Demographic Bonuses, Minimum Wages, and the “Omnibus” Law
Turro S Wongkaren Head of the Demographic Institute of the Faculty of Economics and Business, Universitas Indonesia
Two labor issues have been the hot topics of discussion lately: setting minimum wages and plans to submit “omnibus law” on expanding employment opportunities.
Many people do not realize, the two issues are related to the demographic bonus that will reach its peak in the 2020-2024 period. In that period, the ratio of the productive age population reached the largest number compared to other periods so that employment issues became very important to consider. In 2019, there are around 137 million workforce and it is estimated that by 2024 that number will reach around 152 million people.
With our open unemployment rate slightly above 5 percent per year, at any time there are around 6.5 million Indonesians who want to work but don’t get a job, either because the jobs do not meet their expectations or indeed no one employs them.
While every year around 2.2 million people enter the job market and need jobs. Many of them are young people who are entering the labor market for the first time. Whether or not the availability of labor is absorbed by the labor market is affected by the wages and demands of the company.
Minimum wage
The (provincial) government sets the lowest wages provided by companies to workers as compensation for their work. The relationship between minimum wages and open unemployment in Indonesia is quite complex. In general, provincial minimum wages always increase. However, the open unemployment rate does not show a fixed trend. The unemployment rate in the provinces of Java increased until the mid-2000s, but has since continued to decline.
Various studies have also shown conflicting results: some have a negative impact (an increase in the minimum wage followed by an increase in the unemployment rate), but some are positive (an increase in the minimum wage followed by a reduction in the unemployment rate) or neutral. This shows that unemployment may not be influenced by wages alone, but also by other things.
In Indonesia, some unemployed are those who have enough resources to (able) unemployed. Data on the characteristics of job seekers support this: around two thirds of job seekers at least graduate from high school / vocational school.
In addition, the higher the level of unemployment education achievement, the longer the period of finding a job and the greater the proportion who have never worked before. The average time to look for work is more than five months, which shows their ability to live more than the ability of many workers who can only live a maximum of 2-3 months if they lose their jobs.
Thus, the unemployment rate does not fully reflect the life difficulties of the workforce because most unemployed people actually have the resources to live. They only want to work if the reward received reaches a certain value, which in economics is called a reservation wage. For unemployed people from this group, an increase in the minimum wage might even make them enter the labor market. If this group is large enough, an increase in the minimum wage reduces the unemployment rate.
Thus, the unemployment rate does not fully reflect the life difficulties of the workforce because most unemployed people actually have the resources to live.
While research that shows the negative impact of minimum wages provides a different picture for the young and old workforce. When minimum wages increase, young people are simply not recruited / employed, while older people are more likely to experience layoffs. This is supported by BPS data which shows that young workers are more likely to lose their jobs due to issues originating from within themselves (for example unsatisfactory income or expertise that does not fit into the job), while older workers are more likely to be due to outside issues (e.g. layoffs).
Option for companies
The unclear impact of the minimum wage on unemployment does not mean the minimum wage has no impact at all. If the company’s cost structure is tight, to maintain profits, they must increase efficiency. For this reason, companies have options: reduce labor used (both through layoffs and reduced working hours), relocating businesses to areas that have more competitive wages, or, if access to technology allows, automation. The first option, layoffs, is not easy to do formally.
Existing regulations require various things that must be met if a company wants to lay off on the grounds of efficiency, for example, the company must lose money for a long time and is obliged to give substantial severance. Plus the possibility of having to deal with unions, this makes companies, especially those with tight financial conditions, have to think twice before laying off.
The second option, business relocation, is more likely. The company will move its business to a region with a lower wage structure. Companies can shop which areas are best for them by considering wages, distance, and the quality of labor and other inputs. Regions with low minimum wages and quality workers who at least meet the basic skills requirements of the company will benefit. Some data indicate this has happened.
Of course, relocation is not limited to moving to another province, but it is also possible to other countries where labor conditions (including wages) are more attractive than Indonesia. Many large companies in manufacturing that pay wages in Indonesia are foreign investment companies (both pure and collaborate with local parties). Depending on whether the production here is part of their global value chain or indeed for the domestic market. An increase in the minimum wage can affect their decision to stay in Indonesia or move.
