How will Indonesia's labour law reforms help the economy?


With President Joko Widodo, better known as President Jokowi, voted in for a second term in 2019, the focus in early 2020 was on key structural reforms – the kind of changes which could be difficult to adjust to but at the same time create new opportunities in sectors that are seen as underperforming, such as manufacturing. Draft versions of omnibus laws have been proposed to reform key areas such as tax, regulation, and, controversially, labour laws. Despite opposition from labour unions, the government has pledged to forge ahead with structural changes to workers’ rights, and in January 2020 President Jokowi called them his first priority. To this end, the Omnibus Bill on Job Creation was submitted to the House of Representatives on February 12, 2020, proposing amendments to 73 laws, including the labour law, and restrictions on hiring and firing.

Boosting Growth

In the first four years of President Jokowi’s leadership, the economy grew at an average annual rate of 5.1%; however, according to a 2019 report by the IMF – published before the global Covid-19 pandemic – growth of up to 6.5% is possible if key structural reforms are implemented. To achieve this it will be necessary to boost jobs in the formal economy.

The existing labour law, enacted in 2003, features a complicated minimum-wage system, restrictions on hiring and firing workers, and severance packages that the World Bank says are the world’s third-most generous. Workers fired after a year are owed four months’ salary, for example. The rules are valued by employees in the formal economy and union leaders vow to fight for them, especially as the regulations have protected against widespread job losses during the pandemic. However, the administration believes the rules hinder investment and are not productive for the country as a whole, especially as only a minority of citizens work in the formal sector and enjoy these benefits.

Another oft-cited issue is that investors looking to set up labour-intensive businesses in sectors such as manufacturing are wary of the costs inherent in firing employees when necessary and instead opt for other South-east Asian markets with fewer restrictions. That leaves many Indonesians who might enjoy full-time employment relegated to working on a contract basis for a formal sector employer.

New Law

Among the documents describing the potential changes, severance packages are not mentioned, but a scheme has been proposed in which the newly unemployed can seek state benefits. Legal changes would not apply to workers in their existing jobs, which could defuse some opposition but may also create a bifurcated labour market, where legacy workers enjoy protections that new hires do not. The proposal has led to peaceful protests and union leaders have declared it offers no protections for new employees. Some observers have suggested that the main obstacle to the bill’s promulgation is not parliamentary, as the ruling coalition has majority control, but that it would force an unpopular legislative package on voters.

However, Indonesians could also find the benefits a worthwhile trade-off. The IMF estimates that every percentage point of growth produces 400,000 new jobs a year. At the current rate of about 5% growth, that is enough to cover the roughly 2m new jobs annually. If the Omnibus Bill passes, it could increase yearly GDP growth by 1.4 percentage points, creating almost 600,000 extra jobs. According to economic commentary from Manulife Investment Management, this would mean more manufacturing capacity and the ability to benefit from shifting regional supply chains.

Educational Needs

Even with labour market reforms, Indonesia could benefit from improving education. The 2003 constitution mandates that the government spend 20% of its budget on education, which was double previous levels, but outcomes have been underwhelming. Youth unemployment (15-24 years old) stood at 16% in 2019 and is highest among recent graduates, suggesting a mismatch between the skills young people possess and those employers seek.

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The Report: Indonesia 2020

Economy chapter from The Report: Indonesia 2020

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