The partnership that became the most powerful business group during Suharto's time started from very modest premises. In the late 1960s, when the four men — Liem, Sudwikatmono, Djuhar Sutanto and Ibrahim Risjad — began working together, their office was a non-airconditioned room measuring 8 × 6 metres on the top floor of a nondescript building in the heart of Jakarta's Chinatown. One had to hoof it up four storeys to get to the austere office at Number 20 Jalan Asemka, as there were no elevators. Initially, the room had only one desk and two chairs. There was a single telephone, and even that line was shared with another office. Sudwikatmono, or Dwi, as he was often called, recalled that in the early days, when the four partners had their meetings, two of them would be standing while two sat. Dwi remarked that the highly superstitious Liem was always reluctant to make changes that might affect his luck or disturb the good feng shui of a room or building.

IN THE BEGINNING

The conglomerate that arose from those humble beginnings, usually simply called the Salim Group, was essentially a Suharto creation. At the very least, he played the role of midwife in its birth. After all, he put Liem together with Dwi, and suggested Liem team up with Djuhar. Match-making business partners seemed to be an activity the new leader liked to make time for. He got his financial generals working on ventures with Chinese businessmen. In 1967, a Sukarno-era trading company, Hanurata, got new shareholders — two of his yayasans, Trikora and Harapan Kita. Liem Sioe Liong provided the capital and was asked to run it. Suharto also installed his brother-in-law in the company and arranged for his cousin Dwi to be there. The successful pairing of Liem and Dwi was a Suharto initiative, but other business match-making propositions did not work out so well.

Liem Sioe Liong was a relative newcomer to the Suharto inner sanctum; as mentioned earlier, two other Liems preceded him: Jantje Liem and Liem Oen Kian (Djuhar Sutanto). Suharto suggested that the three Liems joined forces. They tried but it didn't last.

INTRODUCTION

Indonesia's ‘big bang’ decentralization program has already generated a considerable literature, although few of the published studies examine the post-2001 changes in light of previous debates on central–regional political and economic relations in Indonesia. A common assumption appears to be that the system in place from the transfer of power from the Dutch in 1949 until the end of the Suharto era in 1998 was highly centralized. Section 2.2 of this chapter reviews the changes in the structure and role of provincial and subprovincial governments in Indonesia after independence, and examines the debates in the early 1950s culminating in the Nasroen proposals for reforming central–regional fiscal relations. Had the proposals been properly implemented, they would have made a considerable difference to the future course of central–regional relations. But they turned out to be the road not followed; instead, after Suharto took power in 1966, a process of recentralization of economic and political power took place. Section 2.3 examines the consequences of the Suharto-era policies for regional development in Java and elsewhere.

DEVELOPMENT OF REGIONAL GOVERNMENT AFTER 1950

Federalism: the path not taken

To many observers both at the time and later, it would have seemed logical for the newly independent Indonesian republic to choose a federal constitutional structure in 1949. Indeed, as Feith (1962: 72) has claimed, there were some convinced advocates of a federal structure within the republican leadership, ‘and Prime Minister Hatta appeared at times to be one of them’. In an interview after Suharto had left office, Feith pointed out that Hatta, ‘who played the central role in dissolving that federal structure, was actually a federalist’ (Jakarta Post, 18 November 1999). Hatta became Indonesia's first prime minister after the Dutch finally conceded sovereignty in 1949. He wanted to hold an election immediately so that an elected body could decide between a federal and a unitary state. But this did not happen; instead, general elections were held only in September 1955. Elections for a Constituent Assembly (Konstituante), which was to decide on a constitution, followed in December 1955. Voter turnout for both elections was high (Nasution 1992: 30).

