This paper contributes new evidence from two large household surveys on the compliance of firms with severance pay regulations in Indonesia, and the extent to which changes in severance pay regulations could affect employment rigidity. Compliance appears to be low, as only one-third of workers entitled to severance pay report receiving it, and on average workers only collect 40 percent of the payment due to them. Eligible female and low-wage workers are least likely to report receiving payments. Widespread non-compliance is consistent with trends in employment rigidity, which remained essentially unchanged following the large increases in severance mandated by the 2003 law. These results suggest that workers may benefit from a compromise that relaxes severance pay regulations while improving enforcement of severance pay statutes, and possibly establishing a system of unemployment benefits.
The financial crisis that emerged in the United States in mid-2007 quickly transformed into a global credit crunch that sharply reduced global trade flows. Many countries were affected by the severe global recession that followed, and millions of individuals throughout the world lost jobs, leading to increased informality and working poverty. In the aftermath of the crisis, policymakers throughout the world are questioning whether existing labor market regulations successfully balanced the competing goals of maintaining flexibility and protecting workers.
While discussions over the scope of labor market regulations are often heated, views are typically based either on the predictions of theoretical models or anecdotes. The lack of evidence is particularly acute for developing countries, where hard data are rare and mechanisms for enforcing regulations tend to be limited. Lack of enforcement is a particularly serious concern, given that significant portions of workers report earning wages that fall below the statutory minimum.2 No systematic evidence, however, exists regarding compliance with other labor regulations, making it difficult to make an informed assessment of the costs and benefits of regulatory reform.
This paper contributes new evidence on the compliance of firms with severance pay regulations in Indonesia, and the extent to which changes in severance pay regulations could affect employment rigidity. This evidence sheds light on a vigorous policy debate that arose in Indonesia prior to the onset of the global financial crisis, following the passage of a 2003 labor law that increased employment protection and severance pay. The debate pitted the business community, which warned that increases in severance pay regulations would reduce employment, against organized labor, which argued that severance pay makes an important contribution to income security.
Author: Brusentsev, Vera ; Newhouse, David ; Vroman, Wayne; Document Date: 2012/01/01.Document Type: Policy Research Working Paper.Report Number: WPS5933
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