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Starting from the bottom: a tale of the informal economy and inequality

Namira Samir

By Namira Samir

Of the five administrative cities of the Special Capital Region (DKI Jakarta), East Jakarta has the second-highest number of people living below the poverty line, according to the Central Bureau of Statistics. My minibus trip to East Jakarta has taught me about poverty and inequality more than books and lectures have ever done.

The journey turned out to be an experience that is likely to endure through time. I was the first passenger to make my way inside the bus. I waited for about 15 minutes, and it was still only me, no one else.

Then a middle-age woman, possibly in her early 50s, joined me. She was carrying quite a lot of shopping bags. I presumed she came from Tanah Abang Market, the largest and possibly one of the cheapest textile markets in Asia.

From our brief chat, I learned that she was a frequent user of the minibus. I asked her when the bus would depart, because it was way behind schedule. She said, “It will not depart until the bus is at least half full, my dear.”

I was disappointed, because I had decided to take the bus to avoid traffic and it was the most efficient option available, or at least that was what I thought based on my Internet research.

Five minutes later, the driver stepped in and we finally left the station. Throughout the journey, I beheld people from different professions and backgrounds. But here’s the thing: They all were people who struggled to meet their basic needs.

There were fruit and vegetable sellers who I believed were on their way to another market where they would sell their products. There were beggars who despite seeming physically healthy, kept asking for easy money. There were elderly people who were hardly capable of walking on their own feet but had no other choice.

There were also food and goods vendors marketing their products during the journey until the bus reached its final destination. None of us paid even the slightest attention to the vendors. One man optimistically elaborated the perks of the product he was selling, pointing to the price, which was significantly lower than if we were to purchase such products in the retail shops or shopping malls.

I suppose the ending of the story is predictable. None of us passengers bought the product. He left the bus empty-handed.

That was and still is the reality of the Indonesian economy that most of us fail to recognize. Our attention and interest are only on how to create grand programs, tackling unemployment with projects that eventually fail to reach the right beneficiaries.

Pericles, a prominent and influential Greek statesman, once said, “There’s no shame in poverty, only in not doing something with it.” The vendor that I met, despite living in hardship, chose not to give up on his situation. Shouldn’t we be ashamed of doing nothing to help transform their situation into something better?

GDP per capita in Indonesia averaged US$3,877 in December 2017. The poverty rate fell to 9.82% of the total population in the first quarter of 2018. Yet Indonesia still has very high income inequality, and the unemployment rate rose from 5.13% in the first quarter of 2018 to 5.34% in the second quarter.

In addition to high unemployment, many of the existing jobs, especially those in the informal sector that absorb the largest proportion of the Indonesian workforce, are of low quality, which constitutes a major drag on workers’ well-being.

Looking at this issue, the scholars David Simon and Sarah Birch in their 1992 paper “Formalizing the Informal Sector in a Changing South Africa: Small-scale Manufacturing on the Witwatersrand” suggested the formalization of the informal sector in South Africa. The idea is often repeated in various research and reports such as in “Transitioning the Informal to the Formal Economy,” a 2014 report by the International Labor Organization.

There is no doubt that the informal sector in Indonesia is characterized by acute shortages of decent jobs. It is where the majority of the destitute make a living, although it hardly offers reasonable livelihoods and incomes. They are prone to inadequate and unsafe working conditions, and have high illiteracy levels. They are not able to benefit from social-security schemes or labor protection.

But proposing to formalize the informal economy is not the appropriate policy response. Doing so would require workers to obtain a license, register and pay taxes, which would add costs to the people whose livelihoods depend on this sector.

People who work in the informal sector lack the education and skills necessary for a more sustainable means of livelihood. Data from Statistics Indonesia (BPS, 2015) demonstrate that about 80% of employment in the informal sector is for those who are junior-high-school graduates or below.

The formal sector, such as office work, requires administrative or analytical skills. Therefore, without improving human-resources quality, those working in the informal economy will always be excluded from better job opportunities.

As such, policymakers must address this issue in order to improve the welfare of the workers in the informal economy as well as improving the overall national economy.

There are several things that government can do to solve this problem. First, local and national governments can design programs that can directly reach this layer of society, for example by providing training and providing easier access to education for workers who are still at compulsory school age.

Improving the quality of human resources needs to start from the bottom. Imagine the powerful impact it would create if the quality of human resources in the informal economy, which makes up 60% of the workforce of Indonesia, were escalated.

As documented in the ILO’s World Social Protection Report (2017), 61.1% of people in Asia and the Pacific remain without social protection. Such underinvestment in social protection or so-called exclusionary policy will jeopardize workers’ well-being and prevent Indonesia from achieving sustainable economic growth.

Therefore, in addition to enhancing the quality of human resources in the informal sector, macroeconomic policy needs to ensure that labor rights are protected. Referring to a report by the Organization for Economic Cooperation and Development (OECD, 2016), policymakers need to develop social protection system which can reduce labour market insecurity.

Second, the Indonesian government needs to provide workers in the informal economy access to financial services, since low financial inclusion may pose threats to both the societies affected and the country’s overall economy.

To illustrate this, the relationship among financial inclusion, real output and interest rates might be provided as an example. According to the neo-Keynesian macroeconomic model, an increase in policy interest rates contributes to lower private expenditures, which reduces real output, and vice versa.

However, the model is flawed in the way it assumes that all consumers as private agents have access to financial services. This would certainly ring false in a lower-middle-income country like Indonesia, where more than 60% of the total population are excluded from accessing financial services. Hence these financially excluded private agents would weaken the elasticity of private spending and reduce the monetary transmission mechanism through interest rates that might affect aggregate demand.

According to a 2015 analysis by Aaron Mehrotra and James Yetman, accessibility to saving or borrowing is the essential characteristic of financial inclusion. Since financial inclusion helps smooth consumption, increased financial inclusion will increase the incentive to buy of the workers, propel the demand for goods and services, hence causing gross domestic product to rise.

Seeing that the degree of financial inclusion is associated with the outcome of monetary and fiscal policies whose underlying motives include financial and economic stability, and seems to reduce inequality, the government needs to put more emphasis on improving financial inclusion in Indonesia.

The government can utilize technology to facilitate credit for workers in the informal sector who want to develop businesses or want to become entrepreneurs so that they can get more secure jobs while the government progressively reforms the human capital of the country.

Poverty and inequality are the biggest threats to the world’s sustainability, and only if we attempt to address the core issues we would all live happily and peacefully.


Namira Samir

Namira Samir Namira Samir is an economist and consultant specializing in Islamic finance, multidimensional poverty and women’s empowerment. She holds a master’s degree in Islamic finance and management from Durham University in the UK.

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