International Trade, Commodity Production and the Skill Premium: Evidence from Colonial Indonesia

How does the expansion of commodity export production impact the skill premium in a developing economy? Drawing on a newly-constructed dataset of regionally-disaggregated production figures and wages, we provide new evidence that agricultural commodity production can increase the skill premium if such production involves extensive local processing. This local processing can be necessitated by the biological features of the commodity. In the case of early twentieth-century Indonesia, coffee beans underwent little local processing. In contrast, sugar cane needed to be processed locally because it deteriorated quickly after harvesting. The production process from sugar cane to highly-refined ‘superior sugar’ was capital- and skill-intensive. We also provide evidence that the capital that enabled this local processing can be seen as North-South capital flows and that value chain upgrading occurred. Using several instruments exploiting exogenous variation in global market prices and local production suitability, we find evidence for a causal effect of sugar production on the skill premium. Whereas increased demand for unskilled workers was easily matched by rising supply, especially in areas well-connected to overland transportation infrastructures, this was not the case for skilled labour, so the skill premium rose.