Some Determinants of Growth in Off-Java Lagging Regions Since Decentralization

Abstract

This paper investigates the determinants of sub-national economic growth in Indonesia, focusing on off-Java manufacturing performance after the onset of decentralization in 2001, known as the “Big Bang.” With provincial and district governments assuming extensive administrative, fiscal, and governance responsibilities—including service delivery and infrastructure—Indonesia has seen sub-national expenditures rise to 37 percent of total public spending, surpassing the OECD average. The study uses panel data for Indonesian districts (kabupaten and kota) between 2001 and 2007, excluding Java, to assess the relative effects of urbanization, localization, government infrastructure investment, population, and human capital on manufacturing development. Three outcome variables are analyzed: the number of manufacturing establishments, the number of manufacturing jobs, and manufacturing value-added per capita. Districts with below-median GRDP per capita are classified as “lagging.” Findings show that lagging districts in both urban and rural areas benefit more from localization effects (industrial concentration) than from urbanization, suggesting Indonesia is not fully leveraging urbanization for manufacturing growth. Additionally, state- and local-government-owned enterprises positively influence outcomes, while direct government participation in industry suppresses growth in urban areas. The results highlight the importance of fostering private sector development while using government-led initiatives as catalysts in lagging regions.