Electrification and industrial development in Indonesia

Abstract

Economists and policymakers have long believed that access to electricity is essential for industrial development, and ultimately growth. Despite this consensus, there is limited evidence of this relationship. In this thesis, I ask whether electrification causes industrial development. I study the effect of the extensive margin of electrification (grid expansion) on the extensive margin of industrial development (firm entry and exit). I combine newly digitized data from the Indonesian state electricity company with rich manufacturing census data. To deal with endogenous grid placement, I build a hypothetical transmission grid based on colonial incumbent infrastructure and geography. The main instrumental variable is the distance to this hypothetical grid. I examine the effect of electrification on local industrial development. To understand when and how electrification can cause industrial development, I shed light on an important economic mechanism - firm turnover. I find that electrification causes industrial development, represented by an increase in the number of manufacturing firms, manufacturing workers, and output. Electrification increases firm entry rates, but also exit rates. Overall, electrification creates industrial activity, as opposed to reorganizing it across space. I then evaluate the impact of electrification on firm-level performance. I find that connected firms are larger, more likely to exit, and younger. This is consistent with higher turnover at the market level. I look at the implications of the previous results on industry productivity. Higher turnover rates lead to higher average productivity and induce reallocation towards more productive firms. This is consistent with electrification lowering entry costs, increasing competition and forcing unproductive firms to exit more often. Without the possibility of entry or competitive effects of entry, the effects of electrification are likely to be smaller. I use detailed product-level production data to structurally estimate a quantity-based production function, which when combined with price data, allows me to estimate marginal cost. Electrification substantially reduces the cost of production of existing products and their prices. While mark-ups don’t change for incumbent firm-product pairs, the average markup increases in the market. This is due to a selection effect where products produced post access have higher mark-ups. These products are new and are more likely to be differentiated.