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The Impact of the Limited Liability Corporation Law Number 40/2007 on Corporate Social Responsibility Policies in Indonesia

Jacquelynn Ayton

GST 6102: Corporate/Social Responsibility

March 25, 2015

Indonesia is a booming, emerging economy due to its vast natural resources1, with a

wealth of biodiversity comparable to the Amazon River Basin2, but it is still developing in

1 Kemp, 102 Ibid, 23

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many ways. One way Indonesia lags behind the West is with its lack of Corporate Social

Responsibility (CSR). Some would consider the concept of CSR within Indonesia to be a lofty

idea, arguing that the greater concern of basic needs and survival in general are not addressed

by CSR3. Furthermore, CSR is typically viewed as a Western construct, which is based on

Western values4, thus, not in line with Indonesian culture. However, by ignoring CSR

practices that are always implemented in the West, international corporations such as Nike,

Reebok, Levi Strauss, and Gap have exploited Indonesia’s developing economy and its

laborers in order to make greater profits in the Westi. Additionally, logging and oil palm

companies have created severe environmental damage5. With this, it is evident that Indonesia

does in fact need the protections of a CSR policy, and in 2007 Indonesia became the first

country6 in the world that passed a mandatory CSR law, the Limited Liability Corporation

Law Number 40/2007, intending to end the abuses suffered by laborers, society, and the

environment.

This research paper aims to focus on this CSR law in Indonesia and answer the

following three questions: What historical economic and political conditions led to the

implementation of the mandatory CSR law? How, if at all, has the law impacted CSR policies

of companies operating in Indonesia? What more can be done to further the cause of CSR in

Indonesia? The first part of this paper will detail the theoretical framework that will be used

throughout. The second part will give a historical economic and political background on

Indonesia, focusing from the time Indonesia was established as an independent republic. The

third part will be a further inspection of Law 40/2007, including previous regulations, how the

law came into existence, the outcomes of the law, and an explanation of Article 74. The fourth

part will include analysis and discussion about the points previously presented in the paper,

3 Ibid, vi4 Ibid, 15 Ibid, 246 Shauki, 201

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and contain the author’s viewpoint. Finally, the conclusion will respond to the questions

proposed in the introduction.

Theoretical Framework

The theoretical framework for this paper is based on the theory of rational choice7.

Under rational choice theory, political behavior is founded on the interests of the actors, or in

the case of this paper politicians, with little regard to the historical and cultural background of

the community, which is Indonesia for these purposes. The theory suggests that politicians are

ultimately opportunistic actors and that important decisions take place within an institutional

setting, such as a legislature.

Throughout this paper, rational choice theory will be referenced in various places.

First, the historical development of Indonesia, primarily under the Suharto regime, shows this

theory in practice. Also, the theory was displayed in the creation of Law 40/2007, and more

importantly Article 74 of said law. Finally, the implementation, or lack thereof, of the

aforementioned law exhibits the theory. In each case, political actors prioritized personal gain

over the needs of the community, which is the basic concept of rational choice theory.

Moreover, because of this self-centered and opportunistic attitude, CSR has failed to fully

flourish in Indonesia.

Historical Overview of Indonesia’s Economy and Politics

Indonesia has an extensive history, but from the beginning of the 17th century until

becoming a fully independent Republic of Indonesia in 19498, the archipelago was under the

colonial rule of Holland and known as Dutch East India. During this time, capitalism ruled,

7 Roskin, Theory of Rational Choice8 Legge, The Revolution

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and thus capitalism was linked to colonialism9. This association, along with the oppressive

treatment of the Dutch colonizers10, led to a “positively hostile” environment for foreign

investors in Indonesia under the regime of the first president, Soekarno, especially from 1958

to 196511.

However, Indonesia opened up to Foreign Direct Investment (FDI) when the second

president, Suharto, took power. Most of Indonesia’s FDI came from countries lacking CSR12,

establishing a trend to ignore CSR practices within Indonesia. From 1968 to 1986, Indonesia

experienced great economic growth due to the international oil boom which saw more than

60% of foreign exchange revenues13. On the surface, Indonesia appeared to flourish under

Suharto, but corruption was rampant14. Much of the profit from this growth was kept by

Suharto, his family, and his political cronies,15 which can be seen as a reflection of the rational

choice theory.

The Indonesian miracle boom did not last forever, and shortly after the start of the

Asian economic crisis of 1997 emerging from Thailand16, Indonesia had a drastic economic

downturn in 1998, with a GNP growth rate of minus 15%17. This led to the end of the Suharto

reign and his so-called “New Order”18. However, through this financial struggle, the economy

has managed to partially recover, and even with the current instability, Indonesia still sees 3 to

5% growth per annum19.

