulating job creation which has succeeded in keeping unemployment at 5.92% in Q1 2013 (Statistics Indonesia). Investment in streamlining production processes through mechanisation in order to boost efficiency has taken a backseat, much to the country’s detriment. Yet, this also serves to illustrate the country’s potential should the necessary investments be made to bring the country on par with its regional counterparts.

National Competitiveness

While the headline figures for Jakarta’s minimum wage rise have been the subject of much debate, it is important to look beyond Jakarta to the country as a whole. Minimum wages are determined each year by provincial governors who are keen to attract investors and provide employment opportunities to constituents. As such, wages across the country rose by a more moderate average of 19.1% in 2012 with provinces such as West Java remaining highly competitive with minimum monthly wages set at 1.5 million RP for general workers.

Labour intensive industries have been quick to relocate to other areas of the country that offer sufficient infrastructure, labour availability and more competitive wage levels. This movement of such manufacturers to other, more resource rich, parts of Indonesia will also facilitate improved production efficiency as well as contributing to making Jakarta a hub for trading and services; sectors that are less affected by minimum wage hikes.

Furthermore, with the renewed focus on improving productivity now is the time for investors with technological know-how and streamlined methods of production in manufacturing, processing and other labor intensive industries to enter the market. Local business players will be more receptive to collaboration with investors knowing that they will need to increase worker productivity to offset a rise in minimum wages. Investors already in the Indonesian market should explore implementing comprehensive training programs to develop their human capital internally to better prepare workers for the introduction of new technologies and production processes.

Outlook

To date, a draft presidential decree states that the 2014 minimum wage increase will be limited to inflation plus 5% for labour intensive industries and inflation plus 10% for others (Ministry of Industry). Assuming that all regions abide by the aforementioned central government recommendation, it remains the case that in Indonesia, labour on average accounts for only 9% of revenues in local companies. In addition the country’s labour as a percentage of operating costs is the lowest in the region. To put things in perspective, it is estimated that a 20% minimum wage increase would be offset by only a 2% increase in revenues from sales (British Chamber of Commerce) illustrating the country’s sustainable competitive advantages.

Investors seeking opportunities in the Indonesian market should therefore not be too quick to overlook the attributes that the country as a whole has to offer within labour intensive industries. That being said, the Indonesian government must balance the desire to maintain citizen’s purchasing power with a managed approach to the minimum wage and seek to motivate local businesses to invest in their efficiency as well as spur the development of companies in other, more cost competitive provinces of Indonesia. Minimum wage increases should therefore not serve to price Indonesia out of the international market, rather they should be seen as an opportunity to distribute gains from a period of sustained economic growth while also facilitating a much needed shot in the arm to local companies to invest in physical capital, improved processes, human resource training and other means of improving labour productivity.

Global Business Guide Indonesia - 21st October 2013

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Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)

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