Gauging Macro-Economy Against a Narrative of Expectation

Regarding the recently released 2020 budget proposal, it is the goal of overall labor-market development and quality improvement that should serve as a paramount focal point around which to gauge the general climate of economic development. Here one would do well to consider the recently published work of Jens Beckert, Richard Bronk, and Robert Boyer on the dangers of popular ‘narratives’ in economic forecasting. Indeed, one could say a mainstream ‘grand narrative’ of economic development in Indonesia seemingly converged around the idea of an ever-expanding formal labor sector driven by manufacturing and services expansion due to capital liberalization and foreign investment, but blindly subscribing to any ‘grand narrative’ creates potentially critical pitfalls.

The strength of a given state’s ‘labor-market’—the availability of employment and labour in terms of supply and demand—is undoubtedly a good measure of economic climate, but only insofar as one takes care to note the intricate dynamics of labor development. Regarding Indonesia, this means acknowledging the paramount saliency of the formal-informal employment sector dichotomy as one axiom for understanding. While many articulate that Indonesia will require foreign direct investment (FDI) and a general increase in aggregate demand to accommodate the youth labor-force, the principal challenge for labor-market improvement will be transferring concentration from the informal to the formal sector. This problem is one that is too often misunderstood, over simplified, or eschewed. In reality, such a transfer is intricately dependent upon public regulatory policies; and upon macroeconomic policy trends, which influence domestic and foreign investment; and the relationship of such investments to regional variations in geographical isolation and available employment opportunities.

Challenges of Labour Improvement: Disaggregating the Components

The overall unemployment rate in Indonesia currently hovers around a modest 5.01 percent. Yet the exact ratios of formal to informal employment have been notoriously difficult to pin down—data from BPS shows that the informal labor sector accounted for just under 60 percent of employment in 2015, an alarming indication, especially given that today, the percentage has only decreased to roughly 57.2 percent. Consequently, while the major challenge for labor-market improvement should be understood broadly as propagating the formal sector, underlying dynamics certainly induce further complexity. Thus, considering labor-market improvement in Indonesia necessarily becomes a manifold analysis.

At the basic level, for a marked expansion/improvement of the formal labor-market to occur, there must, of course, be an increase in the supply of available (or potential) labor. Indonesia is indeed poised to realize such an attainment, as the number of working-age citizens has now increased to dominate the population demographically, making youth employment trends decisive. This fact largely constitutes the driving impetus for President Widodo’s public initiative to strengthen or improve the labor-market. However, in addition to a heightened supply of available labor, there must also be an increase in demand for such formal labor. In this regard, there is certainly potential for expansion in demand. However, the current demand for formal labor remains secondary to the broadly expanding labor force, increasing the draw of the informal sector.

The excess in labor supply is indicative of a general trend in the history of Indonesia’s economic development, and the result has often been the diffusion of eligible workers into the informal economy—especially in eastern regions, where infrastructure development is relatively lagging, while informal employment opportunities have historically been buttressed by both a literal and figurative distance from the central state and the financial capital. In this line, formal labor-market improvement should not be viewed only as a matter of increasing a general demand in order to leverage an abundant supply, but rather as a matter of cultivating an increase in general demand across a comprehensive geographical landscape—it is not sufficient to simply increase employment opportunities across Java or Kalimantan, for example, as the tendency for internal labor migration amongst Indonesians from varying regions appears understudied or under-measured. In principal, to fully realize the labor force potential in Indonesia, formal employment opportunities must present across a vast geographical landscape.

It is certainly true that formal labor opportunities must also present with incentives to woo potential workers away from informal occupation. Here it is fitting to consider a brief history of successful formal labor-market improvement. Historically, it has been manufacturing industry expansion which has shown to be exceedingly effective in precipitously increasing and maintaining formal employment—the industrial revolutions of the West were primarily responsible for constructing both a working-class and its labor organizations (or unions) and regulatory legislation, stabilizing and crystallizing the working-class-dominated formal employment sector as, in a sense, an institution of the capitalist state. Consequently, labor organization and political mobilization largely became key in maintaining a homeostasis of stability in the labor-market.

