Local labor markets dynamics and export shocks: Theory and evidence from Indonesia

Understanding the Impact of Export Shocks on Indonesian Labor Markets

Indonesia's economic landscape underwent a profound transformation in the 1980s when the nation pivoted from import-substitution towards export-oriented development strategies. This transition was accompanied by deregulation to better link Indonesia with the global economy. This spurred a significant structural transformation, with the share of agriculture in the labor force decreasing from two-thirds in 1993 to about one-half in 2014, while services expanded from 18 to 24 percent and manufacturing expanded from 14 to 20 percent. The rise of China has played a key role, growing from less than 5 percent to more than 15 percent of Indonesian export values; while Japan, which accounted for nearly one-third of exports value in the beginning of the period, fell to less than 10 percent by the end.

One crucial outcome has been the transformation of the country's labor markets. In the paper, we delve into how Indonesia’s export transformation and especially the exposure to export demand shocks has influenced various Indonesian labor market indicators.
 

Methodology

To unravel the complex interplay between export shocks and labor market outcomes, we employ a robust quantitative spatial model to simulate various scenarios. By leveraging comprehensive datasets spanning multiple years (the primary analysis is based on a dataset combining the Indonesian labor force survey and UN Comtrade industry exports from 1993 to 2014), we provide a nuanced understanding of how export shocks reverberate through Indonesian labor markets.

An essential aspect of the analysis involves examining regional disparities based on reliance on export-oriented industries. Certain Indonesian districts, for example, such as those in West Papua and Sumatra, emerge as focal points due to their significant contributions to the country's overall exports. Understanding these regional nuances is vital for formulating targeted policy interventions aimed at mitigating adverse effects and leveraging opportunities arising from export shocks.
 

Key Findings

The analysis shows that labor market responses in Indonesia have been consistent with what a quantitative spatial model would predict: employment, labor force, real wages, and real wage bills increased more in Indonesian districts where exports increased more. We show that these shocks persist six years after the foreign demand shock. Moreover, formal employment increased more in these regions compared to informal work, suggesting a gradual shift towards formalization driven by expansion of export-oriented industries. Also, skilled workers tend to reap greater benefits from export shocks in terms of employment growth compared to the unskilled. This finding underscores the importance of skills development and education in capitalizing on the opportunities presented by export-led growth.
 

Figure 1: Effect of Exports on Employment
^{(Elasticity of employment with respect to exposure to exports growth, by horizon)}

^{Source: Authors’ elaborations.}

Conclusions

Our comprehensive analysis offers insights into the multifaceted relationship between exports and labor market dynamics, bridging the gap between empirical evidence and theoretical understanding as countries look at engagement with the global economy.

By looking at labor market effects from increasing exports vary across regions and various segments of the labor force, we provide a solid foundation for policymakers to formulate targeted interventions to harness the potential of export-led growth while mitigating associated risks. Policies that prioritize investment in education and skills development, promote formalization within the labor market, and bolster export-oriented industries can play a pivotal role in fostering inclusive and sustainable economic growth.

More specific goals could include streamlining export procedures and investing in infrastructure to enhance trade efficiency. Additionally, efforts to promote formalization of businesses, such as offering incentives for compliance with formal labor regulations, could help harness the benefits of trade liberalization more effectively and reduce the formality gap.

This paper is a product of the Poverty and Equity Practice at the World Bank Group. It was funded by the Umbrella Facility for Trade. We thank World Bank colleagues (William Hutchins Seitz, Utz Pape, Csilla Lakatos) for their helpful comments and support. The views expressed herein are those of the authors and do not necessarily reflect the views of the World Bank.