The Indonesian Labour Market

Changes and challenges

Shafiq Dhanani, Iyanatul Islam, Anis Chowdhury

• Publisher: Routledge
• Year: 2009
• eBook ISBN: 9781134404988
• Topic: Business
• Subtopic: Business General
• Index: Business

The topics of unemployment, underemployment, wage trends and patterns, and the relationship between poverty and the labour market are of interest to all policy makers, researchers, academics and journalists concerned with economic development. This book traces the evolution of the Indonesian labour market between the early 1970s and late 2000s. This entails a (a) review of macroeconomic policies and their employment impact; (b) review of unemployment and underemployment trends; (c) review of wage trends and living standards; (d) relationship between poverty, inequality and the labour market; and (e) labour market regulations, employment and the business environment.

The book comes up with a number of policy-relevant findings. Macroeconomic policies, particularly inflation targeting in the 2000-2007 period, have not been conducive to employment generation. The assumption that unemployment is an appropriate indicator of labour market performance and, more importantly, that it is closely aligned with poverty, is shown to be inaccurate. Sustained real wage growth in the twenty-year period before the 1997 financial crisis is contrasted with the lack of improvement since then, a period otherwise of respectable economic growth by international standards. The predicted adverse consequences of sweeping labour market regulations in 2000-2007 on properly measured employment, unemployment and labour costs did not materialize, mainly because of low compliance. It seems that a restrictive macroeconomic framework has been more constraining for employment growth than the perceived labour market rigidity during the post-crisis period. The book concludes with an evaluation of several 'reactive' and 'proactive' labour market policies. Though these are complementary, policy makers in Indonesia have probably put too much emphasis on reactive policies such minimum wage and severance pay, and not enough on proactive policies aimed at creating an adaptable and skilled workforce.

1 Introduction

The context: the labour market and economic policy debates

Debates in the realm of economic policy often reflect diverse perspectives on the way the labour market functions. Thus, in conventional macroeconomic policy management, arguments about the existence of a trade-off between inflation and unemployment reflect competing notions of the role that the labour market plays in the economic adjustment process. If the demand for, and the supply of labour services, can adjust swiftly to external disruptions and disturbances, then there will be an innate tendency for the economy to gravitate to its ‘natural’, full-employment rate. Deviations from this rate are a reflection either of ‘voluntary’ unemployment or institutional and policy-induced rigidities in the labour market. This in turn enables one to argue that policy makers, both in poor and rich economies, should focus primarily on engendering price stability by controlling inflation, while allowing market-driven ‘supply-side factors’ to determine real wages and employment. This can be described as the ‘new classical’ view of macroeconomic policy.

The alternative view maintains that, in the real world, there are indeed institutional rigidities, as well as social norms and conventions, which make the labour market different from the market for goods. In such an institutional context, a short-run trade-off between inflation and unemployment is the norm rather than the exception. A preoccupation with controlling inflation is thus counterproductive. This can be described as the ‘new Keynesian’ view of macroeconomic policy.

In the domain of development policy, where one is concerned primarily with long-run growth and the goal of sustainable reductions in poverty, views about how the labour market is governed matter a great deal. Thus, those who subscribe to the virtues of a flexible and competitive labour market regard it as a key determinant of a business-friendly investment climate that in turn engenders sustainable growth and reduces poverty. This model of a fully competitive labour market also underpins ‘new classical’ macroeconomics. The proponents of some form of labour market regulations argue that they are 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. The latter seek a balance between the imperatives of maintaining a business-friendly investment climate and the protection of workers. The aim then becomes one of designing a regulatory framework that can do both.

Indonesia as a case study

How can the competing perspectives on the central role that the labour market plays in policy debates be evaluated and studied? One can adopt a comparative, cross-country perspective; an equally valid alternative is to offer an in-depth examination of a particular country. This study adopts the single-country approach and dwells on the case of Indonesia.

Indonesia is conspicuous for its size and diversity. It is the world’s largest archipelago. It comprises five main islands, Java, Kalimantan, Sumatra, Sulawesi and Papua, and about 30 smaller archipelagos totalling well over 13,000 islands of which about half are inhabited. In terms of land area, it ranks behind India and China among Asian countries. With an estimated population of more than 230 million, Indonesia is the fourth most populous country in the world after China, India and the United States, and contains the largest number of Muslims. Matching its great expanse is the sheer diversity of the country. It is also among the more resource-rich nations in Asia, with oil being its major asset, though Indonesia became a net oil importer in the early 2000s.

