The real challenge of Indonesia’s large informal economy

In a surge of self-confidence, Indonesian President Joko Widodo, better known as Jokowi, bragged to leaders of G20 countries at the recent Rome summit that his country’s economy has remained resilient in the face of to the Covid-19 pandemic – thank you, he said, to 65 million micro, small and medium enterprises (MSMEs). Generating 61% of Indonesia’s economic output in 2020, Jokowi told his audience that nearly two-thirds of these MSMEs are headed by women. And he had a plan to empower them through better access to financial services and business loans.

Jokowi’s presentation, with its microeconomics twist and promise of empowering women, was clearly intended to create a good lens for Indonesia in an international forum. But on closer inspection, how accurate was this representation of Indonesian MSMEs?

Jokowi’s claim that MSMEs are the backbone of Indonesia’s economy is quite true. The 2016 census conducted by the Bureau of Statistics found that 99% companies in Indonesia could be classified as MSMEs. In addition, more than 60 percent of the Indonesian workforce earned their living in the informal sector where most MSMEs operate.

The sheer size of Indonesia’s informal sector sets it apart among the G20 countries.

In neighboring Malaysia, the vast majority of companies are classified similarly as MSMEs, but with one important difference: Malaysia’s informal sector is significantly smaller at just over nine percent, according to 2019 figures. Vietnam, another booming economy in Southeast Asia, also has a large percentage of MSMEs. But, once again, its informal sector, 15 and 27 percent, is smaller than that of Indonesia.

The sheer size of Indonesia’s informal sector sets it apart among the G20 countries. India had a larger informal economy, 93 percent in 2014, but by 2021 the figure has decreased to understand less a fifth of the country’s economy. Some believe that Indonesia’s large informal economy makes the country tougher in the face of global crises. But the informal sector has its setbacks. Informal businesses are not considered “bankable” and are generally not eligible to receive government assistance.

A 2016 report by the International Finance Corporation on Women-owned MSMEs in Indonesia noted that only 24 percent of Indonesian MSMEs used government support services, and that more than half of the companies surveyed had chosen to remain in the informal sector. Almost a third of them said the registration process was too complicated, while 9% said it was too expensive.

Indonesian President Joko Widodo (Andy Buchanan / AFP via Getty Images)

It is naturally in Indonesia’s interest to encourage more MSMEs to formalize, so that they can access financial services and become taxable entities. But a deep mistrust of government agencies is rightly a major obstacle to this.

Fifteen days before Jokowi’s speech, Indonesian social media was full of claims that police were targeting online frozen food merchants for possibly fabricated transgressions against food safety regulations. It started with an Instagram post from a restaurant in Jakarta, the owner of which had been arrested by the police for the sale of frozen ready-to-eat meals during times of large-scale social restrictions. Police said the restaurant did not have a legal license to sell frozen food and could be fined up to IDR 4 billion (AU $ 400,000) under the criminal code.

The Instagram post went viral and drew similar testimonials from micro and small business owners in the food based home industry. Several said they were searched their homes by government officials and threatened with prosecution unless they agreed to pay the authorities.

Police tracking down online food vendors trying to make a living without government handouts ultimately proved embarrassing to authorities.

The news was understandably upsetting as e-commerce became the country’s economic lifeline during the Covid-19 pandemic. According to investigation, the number of Indonesians shopping online rose from 75 million to 85 million during the pandemic. But the actual number of Indonesians using online platforms to buy and sell is undoubtedly much larger as the survey only covered major online grocers such as Lazada, Tokopedia, Shoppee, all of which belong to the formal sector of country.

Most e-commerce in Indonesia takes place informally, on platforms such as Facebook Marketplace, Instagram and WhatsApp, with the majority of “merchants” selling their products from home or acting as resellers. Most of these are seasonal or casual traders trying to make ends meet and they do not pay income taxes. But, since the government has no obligation to provide a social safety net for these outliers in the informal sector, it has gladly turned a blind eye to their non-taxpayer status.

Outrage at police tracking down online food vendors trying to make a living without government handouts ultimately proved embarrassing to authorities. BPOM, the Indonesian food and drug regulatory body, has published a declaration explain the laws and regulations governing the sale of frozen food products. The statement appeared to absolve the Jakarta restaurant of wrongdoing because its products fell under the category of “ready-to-eat meals prepared at the request of end-users” instead of being mass produced.

But that did little to end the confusion over which government agency was supposed to oversee MSMEs. Currently, several government agencies – including the police, the BPOM, the Ministry of Health and local government authorities – are claiming jurisdiction over MSMEs in the food sector and their licensing needs, creating gray areas that are likely to be affected. be exploited by unscrupulous government agents.

While extortion by government and law enforcement officials is a long-standing practice in Indonesia – the IFC report says 54% of companies said they made “informal payments” to appease them. government officials – an illegal practice can only diminish confidence in the system.

Until the issue of predatory behavior by government agents is seriously addressed, progress towards formalizing more Indonesian MSMEs will be bumpy. Any government outreach pledge to support MSMEs will be nothing short of wind.

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