MEMORANDUM

Thanks to robust growth in the Indonesian and Jakartan economy, the

Territory has managed to avoid major increases in unemployment or in the

share of the informal economy, in spite of the global economic crisis (BPS

Jakarta 2010). As you know, eliminating the informal economy—through

coercion if necessary—was a major priority for your predecessor Governor

Sutiyoso. While the pervasiveness of informal labor presents several

significant social and fiscal drawbacks, it should now be painfully obvious

that attempting to punish it away is fruitless and destructive. It is impossible

to chase the informal sector into the formal economy through sticks as

Sutiyoso attempted by imposing crushing fines on poor street vendors (BBC

2007); rather, it must be enticed. Fortunately there are ways to accomplish

this over time.

In the following I describe the nature of informality in the Territorial

economy, and discuss some of its benefits and disadvantages. I also outline

several potential policies that could potentially be used in an attempt to

strengthen the Territory’s labor market, before concluding with my

recommended policy strategy for your consideration.

Informality in the Territorial Economy

An employment arrangement is considered informal if the

“employment relationship is, in law or in practice, not subject to labor

legislation, income taxation, or social protection” (Cuevas et al 2009, 2).

1

Several types of informal arrangement exist. Formal enterprises may employ

workers without reporting the relationship, providing any benefits, paying

the minimum wage, or providing a contract. And of course informal

enterprises nearly all operate in such a manner. Moreover, workers may be

informally “self-employed” though own-account work in informal enterprises

or unpaid family work (ibid.) Each of these different sorts of arrangements

presents its own opportunities and challenges, and will have to be dealt with

in its own way.

Parsing out the exact extent of informal labor in the Territory is not a

trivial task. Actually, it is not technically difficult, but it requires the

willingness to make generalizations that are wrong in many individual cases.

The available statistics from the Central Statistical Agency (BPS) make

possible at best a rough approximation of informal activity, for their survey

does not ask questions sufficient to establish with certainty in most cases

whether workers are engaging in informal employment. The most relevant

question relates to employment status (Cuevas et al 2009, 7). Casual and

unpaid work is certainly informal. Own-account workers and employers with

temporary or unpaid workers could be working either formally or informally,

but for convenience, both will be measured as informal. Likewise, employees

or employers with permanent workers may or may not be working formally,

but they are assumed to be working formally. This is the set of assumptions

recommended by BPS Jakarta and taken by some studies of the informal

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economy in the country (for example see Chowdhury et al. 2009 and BPS

Jakarta 2010).

Figure 1 presents the results of these assumptions. Thirty-four

percent of the Territory’s employment is within the context of informal

arrangements. While this may seem small in comparison with the national

average in February 2010 of 68% of workers—due to the preponderance of

informal work in agriculture—it is huge compared with developed countries,

and certainly much greater than the Governor should be willing to accept

given the Territory’s potential for increasing greatness.

Figure 1 Jakarta Labor by Employment Status (Source: BPS Jakarta 2010)

Feb-08 Feb-09 Feb-10

Employment status Men Women Total Men Women Total Men Women Total

InformalOwn-

account 449,460 233,180 682,650 576,200 308,270 884,470 604,350 325,100 929,450Employer with temp.

workers 139,220 89,560 228,780 169,780 114,310 284,090 136,030 92,630 228,660Casual worker 69,390 24,400 93,780 60,430 28,280 88,710 72,380 41,560 113,940

Unpaid 56,310 153,600 209,920 54,720 172,080 226,800 43,300 133,800 177,100Total

informal 714,380 500,740 1,215,130 861,130 622,940 1,484,070 856,060 593,090 1,449,150

FormalEmployer

with permanent

workers 138,230 37,740 175,960 168,020 39,330 207,350 164,790 35,520 200,310

Employee 1,585,280 1,078,610 2,663,890 1,490,680 1,004,860 2,495,540 1,544,880 1,014,560 2,559,440

Total formal 1,723,510 1,116,350 2,839,850 1,658,700 1,044,190 2,702,890 1,709,670 1,050,080 2,759,750

Total 2,437,8901,617,09

0 4,054,9802,519,83

01,667,13

0 4,186,9602,565,73

01,643,17

04,208,90

0Percent informal 29.303 30.965 29.966 34.174 37.366 35.445 33.365 36.094 34.431

As can be inferred from Figures 1 and 2, women participate in the labor force to a much

lesser extent than men, having comparable or lower unemployment rates (BPS Jakarta 2010).