Moving away from the West, the effectiveness of manufacturing industrial expansion is evidenced by the robust expansion of formal employment and the development of a pribumi (‘indigenous’) middle-class in Indonesia under Suharto’s late-20th century liberal capital reforms, which opened the country to FDI and propagated an increase in private-run enterprise. As a consequence, in a move away from reliance on agricultural production, manufacturing jumped to account for roughly 40 percent of overall production by 1980—an unprecedented rise given that it had only accounted for 15 percent in 1960. In this line, the ‘grand narrative’ of economic development in Indonesia began to converge on the idea of an ever-expanding formal labor sector driven by manufacturing expansion. Evidence for continued subscription to this narrative can even be identified in considering President Widodo’s past fiscal policy emphasis on state investment in skills training for the burgeoning working-age as a means to labor-market improvement, signaling that expectations have formed around the idea that the population will need to meet a labor demand. The narrative does present truth, as Indonesia remains above the global average in regards to the manufacturing sector’s proportion of GDP—after the financial crisis, manufacturing renewed in growth as a percentage of GDP, continuing its climb until 2003 when it peaked at roughly 30 percent. However, looking at data from the World Bank and International Labor Organization (ILO) shows a retraction after 2003, and by 2018, the sector had fallen back to roughly 20 percent of GDP.

Overall, considering the two decades following the 1997 financial crisis, labor-market development has been, in fact, acutely subdued over certain discrete periods, which has bread much speculation as to the true mechanisms or drivers of formal labor-market expansion, stagnation, or retraction. Many have argued that increasingly liberal labor legislation (including the propagation of a relatively high minimum wage) constituted the root cause of post-crisis stagnation or retraction, leading to a climate of passive disdain (largely within the international community) over labor representation and legislation—a sentiment that still appears to permeate even academic discussions today. However, considering that formal labor interest representation first began to take shape with legislation under Suharto in the early 1970s (ahead of robust formal labor-market expansion and improvement) begins to suggest that a deeper look is necessary. Although it is argued that ‘Indonesian Industrial Relations’ (enacted in 1974) served to suppress workers, it did, nevertheless, demarcate industrial workers as a represented constituency within the state, arguably setting a precedent for subsequent labor representation and legislation. While broadly, so-called ‘liberal labor legislation’ has invoked much suspicion as to its role in restricting economic development in Indonesia, more nuanced arguments have suggested otherwise.

In a detailed analysis for the ILO (2009), scholars at Western Sydney University show that formal employment trends unsurprisingly coincided with trends in Indonesia’s overall GDP growth, reinforcing the idea that macroeconomic policy and its relationship to the nature of FDI is far more integral to sustaining a paradigm of formal labor-market development.[i] This surely remains a more accurate line of reasoning, especially since reinvigorated FDI since 2016 correlates with a renewal in formal labor-market development in the services sector, even without overhauling legislative changes to labor regulation. Indeed, instead of labor legislation, it is likely that overarching macroeconomic policy trends have been restricting the potential for precipitous gains in formal employment by, in part, dampening state revenue. According to a study by Paul Gellert (2019), state tax policies on extracted resource exportation have largely left revenues from a major commodity, palm oil, subject to the independent global market, as taxes are only levied in times of increased demand.[ii]

With all this in mind, references to ‘improving or expanding the labor-market’ are essentially grounded in a need to integrate working-age, working-class citizens into the formal economy, which is a challenge made difficult by the sparse geographical clustering of FDI, lacking infrastructure, uncertainty over future general aggregate demand, and a burgeoning working-age population. Additionally, noting the existence of labor organization and representation is necessary because, as previously mentioned, regulatory incentives drive the flow of workers toward Indonesia’s increasing formal sector. Consequently, a key take-away should be that continued formal labor-market development rests not upon the loosening of labor interest legislation (public policy), but rather more upon the broad macroeconomic (or fiscal) policy climate, which directly influences available capital for infrastructure improvements in remote regions, prospects for manufacturing expansion, and public health spending. Positive developments relating to all of these factors should be seen as a necessary driver of personnel integration within the formal economy.

A Contemporary Panoramic View

While the overarching paradigm of regional geographical isolation and a sizable formal-informal employment dichotomy renders labor-market dynamics in Indonesia as a complex system, it is fitting to note where contemporary trends continue to impact improvement efforts.

According to March 2019 data from Indonesia’s BKPM, FDI remains geographically concentrated across Java, Kalimantan (likely due to preparations for the state’s capital relocation), North Sumatra, and Sulawesi. Eastern regions and the Maluku Islands, for example, still remain heavily neglected by outside investment. This, of course, does not preclude domestic investment as an effective tool for expanding formal employment options in these regions, but it does restrict potential avenues for robust expansion. However, indicators of growing state potential are evident too.

A 2019 report on ‘Village Law’ from the World Bank discusses how infrastructure improvements in isolated, rural areas routinely utilize local labor instead of government contractors and/or outside workers. In this way, the relative decentralization of regulatory policy-making works in favor of labor-market improvement, as it introduces the capacity for regional oversight. This renders the prospects of formal labor-market integration in long-neglected regions promising insofar as the budget allocates sufficient capital for remote infrastructure development. Subsequently, any economic outlook should consider how the 2020 budget allocates capital for projects across the extent of the archipelago.