Indonesia’s economic fortunes and global reputation have oscillated over the years. In the 1960s, it was condemned and abandoned by the international community as an irredeemable basket-case. After a bloody political transformation in the mid-1960s that was followed by a remarkable economic transformation, Indonesia in the mid-1990s acquired the mantle of a miracle economy that was distinctive for its rapid growth, sharp reductions in poverty and moderate levels of inequality. By 1997, the miracle economy became the tragic victim of the Asian financial crisis. The country suffered the worst recession in its history; poverty shot up; real wages collapsed; millions retreated to the agricultural sector and sought refuge in the low-productivity informal sector. It took about four to five years for per capita income and real wages to recover to their precrisis thresholds.

The Indonesian economy in the 2000s was characterized by respectable growth, but both the polity and policy makers appeared to be labouring in an angst-ridden era, unsure about how global economic events – characterized by financial instability, persistent fears about global terrorism and extremism, rising food and energy prices and grim speculations about the consequences of climate change – will affect the nation’s future. Just as GDP resumed rapid growth in the second half of the 2000s, the country fell victim to the global financial turmoil in mid-2008, exactly ten years after the first devastating financial crisis, decimating the stock market and the rupiah. The economy was projected to slow down considerably for the rest of the decade following rapidly declining commodity prices and the demand for Indonesian labour-intensive exports, leading to the prediction of significant job losses.

Historical and political background: from authoritarianism to democracy¹

Indonesia has a turbulent history. It experienced centuries of Dutch colonial rule, three and a half years of Japanese occupation, revolutionary war against the Dutch and one of the most tragic episodes of internal strife in the mid-1960s. The history of independent Indonesia can be classified into the following phases:

1. democratic experiment, 1950–1957;
2. the guided democracy of the Soekarno era, 1957–1965;
3. the long period of the authoritarian Orde Baru or ‘New Order’ under late President Soeharto followed by the transitional Habibie government, 1966–1999; and
4. the emergence of a democratic and decentralized Indonesia, 1999–2008.

On becoming independent, the founding fathers of the Indonesian Republic attempted to implement what they knew best: a multi-party, parliamentary democracy modelled on the Netherlands, their erstwhile colonial master. In common with other newly born nations of that era, the democratic experiment soon found itself entangled in a web of internal political wrangles. The ephemeral era of parliamentary democracy met its demise in 1957 and was chiefly characterized by shuffling, short-lived coalitions. The period was significant for delineating the major political forces that would shape the future course of events. These include

• the personal position of Soekarno, who became the first figurehead president under the 1950 constitution;
• the Islamic factions represented by Masyumi and Nahdatul Ulema;
• the PNI as a representative of ‘centrist’ tendencies and the largest political party;
• the Indonesians communists represented by the PKI; and
• the army.

The last years of the era of parliamentary democracy was characterized by increasingly acrimonious quarrels among the established political parties and the outbreak of regional rebellions against the central government in West Sumatra and North Sulawesi. This national crisis led to the promulgation of martial law on 14 March 1957 by President Soekarno and marked the end of parliamentary democracy. Indonesians had to wait more than 40 years for a resumption of democratic governance.

The era between 1957 and 1967 is often referred to as the period of ‘Guided Democracy’. As articulated by Soekarno, ‘Guided Democracy’ envisaged ‘mutual cooperation’ among major partners. In practice, ‘Guided Democracy’ proved to be a more fluid system, born of crisis and constantly shifting. Although dominated by the personality of Soekarno, it turned out to be a competitive arrangement between him and the army leadership. He shared with them the initiative of dissolving parliament and re-enacting the 1945 constitution that called for an American-style presidential system. The army leadership under General Nasution strengthened its position through the successful suppression of the regional rebellions in 1958. In addition, it obtained economic power through the taking over of the former Dutch enterprises and estates, and by moving into the oil industry as early as 1957. In the course of 1960, the army also increased its direct influence over civil administration when five officers became provincial governors.