Surprisingly, perhaps, they are only a bit more involved in informal activity than, men as a

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percentage of jobs. On the other hand, this fact is skewed by the nature of activities undertaken

by men that are classified as informal. For although men perform a higher portion of work on

their own account and as employers of temporary unpaid workers—which could be considered

as sitting atop the informal ladder—women are much more likely to be engaged in unpaid labor.

This suggests that women are much less likely to find acceptable work, formal or informal,

outside the home, and so are driven to take unpaid or domestic work in the family. Hence, the

informal economy reflects and assists in reproducing the gendered division of labor in Indonesia.

Figure 2 Men's and Women's Employment in Jakarta (Source: BPS Jakarta 2010)

Jan-08 Jan-09 Jan-100

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2,000,000

Men's Formal EmploymentWomen's Formal EmploymentMen's Informal EmploymentWomen's Informal Employment

Costs and Benefits of the Informal Economy

The presence of a large informal economy has both costs and benefits

—though this does not imply that there is not ample room to reduce the

costs while retaining some of the benefits. The advantages provided are

easy to describe. High productivity sectors are growing in Indonesia and in

Jakarta in particular, but they are nowhere near large enough to absorb (and

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thus provide subsistence for) the entire population. Own-account workers

and small enterprises in low productivity sectors are may not be able to exist

while meeting the costs of incorporation into the formal economy. Another

way to consider this is that the informal economy exists because economic

actors decide that the costs of incorporation outweigh the benefits (and

avoidance of fines) provided to them by the state in exchange. Either way,

the informal economy enables many Jakartans to provide for themselves in

spite of inadequate provision by high productivity enterprises. These

Jakartans are generally those who are most disadvantaged in the political

economy. Second, informal vendors in particular can actually satisfy

consumer choices in ways that may not be possible if they were policed out

of existence. Is there any formal enterprise that could provide the quick,

delicious, and cheap street food preferred by many commuters and

shoppers? It is uncertain.

There is a third, more dubious benefit. Some employers see informal

hiring as a way to add flexibility to their labor inputs. To the extent that

Territorial and national labor market policies constitute an excessive

constraint on local business and worker decisions, informal work can be a

good way to circumvent some of the policies which may not work well for

them. Certainly there are a few instances in which some of our labor market

policies may not benefit either the firm or the worker.

5

But to the extent that our policies constitute good judgment, however,

the informal economy is a problem. It institutes anarchy in a field where

there should be order and fairness. This is the essential problem: informal

economic activity prevents regulation of that activity to the individual and

common good of the citizenry. First of all, government has a responsibility to

protect both firms and individuals from predatory behavior and exploitation.

At the enterprise level, informal businesses may be subject to extortion by

gangs, thugs, or other illegal turf-based organizations (Jakarta Post 2011).

Informal enterprises may feel unable to reach out for government protection

in such instances, which is a harm both to them and to the community, as

illegal operations may be funded in part by their exactions. More

importantly, informality circumvents the numerous employment benefits and

protections required by law, exposing workers to exploitation. Labor

regulation is intended to ensure that jobs constitute a positive benefit to

workers; informal labor relations utterly defeat this purpose. Finally,

informality can exacerbate divisions and inequality between the working

class and the very poor (or between men and women) by reinforcing a

hierarchy of labor in society. This could help you if your goal is to help secure

the ability of capital to divide and thus exploit the labor of the lower classes;

but if your goal is to increase equality and the vibrancy of Indonesian

democracy, it could pose an obstacle.

Some informal activities may discourage, or appear to discourage,

opportunities for higher-end consumption and tourism in Jakarta. More

6

affluent consumers may be offended by some street vendors, buskers,

informal street services, or mendicants. Formal enterprises may also

consider informal businesses to constitute unfair competition, since the latter

are able to price-compete without bearing the costs of regulation. Both of

these issues can be safely discounted from an economic standpoint, though

you should be aware of them politically. The concern about barriers to high-

end consumption probably derives mostly from the preferences of elites,

rather than any material fact. And few formal vendors market compete for

the same segments as informal enterprises; for if the their market strategy is

similar enough, formal business seriously threatened by informal competitors

can probably go informal themselves.

A final problem to consider is that the informal economy is not directly

taxed,1 thus reducing the already scarce resources of the Territory’s

exchequer—in spite of the fact that informal activities depend on public

goods provided by the government. Granted, in many cases, a properly

progressive tax system will extract few if any resources from those taking

advantage of informality, but this is not always true. For instance, informal

employees or business owners may certainly produce enough to justify

taxation. Moreover, the question of whether to be taxed should be at the

discretion of the state, not the firm or the individual.

