Indonesia's employment challenges : growth, structural change and labour market rigidity

Indonesia continues to bear the scars of the 1997 financial crisis, with the highest open unemployment rate in Southeast Asia. The orthodox interpretation is that the post-crisis era in Indonesia is typified by overly generous labour legislation that has seen an aggressive pursuit of minimum wages and other provisions. The consequent rise in real wages adversely impacted the investment climate and impeded employment growth in the formal sector. Detailed sectoral analysis reveals very little evidence of a wage-driven cost squeeze on profit margins. Econometric estimation of sectoral employment functions shows that output growth plays a more significant role in determining employment than real wage. This is also confirmed by enterprise surveys which reveal that current labour legislation is not at the top of the list of concerns among investors. Thus, this paper contends that Indonesia’s current labour woes are best understood as the reflection of structural change and a demand constrained economy. Any employment-creation strategy must therefore consider both demand and cost factors.