Regulating manufacturing FDI: Local labor market responses to a protectionist policy in Indonesia

Abstract

We analyze the effect of rising protectionism towards foreign direct investment (FDI) on domestic employment, exploiting revisions in Indonesia’s highly granular negative investment list and spatial variation in the initial location of affected firms. The increase in FDI restrictions led to local employment gains, accounting for about one-tenth of the aggregate employment growth observed in Indonesia between 2006 and 2016. These gains were accompanied by a reorganization of the local production structure and new firm entries in the manufacturing sector, particularly among small firms with fewer than 20 employees. While these results are consistent with an increase in the labor-to-capital ratio among regulated firms, we find that at least three-quarters of the employment gains are driven by indirect effects, including integration of firms in local value chains, and increased immigration. However, we do not find evidence of welfare gains at the local level.