1 Though some informal activities could be taxed; it would require an extra step in collection and introduce several complications. This could be one unusual strategy for reducing the incentive to go informal.

7

In sum, the informal economy can both a scourge and boon. Its

greatest benefit is to provide a means of subsistence in a context of

insufficient highly productive work; its greatest vice is its failure to protect

workers. Yet this apparent duality is not a strict tradeoff. Policy can and

should strive to maintain the benefits provided by informality, while

simultaneously moving towards formality for much informal work. Moreover,

the harm produced by some informal work can in many cases be mitigated

without necessarily forcing a choice between conformity or closure. The baby

need not be thrown out with the bathwater.

Possible Policy Approaches

There are a great number of ways to address the informal sector. The

first important thing to remember throughout this discussion is that, as

discussed above, the informal economy is far from monolithic. When

discussing costs and benefits, it was not difficult to imagine which types of

informality each applied to. Similarly, different policy approaches will target

different parts of the informal economy; some, by inducing employers to

obverse labor regulations; others, by producing good jobs in the formal

sector that attract workers from informality; yet others by converting

informal enterprises to formal businesses or cooperatives. The principal

standard by which policies will be judged is the extent to which they manage

to maximize opportunity and equality while eliminating situations of

exploitation.

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Improving formal sector labor market flexibility

Soeharto’s resignation and the establishment of a pluralist democracy

in Indonesia precipitated a decided shift in favor of labor rights and

standards. The country is now considered to have one of the most regulated

labor markets in the developing world (Manning 2008, 6). The market

flexibility argument maintains that strong unions, minimum wages,

severance payment requirements, and other forms of market “rigidities”

discourage hiring by raising the cost of labor above its marginal productivity

and by increasing risk. There is certainly some merit to this argument from

the standpoint of neoclassical economics; moreover, both national severance

pay rates and the Territory’s minimum wage are comparatively quite high

(ibid, 8). If labor regulation were harsh enough to be a primary cause in

driving workers into informal arrangements, it might be wise to pursue

policies to improve market flexibility. After all, there is little point in having

regulation if that regulation drives more people to avoid regulation. You

could press the national government to reduce severance rates, and attempt

to lower the minimum wage in Jakarta.

It is far from clear that market rigidities are a primary cause of

informality, however. The evidence of labor market inflexibility reducing

employment is mixed (Howell et all 2007; Baltar et al 2010). While the

neoclassical argument is theoretically strong, it is less compelling in

predicting exactly which sorts of rigidities lead to which quantities of job loss

9

or informality. There are also reasons to believe that good labor market

regulation can improve standards without reducing employment—for

example by increasing productivity. Additionally, informality in Indonesia is

comparable with other countries at similar levels of development. Such

countries have greatly varying labor market regulatory regimes, while many

high-income states with very small informal sectors also have very high labor

standards. There is little particular reason to suppose that the path to high

standards and minimal informal economies requires weak standards at

earlier stages. Finally, national labor market outcomes are currently strong

due to strong growth—with unemployment falling and formal employment

rising in tandem with informal employment over the past six years, in spite

of supposed rigidities and in spite of the global recession (see Figures 3 and

4; note that BPS considers discouraged workers to be unemployed).

Figure 3 Informal and Formal Employment in Indonesia (Source: BPS 2011)

2004

2005

(Nov

)

2006

(Aug

)

2007

(Aug

)

2008

(Aug

)

2009

(Aug

)

2010

(Aug

)0

10,000,00020,000,00030,000,00040,000,00050,000,00060,000,00070,000,00080,000,000

Formal EmploymentInformal Em-ployment

10

Figure 4 Indonesian Unemployment Rate (Source: BPS 2011)

2004

2005

(Nov

)

2006

(Aug

)

2007

(Aug

)

2008

(Aug

)

2009

(Aug

)

2010

(Aug

)02468

1012

National Unemployment Rate

Unemployment Rate

Structural or demand-side solutions: addressing informality through

industrial policy

The rest of the strategies discussed seek to diminish the informal

sector without reducing labor standards. The main drawback to these

strategies is that sometimes they can be expensive and may not significantly

improve outcomes if they are not thoughtfully designed and implemented.

There are successful examples of each of them, however, and in each of

them rests considerable hope.

The natural counter to the neoliberal flexibility approach is the

strategic us of structural and demand-side economic policy (Chowdhury

2009). This policy does not specifically target the informal sector, but by

increasing opportunities in highly productive sectors, it should sustainably

reduce Jakarta’s dependence on the informal economy. Industrial policy

should seek to develop industries that have a chance of competing globally

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in the long run, that are highly productive, complement existing industries,

and are currently capable of being developed within the Territory (Lal 2008,

123). Naturally, deciding which industries to target and how to develop them

is no simple task; but the details of industrial policy will be left to other

reports.

