Economic Development and the Spatial Allocation of Labor: Evidence From Indonesia

April 2015
Gharad Bryan, Melanie Morten
Nominal wages differ widely across space. Do these differences imply large productivity benefits to moving people across space, or are the differences driven by selection or amenity differences? To answer this question, we construct a general spatial equilibrium framework. Our framework allows us to decompose observed wage differences into four components: i) selection due to comparative advantage, ii) wedges due to migration costs, iii) endogenous amenity differences, and iv) endogenous agglomeration benefits. We show how migration costs can lead to lower aggregate productivity by hindering the movement of labor to where it is most productive. We then estimate the model using detailed micro data for Indonesia and the United States. Two counterfactuals illustrate the quantitative implications of migration costs on aggregate productivity. First, we estimate that between 1976 and 2012 migration costs declined by 35% in Indonesia; the improved allocation of labor to where it is most productive explains approximately 20% of Indonesia’s GDP growth over this period. Second, we estimate that migration costs in the United States are 60% smaller than in Indonesia; higher costs of labor movement in Indonesia explain 4% of the GDP percapita gap between the United States and Indonesia