Working Paper

in Economics and
Development Studies
Department of Economics
Padjadjaran University

No. 200405

The Impact of Job Security

Regulations on Employment and
Hours of Work: Empirical
Evidence for Indonesia

Armida S. Alisjahbana
Muhammad Purnagunawan
Department of Economics,
Padjadjaran University

November, 2004

Center for Economics and Development Studies,

Department of Economics, Padjadjaran University
Jalan Cimandiri no. 6, Bandung, Indonesia.
Phone/Fax: +62-22-4204510
http://www.lp3e-unpad.org
 The Impact of Job Security Regulations on Employment and
Hours of Work: Empirical Evidence for Indonesia

Armida S. Alisjahbana
Rd. Muhammad Purnagunawan

Department of Economics and Development Studies

Faculty of Economics Padjadjaran University
Bandung, Indonesia

November, 2004

Abstract
This paper presents results of the effect of job security regulations in terms of dismissal costs
on firms employment choice decisions. A measure of job security over the 1998-2003 for
manufacturing sector at the ISIC 2 digit level is first constructed to show the extent of the
labor market rigidity in Indonesia. The index is then used to assess the impact of job security
on firms employment versus workers hours of work decision. We found significant negative
effect of job security on employment of regular wage workers in the manufacturing sector
overall as well as across segments of workers for females, and older workers. At the same
time, firms appear to make adjustment through reducing the working hours of female and
prime-aged full time workers while increasing the working hours of older part time workers.
The results show that job security has exactly the opposite effect than it was intended to be,
i.e. to have it more difficult and costlier for firms to dismiss workers. It has on the other hand
been an inefficient and inequitable mechanism because it has reduced overall labor demand
for females and prime-aged workers in a significant manner. Further research is urgently
needed to formulate a job security regulation that will have the beneficial effect of protecting
the workers while at the same time does not act as disincentive to the firms.

Keywords: Job Security Regulation, Employment, Hours of Work, Indonesia

JEL Classification: E24, J23, J65

 The Impact of Job Security Regulations on Employment and
Hours of Work: Empirical Evidence for Indonesia1

Armida S. Alisjahbana2
Rd. Muhammad Purnagunawan

1. Introduction
Indonesia has achieved much in its economic recovery during the past few years with
macroeconomic stabilization undoubtedly been the focus of attention. Improved
macroeconomic performance has yet to translate into higher economic growth that would
absorb more and better jobs for the populace. One of the concerns related to the seemingly
inability of the economy to provide more and better jobs is on the trend of the labor
regulations that has become more and more protective and interventionist (Manning,
2004). During the past 20 years, there have been four major labor regulations taking place,
Labor Law 1986, its revision in 1996, Manpower Ministerial Decree in 2000, and the Basic
Manpower Act No. 13, 2003.

One of the concerns on the trend of labor regulations is that whether it has become more
and more protective and interventionist as to significantly reduce the labor market
flexibility with its adverse consequences on employment creation in Indonesia. Labor
market flexibility is very much influenced by the cost of hiring and firing a worker aside
from minimum wages. Labor regulations normally regulate dismissal procedure and how
much is the severance payment. Another area of the regulation is on contract work, and
outsourcing. All of these regulations that regulate the practice of hiring and firing
comprise the Job Security regulation.

How do job security regulations affect employment? Given that the interest is on the
potential effect of the regulations, it is crucial to evaluate how job security regulations
influence employment through movements in labor costs. The effect of job security
regulations on labor demand can be analyzed from the firms employment choice decision.
Firms employment choices involve interactions between employment and hours of work
in response to changes in output, prices of inputs and regulations.

1
This paper is a further extension to a much broader work the authors being involved on The Effect of Job
Security Regulations on Employment Creation in Indonesia, cooperation between USAID GIAT Swasta
Program with Laboratory for Economics and Development Studies, Faculty of Economics, Padjadjaran
University (LP3E FE-UNPAD), April October, 2004.
2
The authors are Head of Laboratory for Economics and Development Studies, and lecturer and researcher
respectively at the Faculty of Economics, Padjadjaran University, Bandung, Indonesia. E-mail
correspondence: alisjahbana@bdg.centrin.net.id

1
In a more general setting, there are two opposing views on whether or not job security
regulations affect labor market flexibility and hence employment creation (Mondino and
Montoya, 2000). The opponents claim that strong workers rights prevent employers to
take the necessary adjustment due to economic fluctuations such as inhibiting layoffs
during economic slowdown and preventing recruitment of new workers during recoveries.
The proponent of strong workers rights argues that job security provisions have no
observable effects on employment. The above views neglect the fact that firms may trade-
off between employment and hours of work of the existing workers in their employment
choice decisions.

