Indonesia’s Misguided Labor Movement

A 2010 World Bank study shows that a 10% increase in Indonesia’s minimum wage reduces formal employment by 1%. Formal employment in Indonesia is around 44 million today, so a 30% average rise in the minimum wage could reduce formal employment by more than 1.3 million workers.

Labor activists demanding minimum-wage hikes have led protests that brought Indonesian cities to a standstill in recent months. But for all the sound and fury, this preoccupation with wages remains misguided. If politicians are serious about improving the lot of Indonesia’s poor, they should focus on reforming labor laws that protect formal sector jobs at the expense of nine out of 10 Indonesians who are employed informally.

These latter workers get lost in the din when thousands of union members flood Jakarta’s streets and threaten to halt traffic, as occurred last November in the latest round of wage demonstrations. Now an annual feature, such disturbances have spurred local governments to implement unusually high minimum-wage increases.

Labour protestors in Jakarta

Minimum wages have increased across Indonesia by an average of 10% per year over the past four years. For 2013, some 25 provinces, regencies and cities agreed to raise the minimum wage by an average of 30%, with a few as high as 50%. Greater Jakarta, which accounts for the bulk of Indonesia’s manufacturing and services, agreed to 44%, bringing the minimum wage there to 2.2 million rupiah ($225) a month. Unions are encouraged, and their demonstrations are likely to grow in size and assertiveness in the years ahead.

The problem is the 2003 Manpower Act. This places tight constraints on dismissing workers by requiring one of the world’s highest severance payments: 32 months’ worth of wages.

Each time the minimum wage rises, so do legally mandated severance payments. The increases in the minimum wage therefore make layoffs so costly that there is no incentive to hire an informal worker at the margin. Employment is virtually guaranteed for those who already have a formal job.

Such job protection does not help productivity. Nor does it improve Indonesia’s overall employment picture. A 2010 World Bank study shows that a 10% increase in Indonesia’s minimum wage reduces formal employment by 1%. Formal employment in Indonesia is around 44 million today, so a 30% average rise in the minimum wage could reduce formal employment by more than 1.3 million workers.

Vikram Nehru

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Background Reading

Does the Minimum Wage Affect Employment? Evidence from the Manufacturing Sector in Indonesia,” March 24th, 2012, The World Bank  “Using Indonesian firm census data, the paper investigates the impacts of minimum wages on employment and wages in Indonesia in the period of 1993-2006. The paper finds that minimum wages have significant and negative employment effects in small firms, but not in large firms. The effects are especially negative among less educated workers who are hit harder by minimum wage rises; workers with high school education and above do not seem affected. Both production and non-production workers lose their manufacturing jobs when minimum wages are raised, and job losses are more severe for non-production workers, which include workers performing low-skill (non-essential) demanding activities such as cleaners and drivers. The analysis also yields clear gender differentiated effects of the minimum wage: most of the non- production job losses are experienced by female workers. Lastly, the paper also finds that minimum wages are more correlated with average wages in small firms than in large firms.”

“Labour Market Institutions: A Review of the Literature: Background Paper for the World Development Report 2013”  “Research in the 1990s, largely based on cross-country regressions, typically found that strong protective legislation and generous unemployment insurance did slow job growth and increase unemployment. These conclusions motivated the influential OECD (1994) Jobs Study which took a largely deregulation stance, recommending flexible rules for protecting employment and setting wages and hours, and unemployment and welfare systems that minimized work disincentives.”

OECD Economic Surveys INDONESIA, Sep 2012  “Formalisation of workers and firms will be a key source of productivity growth and could be encouraged by preventing excessive increases in the minimum wage, introducing a sub-minimum wage for youth and implementing reforms to make the formal labour market more attractive to workers and firms. One option to effectively protect workers against job-loss risks in the future would be to introduce limited unemployment saving coupled with individual unemployment-insurance accounts, while removing rigidities in the formal labour market. A simplification of the cumbersome licensing process would reduce the administrative burden facing companies.

“In provinces where minimum wages are already high in relation to average wages, resist increases that exceed trend productivity gains. Introduce a sub-minimum wage for youth directly linked to the general minimum wage. Reduce onerous severance payments and ease dismissal procedures in the formal labour market. In return introduce unemployment benefits possibly coupled with individual unemployment saving accounts.”

Global Wage Report, 2008/2009Minimum wages and collective bargaining: Towards policy coherence” ILO International Labour Organization


Effects of Minimum Wage Laws (in the United States)

Executive Summary

The U.S. federal government has imposed a minimum wage since 1938, and nearly all the states impose their own minimum wages. These laws prevent employers from paying wages below a mandated level. While the aim is to help workers, decades of economic research show that minimum wages usually end up harming workers and the broader economy. Minimum wages particularly stifle job opportunities for low-skill workers.

There is no “free lunch” when the government mandates a minimum wage. If the government requires that certain workers be paid higher wages, then businesses make adjustments to pay for the added costs, such as reducing hiring, cutting employee work hours, reducing benefits, and charging higher prices. Some policymakers may believe that companies simply absorb the costs of minimum wage increases through reduced profits, but that’s rarely the case. Instead, businesses rationally respond to such mandates by cutting employment and making other decisions to maintain their net earnings. These behavioral responses usually offset the positive labor market results that policymakers are hoping for.

Increases in minimum wages would be particularly damaging in today’s sluggish economy. Governments should focus on policies that generate low-inflation economic growth and higher worker productivity, which would generate rising wages and more opportunities for all workers.

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Garment makers fear minimum wage rise

Aug 30, 2011. Apparel firms fear a rise in the minimum wage will lead some foreign investors to move out of Vietnam

Vietnam’s textile, garment and footwear industries are likely to be hardest hit by a government decision to increase minimum wages by up to one-third from 1 October.

Wages are being raised to help workers cope with surging levels of inflation – and to reduce the likelihood of strikes.

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