New minimum wage formula :
A labor economics perspective (Part 2 of 2)
Chris Manning ; An adjunct fellow with the Indonesia
Project
at the Australian National
University
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JAKARTA
POST, 17 November 2015
There is a large gap
between wages paid in most small firms and the informal sector, and wages in
the modern sector. This situation tends to be exacerbated by the minimum wage
(MW) mainly paid in the modern sector.
In February 2014, for
example, average wages of manufacturing workers in rural Central Java, most
of whom were employed in small firms, were recorded as Rp 940,000 (US$67) per
month. This compares with just under Rp 2.6 million for manufacturing workers
in Jakarta, many of whom we can be assume were in larger scale enterprises
and were paid the MW (raised to Rp 2.44 million in January 2014).
Government and union
leaders since Soeharto times have claimed that MWs benefit workers in
general, implying that this also applies to those at the bottom of the wage
distribution.
Surveys clearly show
that this is not correct. MW are, in fact, not paid in a majority of
establishments. And especially among small firms — which contribute well over
half of all wage jobs — actual wage rates are often below the MW rate.
Earnings among workers are even lower in the informal sector and among
agricultural workers.
Thus rather than
improve incomes of those at the bottom end of the wage distribution, it seems
that MWs may well have had the opposite effect, at least during the recent
period of wage explosion.
Such an impact is
difficult to measure because of lagged effects and widespread differences in
compliance rates. But some surveys suggest that modern sector establishments
unable to pay the MW have had to lay off workers, pushing workers back into
lower paid small firms and into informal work.
The question is what
is the best strategy to raise wages and the standard of living among most
wage workers, so they have a higher standard of living in the medium to longer
term, while at the same time ensuring that wages reflect to productivity, one
the fundamental laws of economics.
Injecting more
certainty into the minimum wage determination process to encourage investment
is an understandable reaction from business and the government, especially
given that minimum wages are likely to become a political football in the
up-coming elections across many regions.
At the same time, the
longer term implications of the new MW formula are disturbing. Increasing the
gap between wages in the traditional sector and the modern sector and paying
all the benefits of growth to wage workers in the formal sector could well
discourage capital accumulation and encourage investment in labor-saving
technology.
This is certainly no way
to create more jobs. Higher MW of this kind are also likely to put pressure
on prices, especially in protected industries, making goods more expensive
for Indonesian consumers, including the poor.
So what might be done?
The current new formula is here to stay for the present, it seems, if it is
upheld in face of likely legal challenges from the labor representatives. But
perhaps the period for application of the new formula might be reduced to two
or a maximum of three years, at which time the government could renegotiate a
deal that sees MW adjusted only for inflation. This would reverse the
distribution of benefits and giving the gains from real economic growth
(adjusting for cost increases each year) to employers.
Assuming the economy
recovers and begins to grow strongly in coming years, applying a new formula
over a period of 3-5 years would begin to delink MW and actual wages of most
employees and make MW a true safety net. Over the next two years the
government could do two things to facilitate such a radical move.
First, assuming that
such an idea is likely to be fervently rejected by the unions, it would
campaign very strongly to show that this reform is in the public interest,
and especially the large majority workers not covered by the MW in the modern
sector for whom better jobs is the main challenge. The objective would be to
garner political support for the reform, and would require considerable
political courage.
Second, the government
would put serious efforts into improving the industrial relations processes
for more productive negotiation wage increases taking into account
productivity and welfare, with a focus on increasing the bargaining power of
unions.
The bottom line of
such efforts would be to emphasize that unions have a crucial social role to
play in negotiating wages of their members, but not in setting MWs (although
unions certainly need to be consulted on the process of MW setting).
How will the
government help raise living standards among wage workers? By precisely the
innovations which began with former president Susilo Bambang Yudhoyono and
have been extended by President Joko “Jokowi” Widodo in making healthcare and
education more accessible to the poor and disadvantaged, and extending
pensions and social security to all Indonesian workers and their families.
Getting these innovations right will have a much greater effect than raising
MWs, on the welfare among wage workers and especially poorer groups among
wage employees.
Secondly, and more
fundamentally, one of the central processes of economic (and social)
development is to shift relatively poor people from low productivity to
higher productivity jobs.
This is not in any way
an argument about whether wages are too high or too low. Of course, wages for
blue collar or unskilled workers are too low in Indonesia — ranging from
around $50-300 a month depending on region and sector — by almost any
reasonable international standard.
My own research with
Moh. Purnagunawan suggests that this is mainly because of a relative surplus
of low skilled and less educated workers relative to demand, stretching back
to colonial times, on Java in particular.
Creating a MW which is
set in relation to earnings in small firms and the informal sector – maybe at
a level equal to earnings of the second quintile of wage earners – is likely
to be one important supporting reform. Hopefully it would contribute to
longer term improvements in living standards and poverty alleviation in
Indonesia. ●
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