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

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

                                               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. ●