Public sector efficiency of decentralized local government in Indonesia : a political and institutional analysis

Abstract

This thesis investigates public sector efficiency (PSE) of decentralized local governments in Indonesia. Based on the literature review improved efficiency is considered as the main outcome expected from a decentralized system of public service provision. Hence analysing public sector efficiency provides the de facto measure of the ability of decentralized local government in internalizing the benefits of fiscal and political decentralization. In order to identify the significance of the effect of 2004 electoral contest, the first democratic election in the decentralized Indonesia, efficiency in the public sector is investigated in a period from 2005 to 2008. The 2004 electoral contest is considered as an important phase of democratization and decentralization in Indonesia as it was the first election where voters directly chose leaders at every level of government. Political and institutional features which emerged as a result of the 2004 election were expected to have an impact on a decentralized system of public service provision.This thesis employs a two-stage method. In the first stage, non-parametric data envelopment analysis (DEA) is used to generate the efficiency scores of all local governments. Several outcome indicators in the education and health sectors, infrastructure, poverty mitigation as well as macroeconomic performance are taken as a measure of the flow of services that arise from public spending. Hence, public sector efficiency is defined as the flow of services per unit expenditure.The second stage of the method aims to investigate public sector efficiency against non-discretionary variables involving a measure of fiscal decentralization, political and institutional variables, as well as total factor productivity growth as a control variable. In order to do so, this thesis employs an econometric analysis using fixed effect vector decomposition (FEVD). The FEVD is adopted as the political and institutional variables are characterised as time-invariant variables.In the first stage of the method, the DEA estimate reveals that public sector efficiency scores vary across local governments, corroborating the general pattern of the regional disparity in Indonesia. That is, poorly developed regions have relatively inefficient governments. The DEA calculation locates local governments on Java Island at the frontier indicating that these local governments are benchmarking others. On the other hand, Papua and Papua Barat emerge with the lowest efficiency score over the observation period with a large divergence from the frontier. The results also show that the average and the median efficiency scores are drifting downwards, while the distance from the lowest score to the frontier is increasing. This indicates that the regional disparity in the public sector efficiency was increasing over the observation period.The second stage of the method reveals that the ability of a decentralized local government to generate local own-revenue is significant in improving public sector efficiency. The estimation results show that the degree of fiscal decentralization as measured by the ratio of local own-revenue to total public spending has a significant positive impact on the PSE. However, given that the growth of total factor productivity also has a significant and positive impact on the PSE, the result should be seen as a caution that improved PSE might result from overall total productivity in the economy. A local jurisdiction that has higher total factor productivity will present greater public sector efficiency regardless the degree of fiscal decentralization.The second stage estimate also reveals that the formation of the new government as an outcome of the first electoral democracy in the decentralized Indonesia has nothing to do with the PSE improvement. The lost hegemony of Golkar in the decentralized democratized Indonesia, measured as the ratio of seats held by Golkar to total seats in the local assembly, does not show any significant impact on the PSE. The first electoral democracy might have resulted in a new democratic government in Indonesia; however, the new democratic government might be merely a continuation of an old structure with new rules on the limits of democratization. Accordingly, the new democratic government did not impact on improved efficiency in the public sector.Another significant feature of the formation of the new government in the decentralized democratized Indonesia is the rebirth of politik aliran (political parties rooted to a particular socio-ideology). Politik aliran is represented by Islamic based political parties. These parties held a significant number of seats in the legislative councils. The estimation results reveal a negative association between political Islam and PSE, even when PKB (Nation Awakening Party) and PAN (National Mandatory Party) are included in the measure. Both parties do not set Islam as their platform, but affiliate to NU (Nahdlatul Ulama) and Muhammdiyah, the two largest socio-religious organizations in Indonesia. The result may also stand as a confirmation that patron-client affiliation in Indonesia’s electoral democracy fails to leverage accountability and hence fails to result in improved PSE.The second stage estimate finds evidence that democratic participation did not have an impact on the PSE. This contradicts the general representation claiming that greater democratic participation is associated with better economic performance. The estimates reveal a negative impact of democratic participation on the PSE. In the setting of politik aliran, the coefficient estimate is statistically significant. It implies that while political Islam may have increased electoral participation, the participation has nothing to do with improved PSE. This may not be surprising in the case of electoral democracy in Indonesia where electoral participation is characterised by money politics, patron-client political relationship and unbalanced electoral participation.Many parties flourish in the decentralized democratized Indonesia escalating political fragmentation. Using a Herfindahl-Hirschman index as a measure of the size-political fragmentation this study finds evidence that while citizens may have more options to select parties/politicians to best represent their preferences, higher political fragmentation shows ambiguous impact on PSE.The quality of institutional governance and its impact on PSE is represented by a corruption perception index and an infrastructure perception index. The estimation results reveal evidence that public sector efficiency is positively associated with the infrastructure perception index, but fail to find evidence of an effect for the corruption perception index. This indicates that the outcome of decentralization is not contingent with a perception about corruption as it is prevalent in the decentralized Indonesia. It occurs almost in all levels of government and institutions. Thus if decentralization results in improved efficiency, it is not due to a corruption lessening but rather due to variations in the level of infrastructure.