Decentralization and Economic Performance in Indonesia

By Pepinsky, Thomas B.; Wihardja, Maria M. | Journal of East Asian Studies, September-December 2011 | Go to article overview

Decentralization and Economic Performance in Indonesia


Pepinsky, Thomas B., Wihardja, Maria M., Journal of East Asian Studies


Indonesia's 1999 decentralization law gave local governments in Indonesia an unprecedented opportunity to adopt prodevelopment policies. In this article, we study whether decentralization has in fact generated improved economic performance in Indonesia. Using a synthetic case control methodology, we argue that Indonesian decentralization has had no discernable effect on the country's national-level economic performance. To explain why not, we use subnational data to probe two political economy mechanisms--interjurisdictional competition and democratic accountability--that underlie all theories linking decentralization to better economic outcomes. Our findings suggest that extreme heterogeneity in endowments, factor immobility, and the endogenous deterioration of local governance institutions can each undermine the supposed development-enhancing promises of decentralized government in emerging economies such as Indonesia.

KEYWORDS: Indonesia, decentralization, economic development, case control methods

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SINCE 2001, INDONESIA HAS EMBARKED ON A PROGRAM OF POLITICAL AND economic decentralization that has fundamentally altered the political economy of the world's fourth most populous country. The law implementing decentralization (Indonesia 1999) focused on improving the ability of local governments to respond to local conditions, but research commonly links decentralization with superior national economic performance (see Breuss and Eller 2004 for a review). Most simply, if decentralization yields development-enhancing policies at the local level, then the sum of the effects of these policies should be improved economic performance for the country as a whole. Other theoretical links between decentralization and national economic performance include more participatory policymaking (Cheema and Rondinelli 1983), lower inflation (Qian and Roland 1998), decreased corruption (Gurgur and Shah 2005), and more responsive taxation and public spending (Tiebout 1956; Oates 1993). Accordingly, decentralization is a national development policy that can yield national development outcomes--in the words of one Indonesian observer, "through decentralization various national problems will be solved at the regional level by using local means to cope with local challenges" (Simandjuntak 2003, 1).

The specific mechanisms through which decentralization may affect economic development depend on how decentralization is implemented: under political decentralization, local governments gain autonomous control over some local policies; under fiscal decentralization, local governments gain the ability to levy their own taxes; under various forms of federalism, local governments may have veto authority over national policies. (1) Indonesia's 1999 decentralization law was more political than fiscal or federal, and local revenues still come primarily through grants from the central government known as DAU (dana alokasi umum, general allocation grants). Local taxation capabilities, though, were expanded in 2000, and local districts do have autonomous control over their own budgets. (2) This combination of political and fiscal decentralization has afforded local governments unprecedented responsibility for "all areas of government except for foreign policy, safety, law, monetary and fiscal policy, religion, and other matters" (Indonesia 1999; see also Brodjonegoro 2009; Seymour and Turner 2002). Indonesia's decentralization has been heralded as a landmark policy for advancing Indonesian development by giving local governments the ability to adopt locally appropriate regulations, to spend DAU funds in ways seen as suitable for local needs, and to experiment with development- and welfare-enhancing policies.

Indonesia's 2001 switch to decentralized governance was rapid--Hofman and Kaiser (2003) call it a "Big Bang"--and fundamentally transformed Indonesia's political economy. However, evidence that decentralization has improved Indonesia's national economic performance is elusive. …

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