INTRODUCTION

In the last few decades, Indonesia has witnessed many changes in its demographic and socio-economic characteristics. Today, Indonesians have smaller families, longer life expectancy and more education. The average number of children per woman, as measured by the total fertility rate, declined from 4.6 in 1980 to 2.6 in 2010 (BPS 2012). Over the same period, life expectancy increased from 57.6 to 69.4 years. The implementation of compulsory education started with six years of schooling in 1984, increasing to nine years in 1994 and 12 years in 2012. This has significantly increased school enrolment rates; the net enrolment rate for senior secondary school, for example, increased from 17 per cent in 1975 to 51 per cent in 2012 (BPS 2013). In response to such significant changes, and the concomitant developments in local and global economic conditions, population mobility and migration patterns have also changed considerably.

At the same time, there have been significant improvements in transport, especially road and air transport, and in communications technology, which have also facilitated population mobility. The growing Indonesian diaspora, estimated to number 3–6 million (Muhidin and Utomo 2013), is further evidence of Indonesians’ willingness to migrate. Mobility is a complex process involving the interaction of a wide range of factors, both personal and to do with the regions of destination and origin. Using the concept of a ‘mobility continuum’, Pooley, Turnbull and Adams (2005: 3) have observed that population mobility may include simple mobility (travel for work, shopping or leisure), circular mobility (involving regular longer travel) and longer-distance residential migration. The latter concept of mobility is the focus of this chapter.

According to the 2010 population census, Indonesia is home to 238 million people, about 27 million (12 per cent) of whom live outside their provinces of birth (BPS 2011). The proportion of such migrants varies widely across regions, however, from less than 3 per cent in the provinces of East Java, West Nusa Tenggara and Central Java, to as much as 42 per cent in Jakarta and 48 per cent in Riau Islands.

THE ISSUES

In 2001, Indonesia embarked on a ‘big bang’ decentralization involving a major transfer of administrative, political and financial authority primarily to the district/municipality (kabupaten/kota) level of government. Together with the rapid transition from authoritarian to democratic rule in the late 1990s, this initiative has transformed the country's political, social and business life. While national government remains the major area of contestation, power has shifted irreversibly away from the centre. How this significantly increased regional autonomy works will have a crucial bearing on the future of the Indonesian nation-state. This volume, featuring contributions by 43 authors, provides a timely, comprehensive and analytical assessment of the country's regional development dynamics in the post-decentralization environment.

The regions (daerah) are central to an understanding of modern Indonesia. With its 17,000 islands stretching across three time zones, Indonesia is the world's largest archipelagic state. It features enormous diversity in its economy, ecology, ethnography, demography and much else. At the district level, for example, the richest region has a per capita income more than 50 times that of the poorest. Were they independent states, some parts of Indonesia would be classified as upper middle-income states, comparable to much richer Malaysia and Thailand, while other regions would be in the least developed group of extremely poor states. The policy and intellectual paradigms in and on Indonesia reflect this diversity. It is the key sentiment in the national motto, ‘Unity in diversity’ (‘Bhinneka tunggal ika’). Indonesians worry about the preservation of territorial integrity and national unity to an extent that may surprise outsiders unfamiliar with the country's struggle to create a new nation-state. After all, Indonesia did not formally exist as an entity until 1945, or even in the imagination of the nation's independence leaders until the early twentieth century. In fact, it came into existence in part as a result of lines drawn arbitrarily on a map in far-off European metropolitan capitals. Given the colonial history of divide-and-rule tactics, Indonesians are often shocked by the seemingly innocuous observation to the effect that ‘A glance at a map might seem enough to suggest the improbability of Indonesia’ (Cribb 1999: 3).

INTRODUCTION

The prevailing view among many policy makers, policy advisers and other interested observers in Indonesia is that decentralization has been somewhat of a disappointment. This assessment derives from the observation that local public service delivery has improved little, if at all, since the government began implementing its regional autonomy program in 2001, despite an apparently significant transfer of funds to provinces and districts to discharge their newfound responsibilities. A number of theories have been put forth to explain the seemingly meagre results of decentralization, each with its own set of policy reform prescriptions.