In this paper, we provide empirical evidence on the impact of job security regulations on
firms employment and hours work choice decisions in the manufacturing sector. This
paper is motivated by our on-going work funded by USAID-GIAT Swasta Program in
collaboration with LP3E, Faculty of Economics, Padjadjaran University (LP3E FE-
UNPAD). It is an extension of the on-going work in that this paper explores further the
interaction between hours worked and employment choice decision of firms in response to
changes in the job security regulations.3 We look at how changes in job security
regulations have affected labor demand by firms in the manufacturing sector in Indonesia.
Based on the Indonesian National Labor Force Survey data, we constructed panel data set
at the manufacturing 2 digit ISIC level covering the period of 1998 2003. The panel
provides information on employment and hours worked, and wage, while the
manufacturing output data is obtained from the manufacturing survey.

Following the introduction, Section 2 gives the literature review of previous studies on the
effects of job security regulations on employment creation. Section 3 of this paper
summarizes changes in job security regulations on severance payment, and contract worker
over the years 1986 2003. Section 4 shows the estimated effects of job security
regulations on employment decisions of firms. In particular, Section 4 highlights how
firms in the manufacturing sectors have responded through decision on employment and
workers hours of work, while the last section concludes.

2. Literature Review
Empirical estimations to measure the effect of job security regulation on employment have
been made by several authors most notably for the Latin American countries. For
example, the study by Pages and Montenegro (1999) develop a model that analyse the
impact of job security on workers of different age in the case of Chile. Their findings
suggest that job security is associated with a substantial decline in the wage employment-

3
In the GIAT and LP3E FE Unpad study, the scope is much broader in that the qualitative issues from
surveyed manufacturing firms and workers are explored in addition to the impact of the job security
regulations on market flexibility and employment creation at the ISIC 2 digit level manufacturing sector in
Indonesia. The study, however does not exploit the interaction between employment and hours of work
trade-off faced by firms.

2
to-population rate of young workers. Heckman and Pages (2000) reviews some empirical
studies on the impact of job security regulation on employment mostly on some Latin
American countries. The findings are that job security policy tends to be associated
positively with tenure and negatively with labour turnover.4

On the job security impact on average employment, the available empirical evidences
show mixed results. Saavedra and Torero (2000), Mondino and Montoya (2000), and
Kugler (1999) shows that job security is negatively associated with labour demand for the
case of Peru, Argentina and Colombia respectively. In other words, for the cases they
considered, they found an indication that higher job security tends to discourage
employment in general. On the other hand, Pages and Montenegro (2000) study shows that
the relationship is not statistically significant for the case of Chile. The study by Kugler
(2004) analyses the effect of job security on employment in the compliant (formal) sector
versus the non-compliant (informal) sector. Her study concludes that higher job security
tends to increase rate of employment in the non-compliant sectors.

Previous empirical studies have shown that the effect of job security regulation on
employment creation is an empirical matter. Although, the negative impact of job security
regulation on turnover is strongly confirmed by most empirical evidence (Heckman and
Pages, 2000). In extending the empirical studies methodologically as well as to other
countries, there are some issues that warrant attention. Among others, issues on the effect
of the regulation on composition of employment, e.g. age structure, type of jobs (formal-
informal, or permanent-non-permanent, etc.), gender, etc.

Related to the above issues, further refinement is also needed in empirically estimating
how the job security regulations have affected firms employment choice decisions taking
into account the possible interaction between employment and hours of work. The latter
issue is taken by Mondino and Montoya (2000) in their Argentina studies, however further
refinement is possible as they have not specifically disentangle the effects of job security
regulations by type of workers, between full time and part time workers and among
workers by age composition. These issues are the focus of this paper.

3. Summary of Changes in the Job Security Regulations during the 1986

2003 Period
The recently implemented Manpower Basic Act No. 13, 2003 revise some provisions of
the job security regulations in terms of: severance payment, contract workers and out-
sourcing. This section updates the work of Manning (2003) on severance and long-service
payments by incorporating changes made in the Manpower Basic Act No. 13, 2003.

Indonesias labor law regulates workers dismissal based on several categories of workers
into:
4
See Table 2 in Heckman and Pages (2000), p. 15.

3
- Workers who quit voluntarily
- Workers dismissed for minor offences
- Workers dismissed for major offences or violations
- Workers dismissed for economic cause

Table 2.1 highlights the coverage of severance and long-service payments to the above
category of workers through JS regulations changes over 1986 2003. As a note, in 1986
the labor law replacing the old 1964 Law was introduced. Subsequently, it was revised in
1996 and some of its provisions were revised through Ministerial Decree in 2000. The last
revision to the labor law came in 2003 with the implementation of the Manpower Act No.
13, 2003.

How have the changes been evolving throughout the years? The first notable changes were
on rates of severance and long-service pay that have risen significantly over the years and
for longer years in service. The increase was most notable if we compare the 1996
regulation versus the one in 1986, and the 2003 regulation compared with the 1996. Rates
of severance and long service pay are based on a standard formula involving wages by
months of service and governed by Ministerial Decree for the 1986, 1996 and 2000, and
are included in the Manpower Basic Act of 2003. The significant increase is felt especially
for dismissal due to economic cause.