9 Kemp, 210 Ibid11 Ibid, 312 Ibid13 Sasongko, 3714 Kemp, 515 Ibid, 216 Legge, Economic crisis, public unrest, and the fall of Suharto17 Sasongko, 3718 Legge, Economic crisis, public unrest, and the fall of Suharto19 Kemp, 10

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The trend toward CSR in Indonesia started in the early to mid-2000s with the fall of

Suharto20. In the Suharto government, businesses previously had political protections from

community needs which led to the marginalization and impoverishment of community

members21. And after the several decades of corporate exploitation under the Suharto

administration, the public wanted more openness from corporations22, paving the way for CSR

policies.

That being said, the corruption that was extensive under Suharto continues even today,

and this endemic corruption negatively impacts CSR practices within Indonesia. Overall,

workers seem more concerned with earning a wage than getting fair treatment23. Also, labor

conditions are not viewed by Indonesian companies as part of CSR performance and

reporting24. However, the growing influence of Muslim law, Sharia, which explicitly bans

bribery, looting, or deception for the acquisition of land, may lead to a change in CSR

perspectives, and create an environment more conducive to CSR practices25. Additionally, the

government has begun to put pressure on government companies to disclose CSR practices,

showing that the government is trying to deal with CSR26. Also, the recently elected president,

Joko Widodo, has vowed to crack down on corruption27. Ultimately, it is necessary for

Indonesia to keep up with international companies concerning CSR in order to survive in

what is becoming a global market28.

Limited Liability Corporation Law Number 40/2007

20 Achda, 300; Rosser & Edwin, 421 Ibid, 300-30122 Ibid, 30123 Kemp, 824 Cahaya, et. al., 12325 Kemp, 926 Cahaya, et. al., 123 27 Holler, Joko Widodo28 Cahaya, et. al., 124

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The Limited Liability Corporation Law Number 40/2007 has several Articles dealing

with various aspects of corporations, but the Article which specifically addresses CSR is

number 74. Law 40/2007 was originally intended to update Law 1/1995 “to make it more

conducive to capitalist development”29, and Article 74 was not initially part of the law30. Then,

during public hearings, Business Watch Indonesia (BWI) argued for the inclusion of CSR in

the law31, which led to the establishment of Article 74 within the law.

In 2006, before Law 40/2007 was legislated, there was a regulation from the

Indonesian Securities Supervisory Agency (BAPEPAM) that required Indonesian companies

listed in the IDX to report CSR in annual reports32. This regulation could be considered a

precursor to Article 74 of Law 40/2007. The enactment of Article 74 has seemingly

strengthened this regulation from BAPEPAM as it has established sanctions against all

companies, not only the listed ones, dealing with natural resources which did not implement

Corporate Social and Environment Responsibilityii. This mandatory nature is important, as

government regulations are required for the framework of enforcement and community

welfare33. Furthermore, regulations are necessary to give CSR power, since voluntary CSR

can be so freely interpreted34.

The inclusion of mandatory CSR was put forth by BWI, but there were also political

reasons for promoting CSR, as is always the case within rational choice theory. Gas mining

which caused a massive mud flow was widely covered in the news, and was connected to the

Golkar political faction. Opponents of Golkar were quick to push CSR in an attempt to oust

them 35. Although there were plenty of groups who supported Article 74, there were also many

29 Rosser & Edwin, 1130 Waagstein, 460; Rosser & Edwin, 1131 Rosser & Edwin, 1132 Cahaya, et. al., 11433 Achda, 30234 Ibid35 Rosser & Edwin, 12

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businesses that began lobbying against it saying it would damage Indonesia’s competitive

economy36.

While discussing Article 74, there were two coalitions of interest which felt strongly

about the mandatory regulations. From a business perspective, the mandatory nature of

Article 74 was frowned upon, because companies generally do not want to invest in CSR

programs that can negatively impact profits. The three main reasons that businesses argued

against mandatory CSR were: (1) the idea of forced spending was viewed as additional tax,

(2) it increased the possibility of bribes, and (3) it could create capital flight for the companies

that were too financially damaged or disadvantaged by the law37. At the same time, NGOs and

small- and medium-sized enterprises (SMEs) supported the mandatory CSR as it leads to a

communal good. Their argument was that mandatory regulations are necessary as a

“voluntary system privileges profitability over social responsibility whenever the two are in

conflict”38. After a variety of proposed changes, Law 40/2007, including Article 74, was

finally passed with no objections39.

