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In 2003, five years after the fall of Indonesia’s autocratic late President Suharto, the first democratically elected Parliament passed a wide-sweeping labor law that gave workers many benefits, including the freedom to organize.

Since then, the government has encouraged foreign investment while avoiding angering organized labor or employers. However, President Susilo Bambang Yudhoyono has found it increasingly difficult to stand up to labor interests. In 2006, he was forced to withdraw his attempt to amend the labor law after unions objected. The global financial crisis has exacerbated these basic labor tensions in Indonesia, and HR managers of multinational companies should be aware of resulting shifts in wage and labor policies.

Since September 2008, nearly a quarter of a million jobs have been lost in Indonesia. Foreign managers have been confronted with domestic labor debates and international financial pressures. Striking employees, worker migrations, layoffs, and minimum wage and severance pay debates continue to shape the labor climate in Indonesia. These have taken form as the future key problems facing HR managers and the government.

Labor Law Background

Indonesia’s 2003 labor law is generally seen as favoring workers over employers. As such, the Indonesian Employers Association (APINDO) proposed changes to the law in 2006. These included restricting the right to strike, loosening minimum wage provisions and allowing employers to discipline workers. APINDO sought to make it easier for foreign investors to hire expatriates for managerial positions. These changes never solidified.

When the Indonesian Legislature proposed other changes in 2006, Indonesian unions threatened strikes. Proposals included phasing out service pay for dismissed workers and cutting other required payouts by up to 50 percent. The Federation of the All-Indonesian Workers Union (KSPSI), which represents 250 unions nationwide, fought back. In May 2006, KSPSI leaders led rallies of thousands of workers in major cities in Java and in front of the presidential palace, forcing the government to drop its plans.

It remains very difficult to attract new foreign investment into Indonesia. The political ramifications of inaction might play a key role in the Indonesian presidential election in 2009.

Global Financial Crisis

In addition to 250,000 jobs lost since September 2008, the International Labor Organization predicts that 170,000 Indonesian workers will be laid off in 2009 as a result of the global financial crisis. The unemployment rate in Indonesia is estimated to be more than 8 percent and rising.

Meanwhile, the demand for Indonesia’s export products, including textiles, rubber and fabricated goods, has decreased with the current economic downturn. The electronics and automotive sectors in Jakarta have been hit especially hard. In 2009, production in both sectors is projected to drop by more than 30 percent.

In order to cut labor costs further, companies are looking to reduce wages. Factories are moving from Jakarta to smaller towns because of the difference in the minimum wage. Jakarta’s monthly minimum wage was 972,604 rupiah in 2008 (about $80 in U.S. currency), and the government has planned to raise the wage to 1,069,865 rupiah (about $89 U.S.) in 2009. Minimum wage in more rural areas can be as low as 500,000 to 700,000 rupiah (between $41 and $58 U.S.).

Labor Costs

Labor costs account for about 5 to 6 percent of production in Indonesia. With the exception of Vietnam, labor costs in Indonesia are lower than those in any of the other 10 members of The Association of Southeast Asian Nations (ASEAN). However, there is a high cost for terminating workers, which has become increasingly relevant as layoffs increase.

Because the law requires paying severance fees to terminated workers, most companies prefer to allow worker contracts to expire rather than fire permanent workers. Upon laying off workers, employers must pay compensation for time worked, severance pay and service pay. Severance pay includes one month’s salary in addition to one month’s salary for each full year worked. Those who have worked more than three years are entitled to an additional month’s salary for each three-year period as service pay. As such, Indonesia has been ranked by the World Bank as the world's sixth-most-expensive place to dismiss workers and the second-most-expensive in Asia, after Sri Lanka.

According to the World Bank, Indonesia is the only major economy in Southeast Asia that did not experience a growth slowdown in the first half of 2008. However, its growth is projected to fall from 6 percent in 2008 to approximately 4.4 percent in 2009.

The global financial crisis is expected to have its most profound effect on foreign investment and exports.

In the meantime, the debate among labor, employers and the government over the best ways to bring in foreign investment will continue. The government might have to reform minimum wage and severance pay policies to account for the economic downturn—and resulting unemployment—and attract corporations back to the larger cities.

These issues will be brought to the forefront in the Indonesian presidential election occurring in 2009. And, to the benefit of employers, a new political climate might bring a change in course from the 2003 labor law.

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