New minimum wage formula : A labor economics perspective (Part 1 of 2)

New minimum wage formula : A labor economics perspective (Part 1 of 2) Chris Manning  ;  An adjunct fellow with the Indonesia Project at the Australian National University

                                               JAKARTA POST, 16 November 2015

                                                                                                                                                           

                                                                                                                                                           

The government finally bit the bullet on wage reform, after three years of turbulent disputation over minimum wages in Indonesia’s major industrial areas. This came in mid-October as part of the raft of reforms stretching back to mid-September. Employers have bought greater certainty, in return for handing over all the returns from growth to labor. Rather surprisingly, spokespersons for business said their members were happy with the deal, according to statements from Indonesian Chamber Of Commerce And Industry and Indonesian Employers Association representatives. The government believes it has clinched a deal that will contribute to a more attractive investment climate. Revision to the minimum wage-setting process and principles is an important reform for economic competitiveness, employment and equity. It’s worth looking at closely, even if the deal is by no means clinched, given an imminent challenge from some governors and the unions. The new arrangement has been praised for its simplicity and for taking politics out of the wage determination process — which the governors of Jakarta and Central Java are clearly unhappy with. The minimum wage (MW) in each region (province and city/regency) will now be adjusted based on the national rate of growth (in real terms) and the national increase in the cost of living, the CPI. This formula is to be applied to the existing MW in each region, except for a special arrangement for catch-up in several provinces outside the main industrial areas. In 2016, the increase is to be 11.5 percent, not too different from the previous year in and around the national capital (it is less than in many regions outside greater Jakarta that were trying last year to catch up to the pace setters in regions near the capital). But by most standards it is generous for an economy struggling in the midst of a stumbling world economy. Taking the annual tug of war over the changes in the decent standard of living for workers at district level and setting of minimum wages by provincial governments must be considered a major step forward towards a more rules-based system. Gone will be the pressures from ambitious union leaders and local politicians to push for large increases in wages by international standards. Potentially, it means an end to industrial action and political maneuvering, which meant that MWs spiraled upwards in the main industrial regions in and around Jakarta and Surabaya from 2010-2015 — by around 20 percent per annum in nominal terms, and 15 percent per annum after adjusting for inflation. From an investment climate point of view it all seems too good to be true. But what about the public interest? To assess this we need to go back to basics: how is the MW related to actual wages, employment and the welfare of wage workers in general? Going back to first principles, the MW were historically designed to play the role of a social safety-net for blue collar (mostly unskilled) workers in establishments where wages are very low. It was argued that many workers were exploited by employers, owing partly to “monosonistic” conditions in the labor market, which enable some employers to push wages to very low, inhumane levels. A lack of bargaining power gives often immobile, uneducated and ignorant workers little choice but to accept these wage offers. In reality, MW have often been adopted by governments to play quite a different role in countries at an early and transitional stage of development, when wages are still very low. The authorities have in reality sought to regulate the “entry level” of wages into jobs for most blue collar workers, partly to garner political support and partly with the aim of improving the general standard of living of wage workers. Thus the MW does not just apply to those in firms paying wages at the bottom-end of the wage distribution. However, implementation of such a policy is complicated by a dualistic (some say differentiated) structure of wages, which is especially evident in developing countries. At the heart of it is a large gap in productivity and wages between the modern and traditional sectors. This complicates policy enormously, combined with low levels of unionization and a limited administrative capacity to implement policy in smaller firms. Often MW only apply to the modern sector, and even here coverage may be far from complete; on the other hand, wage workers in smaller firms are rarely covered by the MW, even though these establishments account for around half and often more of all wage employees. The above description mirrors the case in Indonesia. The recent, rapid increases in the MW have strengthened this tendency. Thus wages are not determined by productivity for the modern sector workers but by the whims of the government and the bargaining process among unions and employers. Trends in unit labor costs — the cost of wages to the employer, relative to productivity — in this part of the economy, which accounts for around one third of all jobs are estimated to have risen sharply in recent years. Importantly, the modern sector includes many of the large, labor-intensive and often export-oriented firms that have provided better jobs for many rural-urban migrants in past periods of rapid growth. These firms have been struggling in recent years, partly because of high wage costs relative to productivity. If minimum wages are to play the role of a social safety net, and wage revisions to reflect changes in productivity, thus contributing to economic progress, one challenge for Indonesia is to reconnect wages and productivity, especially in internationally competitive industries. Let’s assume that doing away with minimum wages altogether — as some economists would recommend — is not an option politically. Then the strategy for safeguarding jobs is to “decouple” MW setting from actual wages paid by most enterprises. That is, over time, MW are increasingly based on wages paid to most workers in the traditional sector, and really act as a social safety net for wages paid by greedy managers below this standard. ●