Regarding macroeconomic policy and FDI, in line with Paul Gellert’s findings, macroeconomic policy trends since 2003 have largely propagated a shift toward incentivizing FDI in extractive industry. This is no secret. The state’s macro-policy strategy of downstream investment in mineral resource processing has left upstream extraction opportunities wide open, while propagating continued state-ownership of ‘linkages’ in the extracted resource supply-chain. In much the same way as Suharto’s quasi-pivot back toward state-run enterprise in the early 1990s, this shift likely bares a great deal of responsibility for the post-2003 retraction of robust manufacturing industry growth. According to BKPM’s March 2019 numbers, manufacturing now ranks 15th out of 22 listed sectors attracting FDI—well behind mining. FDI’s ability to facilitate increased formal employment opportunities through investment in extractive industry is limited. While, extractive industry in Indonesia undeniably generates critical capital for the state, allowing it to pursue important development strategies, extractive projects often utilize low-wage labor and require less manpower. Having said this, what appears to be a renewing trend of foreign investment within the services could off-set extractive industry’s pull, but this will largely depend on the nature of both national and global aggregate demand.

One salient development to watch is the impact of the recent ‘Indonesia-Australia Comprehensive Economic Partnership Agreement’ signed in March 2019, which will facilitate trade between the two states by eliminating Australian tariffs on Indonesian imports and eliminating roughly 99 percent of Indonesian tariffs on Australian imports. Examining the Australian business coalition advocating the agreement shows a mix of various industries, including many extractive-oriented businesses. A paradigm in which ‘extracted’ commodities dominate subsequent trade would have an impairing effect on the potential for labor-market improvement. Alternatively, diversification in traded goods and services could have widely beneficial impacts for formal labor-market improvement.

Labor-Market Improvement: Necessity and Complexity

While the ‘grand narrative’ of an ever-expanding formal labor sector driven by manufacturing through capital liberalization and FDI has manifested to some degree, critical analysis sheds some insightful light on the nuances and contradictions in Indonesian labor-market development. In this way the picture becomes markedly more complex. Yet the fact remains that the idea of improving the labor-market inherently relies upon narrowing the formal-informal employment gap. This can happen in sometimes-unexpected, undirected ways.

Returning to lessons from historical analysis, even though formal labor-market expansion stagnated in the aftermath of the financial crisis, in a true display of complexity, formal labor gained a stronger foothold in the rural, agricultural-dominated regions. In other words, while FDI dropped off and the manufacturing industry stagnated, a previously large informal employment sector (agricultural production) was further integrated into the formal labor-market sphere—a point supported by the aforementioned 2009 ILO report. As job-loss led to an exodus of workers from industry-dominated developed or centralized areas toward rural regions just as ‘Decentralization’ policy was extending regulatory autonomy to local ‘provinces’ and ‘regencies’. In this way, the integrity of the labor-market saw a relative strengthening or ‘improvement’, even under otherwise stagnant or retracting conditions.

Of course, the surmounting challenge posed by a working-age surplus is undeniably relevant to Indonesia’s long-term economic development. Generally, unemployment propels social and political instability—a particularly important factor when considering Indonesia, as latent populist politics and/or religious conflicts could gain renewed traction. Even introducing the variable of informal employment opportunities still means vital tax revenue is left untapped, restricting the state’s social and infrastructure development projects. Informal employment also maintains workers as outside of labor regulation and thus as outside of its inherent protections. In this way alone, ‘jobless growth’ (as it relates to the formal sector) is too obviously unsustainable.

The historical relative emphasis on state investment in skills training and education as a means to labor-market improvement was arguably too narrow. Given a macroeconomic policy paradigm that still incentivizes extraction together with the continued strength of the informal sector (especially in isolated regions), labor-market improvement will require broader policy and investment strategies. The 2020 budget, and the chatter surrounding it, suggests that such a turn will likely further materialize, facilitating increasingly diverse foreign and domestic investment opportunities and the subsequent realization and integration of amassing labor potential. Yet while altogether promising, those with assuredness should be wary of linear thinking—considering complexity can lower the risk of surprise.

Charles Baker recently graduated from Yale University with B.A. in Political Science, focusing primarily on Indonesia and the MENA region. He is currently finishing his MSc. in Political Sociology at The London School of Economics, where he devotes his time to studying Islamic politics, economic sociology, and the emerging global trend of populism. He also speaks Bahasa Indonesia.

[i] Chowdury, Anis et al. (2009). “Indonesia’s Employment Challenges: Growth, Structural Change, and Labour Market Rigidity”. European Journal of East Asian Studies.

[ii] Gellert, Paul. (2019). “Neoliberalism and Altered State Developmentalism in the Twenty-First Century Extractive Regime of Indonesia”. Globalizations.