The main intent of this chapter is to review the experience with decentralization since 2001, to critically assess various explanations for the failure of regional autonomy to significantly improve local services and to gauge the prospects for reform going forward. First, the chapter provides a brief review of the history of fiscal decentralization in Indonesia (section 6.2). Next, it examines some of the empirical evidence on decentralized service delivery outcomes (section 6.3). It then discusses and appraises the standard rationales for poor service outcomes (section 6.4). In section 6.5, the chapter offers an alternative explanation for inadequate decentralized service delivery, and in section 6.6 it evaluates the near-term policy reform agenda for decentralization. The chapter concludes with a consideration of the likelihood of successful reform.

A BRIEF HISTORY OF FISCAL DECENTRALIZATION

Indonesia is a unitary country comprising central, provincial and local levels of government. Until 2001, the regional administration of public affairs operated through a hierarchical, multi-tiered and parallel system of deconcentrated central government agencies and nominally autonomous subnational units.1 Throughout most of its history, Indonesia's public sector was counted among the most centralized in the world (Smoke and Lewis 1996; Lewis and Smoke 1998).

Many observers would date Indonesia's modern administrative and fiscal decentralization program to Law 5/1974 on Basic Principles on Administration in the Regions. This legislation did indeed provide a basis for greater involvement of decentralized subnational governments in the provision of those public services that existed at the time. In the early 1990s some implementing regulations were written and a pilot program for regional autonomy was undertaken, but little real progress was made in operationalizing the general principles outlined in the early law over the succeeding 25 years (Brodjonegoro and Asanuma 2000; Lewis 2002b).

INTRODUCTION

Has Indonesia's decentralization in 2001 been successful at improving service delivery and governance quality at the local level? Has democratization in the districts helped foster the quality of public services? More than 10 years into decentralization, we are able to provide an assessment based on systematic empirical evidence from the districts. This chapter reports results from large panel data analyses studying the effects of decentralization and local democratization on government spending (Kis-Katos and Sjahrir 2014), on governance quality (Sjahrir, Kis-Katos and Schulze 2014) and on public service delivery (Schulze and Sjahrir 2014). A synopsis of these three perspectives allows a well-rounded, balanced picture of the impact of these two far-reaching structural reforms on the quality of local government behaviour. It allows us to portray and identify the effects of these reforms on the production process for public services, comprising inputs, technology (governance) and output.

The effect of decentralization and democratization on the quality of government behaviour has been a contentious issue in the academic debate, both theoretically and empirically. The first generation of the fiscal federalism literature stressed that decentralization allowed easier generation of location-specific knowledge and better preference matching (Hayek 1948; Oates 1972 and others); moreover, mobile individuals could sort themselves into the jurisdictions that offered the best mix of public services and taxes for them (Tiebout 1956). The second generation has focused on the effects of decentralization on accountability and the political process in general. Inter-jurisdictional competition for mobile factors (firms and individuals) curbs the ability of local governments to exploit their citizens and forces them to provide better services to attract these mobile factors (Brennan and Buchanan 1980). As decentralization brings decisions closer to the people, the transparency of and participation in the political process should be enhanced. Incumbents seeking re-election will be disciplined, at least partially, by the requirement to secure a majority of the vote (Ferejohn 1986). Decentralization implies unbundling of public goods provision, both regionally and by government function, which allows citizens to hold decision makers more directly accountable (Seabright 1996; Farfán-Vallespín 2014). Whereas, under centralization, a local constituency can hold the (central) decision maker accountable only in cooperation with other constituencies representing at least half the population, under decentralized rule a local constituency can hold its (local) decision maker directly accountable.

INTRODUCTION

Improved local governance has been the spirit of decentralization in Indonesia. Enacted not long after the start of the reformasi era in 1998, and effective since 2001, Law 22/1999 on Regional Government explicitly stated that democratic principles and public participation would be the basis of regional autonomy. The law also referred to various decrees issued by the People's Consultative Assembly (Majelis Permusyawaratan Rakyat, MPR) in 1998 to reform governance and counter corruption. The revised law on regional government (Law 32/2004) continues to emphasise the importance of community empowerment, grassroots participation and democratic principles to accelerate people's welfare and improve regional competitiveness.

