The spatial effects of fiscal decentralization on regional convergence: the case of regions in indonesia

Since 2001, Indonesia established fiscal decentralization to address the growing economic and social inequalities and promote regional economic development. Two decades later, the spatial effects of decentralization in reducing regional inequality in Indonesia are still unclear. Various studies indicate that geographical proximity, spatial linkages, and spillovers have major impacts on economic growth. This paper offers an empirical analysis of the long-run effects of fiscal decentralization and its spatial impacts on regional growth and convergence in Indonesia. The study uses district-level panel data over a 10-year period (2003–2013). We apply regional distribution indices, spatial cluster analysis, convergence analysis, and spatial econometrics. The convergence analysis uses GMM and spatial models. Our findings highlight the persistence of regional divergence and a widening development gap between regions, especially at the provincial level. The results show regional polarization and backwash effects with the strengthening of core regions and weakening of hinterlands. The paper shows that equalization funds are ineffective in reducing vertical and horizontal inequalities. Their distributional effect is unclear except for the revenue sharing fund which boosts economic growth. Furthermore, the paper demonstrates the importance of urban agglomerations, spatial proximity, labor size, and a skilled labor base in increasing regional economic performance. There are two main policy implications of this study. First, place-based economic policies are needed that emphasize endogenous local development and highlight the mobilization of resources (labor and capital). Second, national policies must support regional development based on a thorough understanding of the caveats of liberalization policies.