The second major change was that for those who quit voluntarily, they received long
service pay only during the labor regulation covering the period 2000 2003, and no
severance payment. Lobbying effort by employer association has successfully overturned
the 2000 regulation on long service pay for workers who quit voluntarily. The exclusion is
for workers who quit voluntarily for reasons that the firm undertakes restructuring
activities. In this case, the worker entitles to one severance pay and the respective long
service pay.

Another major change occurred in 1996 was that long service pay was given to workers
dismissed for minor and major cause. In this case, no severance pay was given as in
previous regulation. The law of 2003 adds the so called Uang penggantian hak to cover
housing, and medical allowances. The amount is 15% of total severance payments. The
provision of Uang penggantian hak has increased the total dismissal cost of all categories
of workers, and the increase is higher for long serviced workers dismissed due to economic
cause.

[Table 2.1 about here]

4. The Effects of Job Security Regulations on Employment and Hours of

Work
4.1. Analytical Framework and Empirical Model

4
Job security provisions are regulatory measures as a means of social protection to mitigate
the risk of workers being laid off by forcing firms to provide large severance payments
during economic downturns. The mechanism and procedure for workers laid off are also
lengthy and thus implies further costs to the firms. The regulation is often perceived as
hindering the macroeconomic adjustment necessary for firms facing economic difficulties
with the resulting implication that jobs may be shifted towards the informal sector. It is for
this reason, that job security provisions are thought to have inequitable consequences for
unprotected workers. This is especially true for segmented labor markets in which case an
increase in the job security provisions leads to greater mobility into the informal sector.

Job security is a form of non-wage compensation, and hence contributes to increases in

labor costs to the firms. If wages and other non-wages compensation are flexible, then
firms may substitute among the various labor cost components in response to changes in
the job security provisions. The costs to the firms of job security, however could not be
measured solely in terms of its direct costs such as severance payments as they also
involve lengthy dismissal procedures. A measure of job security that takes into account
severance payments due to workers dismissal is at best an approximation of the job
security provisions to the firms. In Indonesia, as in other countries, the regulation is
confined to the formal sector that employs regular wage workers. How would we measure
the impact of the regulation on employment creation in Indonesia?

The impact of JS regulation is best assessed through firms labor choice decisions. An
increase in JS increases the cost of hiring due to the change in the expected future
severance payment, should the worker be dismissed in the future, and the cost of foregone
output due to potential mismatches (Mondino and Montoya, 2000). In hiring new recruits,
firms must take into account the high potential future severance payment with the
alternative of waiting for a few more periods. Likewise, in firing workers firms must
consider the cost of providing severance payments depending on cause of dismissal and
length of tenure.5 Of particular interest are the likely effects of the job security provisions
that have become more stringent on employment versus hours of work.

In this paper, we present estimation results of firms demand for labor in the manufacturing
sector in Indonesia. The analysis considers the adjustment made by firms in employment
and hours of work during the period 1998 2003. The empirical approach considers
firms demand for labor in a general setting. Firms employment choices are characterized
as dynamic interaction between employment and hours of work in response to changes in
output, labor costs, other factor prices and regulations. The specification of the model is
based on the standard model of firms demand for inputs with the possible interaction
between employment and hours of work choice decisions (Mondino and Montoya, 2000)6.
The equations to be estimated can be summarized as:

5
For example, in the Indonesian context, the JS regulation provides higher severance payment for dismissal
due to economic cause (see Table 2.1 for details).
6
See also Saavedra and Torero (2000) for slightly different specifications.

5
Ln Emplyit = 1 lnWageit + 2 ln Outputit + 3 JS Index it
+ 4 ln Hours(t-1)it + u1it .......... (4.1)

and u1it = 1i + 1t + 1it

Ln Hoursit = 1 ln Wageit + 2 ln Outputit + 3 JS Index it

+ 4 ln Hours (t-1) it + u2it ......... (4.2)

and u2it = 2i + 2t + 2it

Where:

Emply : employment
Hours : average daily hour per worker of regular wage
worker working in main job
Wage : average wage real
Output : average output real
JS Index : Job security index to be constructed below (see
section 4.2)
s : parameters to be estimated from the employment
equation
s : parameters to be estimated from the hours of work
equation
i : manufacturing sub-sectors (2 digit level)
t : 1998, ..............., 2003
uit : error component of the model
i : unobserved variables that vary across the
manufacturing sub-sectors but constant over time
(fixed effect)
t : unobserved variables that vary over time, but
constant across the manufacturing sub-sectors (time
effect)
it : random error term

6
The empirical models (4.1) and (4.2) are estimated based on a panel of manufacturing sub-
sectors at the ISIC 2 digit level for the period 1998-2003. To account for manufacturing
sub-sectors idiosyncratic factors, the model is estimated with fixed effects as well as year
dummies.

