ABSTRACT
The first few years following the 1997-1998 Asian financial crisis witnessed a relatively rapid recovery of real wages, which had collapsed during the 1997 financial crisis due to high inflation. The government mandated real minimum wages in the regions were also raised substantially several years in a row. These developments in the labour market coincided with the passing of five labour laws: the Trade Union Act of 2001 on basic labour rights and freedoms; the Manpower Act of 2003 governing severance pay, minimum wage and contract work; the Industrial Dispute Resolution Act in 2004; the Migrant Worker Act of 2004; and the Social Security Act of 2004. Prior to these, and soon after the crisis, Indonesia ratified a range of core ILO standards related to child labour, discrimination and union freedoms. The comprehensive manpower act of 2003 gave a higher legal standing to a series of ministerial regulations issued since the 1997 financial crisis to protect labour. This naturally led some policy makers, academics and international organizations to reassess the role of labour market regulations on the prevailing investment climate. In 1988, the first year of the onset of the Asian financial crisis, GDP dropped by 13 per cent. After stagnating in the following year, GDP resumed moderate growth between 2000 and 2004 but at a rate far below that prevailing before the crisis. Investment also slowed down during the first half of the 2000s, as noted in Chapter 2. The combination of sluggish economic growth, low foreign and domestic investment, the rapidly rising official estimate of the unemployment rate and stagnant manufacturing employment gave rise to concerns about the post-crisis investment climate. Although GDP picked up speed again in 2005 and reached 6.3 per cent in 2007 (6.9 per cent for non-oil and gas GDP), and investment rose to 26 per cent of GDP in the first half of 2008, some observers considered the 2000s a period of jobless growth. Critics argued that the emerging labour market regulations were primarily responsible for what they saw as poor labour market outcomes in the 2000s, combining limited employment growth in the formal sector, the decline of labour-intensive manufactured exports, and the rise in the official estimate of the unemployment rate. They pointed out that the existing labour regulations reduced labour market flexibility and slowed down the growth of employment opportunities in the formal sector. The post-crisis situation represented a contrast
to the virtuous combination of rising employment, growth in real wages, and structural transformation in the pre-crisis era. The government itself, worried that the new labour regulations compromised its employment generation goal, sought to revise the 2003 manpower law in 2006, but backed down in the face of opposition from trade unions. On the other hand, proponents of some form of labour market regulations argued that they were necessary to respect labour rights and protect workers against labour risks, and that they could indeed promote productivity and economic growth in the long run. They noted the asymmetrical way economists treated the benefits of regulations that seek to protect private property rights and regulations that seek to protect labour rights and standards. The former was seen as essential for growth; the latter was treated as a hindrance. They also argued that compliance could not be high in a country where employment in the formal sector employment was so limited, and where employers in the formal sector could readily circumvent labour regulations. The first part of this chapter reviews the arguments for and against regulating the labour market. Both sides provide compelling arguments to substantiate their case. In order to shed more light on this debate in the Indonesian context, the next section provides a comprehensive empirical review of the impact of labour market regulations on labour market outcomes both before and after the Asian financial crisis. The extensive evidence reviewed in this chapter, as well as in the three previous chapters, indicates a relative stability in a range of labour market indicators over the post-crisis period 2000-2007 taken as whole. Thus the evidence to date was not able to demonstrate the adverse consequences of labour market regulations enacted in the early 2000s. Minimum wages and other imposed labour standards turned out to have limited impact due largely to low compliance, and the limited regressive effects they had were offset by economic growth, efficiency wages and other factors explored in this chapter. This does not mean that the existing labour laws and institutional arrangements, particularly those governing severance pay, minimum wage and contract work, were either appropriate or effective in responding to the particular needs of the Indonesian economy. They restricted the flexibility of employers and imposed certain transaction costs on them to circumvent them. While there is thus a case for reforming the existing labour regulations, the challenge is to seek the right balance between the imperatives of growth and employment creation, and the goal of protecting and respecting labour rights.
