Agglomeration, transport and regional development in Indonesia’, Policy Research Working Paper

How effective are public interventions in addressing significant regional disparities in formal manufacturing concentration in a developing economy? We examine the aggregate and sectoral geographic concentration of manufacturing industries for Indonesia, and estimate the impact of factors influencing location choice at the firm level. We distinguish between natural advantage, including infrastructure endowments, wage rates, and natural resource endowments, and production externalities, arising from the co-location of firms in the same or complementary industries. The methodology pays special attention to empirically distinguishing the impact of measured production externalities from unobserved local characteristics. Depending on the sector, we find that a mix of both forms of regional advantage explains the geographic distribution of firms. Based on the estimated location choice model, we illustrate the potential impacts of policy interventions on manufacturing distribution by simulating the effectiveness of transport improvements on relocation of firms. Our findings suggest that improvements in transport infrastructure may only have limited effects in attracting industry to secondary industrial centers outside of Java, especially in sectors already established in leading regions. The findings underscore the challenges for addressing the industrial fortunes of lagging regions, either through local decentralized policy interventions or national policies focused on infrastructure development