In order to counteract the growing influence of the army leadership, Soekarno sought alliances between the PKI and the air force. The PKI in particular relied on Soekarno for its survival. The party and its ancillary organizations enjoyed spectacular growth over this period to the alarm of the conservatively inclined army leadership, Muslim factions, and other anti-communist groups. Although the PKI was never effectively in any position of power in the various cabinets, its visible links with Soekarno, its trenchant criticism of the role of the army in the economy, the left-sounding ideology of ‘Guided Democracy’ and closer relationships with

China conspired to pave the way for its subsequent, bloody liquidation. The demise of guided democracy was ushered by the abortive coup of 1965. The event remains shrouded in mystery. Several interpretations are available. The official version is that it was a PKI or communist-inspired coup against the government of the day, a view that led to the banning of the party after 1965. The bare factual details are as follows: on 30 September 1965 a group of middle-ranking officers led what is known as the 30 September Movement or G-30-S. The plotters claimed that they wanted to kidnap some generals to bring them to Soekarno in order to account for corruption and disloyalty in the top ranks of the army. They also wanted to pre-empt a coup against Soekarno by the ‘Council of Generals’.

The movement turned out to be bungled: six kidnapped generals and an army officer were killed. In the confused period following the G-30-S, the army under Soeharto took control. Within a relatively short space of time, Soeharto legitimized his authority. Soekarno handed power to him on 11 March 1966. Soeharto became ‘acting’ President a year later and eventually a full President by 1968. The foundation of the ‘New Order’ was thus firmly laid. The birth of the New Order was stained by one of the worst bloodbaths in Indonesian history. The official allegation of the PKI’s involvement in the G-30-S movement provoked a mass hate campaign, leading to the killing of hundreds of thousands of members of PKI. The official banning of the PKI was thus matched by its physical liquidation of extraordinary ferocity.

The Soeharto regime turned out to be remarkably durable and ruled Indonesia for 30 years. It came to an abrupt end in May 1998, when Soeharto resigned in the wake of popular unrest unleashed by the 1997 financial crisis. He handed over the reins of government to his Vice President, Habibie, a trusted acolyte. The Habibie government was short-lived. By 1999, Indonesia embarked on a promising path to democratic governance.

There is little doubt that the New Order’s image has been tarnished by the bloody circumstances of its birth and that there are enduring black spots in its human rights record. This was most conspicuous in the case of East Timor that was a province of Indonesia until 1999. There is also little doubt that it was an authoritarian regime where political activities were closely controlled, secessionist movements were brutally suppressed, and the army-backed organization GOLKAR won a string of stage-managed elections. Parliament primarily acted as a body that rubber-stamped the decisions emanating from the President’s office. Of course, there were competing factions both within the army and without, but such competition was unable to restrain the capacity of the Soeharto regime to build an elaborate network that ultimately enriched Soeharto’s close-knit family and close affiliates. Corruption and nepotism, or KKN as the Indonesians call it, became synonymous with the New Order. To make matters worse, the aging President was unable to put in place a process of succession that would have entailed a smooth transition to a new generation of leaders. When the 1997 financial crisis struck, the New Order was essentially an ancien regime unable to re-invent itself to respond to monumental changes in the political landscape.

After the fall of Soeharto, a general election was held in June 1999. The transitional Habibie government gave way to the reign of Abdurrahman Wahid, a charismatic religious leader. The Wahid regime earned its distinction as the first democratically elected presidential government, but quickly faded away and failed to meet popular expectations of a new beginning for Indonesia. His successor, Megawati Soekarnoputri, the daughter of Soekarno, did not fare much better, despite her pedigree and iconic status. The 2004 elections ushered in the current government of President Susilo Bambang Yudhoyono, or SBY as he is popularly known.

Indonesia’s evolution as a new democracy is also juxtaposed with its evolution as a decentralized polity – a process that was set in motion in 1999. This is quite remarkable, given decades of highly centralized governance and a strong allegiance among its political elites to the traditions of a unitary state (Ananta and Riyanto 2006).

There was an upsurge of sectarian and communal violence following the fall of the Soeharto regime. Secessionist tendencies are still present. Natural disasters, such as the devastating Tsunami of August 2004 rocked the nation. Sporadic outbreaks of religious extremism continue to pose a threat to social cohesion and stability. Despite such challenges, Indonesia has undergone significant political transformation without having to relive the bloody turmoil that accompanied the birth of the New Order.

