The Transformation of Economic Structure: Unlock The Labor Interchange Theory

Motivation: The enormous amount of labor, particularly in agriculture and low-wage industries, continues to drive Indonesia's growth and economic transition. However, the large population, unskilled labor, and productivity concerns provide challenges for structural transformation to the service sector. Nevertheless, when the pandemic hit in 2020-2021, practically all industries plummeted and contracted to negative levels, but the agriculture sector remained resilient and had growth. Based on this condition, we investigate the possibility of structural changes by measuring sectoral performance using productivity and the elasticity of sectoral labor to each GRDP. Aim: In this paper, we introduce a novel concept of structural change based on sectoral productivity to examine how the strength of sectoral labor affects sector development. We used sectoral labor and the Gross Regional Domestic Product (GRDP) of Indonesia's 33 provinces from 2011 to 2022, then evaluated the model using productivity and labor elasticity to the GRDP. Results: We discovered that the biggest impact and most positive-significant coefficient of primary and tertiary labor to the GRDP are not linearly related to their low productivity, and vice versa. However, very high productivity may suggest a high-efficiency business through machines and technology; similarly, low productivity but a significant effect of labor and high GRDP strongly indicate labor excess in the sector. Our hypothesis distinguishes between subsistence, secondary, and tertiary production factors based on their dominance. We discover strong productivity gains in services, even without labor interchange from the primary. We predict that the primary sector, manufacturing, and services will grow and that structural transformation will be driven by the dominance of production factors in industries rather than labor exchange.