Decentralization, Indonesia-Style

Abstract

Indonesia’s 1999 decentralization law gave local governments in Indonesia an unprecedented opportunity to adopt pro-development policies. We estimate the effect of decentralization (enacted in 2001) on national economic performance using a synthetic case control methodology. Our results indicate that decentralization has had no discernible effect on Indonesia’s economic output as measured by gross domestic product. To explain this finding, we use subnational data to probe two 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 institutions can each undermine the supposed development-enhancing promises of decentralized government in developing countries.

Keywords: decentralization, economic development, economic growth, Indonesia, synthetic case controls

JEL Classification: I3, N45, O18, O53