# **1. Introduction**

In the mid-1980s, Indonesia shifted its development strategy focus from import substitution to export orientation. This transition was accompanied by deregulation aimed to better link Indonesia with the global economy (Saryahadi, 2001). During the 1990s, the country’s employment and trade patterns evolved, with agricultural employment decreasing in relative importance and trade partners such as China and India emerging as important destinations.

In this paper, we assess the degree to which changes in exports affect labor markets in Indonesia. We estimate how exports affect a range of local labor outcomes, including wages, employment, informality, and labor force participation. Up to six years after an initial shock, we calculate Impulse Response Functions (IRFs) that capture the evolving short- and long-run impacts of export exposure on labor outcomes.

The primary analysis is based on a dataset that combines the Indonesian labor force survey (Sakernas) and industry exports (UN Comtrade) spanning from 1993 to 2014.<sup>2</sup> To address the potential endogeneity of exports (the fact that exports are potentially correlated with unobserved characteristics of firms/regions), we isolate the exogenous part of exports using foreign demand shocks of Indonesian trade partners. Intuitively, this strategy leverages the fact that each local market in Indonesia is a small open economy; that is, they are engaged in international trade but are small relative to the world market and must take prices and global demand as given rather than trying to influence them strategically. Therefore, each region is exposed to global demand shocks, which are likely uncorrelated with the distribution of unobserved characteristics across the Indonesian districts.

The findings suggest that employment increases, the labor force expands, and unemployment declines in districts that experience an increase in exposure to foreign demand. More specifically, on average, the elasticity of employment with respect to exports is 0.1 over the short run and 0.3 over the long run. The long-run elasticity of the labor force with respect to foreign demand shocks is positive but smaller than that of employment. Six years after the foreign demand shock, the cumulative response of the labor force is about 0.17%. A 1% increase in exports induces a decrease in the unemployment rate of 0.08 percentage point six years after the shock.

Effects on real average wages are also positive, with an elasticity of 0.6 over the long run. We try to proxy for overall welfare by estimating the elasticity of the real wage bill with respect to exports: it is high and highly significant, reaching 1.2 six years after the shock.

> 2 During the 1990s Indonesia experienced several liberalization efforts that boosted exports as well as a backlash induced by the currency crisis. The team considered it interesting to incorporate trade data associated to periods of boom (1993-97), recession (1998-2000), and recovery (2001-onwards) of export values for the medium- and long-run implications of the results. The second reason, finishing the study period in 2014, relates to a life-cycle project the team was planning to conduct using a representative individual-level panel (IFLS data) for the same period 1993-2014 (the last round of IFLS took place in 2014). The team considers comparing results for district-level averages with those using much more granular data between 1993-2014 would be of great interest. Extending the horizon of the current study to 2022 is doable and will be incorporated in future versions of the paper.

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