August 9, 2016 5:15 pm JST
Commentary

Emma Allen -- Raising Indonesian labor productivity

Indonesia boasts the fourth-largest workforce in the world and by far the largest in Southeast Asia. The country's dynamic, youthful labor force has made it a magnet for foreign investment and been a driver of economic growth over the past two decades.

But Indonesia is now at the end of a resources boom, requiring adjustments for tougher times. The economy has not been creating jobs and there is an urgent need for businesses and government to work together to ensure that Indonesia remains Southeast Asia's engine of growth and opportunity.

According to a review of Indonesia's labor market by the Asian Development Bank, there are several constraints that need to be addressed. One in every two workers can be classified as under-qualified for their job. A majority of people work on temporary or informal contracts and are unlikely to have had certified training to improve their skills.

Average wage growth has been slow, rising at less than 2% a year in real terms over the last five years. Though minimum wages have increased rapidly, statutory non-compliance is high, with one in every two regular employees earning below the legal threshold.

Breaking from these trends is crucial and has been a major focus of Joko Widodo's administration which in 2014 introduced a new development agenda known as Nawa Cita, or "nine goals." It places a strong emphasis on improving living standards and increasing productivity and competitiveness. Progress towards this policy agenda will require more and better jobs and a more productive workforce.

There has been some progress over the last five years. Regular wage employment has expanded to 46 million from 35 million five years ago. Recent trends in labor productivity also seem quite encouraging, with data showing an average rise of 4.3% a year in real terms between 2010 and 2015. However, digging a little deeper, it is apparent that recent increases in labor productivity are more related to slow job growth than efficiency gains. More people are working as regular employees, but their contracts are mostly short term.

More improvements are needed in at least three key areas: a better linking of wages and productivity; an improved combination of flexibility for enterprises and security for workers; and the strengthening of systems and incentives for skills formation.

First, gains in labor productivity are essential for the economy as a whole to maintain competitiveness. A necessary ingredient for inclusive growth is the maintenance of linkages between wages and productivity. Workers in high-productivity sectors such as manufacturing have seen significant increases in real wages. Unfortunately, this link has been broken in many other sectors.

There are clear benefits for ensuring that wages move in line with productivity. For employers, linking real wage growth to productivity implies stable real unit labor costs and profit growth in line with productivity growth. For workers, alignment can provide a more direct link between their skills, efforts and remuneration. Productive dialogue between employers and labor around gain-sharing can translate into better-quality jobs for workers while enhancing the sustainability of enterprises.

In addition, a productive dialogue on wages and productivity is important at a broader level, as trends indicate that pay gains won through the raising of the minimum wage have not filtered through to all workers. Compliance is low, average wages have stagnated and job growth has slowed.

This situation calls for two measures: a strengthening of alternative avenues for pay negotiation at the industry and enterprise levels and an improvement in labor market governance to ensure higher rates of regulatory compliance. The expansion of collective bargaining agreements could help.

Second, the incentive for companies to rely on short-term contracting has led to underinvestment in human capital and hindered the pace of labor productivity growth. For employers who expect to have an employee in their company for a short time, the cost of training is often perceived to outweigh the potential returns, so training is not always seen as an investment in company productivity.

A similar situation exists for workers. Employees on short-term contracts may not see the potential for career progression or improvements in the nature of their duties and so may perceive little incentive to develop skills on their own.

Ensuring that the regulatory framework provides the right combination of flexibility for enterprises and security for workers is critical. This aspect of labor market reform can be controversial but deserves attention, particularly if current systems are discouraging stable employment, skill formation and career progression.

Labor law provisions on short-term contracting, outsourcing, worker dismissal, severance pay and unemployment insurance should be based on the need to accelerate skill formation and gains in productivity. With time and dialogue, reforms in this area have the potential to contribute to competitiveness and ensure that the benefits of growth are shared.

Finally, investments that support skill formation are essential for driving gains in labor productivity and expanding productive employment. The government has increased investment in education which has expanded the pool of educated workers. However, Indonesia still scores poorly on international tests for secondary students and employers often note that skills shortages remain a challenge. Systems and incentives, along with strong private-sector partnerships, are needed for driving productivity gains through investment in training.

Investing in skills cannot be "one size fits all." Different solutions will be needed as Indonesia transitions to a richer, more developed economic model. Given its youthful population, policies that support skill-building for new entrants to the labor force to ease the school-to-work transition and reduce youth unemployment are especially important. Quality apprenticeship systems are normally the gold-standard solution for addressing such challenges.

Another step will be to ease skill mismatches by making it easier for workers to learn new skills or upgrade existing ones. This may also improve job growth. Implementing such policies will, by no means, be straightforward and will require substantial private-sector financing commitments. Policymakers will also need to provide tangible assurances of productivity improvements in order to justify the use of public funds.

Making a break from the trends of the past will be a daunting task. To address the challenges, a broad commitment from employers and workers to strengthen linkages between productivity and wages and to comply with regulations is needed. Employers and workers need to invest in skills and become better at working together. Regulatory frameworks that provide an enabling environment for this to take place are needed.

Such changes will not occur overnight but they would be an important investment in the competitiveness of the economy and the living standards of the Indonesian people.

Emma Allen is country economist for the Asian Development Bank in Jakarta.

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