Spatial wage differentials and agglomeration externalities: Evidence from Indonesian microdata

Abstract

Abstract This paper examines the sources of labor wage differentials and investigates human capital externalities across Indonesian districts. Based on microdata on individual workers from 2006 to 2015, we show that, in addition to individual (labor) characteristics, regional endowments and agglomeration forces play an important role in explaining wage variations across Indonesia districts. The role of agglomeration forces in wage variations results from the spatial proximity of firms to each other, labor market pooling, and knowledge spillovers. We further found strong evidence of positive human capital externalities, particularly in agglomerated regions. These findings suggest that skills and agglomeration are important tools that can be exploited by policymakers to boost local productivity vis-a-vis reducing income/wage inequality.