NCPA - National Center for Policy Analysis


December 8, 2006

Business people, government officials, economists and even some labor activists say Indonesia's 2003 labor law is discouraging new investment at a time the country urgently needs to create jobs.  The law may be costing Southeast Asia's largest economy a chance to lure foreign shoe, garment and other manufacturers looking for alternative production sites to China, where wage costs are on the rise, says the Wall Street Journal.

Employers say Vietnam -- where wages are lower and productivity higher than in Indonesia -- is well placed to woo manufacturers looking for new bases outside China. Indonesia should also benefit from this move away from China, they add, but the labor law is proving a major deterrent to investors:

  • The law requires that dismissed workers in all industries, both foreign and locally owned, receive up to several years in severance pay; even employees who quit are entitled to payouts.
  • The World Bank estimates that legally mandated severance costs in Indonesia are on average equivalent to 108 weeks of pay, based on assumptions including 20 years of full-time employment, making the country one of the costliest in the world in which to fire workers.
  • The law allows local governments to set minimum wage increases for private-sector workers, rather than letting employers link the annual raises to productivity.

Meanwhile, quotas imposed this year by the European Union on shoe imports from Vietnam and China created a surge in interest in Indonesia.  But "when companies come to see us, and see this labor law, they postpone" investment, says Eddy Wijanarko, chairman of the Indonesian Shoe Manufacturers' Association, and whose company makes goods for British retailer Marks & Spencer Group PLC.

Labor issues add to Indonesia's investor woes including poor infrastructure, widespread government corruption, an unreliable judiciary and complicated bureaucratic procedures, says the Journal.

Source: Tom Wright, "Indonesian Labor Rules Take Toll on Investment: High Severance Costs Deter Manufacturers; Turning to Vietnam," Wall Street Journal, December 6, 2006.

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