Under perfect competition setting, where firms are purely act as price takers both in the
output and input markets, it would be reasonable to assume that wages and outputs are
exogenous to the firms. On the other hand, in most reasonable assumptions, firms output
and wages determination are likely to be correlated with employment decisions. The
estimations will check through exogeneity test to the output and wage variables if this is
the case. For the cases when output and wage are proved to be endogenous, instrumental
variable methods are employed.7

Some cautionary notes are in order in this estimation. The period of observation, 1998
2003 is relatively short to be able to fully measures the changes in JS regulations over
time. Another note is on the period covered which saw extraordinary changes in many
respects. These included the economic crisis that started in the latter part of 1997, and had
its full effect during the 1998. The subsequent years of 1999 and 2000 are known to be the
recovery period. It is also considering the latter reasons that we have included the output
variable in the empirical model to account for the dynamic effects of firms output demand
on their employment choice decisions.

4.2. The Data

The main source of data used in this study is the National Labor Force Survey (Survei
Angkatan Kerja Nasional or Sakernas) data from 1997 to 2003. Sakernas is a
representative survey by the Indonesian Central Bureau for Statistics (BPS) that collects
data on the general workforce situation. The survey is conducted throughout Indonesia,
covering more than 45,000 household and individual units. Information provided, among
others, cover individual main employment activities, earnings, hours of work on the
primary job, and individual characteristics such as gender, education and age.

Data on individual wages, working hours and employment in manufacturing sector from
the Sakernas are aggregated at the 2 digit ISIC level. Data on the manufacturing sub-
sectors at the 2 digit ISIC average monthly wages per worker, working hours and
employment levels calculated for all regular wage formal workers, is then combined across
years to form a set of panel data with manufacturing sub-sectors as the unit of observation.
This panel data set is then merged with manufacturing sub sector-level data on outputs

7
The exogeneity of output and wages to firms at the sub-sector levels is difficult to assume a priori. For
example, under imperfect competition firms decision to hire workers and set output level is closely related
and disturbances that affect one will probably affect the other. In the case of Indonesia, regional minimum
wages have been enforced and to the extent wages set by firms are above the minimum wages, the issue of
endogeneity of wages to firms is still relevant.

7
which have been deflated by the sub-sectors yearly wholesale price index (IHPBit). The
manufacturing sub-sector output data at the 2 digit ISIC level is taken from the Indonesian
Central Board of Statistics Annual Manufacturing Survey. The complete panel data set is
constructed for 9 sub-sectors, covering the period from 1998 to 2003. In total there are 54
points of observation.

Hours of work, which were measured from average daily working hours of regular wage
worker, is included in the equation to capture the trade-off effect of Job Security regulation
on employment and hours of work. The data was then divided into two sub-sets, i.e. full
time workers and part time workers. Full time worker is a worker who works at least 40
hours per week within 5 days work, or on average working at least 8 hours per day. The
part time workers, is a worker that works for less than 40 hours per week or less than 8
hours per day. All data, except for output and wholesale price index, were also divided
into several subsets, i.e. by gender (male and female) and by age composition (less than 24
years, 25 44 years, and 45 years or older). Separate data sub-sets are also done by type of
workers: all regular wage workers; full time regular wage workers, and part time regular
wage workers.

4.3. Construction of the Job Security Index8

Workers dismissal and severance pay regulations have been part of Indonesias labor
policies which have been modified throughout the years by altering the maximum amount
that a worker could receive or the instances under which a worker could be dismissed.
Section 2 has highlighted the changing severance pay regulations, the summary of which is
provided in Table 2.1. The key points in the severance pay regulation changes involve
three recent regulations, i.e. the Ministerial Decree 3/1996; then the Ministerial Decision
150/2000 (KepMen 150/2000), and lastly the Basic Manpower Act 13/2003. As the
discussion in Section 2 shows, the regulations on severance pay have become more and
more stringent.

These changes in the regulations are reflected in an index on Job Security. The index
measures the relative rigidity of the Indonesian job security regulation over the years. The
methodology followed is a variant to the one developed by Pages and Montenegro (1999)
and Heckman and Pages (2000) adapted in line with the Indonesian labor codes on
dismissal and severance payment. The index is a Job Security Index as it combines
information on compensation for dismissal, the cause for such a dismissal, and the
mandated severance payment (and other mandated payments) that is due in that event. The
formula to compute the cost of job security index in period t is as follows:

8
This section draws heavily on the Job Security Index construction in the USAID-GIAT and LP3E FE-
UNPAD study.

8
 T
[ ][
Index t = i i 1 (1 ) a (SPtv+i + LSPtv+i ) + b(SPtEc Ec o o
+i + LSPt +i ) + (1 a b)(SPt + i + LSPt +i ) ]
i =1
where:

i : tenure in years ( i = 1, ..................., T)

: average real rate of return of an international diversified portfolio
: probability remaining in job (which is: 1 turnover rate)
i-1
(1-) : probability dismissal after i years at firm
a : the expected proportion of workers who would quit voluntarily
b : the expected proportion of workers who would be dismissed due
to economic causes
(1-a-b) : the expected proportion of workers who would be dismissed due
to violation after i years at the firm (major + minor)
V
SPt+i : severance payment for voluntary quit after i years at the firm
V
LSPt+i : long service payment for voluntary quit after i years at the firm
EC
SPt+i : severance payment for dismissal due to economic cause after i
years at the firm
EC
LSPt+i : long service payment for dismissal due to economic cause after i
years at the firm
o
SPt+i : severance payment for dismissal due to violation after i years at
the firm (minor=90%; major=10%)
o
LSPt+i : long service payment for dismissal due violation after i years at
the firm (minor=90%; major=10%)

