The effect of decentralization and free trade agreements on regional disparity in a developing economy: the case of Indonesia, 1993–2005

ABSTRACT

Since 1993, Indonesia has experienced both upward and downward restructuring of state power through the ASEAN Free Trade Agreement (AFTA) and fiscal decentralization, respectively. In this study, we investigate the impact of state restructuring on regional disparity. Indonesia is an interesting case because it is one of the few economies in which the upward and downward restructuring of state power occurred almost simultaneously. Based on a panel data analysis of micro-level firm data for the period 1993–2005, we find evidence of neoclassical convergence. Furthermore, decentralization was found to slow this convergence, while the AFTA had no statistically significant impact during the study period.

KEYWORDS:

• Indonesia
• decentralization
• regional disparity
• free trade agreement

Disclosure statement

No potential conflict of interest was reported by the authors.

ORCID

Jung Won Sonn http://orcid.org/0000-0002-6986-6318

Notes

1 On the other hand, empirical cross-country analyses have found little evidence of increasing disparity. See Ades and Glaeser (1995), Brulhart and Sbergami (2008), Nitsch (2006), and Ramcharan (2009), among others.

2 PCA is a statistical methodology to reduce the number of variables of interest into a smaller set of components. All the variance in the variables are included it into a new set of components equal to the number of original variables.

3 Available at www.bps.go.id.

4 The Special Region of Capital Jakarta is a province with five non-autonomous districts and one regency.

5 See http://www.oecd.org/tax/federalism/oecdfiscaldecentralisationdatabase.htm#C_3.

6 Assuming a Cobb–Douglas technology (Amiti & Konings, 2007).

7 We conduct the PCA analysis using the ‘pca’ command in STATA 14. The PCA scores for P3 and P4 are stored using the command ‘predict’ and are used as indices in the regressions.

8 If we decompose to three types of regional division—within province, between province, and between regions—we observe that the disparity among districts within provinces has declined sharply, whereas the disparity between provinces has also declined, although not significantly. An interesting finding is that the disparity between regions (Indonesia’s regions are commonly separated into the western, middle, and eastern parts of the country) increased from the early 1990s and peaked during the early 2000s before reaching its current position. This supports that the eastern region of Indonesia has been left behind severely in terms of its economic welfare. For a full discussion on the various aspects of disparity in Indonesia, please see Aritenang (2012).

Additional information

Funding

During this research, Sonn was financially supported by Ministry of Education of the Republic of Korea and the National Research Foundation of Korea [grant number NRF-2015S1A3A2047036].