An important aspect of this strategy is to improve Jakarta’s potential to

develop quality jobs. One tactic, which can safely be used in periods of

relatively slow growth, is to use targeted investments in infrastructure to

increase aggregate demand while creating public goods that may be

beneficial to a variety of productive industries. Both industrial policy and

reductions in the informal sector will also require large investments in health

and education, for the reproduction and socialization of a workforce which

can meet the demands of high quality employment.

Working with the informal sector to raise standards and productivity;

Tutelary enforcement

How should existing informal enterprises and work arrangements be

dealt with? Informal economic activity is illegal, but given its pervasiveness

in the Territory, strict enforcement is neither possible nor desirable—unless

unemployment rates frequently in excess of 45% are deemed an acceptable

outcome. First of all, the government should be able to coax informal

establishments into the formal sector if it provides benefits to incorporation

12

that exceed the burdens. Fortunately the government has benefits it could

provide.

Industrial policy, for one, can and should specifically target existing

informal clusters. This need not be a particularly expensive strategy. First of

all, once firms in a cluster realize that the government is paying attention to

them and is committed to bringing them into the formal sector, they may

exert the extra effort necessary to comply with regulations (Tendler 2002, 6).

The tutelary enforcement model—allowing some leniency while firms learn to

comply, but also promising consequences in the case of stubborn defiance—

can facilitate this process (Schrank and Piore 2007, 15). Additionally,

government can facilitate collaboration between small firms and seek to link

them with other complementary formal and informal sectors. Most

expensively, government resources can target financing, infrastructure, and

technological upgrading in informal clusters (Lal 2008, 123).

The current mode of enforcement against informal work in the

Territory is not only unfair and regressive—it also probably does not work.

The government policy enacted during Governor Sutiyoso’s term exacts

exorbitant fines on selected segments of the informal economy, especially

the more visible own-account workers and vendors (BBC 2007). By focusing

on the most visible forms of informal work, they unequally apply the law,

which belies their motivation for enforcing the law in the first place. Worse,

informal workers generally have no alternative to informal work—aside from

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the up-to-six months spent in prison—so punishing them outright is unlikely

to prevent them from working informally in the future. This point

demonstrates the necessity of upgrading and adopting a tutelary, rather

than punitive, approach to enforcement.

Increased social welfare decoupled from the employment relation

Decoupling social protection from the employment relation would

provide a basic minimum of provision while simultaneously introducing

increased market flexibility (Lal 2008, 123). One possibility would be a

universal basic social allowance, modeled after Brazil’s Bolsa Familia. The

benefits conferred by such a policy are clear. Most relevantly, workplace

exploitation becomes difficult to maintain when families have an alternative

survival strategy. All families, except those with high enough income levels

to be net contributors, would experience increased living standards. And

decoupling benefits from the employment relation would reduce the onus on

business to provide for individual workers, thus reducing the costs and risks

of hiring. Such a policy would clearly be extremely expensive; certainly it is a

massive redistributive policy. If enacted at the local level, the policy would

risk rapid and unsustainable urbanization; hence, you would have to press

for it to be enacted at the national level. Given that 68% of the workforce is

in the informal sector, however, organizing a national coalition around it may

prove quite feasible. The allowance could be made conditional on compliance

with some basic, easy to follow requirements, such as the truthful

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registration of family employment activities. Finally, the deadweight loss

represented by such a large redistribution may be offset by the advantages

incurred by an increase in domestic aggregate demand, and would certainly

be justified by its redistributive aims.

Incidentally, the institution of a social allowance could potentially be

packaged with a decrease in severance rates or the minimum wage, if

politically necessary. The potential power of a basic social allowance to

guard against exploitation might well justify such a maneuver.

Encourage the organization of informal workers in formal or linked

establishments

This final approach would target the employment relation of workers informally

employed in formal enterprises, or in establishments closely linked to formal industries (Lal

2008, 123). As a policy strategy it is straightforward, except that the Governor’s role would

probably be limited. It may be worthwhile to deploy some staff to investigate the possibilities

and constraints of implementing such a strategy, and potentially reassure unions that they have

the support of the Territorial government. On the other hand, attempting to intervene in such a

way could expose the Governor’s office to excessive political risk. The most obvious drawbacks

to attempting to unionize such workers are the risk for violent conflict and the possibility that

workers may lose even their tenuous informal employment with nothing to show for it.