It is unlikely that Indonesian politics will ever see the return of a Soeharto-style regime of such remarkable longevity and centralized control. At the same time, many presumably yearn for the combination of political stability and robust economic growth that characterized the Soeharto regime. The era of democratic governance has probably failed to meet high expectations of a clean break from the past. Concerns about endemic corruption remain widespread. The turbulent international economic environment has cast its baleful influence on domestic political discourse. The collective aspiration for Reformasi (or comprehensive economic and political reforms) remains unfulfilled, but Indonesia has come a long way from its authoritarian past. Its parliamentary institutions no longer meekly rubber-stamp executive decisions. GOLKAR remains a potent political force, but had to cede its monopoly of the electoral process in a new era of multi-party politics. There is a relatively free press and a robust civil society. The judiciary is (on paper at least) independent. The institutional ingredients thus exist for a democratic Indonesia to look forward to a prosperous future.

From politics to economics: the transformation of a ‘1960s basket-case’²

The combination of populist politics and disastrous economic management characterized the Soekarno era. Hyperinflation ravaged the economy with a rate of inflation that hovered around 100 per cent per annum from late 1961 to 1964. By 1965, it jumped to 500 per cent and by the end of that year, the price of rice was believed to be rising at an annual rate of 900 per cent. The export/GDP ratio fell markedly, from 9 per cent in 1951–1957 to 1 per cent in 1961–1962. The total capital stock, including land under cultivation, shrunk and per capita income declined (Woo and Nasution 1989; Booth and McCawley 1981: ch. 1).

It is important to distinguish between two periods of the Soekarno era, one encompassing the 1950s, and the other entailing the first half of the 1960s. The early years of the Soekarno era, and the 1950s generally, did see some modest growth. Between 1951 and 1957 the GDP growth rate was a respectable 5.5 per cent, but plummeted to 1.0 per cent between 1962 and 1965. Inflation too was relatively modest in the 1950s when judged against the hyperinflation of the 1960s. In 1951–1957, the average inflation rate was 24 per cent, but in the 1962–1965 period it reached 234 per cent (Woo and Nasution 1989; Booth and McCawley 1981: ch. 1).

The Soekarno regime’s attention towards economic affairs was diverted by secessionist rebellion in the Outer Islands and assertive foreign policies, first against the Dutch over Papua, and later on against Malaysia. The stance of the regime became increasingly anti-Western and even autarchic. In a celebrated speech, Soekarno told the United States to ‘go to hell’ with its foreign aid. Such rhetoric was matched by the policy pronouncement to unilaterally revoke Indonesia’s huge international indebtedness.

If the Soekarno era, especially the period under ‘Guided Democracy’, was regarded as a mixture of populist politics and poor economics, the Soeharto era regime was characterized by centralized political control, outright repression, and competent economic management in the realm of macroeconomic policy as well as sectoral policy, particularly with regards to agriculture, manufacturing, education and health. The government consciously sought to create political legitimacy by emphasizing economic performance above anything else.

The early years of the Soeharto era marked the rise of the so-called ‘Berkeley mafia’, a group of US-trained economists who provided leadership in economic policy making. The long duration of the Soeharto regime entailed several policy epochs. One can identify the following periods:

1. the stabilization years, 1967–1972;
2. the petroleum boom, 1973–1982;
3. the oil price collapse and the deregulation phase, 1982–1997.

The primary goal of policy makers during the stabilization years was to bring hyperinflation under control and rehabilitate an economy that suffered heavily from the setback of the mid-1960s. This happened rather quickly. One could argue that it was a striking example of how a combination of motivated domestic political actors and international assistance can turn around years of economic misrule. The Soeharto regime benefited from the geopolitics that marked the Cold War years. The US government and its allies found themselves pitted against an ideological battle against the global appeal of Soviet-led communism. The Soeharto regime became one of the front-line anti-communist states in East Asia. Growth statistics amply demonstrate the sharp break from the past. Thus, between 1960 and 1965, per capita income stagnated (–0.1 per cent), but jumped to 4.0 per cent between 1965 and 1971 (Islam 1983: ch. 1)...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• List of illustrations
• Acknowledgements
• 1 Introduction
• 2 Growth, employment and the macro-economy
• 3 Unemployment and underemployment
• 4 Real wages and labour productivity
• 5 Poverty, inequality and the labour market
• 6 Labour regulations and business climate
• 7 Conclusion and a policy agenda
• Notes
• Bibliography