The report comes as the secretary general of the Organisation for Economic Cooperation and Development (OECD), Mr Angel Gurria, visits Indonesia to meet President Susilo Bambang Yudhoyono and other officials.
It said Indonesia's economy had bounced back from the 1997 Asian financial crisis but had to take steps like simplifying regulations and removing barriers to investment to boost growth and overcome poverty.
Estimated 2008-2009 economic growth of more than six per cent would help cut poverty, but the economy needed to expand more quickly to significantly lift living standards, it said.
Deregulation and better law enforcement would encourage more foreign investment, and Indonesia should ease restrictions on foreign ownership, including ceilings applied to some sectors, the OECD report argued.
Indonesia should also roll back laws that make it hard to dismiss workers and which provide for generous severance pay regulations, and cut minimum wages, in order to attract investors, the report said.
Higher labour costs mean Indonesia is being overlooked for investment in labour-intensive sectors, such as manufacturing, in favour of regional rivals, it said.
'Burdensome labour laws, including minimum-wage provisions, often penalise vulnerable workers, instead of protecting them ... unemployment insurance could be introduced in lieu of onerous dismissal/severance compensation entitlements', it said.
Foreign direct investment in Indonesia reached US$10.34 billion (S$14.08 billion) last year, 73.2 per cent higher than the year before, with Singapore the biggest source of funds.
Indonesia's relatively high labour costs, crumbling infrastructure, widespread corruption and confusing laws and regulations are frequently cited as concerns by investors, despite a large pool of consumers and rich resources. -- AFP