Regional Economic Growth and Inequality in Indonesia : Does Fiscal Decentralization Matter? A Cross Province Analysis

The purpose of this study is to analyze the effect of fiscal decentralization policy on regional economic indicators such as economic growth and inequality in Indonesia. Theoretically, fiscal decentralization can lead to economic growth because it creates efficiency by bringing government closer to the public (Musgrave, 1959). This study argues that besides directly affect economic growth, fiscal decentralization also indirectly affects economic growth through other economic indicators such economic inequality. There are several indicators can be used to measure fiscal decentralization as explained by IMF Government Financial Statistics (2001), this study uses one of them, which is fiscal decentralization as a total provincial revenue as a share of GDP as fiscal decentralization measurement, and for robustness test, this study uses the other indicator measurement from the IMF which is fiscal decentralization as a total provincial expenditure as a share of GDP. Furthermore, this study analyzes the effect of fiscal decentralization across 33 provinces in Indonesia from 2004 to 2013. This study uses panel data and seemingly unrelated regression method in the analysis to accommodate the indirect effect of fiscal decentralization on economic growth through inequality. The result shows that fiscal decentralization does have a significant relationship with economic growth directly and indirectly through inequality level. The direct effect of fiscal decentralization on economic growth is negative, but the positive effect of fiscal decentralization in reducing inequality levels indirectly improves economic growth, which makes the actual total effect of fiscal decentralization on economic growth is positive.