Natural Resource Revenue Windfalls and Public Service Spending : A Causal Analysis of Indonesian Local Governments

Natural resource revenues contribute to sustainable development when they are reinvested sufficiently in public services, such as education, that offer long-term social returns. Cross-country evidence suggests that resource-rich countries fail at this, spending less on public services than non-resource-rich countries do. However, extant evidence suffers from endogeneity problems and does not show a causal link between resource richness and public service spending. This paper exploits plausibly exogenous temporal fluctuations in natural resource tax revenues to assess if and how natural resource windfalls crowd out public spending. The sample comprises more than 150 subnational Indonesian governments that receive fees and royalties from production in nearby areas but exert no control over prices and production volumes. The analysis indicates that governments spend resource revenues productively. For instance, 36% of natural resource windfalls are spent on education (on average), a percentage much larger than the share of local taxes or central government funds that are spent on education. When considering the broad range of government expenditures, the analysis reveals a solid proclivity to use windfalls for long-term public investments. Thus, I conclude natural resources can contribute to long-term development via public service spending