Will Indonesia’s Omnibus Reforms Support Recovery From COVID-19?

Author: Roland Rajah, Lowy Institute

Indonesia’s new “ omnibus job creation law ” has been spoils by the public controversy that surrounded its passage at the end of last year. The government nonetheless hailed the law as a major regulatory overhaul that would attract foreign investment and create jobs. In reality, it lacks important details, which means that its success will ultimately depend on the vagaries of implementation.

The first set of implementing regulations released this year, however, looks promising – introducing important measures to liberalize the labor market while theoretically removing a plethora of restrictions on foreign direct investment (FDI). Despite significant limitations, this is the first round of serious liberalizing reforms to be introduced under President Joko Widodo after nearly seven years in power.

While sixteen so-called “ reform packages ” were issued during Widodo’s first term, they were not ambitious enough produce much acceleration of economic growth and job creation in the formal sector. They have also failed to attract more foreign direct investment (FDI) or capture international supply chains from China, which went elsewhere in Southeast Asia.

The latest measures significantly alleviate two long-standing issues in Indonesia’s labor code for international competitiveness, while also leaving strong protections for workers. almost intact.

First, the severance payments that companies have to pay when they lay off workers have been downward revision, effectively reducing these costs by about half. This should bring Indonesia back broadly in line with its Asian peers, having previously had one of the highest severance pay requirements in the world.

Second, the rules governing minimum wage increases have been significantly tightened. This will help contain the rapid increases that have eroded Indonesia’s external competitiveness while nonetheless failing to serve as a effective safety net for workers. Over the past decade, the productivity of manufacturing labor in Indonesia has increased by less than 20 percent while the nominal minimum wage has doubled.

Future minimum wage increases will be based on either local inflation or real economic growth (whichever is greater), rather than the sum of the two – as was the case since 2015, when Widodo last attempted to tighten the rules. It’s another decent step forward. However, since increases in the minimum wage can still exceed growth in labor productivity, this remains a partial solution.

Recent FDI reforms are potentially more transformative, at least on paper. Indonesia previously had one of the most restrictive FDI policies among the 84 economies assessed by the OECD. The reforms significantly reduced the number of industries subject to FDI restrictions from 528 to 215, including in areas important for industrial modernization such as telecommunications, e-commerce, transport, vocational training and education. health.

The investment environment in Indonesia, however, is notoriously complex, not only because of rent-seeking and corruption, but also because of the inconsistencies between the central FDI policy regime and embedded protectionism at the level. sectoral.

The end result is therefore likely to vary considerably depending on the area. For example, mining is now fully open to foreign ownership, but existing mining sector policies still require a gradual divestment from majority local ownership. Given the government’s propensity to resource nationalism, the inconsistency is probably intentional. But in other areas such as telecommunications and construction, follow-up sector reforms may be more likely. Much will also depend on specific regulatory decisions and practices in certain sectors, for example medical services.

The latest reforms could ultimately be thwarted by protectionist forces. Again, world Bank The analysis suggests that the past liberalization of the central FDI policy regime has indeed led to an increase in FDI inflows – which suggests that the latest reforms will also see some materialize.

Many other obstacles remain in attracting significantly greater investment – from infrastructure failures to the proliferation of non-tariff barriers that limit access to the best inputs and make it difficult to participate in complex supply chains that cross international borders. In the immediate term, overcoming the pandemic and reviving the national economy is an absolute necessity – especially since Indonesia’s large domestic market is a key point of attraction for foreign investors.

Indonesian policymakers are nonetheless right to take FDI more seriously as a key element of the recovery strategy. Not only does FDI generally confer significant productivity benefits, but in the aftermath of the pandemic, other means of financing Indonesia’s growth and development will be severely constrained. Banks, state-owned companies and private companies will all be damaged financially, hampering investment. And if fiscal policy is to be used to support the recovery, the ability to do so will be hampered by an increase in debt service payments and the imperative to bring the budget deficit back to the normal legal limit of 3% of GDP. on time.

As domestic demand recovers, the current account deficit could also return as a key macroeconomic vulnerability. The US Federal Reserve will ultimately seek to unwind its crisis policy parameters. This could threaten a rebroadcast of 2013 ‘Taper Tantrum’ but at a potentially more damaging time. With such risks on the horizon, relying more on FDI rather than volatile portfolio flows would be a real advantage.

Roland Rajah is Senior Economist and Director of the International Economics Program at the Lowy Institute.

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