Global Business Guide Indonesia

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Business Updates | Labour Pains in Indonesia

Having slid down to 37th position in the World Economic Forum’s (WEF) 2015-2016 Global Competitive Index, Indonesia has yet to address one of the major impediments to business that precipitated this decline, namely, the country’s labour policies. Despite the WEF citing rigidness in wages and inflexible firing as well as hiring procedures as key challenges that have dimmed the light on Indonesia’s competitiveness this year, President Joko Widodo’s administration has thus far steered clear of substantial reform in this domain in spite of being afforded with the opportunity to do so as part of a series of economic policy packages recently released to boost investment (See Indonesia’s New Economic Package: A Disappointing Start to Deregulation and Twice as Nice? – Indonesia Unveils Second Economic Policy Package).

With one of the ASEAN’s highest severance pay requirements (ranging between 1 to 9 months’ pay depending upon number of years worked), Indonesia has seen its industries rely heavily on the market’s unsustainably large proportion of informal workers, much to the detriment of the development of a skilled, stable labour force. This issue is compounded by the lack of clear rules and criteria applied to minimum wage hikes, which are presently being carried out on a yearly basis at an average annual uptick of 12% since 2011 (Capital Economics, CNBC). Given Indonesia’s continued focus on labour-intensive industries as the crux of its manufacturing sector (See Indonesia’s Textile Industry – Testing Times Upstream), serious progress needs to be made in revising a number of labour policies that not only dissuade investment but also serve as a barrier to long-term employment for the local workforce.

High price of worker dismissal

While the government downplays the urgency to revise labour policies governed by Law No. 13/2003 regarding Manpower (also referred to as the ‘Labour Law’), Indonesia’s workforce is suffering from an absence of skilled human resources predicated on the business community’s current preference for informal labour. Due to the high severance pay rates in the country – best evidenced by Indonesia ranking in the top three globally for the size of severance pay for redundancy dismissal (max 1 year employment) – employers have turned to fixed-term contract employees as well as temporary or outsourced workers that provide businesses with flexibility over their overheads as well as reduced labour liabilities. 54% of Indonesia’s reported 118 million strong workforce is comprised of informal workers (Central Statistics Agency, 2012) thus outweighing those in the formal sector. This leaves many of the country’s working individuals unprotected and bereft of benefits such as a fixed income and training opportunities thus dampening opportunities for social mobility.

Labour laws, as currently mandated in Indonesia, engender circumstances in which businesses have an incentive to release workers prior to them becoming eligible for prohibitively high severance payments. For the vast majority of Indonesians with only basic levels of education, this limits job openings to temporary, low-skilled employment opportunities which fail to take full advantage of their capacity to develop new capabilities and become more productive. Without greater access to long-term employment and training, Indonesia’s youthful demographics will act as a double-edged sword, in that the advantages brought about by a sizeable productive segment of the population can be rendered moot by growing labour dissatisfaction in regards to the nature of the jobs made available.

The World Bank highlighted the importance of action in addressing this facet of Indonesian labour laws in its Development Policy Review 2014 report, specifically drawing attention to the need for greater leeway in the severance pay rule given that such a high benchmark benefits neither the employer nor worker. Pressure should be on the government to amend this regulation as part of a broader move to invest in its human capital development as a means of maintaining competitiveness amid worrying signs that the country is being left behind in this measure. Indonesia placed 69th in the WEF’s Human Capital Report 2015, thus making it one of the least attractive talent pools in the region.

New costs to cover

The labour pain felt by employers is further fuelled by the country’s new universal health insurance scheme (BPJS Kesehatan) and social security program (BPJS Ketenagakerjaan) introduced over the course of 2014 and 2015 (See What Social Security Reform Means for Business in Indonesia). Taking into consideration that the new programme requires employer contributions to cover pensions (2% of monthly salary per employee), old age savings (5%), death insurance (0.3%), accident insurance (0.24% - 1.74% depending on sector) and health insurance (4%), businesses in Indonesia are increasingly being saddled with new labour-related costs on top of rising minimum wages.

Though the universal healthcare scheme was designed in part to create a healthier workforce better positioned to increase productivity, this positive outcome has yet to be realised as a result of a lack of healthcare facilities in Indonesia. The severe dearth of qualified medical personnel taken in conjunction with the low number of hospital beds set to only reach 15,000 by 2017 (a figure far below the estimated 700,000 hospital beds needed, according to Ernst & Young) means that employers are presently paying into a system without seeing its intended benefits. Moreover, a shortage of medical facilities requires many employers to continue to pay for private insurance plans in addition to the BPJS scheme, so as to maintain employee perks in the form of access to high quality healthcare services.

As is very often the case in Indonesia, businesses will need to exercise patience in waiting for these social security costs to bring about tangible benefits to the quality of the local labour force. Much needed help, however, might be on the way through the ASEAN Economic Community and its initiative to allow for the freer movement of labour between member states. This of course, depends upon the extent to which Indonesia will be willing to waive its barriers to the entry of foreign physicians for its Southeast Asian counterparts, among which are markets such as Thailand that have enjoyed considerable success in developing a thriving medical sector.

Rising wages taking centre stage

Labour unions in Indonesia have experienced gradually increasing influence after the Suharto era ended in 1998. Wage increases since 2013 have ranged between 9% - 50% throughout various parts of Indonesia and are often bolstered during political campaign seasons. Increasing the minimum wage played a significant role during President Joko Widodo’s presidential campaign as well as during his term as Jakarta’s then-governor. Despite labour unions being handed the right to better pay for the past three years, the unwelcome fact is that for every 10% increase, formal employment reduces by 1% (World Bank).

There are legal grounds for the labour unions’ requests for minimum wage of at least 100% of an individual’s living needs – included in Article 89 of the Labour Law – yet the government, in theory, is allowed to refer to productivity growth and economic factors in determining the set wage level. In practice, however, the country has since 2011 only experienced an average increase of 4% in productivity growth indicating an unsustainable business environment in which wage increases have considerably outstripped gains being made in productivity, thus increasing the overheads for employers. Taking into account factors such as the inflation rate and the Cost of Living index (Kebutuhan Hidup Layak), the wage increase varies across provinces with the Greater Jakarta area offering the highest minimum wage at 2.7 million IDR per month in 2015.

The uncertainty behind the demand for a fair minimum wage may soon be clarified provided that Indonesia’s Ministry of Manpower and Transmigration realises its plans to introduce new regulations that would limit minimum wage negotiations to once every five years (The Wall Street Journal) – a considerable change from the current year-by-year arrangement. The measure is the most recent bid by Manpower Minister, Mr M Hanif Dhakiri to provide certainty to investors and workers though no deadline has been set for its announcement.

With less robust economic growth in the country coupled with unfavourable macroeconomic conditions, Indonesia is slowly addressing challenges to its business landscape in seeking to cater to both investors and the local workforce. Teetering between the interests of both parties, Indonesia can no longer rely on its safety net of cheap labour and young demographic to attract foreign investors and business owners and as such must at some point take steps to revise sections of its Labour Law deemed unattractive by industry players. Indonesia’s low rankings on the WEF’s Human Capital Report 2015 and 2015-2016 Global Competitive Index should prompt the government to address this prolonged investor issue in order to create a competitive workforce able to compete amidst rising regional integration. Though not set in stone by any means, early signs from labour intensive industry associations suggest that this reform may in fact be included in forthcoming policy packages – a turn of events that would prove symbolic of a government truly coming to grips with the economy’s biggest shortcomings.

Global Business Guide Indonesia - 9th october 2015

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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)