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Recommendations and Conclusion

Except for the market flexibility approach, the benefits of each of the

above strategies outweigh the costs. Additionally, these strategies are

complementary and could be pursued simultaneously; indeed, a

comprehensive approach to reducing the negative impacts of the large

informal sector would recommend doing so. They are complementary

because they each target a different segment of the informal economy or

address one of the root causes of informality. Working to upgrade informal

clusters and enacting tutelary enforcement targets existing informal

establishments. Organizing informal workers in formal or linked

establishments would bring these workers into the formal economy.

Introducing a social allowance decoupled from the employment relation

would provide exit options to minimize opportunities for economic

exploitation, while conveniently increasing labor market flexibility. And labor

demand-side solutions would seek to create quality jobs to replace informal

work, and upgrade human capital to match with those jobs. Together, they

would constitute a coherent strategy for upgrading the Territorial economy

and maximizing the benefits and reach of the formal economy. Therefore, I

recommend pursing all four strategies together, comprehensively.

Of course it is an easy thing to recommend a comprehensive solution;

it is well another to implement it as an official. The fact that the strategies

have different timeframes could provide a way for you to decide how to

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proceed in the short term. As mentioned above, organizing is mostly out of

the Governor’s control; the best you can do in the short term is probably to

commit to supporting labor in whatever campaigns may arise. Likewise,

instituting a social welfare allowance will have to take place at the national

level and will prove a major struggle. At the moment you can test the

political waters and prepare the political ground for this struggle. “Industrial

policy” itself is a short term for a very wide-encompassing comprehensive

approach to economic policy. In the short term you can revisit Territorial

plans for infrastructure upgrades, economic development, and education

policy to ensure that these accord with a comprehensive approach to

industrial policy. You can also lobby for complementary policies at the

national level. Your staff are probably already well acquainted with industrial

clusters in Jakarta, but if they are not, they should begin researching and

establishing relationships. I am not certain where authority lies in

enforcement, but you should do what you can to transfer to a tutelary rather

than punitive approach. You should direct your police force to immediately

cease the punishment of street vendors and beggars; the policy benefits no

one. Finally, better statistics that accurately distinguish informal work would

aid immensely in the future development and refinement of policies. You

should lobby BPS to add relevant questions on their next survey.

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Works Cited

Badan Pusat Statistik. 2010. “Berita Resmi Statistik Provinsi DKI Jakarta. No 17/05/31/Th.XII, 10 Mei 2010.” Last Accessed June 2011. http://jakarta.bps.go.id/BRS/Sosial/Tenaker_1002.pdf.

Baltar, Paulo, et al. 2010. “Moving Toward Decent Work – Labor in the Lula Government: Reflections on recent Brazilian experience.” Global Labour University Working Papers 9.

BBC. 2007. “Jakarta Bans Beggars and Buskers.” Last accessed June 2011. http://news.bbc.co.uk/2/hi/asia-pacific/6989211.stm

Chowdhury, Anis, Iyanatul Islam, and Mohammad Zulfan Tadjoeddin. 2009. “Indonesia’s Employment Challenges: Growth, Structural Change and Labour Market Rigidity.” European Journal of East Asian Studies 8, 1: 31-59.

Cuevas, Sining, Christian Mina, Marissa Barcenas, and Aleli Rosario. 2009. “Informal Employment in Indonesia.” Asian Development Bank Working Paper Series 159.

Howell, David R., Dean Baker, Andrew Glyn, and John Schmitt. 2007. “Are Protective Labor Market Institutions at the Root of Unemployment? A Critical Review of the Evidence.” Capitalism and Society 2, 1: 1-71.

Jakarta Post. 2011. “Street vendors boxed in on all sides.” Last accessed June 2011. http://www.thejakartapost.com/news/2010/10/18/street-vendors-boxed-all-sides.html.

Lal, Radhika. 2008. “Macroeconomic Policies to Address Informality: A Two-pronged Strategy to Foster Dynamic Transformations that Reduce Informality.” IDS Bulletin 39, 2.

Manning, Chris. 2008. “The Political Economy of Reform: Labour After Soeharto.” Indonesian Studies Working Papers No. 6.

Schrank, Andrew and Michael Piore. 2007. “Norms, standards, and labor market regulation in Latin America.” CEPAL – Serie Estudios y Perspectivas No. 77.

Tendler, Judith. 2002. “Small Firms, the Informal Sector, and the ‘Devil’s Deal.’” Institute for Development Studies Bulletin 33, 3.

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