Once the law was approved, the Indonesian Chamber of Commerce (KADIN) and

other corporations questioned the legality of Article 74 and brought it to court. The three

reasons that the legality was questioned were: (1) It showed legal uncertainty as it was in

opposition to the voluntary nature of CSR, (2) it was especially discriminatory against

corporations in the natural resources sectors, and (3) it would create a negative impact on the

economic situation of the companies impacted, namely those within the natural resources

sector. Although the legality was questioned, the Indonesian courts decided to uphold the

Article40.

36 Ibid, 1437 Ibid, 6-838 Ibid 39 Ibid, 1640 Waagstein, 456

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Article 74 of Law 40/2007 has played a role in instituting CSR in Indonesia in four

important ways41. First, it has legally strengthened CSR due to the mandatory nature of the

law. Second, it has furthered the reception and implementation of CSR within Indonesia.

Third, it is a preventative mechanism meaning companies cannot unduly benefit from the law.

Fourth, it creates a precedent for other countries to establish mandatory CSR laws.

At the same time, there are a few questions that Article 74 leaves unanswered. The

first of these is clarification on which corporations are affected by the mandatory

requirements, i.e. what does it mean to be “connected” to a business in the natural resources

sector. Next, it is not clear who is responsible for the implementation and funding of the CSR

policies. Also, it is not specified which CSR standards should be applied. Finally, the

questions of how and by whom sanctions will be imposed on those companies that do not

implement the proper CSR policies is not clarified42.

The lack of implementation leads some to suggest that Article 74 is actually a “de

facto retention of a voluntary approach to CSR”43. With the lens of rational choice theory, it

would seem that the politicians prioritize business interests, as the task force created to

implement Article 74 was filled with representatives of big business44, effectively stalling the

implementation for the benefit of corporations that are opposed to mandatory CSR.

Analysis and Discussion

The relationship between CSR and Indonesia is quite complicated as the majority of

CSR motivations lie outside of Indonesia45. Within Indonesia, CSR is seen more as a

management tool for social relationships, and is not generally incorporated in corporate

41 Ibid, 46042 Ibid, 460-46143 Rosser & Edwin, 244 Rosser & Edwin, 1645 Kemp, 11; Waagstein, 458

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strategy46. Indonesia seems slow to accept CSR due to lack of knowledge on the topic, as well

as the social and legal problems which continue to exist in the country47. Furthermore, codes

of conduct are seen as a Western imperative and employment is more important for

Indonesians than codes of conduct48. With a reference to the often (mis)quoted Marie

Antoinette quip, Kemp states, “the West may be trying to distribute cake, when what is truly

needed is bread”, highlighting the disconnect between Western attitudes on CSR and the

implications for Indonesia49. A further issue for CSR in Indonesia is that initiative and protest

by workers are generally punished50, dissuading public support for such efforts. That being

said, CSR still exists in Indonesia, generally in the most popular form of community

development51. At the same time, though it can be seen as a form of philanthropy, community

development is frequently referred to by companies as “enlightened self-interest”52, so it is not

an advanced form of CSR.

While Article 74 can be easily viewed as a step in the right direction, there are

additional implications brought up by Waagstein that should be discussed53. The first of which

is whether the mandatory nature of Article 74 violates the essence of CSR. Although CSR

was originally established as a voluntary contribution by corporations, it has come to be more

than just a suggestion. Wayne Visser highlights everything from increased deforestation to

rampant malnourishment when explaining that the world we live in today is worse than it was

before54, which is what makes CSR no longer an option, but a necessity for life.

Waagstein’s second question is whether mandatory CSR will ensure its effectiveness.

In countries like Indonesia, it is easy to be cynical about the effectiveness of mandatory 46 Razafindraminina & Kariodimejo, 947 Waagstein, 45848 Kemp, 15-1649 Ibid, 3350 Ibid, 2151 Razafindrambinina & Kariodimedjo, 952 Achda, 30353 Waagstein, 46154 Visser, 27-39

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requirements when looking at the endemic corruption within the society, especially when

applying rational choice theory and the belief that politicians, like corporations, are out for

what is solely in their best interest. At the same time, mandatory regulations may prove more

effective than voluntary ones simply due to the fear of sanctions that could be costly. This

easily ties into the third question, which is whether the mandatory nature of CSR will increase

corporate cost. While there is no link between financial profit and CSR55, as previously stated

the world has come to a breaking point and something must be done even if the financial cost

is high. In the end, human life is worth more than any monetary profit, but this is

unfortunately not always an accepted norm, which leads to companies being more concerned

about financial loss over human loss.

The final question put forth by Waagstein is whether the mandatory regulation of the

CSR law would result in a competitive disadvantage. Competitive disadvantage is elaborated

on in two ways56. First, an advantage based on profit. Second, an advantage for corporations

not mandated to include CSR. Although any form of competitive disadvantage is viewed

negatively in the business world, it is important to get back to why CSR is important. The

goal of CSR is not to increase profits or improve image, but rather to expand the quality of

life for all people, not just a privileged few.