The constructed index measures the expected cost, at a time the worker is hired, of
dismissing a worker in the future. The index would capture the whole profile of severance
pay and reflects the marginal cost of dismissing full-time permanent workers. Higher
values of the index indicate periods of relative high job security, and lower values indicate
period when dismissals were less expensive. The index, does not yet capture the effects of
the possibility of hiring temporary and fixed-term contracts, however if it is assumed that
fixed-term contracts and temporary workers are not perfect substitutes of tenured workers,
the index would still capture the marginal cost of firing a permanent worker (Heckman and
Pages, 2000).9

Based on information on the severance payment regulation summarized in Table 2.1 of

section 2 in this paper, we then feed the parameters into the index formula. The schedule
of the severance payment due to the cause of dismissal is clearly stated in the labor codes
and therefore could be readily used in the formula. To obtain the expected proportion of
workers dismissed due to reasons: voluntary quit, economic or violations, we need to rely
on the respective figures from the Sakernas data. Sakernas data since 1998 have
9
As indicated in Heckman and Pages (2000), firms maybe at the margin of firing temporary workers, and if
this is the case, then the index would overstate the true marginal cost of dismissing a worker.

9
information on causes of workers leaving job into those who quit voluntarily (a), those
who are dismissed due to economic cause (b), and those who are dismissed because of
committing violation (1-a-b).

Table 4.1 shows the Job Security index constructed for the manufacturing sector for the
period 1998 to 2003. The indexes for 1998 and 1999 capture the 1996 regulation, the
indexes for 2000, 2001 and 2002 are based on the 2000 regulation, while the 2003 index is
computed based on the 2003 regulation. Changes in the index overtime are reflection of
changes in the severance payments due to regulations, and composition of workers
dismissed due to quit (a), economic reasons (b) and other reasons (1-a-b). A JS Index of
3.778 in 1998, for example, means that the expected cost of dismissal of a permanent
worker in the future at the time he/she is hired is equivalent to 3.778 monthly wages. This
number is equivalent to 31.4 percent of annual wage.

Table 4.1
Job Security Index
Manufacturing Sector
Indonesia, 1998 2003

Years a b 1-a-b JS Index

1998 0.92 0.88 0.166 0.666 0.168 3.778
1999 0.92 0.88 0.262 0.516 0.223 2.890
2000 0.92 0.88 0.340 0.444 0.217 3.836
2001 0.92 0.88 0.331 0.369 0.300 3.634
2002 0.92 0.88 0.275 0.469 0.257 5.226
2003 0.92 0.88 0.248 0.519 0.233 4.521 - 4.745**
*

Source: Authors calculation based on National Labor Force Survey

Notes:* Severance payment voluntary quit 2003 = 0
**
Severance payment voluntary quit 2003 equal to long service payment for
voluntary quit 2000 (uang pisah)

4.4. Estimation Results: Is There a Trade-off between Employment and Hours

of Work?

Table 4.2, Table 4.3 and Table 4.4 present estimation results for the firms (at the sub-sector
level) employment regression, full-time and part-time workers hours of work regression
results respectively. The models are valid as shown by the high values of the Wald-chi 2
and the R2.

10
The estimation result for employment regression shows that JS Index has a negative and
statistically significant effect on total employment with elasticity of -0.813.10 This means
that a 10% increase in the JS Index would reduce employment for the regular wage
workers in the manufacturing sector by 8.3%, by holding output and wage levels constant.
The result is slightly less to the one obtained by Saavedra and Torrero (2000) in the case of
Peru during the 1987-1990 at the height of job security regulations in that country.11 It is
not a surprising result as Indonesia has moved to become a country with one of the most
restrictive job security regulations in the world. On the other hand, Latin American
countries such as Peru have deregulated their labor market regulations to become less
restrictive since the mid-1990s.

Impact of job security across the gender line show that female workers have been hurt
most with elasticity of employment with respect to the JS Index -1.949. This means that a
10% increase in the JS Index will reduce employment of the female regular wage workers
in the manufacturing sector by 19.49%, holding output and wage rates constant. Results of
the estimation for regular wage workers based on age composition reveal that the
regulation has affected most those in the 45+ followed by young age workers. The
employment elasticities with respect to JS Index are -1.265 and -1.14 respectively.12

