This thesis examines the rural-urban linkage in Indonesia by investigating the degree of integration between the rural labor market and the urban labor market in Indonesia. It focuses on finding the determinants of rural wage rates in Indonesia, which from policy perspective is especially important since most Indonesian poor work as agricultural laborers in the rural area and are net consumers of rice; and hence any policy intervention directly or indirectly affecting rural wage rates is likely to affect the poor. Long-run relationships among real agricultural wage rates and real urban wage, agriculture prices, and real urban GDP are empirically studied using the Johansen cointegration framework. The estimates of the long-run elasticities are obtained based on 1983-2009 quarterly data compiled from government official statistics.

Results for three most populated Indonesian provinces (West Java, Central Java and East Java) show that urban variables (ie. real urban wage rates and urban GDP) are much more important than rural variables (ie. rice price) in determining the long-run rural wage rates. The long-run elasticities for real urban wage rates are between 0.14 and 0.53, with an average elasticity of 0.31, while the agriculture (rice) price has elasticities merely between zero and 0.17. Furthermore, the long-run elasticities of real urban GDP for West Java, Central Java, and East Java are 0.14, 0.19, and 0.19, respectively.

The policy implications are significant. For instance, the long-run impact of government protectionist trade policy by raising rice prices to help the poor is likely to be very limited. A 25% import tariffs, for example, would have raised rural wage rates in Java on average by merely 2.6%, a negligible increase, given it’s only a once-and-for-all increase. Conversely, using a similar argument, if the government decided to liberalize trade policy in rice by completely dismantling tariff barriers, there would be virtually no effect on rural poverty, as measured by the rural wage rate. In fact, lower rice prices would translate into increased food security for poor consumers in urban areas, and even in rural areas where almost all the truly poor are net consumers of rice.