Indonesia: Regulations in need of review

The need to relax rigid labour restrictions that enforce high severance pay and make it hard to fire staff is becoming a priority for Indonesia. With outdated employment laws affecting investor confidence and benefitting neither employers nor staff, the country is accelerating moves to update employment regulations.

While a review of existing legislation is currently under way, the Ministry of Manpower said in mid-2010 that it will not be completed for another one or two years, and late last year the House of Representatives removed proposed revisions to the 2003 legislation from a list of bills to be prioritised in 2011.

Problems stem from a 2003 law that introduced flexibility to the labour market but imposed a series of costly obligations for employers. The law was passed amid an economic transformation strategy launched at the end of the 1967-98 Suharto era, which saw industrial relations restructured to grant workers universal labour rights while introducing labour market flexibility.

The post-Suharto period was marked by a convergence of demands from trade unions and a succession of governments advancing labour-friendly agendas. Thus, rigid rules were introduced on employment termination and generous provisions related to strike action were enshrined in the 2003 Manpower Law.

One example is the law’s increase in severance rates for workers with three or more years of service, as well as an additional 15% gratuity payment. As a result, severance pay is perceived to be equivalent to a “hiring tax” of around one-third of a worker’s annual wage.

A recent study by the World Bank published in September 2010 found that the law does not adequately protect employees. Some 78% of workers dismissed within the last two years did not receive the full severance to which they were entitled, with 34% getting nothing at all. Additionally, some believe that to avoid high firing costs for permanent employees, firms are increasingly relying on fixed-term contract arrangements, including temporary staff and outsourced employees that are less likely to be eligible for severance pay.

“These current regulations not only leave workers unprotected but may dampen job creation too. Indonesia’s high de jure severance rates deter foreign investment and discourage entrepreneurs from creating new businesses,” according to the bank’s September 2010 report.

“Labour law is one key area which is hurting the investment climate for Indonesia,” Anton Gunawan, chief economist for Bank Danamon, told Reuters news agency last year. He also expressed skepticism that a new draft labour law would be ready within two years as the ministry claimed, since the issue was a politically sensitive one and an election is scheduled for 2014.

Attempts by Jakarta in 2006 to revise the law to allow employers to sack workers based on the reason of “force majeure” – with no explanation of its definition and criteria and with the possibility of no severance pay – was rejected by the unions. Mass protests eventually forced the government to drop the plan.

Compounding labour problems is an education system that, despite improvements in basic schooling, is still underachieving in terms of the quality and accessibility of secondary provision. This makes it hard for firms to recruit skilled employees domestically, another challenge for investors. According to the World Bank report, a recent employer skills survey confirmed that secondary school graduates did not meet employer’s expectations. Respondents ranked some 25% of new hires as “poor” or “very poor” and only 7% achieved a “very good” assessment.

Findings by the Economist Intelligence Unit (EIU) in January echoed the feelings of business leaders, with a risk report rating the labour market as “D”, the second-highest “most risky” rating. “Reform of the onerous labour law is central to the government’s efforts to boost job-creation and encourage investment,” said the EIU.

Local media forecast late last year that the country will see some 1.2m job seekers enter the market in 2011. However, with just 300,000 job opportunities expected, this imbalance is set to send the unemployment rate up to 8% from its current level of 7.14%.

The lack of investment is one of the reasons for low job creation. Consequently, “the flow of jobseekers to the informal sector will likely grow after they fail to find jobs in the formal sector, leaving the majority of the workforce unprotected,” according to a December editorial in the Jakarta Post.

Trade unions have insisted they are prepared to compromise on issues such as severance pay and easing termination, with officials from the Confederation of Indonesian Labour Unions (KSPSI) stating last year, “employers want lower severance payments; we also want some articles to be amended. So, both of us want this law to be amended. But we have not yet reached a compromise on how to amend the law.”

Despite concerns over the labour market, Indonesia saw a 13.6% jump in foreign direct investment (FDI) in the third quarter of 2010. The country’s investment board said FDI reached Rp40.1trn ($4.55bn) for the quarter, taking the total for the first nine months of 2010 to Rp111.1trn ($12.61bn). The Ministry of Finance also expects GDP to grow by 6.5% in the first quarter of 2011.