The results of job security on employment by age group for Indonesia can best be
explained in terms of employment adjustment during the 1998-2003 periods. This period
is marked by significant changes, both in the economic environment surrounding the
manufacturing sector as well as the regulatory conditions on job security. The year 1998
was peak of the economic crisis when the economy contracted by about 14% in that year,
and the brunt of the impact was felt in the manufacturing sector. Just about that time, the
labor market regulation has become more and more stringent. Job security regulation in
terms of severance pay has jumped in terms of rate by two-fold with the introduction of the
new regulation in 1996 compared with the previous one (see Section 2 and Table 2.1 for
details). The introduction of KepMen 150 in 2000 which specifically gives long service
payment to those workers who quit voluntarily has contributed to an increase in workers
who quit voluntarily during 2000-2003 period

Estimation results from the employment regressions thus show the effect of job security
has been negative and significant across regular wage workers in the manufacturing sector,
with the exception for male and the prime-aged workers. This result conforms with the
severity of the job security regulation during the period with its consequent adverse effect
on employment across the workers segments. Although, the result also shows different
effect in terms of elasticity with female workers and those in the older age groups who
were affected the most. Other variable that has significant positive effect is output level
which shows that firms employment decision is affected by the current output level in a

 Elasticity for the percentage change in employment with respect to a one percentage change in the JS
Index is calculated as = 3 * average JS Index.
11
Saavedra and Torrero found employment elasticity w.r.t. job security estimates of about 1.02.
12
The result for the young age groups =<24 years, however is statistically insignificant.

11
positive manner. How many workers firms are going to employ very much depends on the
current production level.

How does the result compare with the working hours per worker estimations? The results
for full time regular wage workers in the manufacturing sector, and the part time workers
are presented in Table 4.3 and 4.4 respectively. We divided workers into those who work
full time, i.e. 8 or more hours per day and part time who are those working for less than 8
hours per day in his/her main job. The comparison will enable us to disentangle any trade-
off effect between hours work full time versus part time workers. Interesting results are
shown for full time workers, where the effect of job security is negative and significant for
female workers, and by age groupings for those ages 25-44 and younger workers
(significant at 10% level). On the other hand, the results for the part time workers indicate
more hours of work for the older workers (45+ years).

The overall estimation results from employment and working hours regression show the
following patterns. First, job security has significantly affected overall employment of
regular wage workers in the manufacturing sector in a negative manner. The effect is most
significant for the older and female workers, but not significant for the youth and male
workers. Second, although job security does not appear to affect employment of youth and
male in a significant manner, however results from working hours regression show
interesting pattern. There seems to be reduction in hours work for female, youth and
prime-aged full time workers, and a substitution away into longer working hours for older
(45+) part time workers.

A clear pattern seems to emerge from the above results that job security does not
necessarily affect the employment directly. At least for some segmentation of the workers,
job security could affect the workers through shorter hours for those who work full time
and longer hours for those working part time. There is a trade-off between dismissing a
worker versus still employing them, but having them work for less hours. This could also
imply having more hours worked for part time workers. Another interesting result is that
lag hours work is an important factor in firms decision in employing part time workers for
longer hours of work, the effect of which is significant and positive13 The above results do
not necessarily imply having more hours for certain segment of part time workers as firms
hiring contract workers. The Sakernas data precludes us from categorizing workers into
permanent versus contract workers and therefore we are not able to make this distinction in
our analysis.

13
The exception is for youth and older workers (see Table 4.4 for details).

12
 Table 4.2
Results of Employment Regression
Total Regular Wage Workers Manufacturing Sector

All worker Male Female Youth Adult

Independent Total regular Regular wage Regular wage Regular wage Regular wage workers
Variable wage workers workers workers workers
25-44 45+
(=< 24)

Job Security -0.214 -0.154 -0.513 -0.300 -0.124 -0.333

Index
(-1.930) * (-1.210) (-2.230) ** (-1.560) (-1.260) (-2.250) **

Log avg -0.319 -0.336 -0.275 -0.042 0.115 -0.172

wage real
(-0.590) (-0.610) (-0.630) (-0.070) (0.330) (-1.610)

Log output 0.525 0.461 0.790 0.643 0.555 0.518

real
(4.310) *** (3.880) *** (3.180) *** (3.340) *** (5.190) *** (4.100) ***

Log working -6.032 -4.920 -0.762 -0.197 -8.334 -3.713

hours(t-1) (-1.520) (-0.980) (-0.250) (-0.060) (-2.360) ** (-1.830) *
24.795 23.220 11.256 7.280 23.295 16.346
Constant
(2.590) *** (1.910) * (1.430) (0.610) (3.180) *** (3.280) ***
Year
dummies
Yes Yes Yes Yes Yes Yes
R Squared 0.966 0.962 0.884 0.924 0.964 0.908
Wald Chi 25.800 21.040 15.330 15.700 34.010 27.900

Notes :
With fixed-effect
Prais-Winsten regression, correlated panels corrected standard errors (PCSEs)

Numbers in parentheses are z-score

*** is significant at 1 percent level
** is significant at 5 percent level
* is significant at 10 percent level

13
 Table 4.3
Results of Working Hours Regression
Full Time Regular Wage Workers Manufacturing Sector

All worker Male Female Youth Adult Full time

Independent
Full time Full time Full time Full time
Variable 25-44 45+
(=< 24)

