Posted by: nsrupidara | February 3, 2010

The Influence of Institutional Environment on HRM Practices in Multinational and Local Companies in Indonesia

Neil Rupidara and Peter McGraw, Macquarie University, Sydney

Overseas multinational corporations (MNCs) have played an increasingly important role in the Indonesian economy during the last three decades, particularly with respect to the manufacturing sector (Takii and Ramstetter, 2005). This paper explores recent developments in the institutional environment of labour relations in Indonesia and its impact on local and multinational companies (MNCs).

In the paper it will be argued that there are at least four key factors influencing the pattern of labour relations within and between local companies and MNCs in Indonesia. First, in many developing countries there is a major demarcation to be drawn between the formal and informal sectors. The formal sector includes workers employed in larger enterprises with more formal systems of production often modeled on systems imported from developed countries. Typically it is this sector that attracts Foreign Direct Investment in developing countries and hence is naturally the most likely sector for the location of MNCs. The informal sector often employs a large proportion of the workforce and comprises low wage, small enterprises which are beyond the reach of or exempt from labour regulations. In a populous, complex and geographically dispersed country such as Indonesia this sector employs over half of the working population (Alisjahbana and Manning 2006). Whether or not the formal sector and specifically that comprising foreign MNCs has had a beneficial ‘trickle down’effect of improving labour standards or a more pernicious effect in actually widening the gap between the formal and informal sectors in Indonesia is an issue that will be explored in the paper.

Second, the level of compliance with labour regulations is often an issue in developing countries because of poor enforcement mechanisms, cronyism and corruption as well as low rates of unionization (Manning and Roesad, 2007). In addition, the physical coercion of labour activists adds a dimension to labour relations which has not been present in developed countries, except in unusual circumstances, for several decades. In Indonesia all of these factors can play a part in the overall labour relations and in extreme cases can provide a political focus for reform movements. Such an incidence was evident in 1993 in the infamous Marsinah case which is referred to later in this paper. The paper will discuss labour law compliance issues in Indonesia in both MNC and local companies.

Third, MNCs are usually more likely to be found in the larger, more formal, more capital intensive and more visible sectors of the economy. Thus in developing countries such as Indonesia MNCs are often subject to a more stringent interpretation of labour law than comparable local companies. An additional factor influencing the more rigorous adherence to local labour regulations by MNCs is the issue of reputational risk and the possible adverse business consequences of being perceived as an unfair employer that fails to provide decent terms of employment. The paper will outline the sectors of the Indonesian economy where MNCs are most common and discuss associated compliance issues.

Fourth, by their very nature MNCs are more likely to display some degree of institutional isomorphism with the overseas parent organization and thus use different internal transformation processes than locals. The competitive strength of MNCs is largely based on some degree of transnational integration centred on specialisation, interchange and scale. As Kobrin (1991) has argued, integrated MNCs gain competitive advantage from comparative advantage (based on different national resource advantages), the bargaining strength and flexibility of an international network and internal economies of scale, scope and learning which can be leveraged across different international locations (Kobrin, 1991, 18). The competing forces of localization and centralization will be analysed with reference to MNCs operating in Indonesia.

In addressing the four factors referred to above the paper will also chart key events in the recent history of the Indonesian labor regulations and industrial relations systems which have undergone significant changes since 1997. These are briefly outlined in the remainder of this abstract and will be more fully expanded in the full paper.

A major turning point in Indonesian labour relations resulted from the 1997 financial crisis, the intervention of the IMF, and the subsequent fall of the Soeharto regime in 1998. This led to the introduction of the so called Era Reformasi or Post-New Order Era. Before 1998 the formal tripartite Indonesian industrial relations system was effectively under tight state control and was an element of its industrialization strategy. This policy was characterized by the subjugation of independent unions and tight wage control aimed at ensuring international competitiveness and attracting foreign direct investment (Manning 1993; Rupidara 1997). Despite this policy there was significant labour unrest during the Soeharto era, especially in late 1980s and 1990s. This unrest culminated in the infamous Marsinah case in 1993 where a young female labour activist was raped and murdered allegedly as a result of her leadership role during a strike.

From 1998 onwards under the Era Reformasi there were simultaneous pressures for continuity and change. On the one hand the Habibe government moved away from the single vehicle trade union model of the Soeharto era and ratified ILO Convention 87 which guaranteed trade union freedom and the right to organize (Quinn 2003). On the other hand the new government implemented key elements of the 1997 Manpower Law which was consistent with the old regime and promoted the same economic policy goals of stable economic growth through FDI and protection of the interests of the investors via tight controls on labour. Although there were undoubted attempts to improve normative labour standards during this era through the enactment of supplementary laws covering union rights and the establishment of an Industrial Relations Tribunal, serious problems in the consistency of law enforcement remained and many of the standards were not widespread. Overall, the new government’s initiatives on labor issues were perceived as reactive, partial and an attempt to appease international opinion whilst retaining the substance of the old order (Ford, 2000).

By 2003 the Presidency of Indonesia had passed to Megawati Soekarnoputri and major changes were introduced to the Manpower Law (13/2003) with the assistance of the International Labour Organisation and as part of a wider re-affirmation of the principles of Pancasila. The new law provided for collective bargaining and the registration of legally binding collective labor agreements as well as the exercise of other trade union functions. In addition a parallel system of company regulations, which could be ratified with the government and enforced, was initiated. For non union workers and those in the informal sector of the economy the government reaffirmed its protective role and encouraged the filing of complaints. Notwithstanding these changes, there were many reports that both domestic and foreign-owned companies, undertook only perfunctory consultations with workers and that these were often with management-selected employees. Moreover, there were reports from NGOs that, in practice, collective agreements often did not go beyond the legal minimum standards established by the Government, and that employers often dictated the terms of the agreements rather than genuinely negotiating them (US Department of State, 2003).

More recently under the government of Susilo Bambang Yudhoyono there have emerged new proposals to amend the 2003 Manpower Law. The basis for these changes is the claim that the Law is having a negative impact on the growth of employment because it imposes inflexible working conditions, restricts productivity and increases net labour costs (Kuncoro, 2006). According to a recent World Bank study, Indonesian labour regulation is perceived as uncompetitive by comparison with other Asian countries. Problems highlighted include, wage rigidity through indexation the high costs of employee severance and termination (even when the employee is demonstrably culpable), the high costs of outsourcing and needs based minimum wage policy This has led to a number of foreign ambassadors warned the Ministry of Manpower and Transmigration about the potential adverse impact on FDI to Indonesia. As yet the proposed changes have not been finalized whist the debate over their merit continues. An update on the latest developments as well as a fuller elaboration of the issues and themes developed in this abstract will be provided in the full paper.

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US Department of State. 2003. Country Reports on Human Rights Practices – Indonesia, Bureau of Democracy, Human Rights, and Labor February 25, 2004

Note: This abstract was submitted to HRM Global 2008 Conference, held in Turky, Finland, by Turku School of Economics and HRM Study Group International Industrial Relations Association (Prof. Satu Lahtenmaki + Prof. Stephan Zagelmayer, Conference Chair). The full paper (with adjusted title) was presented by Neil on 29 August 2008. Please visit:


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