Indonesia’s Generous Severance Packages May Soon Be Rolled Back

The Indonesian Government will soon consider a roll-back of its generous employee severance package regime. This move aims at placing the country in a more competitive position vis-à-vis other ASEAN region economies.

Major Changes to Labor Rules Proposed

Newly re-elected President Joko Widodo has promised major changes to labor rules and corporate taxes to stimulate factory output and increase employment and foreign investment. This might also help him achieve the 7% economic growth rate he promised in his first term but has not yet achieved. The President hopes these changes will be enacted by the end of 2019 with the help of his coalition partners in Indonesia’s Parliament. Reform of the country’s labor laws has been promised before but never passed. Widodo is now in consultation with the country’s business and labor communities in order to muster support for the proposals.

An Underemployed Labor Force

At present, Indonesia’s large labor force consists of millions of part-time workers, with a jobless rate of 5%. While unemployment is low, 39 million Indonesians – 30% of the country’s labor force – are underemployed, and 74 million are employed in the informal economy.

Employment Rules Hindering Competitiveness

Indonesia has one of the highest severance regimes in the world, providing employees with 95 weeks of severance for every 10 years of work (almost 2 years of severance pay). This severance regime is nearly double that of neighboring ASEAN region economies, including Thailand, Vietnam, the Philippines, and Malaysia. Also, Indonesia’s minimum wage is approximately 50% higher than Vietnam’s. Notably, Indonesia’s regional governments and city administrations set minimum wages, which can vary by sector and can lead to fragmentation of the labor market. The country’s business sector, therefore, is seeking more certainty around the minimum wage.

Labor Laws a Barrier to Foreign Investment

The country’s labor laws have been cited by the International Monetary Fund (IMF) and investors as a hindrance to investment in the country and a reason for the World Bank to rank the country lower on its ease of doing business rankings versus its peers. Manufacturers in Indonesia are limited in their ability to create greater output and compete for foreign investment with other ASEAN region economies. Increasing manufacturing capacity in Indonesia is seen as risky for foreign manufacturers as it inherently expands exposure to large severance obligations.

Part of the reason for the renewed focus by Indonesia on liberalizing its labor market is the increase in foreign businesses looking to diversify supply chains to avoid or ameliorate higher U.S. tariffs on China. And many of these businesses are looking to Southeast Asia for relief.

Manage Indonesian Expansion Carefully

Based on the stringent nature of Indonesia’s labor laws and the uncertainty of whether changes will be enacted, foreign companies should make sure to carefully assess any planned expansions in the country.

For example, due to Indonesia’s massive severance package system, be careful when calculating the “total” cost of employment. Be aware that these severances are required, regardless of whether an employee voluntarily departs or is fired. While things may change in the future and see Indonesia become more competitive vis-à-vis Vietnam and other ASEAN region economies, companies should remain cautious and ensure they work with an Asia-focused PEO to help them manage their total cost of employment, above and beyond base salary.