Job Security 0.002 0.004 -0.024 -0.015 0.008 -0.026

Index
(0.420) (0.990) (-3.040)*** (-2.380) ** (1.680) * (-3.490) ***

Log avg -0.016 -0.024 -0.001 0.004 -0.016 0.001

wage real
(-1.280) (-1.960) * (-0.100) (0.200) (-1.830) * (0.420)

Log output -0.001 0.000 -0.003 0.004 -0.003 0.006

real
(-0.360) (-0.130) (-0.660) (1.470) (-0.760) (1.620)

Log working 0.251 0.220 0.243 0.443 0.341 0.165

hours(t-1) (1.090) (0.960) (1.030) (2.290) ** (1.580) (1.220)
1.785 1.939 1.733 1.159 1.595 1.796
Constant
(3.000) *** (3.250) *** (2.770) *** (2.200) ** (3.050) *** (6.000) ***
Year
dummies
Yes Yes Yes Yes Yes Yes
R Squared 0.912 0.418 0.894 0.985 0.876 0.985
Wald Chi-sq 6.480 13.340 13.240 30.030 14.700 3650000

Notes:
With fixed-effect
Prais-Winsten regression, correlated panels corrected standard errors (PCSEs)

Numbers in parentheses are z-score

*** is significant at 1 percent level
** is significant at 5 percent level
* is significant at 10 percent level

14
 Table 4.4
Results of Working Hours Regression
Part Time Regular Wage Workers Manufacturing Sector

All worker Male Female Youth Adult Part time

Independent
Part time Part time Part time Part time
Variable 25-44 45+
(=< 24)

Job Security 0.009 0.005 0.004 0.009 0.009 0.025

Index
(1.400) (0.990) (0.590) (0.890) (1.480) (2.340) **

Log avg 0.016 0.005 0.045 0.022 0.001 0.007

wage real
(0.940) (0.350) (3.160) *** (0.930) (0.090) (0.790)

Log output -0.004 -0.002 0.001 -0.005 -0.003 -0.008

real
(-0.860) (-0.690) (0.290) (-0.700) (-1.410) (-1.010)

Log working 0.667 0.746 0.425 0.612 0.785 0.285

hours(t-1) (4.550) *** (6.190) *** (4.400) *** (3.270) *** (6.770) *** (1.620)
0.456 0.438 0.523 0.505 0.401 1.272
Constant
(2.500) *** (2.000) ** (3.390) *** (2.140) ** (2.580) *** (3.220) ***
Year
dummies
Yes Yes Yes Yes Yes Yes

R Squared 0.990 0.996 0.986 0.975 0.994 0.830

Wald Chi-sq 150.610 146.930 49489 41.710 157.080 19.910

Notes :
With fixed-effect
Prais-Winsten regression, correlated panels corrected standard errors (PCSEs)

Numbers in parentheses are the z-score

*** is significant at 1 percent level
** is significant at 5 percent level
* is significant at 10 percent level

15
5. Concluding Remarks
Indonesias job security regulations have evolved to be more and more restrictive
especially in terms of dismissal costs since 1996. It has become one of the most stringent
in the world with adverse consequences on employment creation. An indicator of
Indonesias job security restrictiveness is shown by the magnitude of the Job Security
Index, the index is even stricter for the case of the manufacturing sector. In comparative
perspective, Indonesias job security compares with those of Latin American countries
where job security regulations there have been perceived as contributing to the inability of
their economy to absorb more and better jobs.

While the trend in other countries, such as Latin American countries have been towards
deregulating the labor market, the trend in Indonesias job security regulation has been on
the reverse towards becoming more and more stringent. At the same time, Indonesia is
still reeling and recovering from the economic crisis where the real sector such as the
manufacturing sector is expected to contribute to absorbing more and more employment.
The recent trend has not been encouraging since employment at the formal sector,
including manufacturing has been declining.

The impact of job security on employment decisions of firms in the case of manufacturing
sector shows that the trend in the regulation has not helped in creating more employment..
Estimation results from employment regression model shows that job security has hurt
employment for the overall manufacturing sector, and across segments of the regular wage
workers, with the exception of male and prime-aged workers. On the other hand, there
also appears to be a trade-off mechanism between employment and hours of work at the
firms level as captured through estimation results at the aggregated manufacturing sub-
sector data. Firms may reduce hours work for those full time workers, still keeping some
of them at the job, and at the same time firms may elect to increase total hours work for
part time workers.

The above results have profound policy implications. Job security regulations have exactly
the opposing effect as it was intended to be, i.e. to protect the workers from dismissal. It is
an inefficient mechanism as it reduces firms demand for labor in the formal sector, and it
is also inequitable since it tends to reduce demand for labor of certain segments of the
workers. Female and older workers seem to hurt the most. It is also found that firms make
adjustments through substituting for fewer hours out of full time workers and more hours
out of part time workers. As has been cited in the literature (Heckman and Pages, 2000),
reduce demand for labor in the formal sector implies increasing share of employment
would go to the informal sector. This phenomenon has been found in Indonesia by looking
at the much higher growth of employment at the informal sector versus the formal sector.
A better mechanism of job security has to be formulated that would not be a disincentive
for firms to hire new workers and that would protect the workers from dismissal in a fair
manner. This latter point is a big agenda for further research.

