Developing countries have experienced rapid urbanization, though its causal effect on the welfare of rural households is still not clear. In this study, we utilize a severe earthquake in 2006, which hit one of the largest urban areas in Jawa Island of Indonesia, as a natural experimental event in order to identify the causal relation between urbanization and rural poverty reduction. Referring to the definition of the OECD (2012), we construct an original Indonesian urban area data set from population census data of 2000 and 2010. Then, we merge the data set with household panel data, as well as with village/town level census data. Our estimation results using the instrumental variable approach show that 1) effective market size growth as an index of population urbanization leads to an increase in per capita expenditure of households in rural villages, and especially those of the poorer villagers, and that 2) this increase in the welfare of the poor households seems to be brought about mainly by the increase in income from non-farm business
