Local Labor Market Dynamics and Export Shocks: Theory and Evidence from Indonesia

This paper studies the dynamic effects of export exposure on local labor markets in Indonesia, that is, how an increase in exports affects a range of labor market indicators over time. The paper develops an empirical strategy to instrument exposure to foreign demand shocks and validates it by showing that labor market responses are consistent with what a quantitative spatial model would predict after demand shocks. The results show that employment, labor force, real wages, and real wage bills increase more in districts that are more exposed to foreign demand shocks—that is, where exports increase more—relative to the least exposed regions. Extending the analysis over multiple response horizons shows that these shocks persist six years after the foreign demand shock. Lastly, employment responses are stronger among skilled workers relative to unskilled workers and in the formal sector relative to the informal sector.