Ultimately, in order for Article 74 of Law 40/2007 to have any impact on CSR in

Indonesia, it needs to be thoroughly implemented. At the current rate, very little has changed

because of the political ties of businesses that do not want to see mandatory requirements

effecting their financial profits. Until politicians put human life above bribery, this will

continue to be the state of affairs for CSR in Indonesia. The one hope is that the recent

election of Joko Widodo, referred to in Indonesia as Jokowi and commonly viewed as a

55 Waagstein, 463; Vogel, 3356 Ibid, 463-464

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president of the people57, will see an end to the endemic corruption that has plagued Indonesia

for decades, and allow for a true reform of CSR in Indonesia.

Conclusion

This paper set out to answer three questions. The first question is what historical

economic and political conditions led to the implementation of the mandatory CSR law?

Under the theoretical framework of rational choice theory, the answer lies within the interests

of politicians. Stemming from the Suharto regime, politicians promoted financial gains over

social and environmental responsibility. The exploitation of workers and the destruction of the

environment, chiefly by foreign companies, created a situation in which people became more

concerned with CSR. Additionally, the fall of Suharto sparked a fire among Indonesians to

create a better society. This gave rise to the idea that CSR was necessary and should therefore

be made mandatory, setting the stage for the creation and implementation of Article 74.

The second question is how, if at all, has the law impacted CSR policies of companies

operating in Indonesia? With the introduction of Article 74 in Law 40/2007, the entangling

alliances between politicians and business were further expressed. The group primarily

responsible for the implementation of Article 74 is lined with business people who originally

did not want it to exist. So even though the stage was set for the implementation of a

mandatory CSR law, the idea has still not fully come to fruition. That being said, the

precedence created by Article 74 can easily be developed into further laws promoting CSR.

This simply depends on whether any politicians will pursue the interests of society over their

own.

The third question is what more can be done to further the cause of CSR in Indonesia?

There are two main groups at play when answering this question. The first group is the people

of Indonesia and the second group is the politicians of Indonesia. The people of Indonesia 57 Holler, Joko Widodo

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have to be able to get behind the idea of CSR. This is to say that it cannot be viewed as a

foreign or Western ideology, but instead one that directly effects Indonesians. Once

Indonesians believe the benefits of CSR outweigh the personal costs, they will be able to

thoroughly support its standards. At this time, the people generally appear to be short-sighted.

They are more focused on having a meal today than breathing fresh air tomorrow. This is not

an anomaly among Indonesians, as most people live for the here and now. Thus it is a great

challenge to alter this established mindset, but it is a step that must be taken in order to

promote CSR in Indonesia.

As for the second group, the politicians, they have to sacrifice their own wants for the

needs of the people. This is a goal that would look impossible from the perspective of rational

choice theory. Since rational choice theory only allows for politicians to be self-serving, it

does not allow for them to consider what is best for the community in general. That being

said, there are politicians that are more prone to listen to the people. For example, a self-made

man who rose from the slums of central Java to become the seventh president of the Republic

of Indonesia, Jokowi has made clear his intentions to clamp down on corruption and help the

poor. Looking at Jokowi’s background, it is clear that he is not part of the political

establishment and is thus more likely to put Indonesia on an international stage for its CSR

policy.

In conclusion, CSR in Indonesia has a wealth of potential. It is currently being held

back by a mindset of desperation among the people and a pursuit of self-interest among the

politicians. Yet even though the future of CSR looks fragile at first glance, the creation of

Article 74 in Law 40/2007 and the election of Jokowi point to a massive shift in ideology

among Indonesians concerning CSR. It could even be suggested that Indonesia will one day

serve as a model for other countries concerning CSR policy.

iEndnotes:

Although these companies previously had a poor public image due to exploitation of workers, most have now established CSR norms in an attempt to quell international public outrage at the conditions (Kemp, 11)ii The wording of Article 74 of Law 40/2007 is as follows: (1) Limited liability companies that carry out business activities in natural resource sectors or that are connected with natural resources are obliged to implement Corporate Social and Environmental Responsibility.(2) Corporate Social and Environmental Responsibility, as referred to in paragraph (1) represents a responsibility of a limited liability company that is budgeted for and calculated as an expense of that company, the implementation of which is to be carried out paying attention to appropriateness and propriety (kepatutan dan kewajaran). (3) Limited liability companies that do not implement their obligation as referred to in paragraph (1) will incur sanctions in accordance with the provisions of legislative regulation. (4) Further provisions concerning Corporate Social and Environmental Responsibility will be laid down (diatur) in a Government Regulation (Peraturan Pemerintah).

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