MSME DEVELOPMENT AND REGIONAL EMPLOYMENT: EVIDENCE FROM INDONESIAN PROVINCES

Abstract

This study examined the relationship between micro, small, and medium enterprise (MSME) development and open unemployment across 33 Indonesian provinces from 2017 to 2024. Using two-way fixed-effects panel estimation with province-clustered standard errors, the study decomposed MSME employment effects into three channels: output value, value added, and labor expenditure. Contrary to the conventional employment creation hypothesis, MSME output and value added in absolute terms did not reduce open unemployment and were even borderline positively associated with the unemployment rate. The key finding was that the share of MSME labor expenditure in gross regional domestic product (GRDP) was the only operative channel through which MSME activity significantly reduced unemployment (β = −0.155, p < 0.05). This result remained robust after share-based normalization and the inclusion of province and year fixed effects. Heterogeneity analysis further showed that the positive association between MSME value added and unemployment was stronger in Western Indonesian provinces, consistent with labor force participation effects operating more intensively in economically denser regions. The findings challenged the assumption that expanding MSME scale automatically reduced unemployment and highlighted labor intensity as a critical policy lever. The study suggested that policies targeting MSME labor formalization, minimum wage enforcement, and worker training were more likely to reduce open unemployment than policies focused solely on output or value added expansion.