Regional Competitiveness in Indonesia: The Incentives of Fiscal Decentralization on State Efficiency and Economic Growth

This dissertation examines the implementation of decentralization in Indonesia andmeasures the incentives of fiscal decentralization on state efficiency and economicgrowth. Efficiency of state governments in utilizing fiscal resources to support privatesector development and accelerate economic growth is consistent with the concept ofregional competitiveness. The main goal of this dissertation is to expand existingempirical and theoretical frameworks on fiscal decentralization and economic growth thathave traditionally excluded efficiency factors of sub national governments. Thisdissertation also aims to fill gaps in the way state efficiency is measured as an extensionof institutional quality of public sector.Following a two-stage empirical methodology, the efficiency of Indonesia’s 26 statesgovernment expenditure over a 10-year period (1996-2005) is constructed using DataEnvelopment Analysis (DEA) and a Tobit panel data model is used to analyze thedeterminants of state efficiency. In the second stage, panel data analysis is employed toanalyze the impact of fiscal decentralization and state government efficiency on regionalgrowth.This dissertation found that the degree of fiscal decentralization has a positive associationwith economic growth if there are insignificant imbalances between regions following adisproportionate growth in labor force and population. To a certain degree, regionalimbalances, which are a crucial issue in many developing countries, are one of thedisincentives in a decentralized system.Another finding is that although decentralization provides a greater incentive structure forstates to become more efficient, this does not always lead to robust growth due to theextent of misallocation of fiscal resources and lack of investment in productive spending.Of several factors that potentially determine state efficiency, the degree of fiscaldecentralization, ratio of productive spending, operating costs and revenue independenceare significant and these factors differ between leading and lagging states.Keywords: Regional Competitiveness, Economic Growth, Decentralization, InstitutionalDevelopment, Public Expenditure, Capital Investments, Indonesia