16
References

Bertola, G (1990), Job Security, Employment and Wages, European Economic Review,
34: 851-856.
Heckman, J. J. and C. Pages (2000), The Cost of Job Security Regulation: Evidence from
Latin American Labor Market, NBER Working Paper 7773.
Hopenhayn, H. and R. Rogerson (1993), Job Turnover and Policy Evaluation: A General
Equilbrium Analysis, Journal of Political Economy. 101(5).
Manning, C. (2003), Labor Policy and Employment Creation: An Emerging Crisis?,
Partnership of Economic Growth-USAID, Report No. 110, Jakarta June 2003 (See
http://www.pegasus.or.id/public.html).
Manning, C. (2004), Labour Regulation and the Business Environment: Time to Take
Stock in M. Chatib Basri and P. van der Eng, Business in Indonesia: Old Problems
and New Challenges, Institute of South East Asian Studies, Singapore.
Mondino, G. and S. Montoya (2000), The Effect of Labor Market Regulations on
Employment Decisions by Firms: Empirical Evidence for Argentina, Inter-
American Development Bank, Research Network Working Paper # R-391.
Kugler, A. (1999), The Impact of Firing Cost on Turnover and Unemployment: Evidence
from the Colombian Labor Market Reform, International Tax and Public Finance,
6(3): 389-410.
Kugler, A. (2004), The Effect o Job Security Regulations on Labor Market Flexibility:
Evidence from the Colombian Labor Market Reform, NBER Working Paper 10215
Lazear, E. P. (1990), Job Security Provisions and Employment, Quarterly Journal of
Economics, 105(3), pp. 699-726.
Pages, C. and C. Montenegro (1999), Job Security and the Age-Composition of
Employment: Evidence from Chile, Working Paper 398. Washington, D.C, United
States: IADB.
Saavedra, J. and M. Torero (2000), The Labor Market Reforms and Their Impact on
Formal Labor Demand and Job Market Turnover: The Case of Peru, Inter-American
Development Bank, Research Network Working Paper # R-394.

17
Table 2.1
Changes in Severance and Long Service Pay for Various Categories of
Dismissals/Separation of Workers in Indonesia, 1986 2003

Rates Voluntary Quits Dismissals

(months of salary)
Old New Old Reg New Economic Cause Minor Offense Major Offense
Regulations Reg: Reg: Old New Old New Old New
2003 2003 Regulations Reg: Regulations Reg: Regulations Reg:
86 96 2000 86 2000 86 96 2000 2003 86 96 2000 2003 86 96 2000 2003
and
96
Severance Pay
Less than 1 year 1 1 1m 1m 0 0 0 1 2 2 2 1 1 1 1 0 0 0 0
service m m
Three years 4 4 4m 4m 0 0 0 4 8 8 8 4 4 4 4 0 0 0 0
service m m
Five years service 4 5 5m 6m 0 0 0 4 10 10 12 4 5 4 6 0 0 0 0
m m
Ten years service 4 5 7m 9m 0 0 0 4 10 14 18 4 5 4 9 0 0 0 0
m m
Twenty years 4 5 7m 9m 0 0 0 4 10 14 18 4 5 4 9 0 0 0 0
service m m
Maximum 4 5 7m 9m 0 0 0 4 10 14 18 4 5 4 9 0 0 0 0
m m

Long Service Leave

Less than 1 year 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
service
Three years 0 0 2m 2m 0 2 0 0 0 2 2 0 0 2 2 0 0 2 2
service
Five years service 1 2 2m 3m 0 2 0 1 2 2 3 0 2 2 3 0 2 2 3
m m
Ten years service 2 2 4m 4m 0 4 0 2 2 4 4 0 2 4 4 0 2 4 4
m m
Twenty years 3 5 7m 7m 0 7 0 3 5 7 7 0 5 7 7 0 5 7 7
service m m
Maximum 5 6 10 m 10 m 0 10 0 5 6 10 10 0 6 10 10 0 6 10 10
m m

Total Severance
Less than 1 year service 0 0 0 1 2 2 2 1 1 1 1 0 0 0 0
Three years service 0 2 0 4 8 10 10 4 4 6 6 0 0 2 0
Five years service 0 2 0 5 12 12 15 4 7 6 9 0 2 2 0
Ten years service 0 4 0 6 12 18 22 4 7 8 13 0 2 4 0
Twenty years service 0 7 0 7 15 21 25 4 10 11 16 0 5 7 0
Maximum 0 10 0 9 16 24 28 4 11 14 19 0 6 10 0

Note: The labor regulation of 2003 adds a Uang penggantian hak which is 15% of total severance payment for all categories
of workers dismissal.

Source: Updated from Manning (2003) for the new labor regulation of 2003

1
2