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 economythrough coercion if necessarywas 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 Territorys 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). 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 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 Territorys 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 workersdue to the preponderance of informal work in agricultureit is huge compared with developed countries, and certainly much greater than the Governor should be willing to accept given the Territorys potential for increasing greatness.
Figure 1 Jakarta Labor by Employment Status (Source: BPS Jakarta 2010)
Feb-08 Feb-09 Feb-10

Employment status Informal Own-account Employer with temp. workers Casual worker Unpaid Total informal Formal Employer with permanent workers Employee Total formal Total Percent informal

Men 449,460 139,220 69,390 56,310 714,380

Women 233,180 89,560 24,400 153,600 500,740

Total 682,650 228,780 93,780 209,920 1,215,130

Men 576,200 169,780 60,430 54,720 861,130

Women 308,270 114,310 28,280 172,080 622,940

Total 884,470 284,090 88,710 226,800 1,484,070

Men 604,350 136,030 72,380 43,300 856,060

Women 325,100 92,630 41,560 133,800 593,090

Total 929,450 228,660 113,940 177,100 1,449,150

138,230 1,585,280 1,723,510 2,437,890 29.303

37,740 1,078,610 1,116,350 1,617,090 30.965

175,960 2,663,890 2,839,850 4,054,980 29.966

168,020 1,490,680 1,658,700 2,519,830 34.174

39,330 1,004,860 1,044,190 1,667,130 37.366

207,350 2,495,540 2,702,890 4,186,960 35.445

164,790 1,544,880 1,709,670 2,565,730 33.365

35,520 1,014,560 1,050,080 1,643,170 36.094

200,310 2,559,440 2,759,750 4,208,900 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 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 workerswhich could be considered as sitting atop the informal ladderwomen 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) 2,000,000 1,800,000 1,600,000 1,400,000 1,200,000 1,000,000 800,000 600,000 400,000 200,000 0 Jan-08 Jan-09 Jan-10 Men's Formal Employment Women's Formal Employment Men's Informal Employment Women's Informal Employment

Costs and Benefits of the Informal Economy The presence of a large informal economy has both costs and benefitsthough 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 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
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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. 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
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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 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 Territorys exchequerin 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. 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
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.

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. Improving formal sector labor market flexibility Soehartos 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
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argument from the standpoint of neoclassical economics; moreover, both national severance pay rates and the Territorys 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 or informality. There are also reasons to believe that good labor market regulation can improve standards without reducing employmentfor 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 growthwith 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) 80,000,000 70,000,000 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000 0 2004 2005 (Feb) 2005 (Nov) 2006 (Feb) 2006 (Aug) 2007 (Feb) 2007 (Aug) 2008 (Feb) 2008 (Aug) 2009 (Feb) 2009 (Aug) 2010 (Feb) 2010 (Aug)

Formal Employment Informal Employment

Figure 4 Indonesian Unemployment Rate (Source: BPS 2011)

National Unemployment Rate

12 10 8 6 4 2 0 2004 2005 (Feb) 2005 (Nov) 2006 (Feb) 2006 (Aug) 2007 (Feb) 2007 (Aug) 2008 (Feb) 2008 (Aug) 2009 (Feb) 2009 (Aug) 2010 (Feb) 2010 (Aug)

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 Jakartas dependence on the informal economy. Industrial policy should seek to develop industries that have a chance of competing globally 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 Jakartas 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 desirableunless 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 that exceed the burdens. Fortunately the government has benefits it could provide.

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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 modelallowing some leniency while firms learn to comply, but also promising consequences in the case of stubborn defiancecan 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 regressiveit also probably does not work. The government policy enacted during Governor Sutiyosos 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 workaside from the up-to-six months spent in prisonso 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,

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123). One possibility would be a universal basic social allowance, modeled after Brazils 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 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 Governors role would

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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 Governors 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. 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.

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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 proceed in the short term. As mentioned above, organizing is mostly out of the Governors 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. Indonesias 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 Devils Deal. Institute for Development Studies Bulletin 33, 3.

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