Compared to other countries in Southeast Asia, the minimum wage in Indonesia is medium. Minimum wages in Malaysia and Thailand are higher than us (Singapore does not have a general minimum wage policy). Cambodia, Laos, Myanmar and Vietnam minimum wages are on average lower than ours.
Only the Philippines is more or less commensurate with us. Of course, low wage rates must also be accompanied by productivity. Recent experiences can be a clue. When 33 companies left China due to the trade war with the US, none moved to Indonesia and 23 moved to Vietnam.
Compared to other countries in Southeast Asia, the minimum wage in Indonesia is medium.
The third option, automation, is made possible by advancing technology that enables efficiency. Companies that take this option do not have to reduce the number of their current workers. They only need to transfer existing workers to other jobs within the same company. However, they also will not recruit new workers so as to narrow the employment opportunities of young workers. This is supported by research that shows that young workers are receiving the biggest negative impact from the minimum wage.
In the medium and long term, companies will slowly use technology to do jobs that were previously done by humans. Some estimates show that around 60 percent of Indonesian workers have the potential to be impacted by automation in the future. All that happened without the company violating applicable labor regulations.
Faced with that condition, how do we create employment? First of all, keep in mind that although minimum wage regulations are legally binding on all companies, in reality minimum wages are more strictly adhered to by formal companies, and are applied more to those who work as employees / laborers / employees. That is, an increase in the minimum wage will not be enjoyed by most workers in Indonesia. Wages of workers in the agricultural sector, for example, which are still around one third of our workers, will not be affected by the increase in minimum wages. Therefore, to increase employment opportunities, we need to see not only those who are directly affected by the minimum wage, and those who are in fact not directly affected.
Some estimates show that around 60 percent of Indonesian workers have the potential to be impacted by automation in the future. All that happened without the company violating applicable labor regulations.
First, for those who are directly affected. With minimum wages continuing to rise, companies need to be given other ways to absorb the annual increase in minimum wages and not be forced to take counter-productive options for expanding employment. You do this by providing tax incentives and reducing costs associated with bureaucracy and others. Referring to the aspects contained in the ease of doing business of the World Bank, an economist mentions three costs related to bureaucracy that need to be immediately lowered: costs to start a business, licensing fees for construction, and the cost of property registration. In all three aspects, Indonesia scores the lowest in the 2020 report. It is hoped that, with these costs reduced, companies will be able to accommodate the annual increase in minimum wages.
Second, for those who are not directly affected by the minimum wage because they work in micro and small scale businesses (MSMEs) or types of businesses that tend to be informal, need to be empowered by providing appropriate training. According to the Economic Census, MSMEs in Indonesia number around 26 million or 98.7 percent of all businesses in Indonesia, with 59.3 million workers or 75 percent of all workers. Meanwhile, medium and large businesses 349,000 businesses employ 19.4 million people or a quarter of all workers in Indonesia. From this data it is clear that the expansion of employment opportunities cannot be separated from the empowerment of MSMEs.
The problem is, not everyone has the talent or ability to be a successful entrepreneur. Research shows that successful entrepreneurs have special characteristics, both skills and psychologically; for example more adaptive to change, and resilient. To support MSMEs in addition to credit efforts, appropriate training needs to be given at various institutions such as BLK or those managed by private sector / NGOs. For that, they need the ability to identify which trainee candidates are more appropriate for entrepreneurs, and which are more appropriate for employees, because their training needs are different. It is hoped that, with appropriate training, MSMEs can be sustainable.
The problem is, not everyone has the talent or ability to be a successful entrepreneur. Research shows that successful entrepreneurs have special characteristics, both skills and psychologically; for example more adaptive to change, and resilient.
It seems that in general the government has thought about this. At the end of last October, through his Twitter account, President Jokowi invited the Parliament to complete two seemingly separate but closely related laws: the Law on Employment Creation and the Law on Empowerment of Micro and Small and Medium Enterprises (MSMEs). Both need to be part of the omnibus law on expanding employment opportunities if we do not want the demographic bonus to turn into a demographic disaster.
Turro S Wongkaren Head of the Demographic Institute of the Faculty of Economics and Business, Universitas Indonesia