The Legacy of the Reformasi: The Role of Local Government Spending on Industrial Development in a Decentralized Indonesia

Abstract

Starting in 2001 the government of Indonesia employed Regional Autonomy law, providing larger fiscal role to the province and district governments. However, our understanding of its impacts on economic development of Indonesia is still limited. This paper seeks to find the relationship between increasing local government’s capital expenditure on industrial development with focus in the non-oil and gas sector. Capital spending is thought to have moderation effect on investment, the main channel for industrialization, that should contribute to industrial growth. Our System GMM result suggests that there is significant correlation between capital spending and industrial growth. However, we fail to find significance moderation effect between local spending and investment towards the industry. Decentralization progress in Indonesia has been institutionally anchored by the central government particularly with the introduction of concurrent affairs in 2004, allowing central government to take a major developmental role at the local level. In the long run this contributes to the weakening capacity building at the local level, resulting in our non-positive findings. We propose a new institutional model that promote better central-local collaboration.