Indonesia's labour-intensive engine is misfiring: The Jakarta Post columnist

Labourers at a construction site in Jakarta on Feb 4.
Labourers at a construction site in Jakarta on Feb 4.PHOTO: REUTERS

Widespread lay-offs in factories across Indonesia since early February have raised fears that rising unemployment will damage the country's economic health and political stability. 

The issue of unemployment was among the many problems plaguing the economy when President Joko Widodo arrived in office in October, 2014.

At the time, the economy was marked by huge fuel subsidies amid falling energy prices, a trade balance deficit as a result of a decline in exports and an overall global slowdown, with rampant unemployment creating 20 million job seekers.

A 2014 study by the Centre for Public Policy Transformation (Transformasi) found that a labour-intensive, export-oriented manufacturing strategy was the ideal development model, given its ability to take advantage of the demographic bonus, create more jobs in the formal sector, protect low-income workers through a social protection programme and increase the competitiveness of the Indonesian workforce.

In a bid to increase investment in the manufacturing sector, most of the economic policy packages launched since September last year have tackled contentious issues such as the deregulation of licensing requirements, minimum wage increases and the provision of tax incentives for labour-intensive industries.

These industries, such as textiles and footwear, are widely accepted as one of the best tools of employment generation, particularly in countries with a scarcity of capital but an abundant supply of low-skilled labour. 

Nevertheless, the domestic labour market poses some of the biggest challenges facing labour-intensive industries in Indonesia, primarily due to unresolved issues related to lack of competitiveness in wage levels, workers' productivity and tight labour regulations.

Indonesia's minimum wage levels are not the most competitive for labour-intensive industries.

In 2015, Indonesia's monthly average minimum wage stood at US$123 (S$172.4), higher than its competitors in labour-intensive manufacturing such as Vietnam (US$118), Bangladesh (US$68) and India (US$77). 

The new minimum wage policy, which calculates annual wage hikes based on inflation rate and economic growth, guarantees that workers' wages will increase every year.

Indonesia's competitiveness in labour-intensive industries thus becomes even more questionable when productivity stagnates and the discrepancy between wage and skill levels widens over time. 

Another challenge facing the labour market in Indonesia is workers' productivity, which has been cited by businesses as one of the key determinants when selecting a location to invest in. 

Vietnam, Indonesia's main competitor in the region for investment in labour-intensive industries, attributed 38 per cent of its GDP growth between 1990 and 2013 to labour productivity growth, vis-a-vis labour input contribution. 

Indonesia, over the same period, attributed 36 per cent to labour productivity growth, of GDP growth. 

Tight labour regulations also mean that it is more difficult to hire and fire in Indonesia than in other developing countries. 

The 2013 Labour Law is considered strict by international standards and sets high rates of severance pay.

Permanent workers, upon dismissal, receive more than 20 per cent of the annual wage for every year worked.

As a result, firms tend to either stay small or use contract labour to reduce the costs of severance pay.

Focus-group discussions among stakeholders reveal that the rate of severance payment is considered by many companies in Indonesia as demoralising for the working environment. 

There have been past cases whereby workers refused to participate in peaceful wage negotiations, and instead demanded to be fired so that they would be eligible to receive severance payments. 

As such, there are several aspects of the labour market that the government may wish to re-evaluate in order to make labour-intensive industries more competitive and attractive.

First, productivity should be considered as an additional criterion when companies are in the process of hiring workers. Productivity in this sense is measured in output per labour hour, therefore assigning a monetary value to the time spent on each product.

Some concrete measures will need to be taken in order to increase workers' productivity, which include the provision of basic education for workers and industry-provided training for jobs that require more specific skills.

Applying the concept of agglomeration, in which firms are located in the same sector cluster, will also assist both the government and the private sector to design a comprehensive training program for a particular sector.

Second, preferential labour policies may be applied in a selected special economic zone or industrial estate, as well as in a specific industry or firm. Establishing pilot projects is a good way to test out preferential policies, since the impact is minimised in the case of failure. 

Having the right to start and terminate employment contracts more easily would also give companies a powerful incentive to relocate to these development zones, especially those situated in regions located further away from the capital. 

Another pilot strategy that Transformasi's research recommended is to reduce the burden of severance pay on the manufacturing sector by having a large firm, a group of firms or a whole industry voluntarily shift from the current severance pay rules to a flexible unemployment insurance scheme.

Under this scheme, employers would pay a smaller per cent of their wage bill into the insurance fund at an amount agreed to by workers, unions and employers, while the government offers an initial subsidy to build up the fund. 

This will eventually lead to a more stable labour force in the long-run, since there will no longer be any advantage to using contract labour as opposed to permanent workers.

Finally, it is important to note that the issues surrounding labour-intensive industries in Indonesia are not limited to the labour market. 

Other factors such as complicated bureaucracy, infrastructure and transportation costs also play a large role, and will need to continuously be addressed by the current administration. 

* The writer is a senior researcher at the Centre for Public Policy Transformation in Jakarta.