Globally, good governance is believed to be the main path to sustainable economic growth and improvements in welfare. In Indonesia, a number of studies have examined the relationship between the quality of governance and economic growth. This chapter complements those studies by analysing the correlation between various local governance indicators – economic, budget allocation and public sector financial management – and development outcomes, with the latter defined with reference to household-level expenditures and the Human Development Index (HDI).

Section 7.2 discusses recent developments in local governance, including key reforms to lift standards, and describes the current state of public sector financial management. Section 7.3 focuses on issues related to local budget policy and execution, and section 7.4 provides a brief overview of levels of development across the country. Section 7.5 dwells on the correlation between economic and social outcomes, good governance indicators, budget policy indicators and administrative characteristics. The chapter concludes by offering some policy implications.

RECENT DEVELOPMENTS IN LOCAL GOVERNANCE

More than a decade after decentralization, it is not clear that the quality of local economic governance has improved. This is the main conclusion from two datasets derived from surveys of businesses conducted by Regional Autonomy Watch (Komite Pemantauan Pelaksanaan Otonomi Daerah, KPPOD) and the Asia Foundation in four provinces: East Java, West Nusa Tenggara and East Nusa Tenggara (as part of nationwide surveys conducted in 2007 and 2010–11) and Aceh (which was surveyed separately in 2008 and 2010) (KPPOD and Asia Foundation 2008a, 2008b, 2010, 2011). These were the only four provinces to be surveyed twice, allowing comparison of the progress of local economic governance over time.

INTRODUCTION

Since 2005, one of the most remarkable achievements in global peace making has occurred in the province of Aceh. The former rebel movement, the Free Aceh Movement (Gerakan Aceh Merdeka, GAM), has transformed itself into a largely civilian political movement that competes for power through elections. Political violence has declined dramatically, and most of the violence that does occur is not between Indonesian security forces and GAM supporters as it was during the conflict years. Most observers have ascribed the success of the peace process in part to the autonomy arrangements promised to GAM during the peace talks in Helsinki in 2005. GAM supporters describe these arrangements as ‘self-government’, while representatives of the Indonesian government typically use the term ‘special autonomy’. These arrangements were embodied in Law 11/2006 on the Governing of Aceh a little over a year after the Helsinki peace agreement was signed. It has provided the framework for organizing Aceh's governmental affairs ever since.

While observers are right in attributing the success of the peace process to the compromise reached in Helsinki, and subsequently formalized in Law 11/2006, it would be a mistake to think that the autonomy package represents a set of ingredients that could successfully be transplanted to other conflict zones with similar results, regardless of circumstances. In fact, most of the ingredients had been tried before in Aceh but had failed. Following the fall of the Suharto presidency in 1998, the Indonesian government made several efforts to resolve the Aceh conflict by way of special autonomy, including two laws passed in 1999 and 2001. Many of the elements in the 2006 law had in fact already been included in the 2001 law, but were rejected at the time by GAM leaders as being a poor substitute for independence. Moreover, as we shall see, in several ways the autonomy arrangements put into effect in Aceh have fallen short of GAM supporters’ expectations, and Jakarta retains decisive authority in various areas of Aceh's affairs.

What, then, has made the post-2005 special autonomy deal so successful? I argue that it boils down to a combination of two elements. First are the core political provisions in the Helsinki memorandum of understanding (MOU) and the 2006 law that have allowed GAM to transform itself into a political force and compete for power through elections.

INTRODUCTION

Over the past decade Indonesia has made significant progress in reducing poverty. According to official statistics produced by the national statistics agency (Badan Pusat Statistik, BPS), the poverty rate fell from 23.4 per cent in 1999 to 11.4 per cent in 2013. Viewed from any angle, this is a tremendous achievement. However, as demonstrated also by Amri Ilmma and Matthew Wai-Poi in Chapter 5 of this volume, Indonesia's success at the national level masks the existence of substantial regional differences. This chapter focuses on this regional heterogeneity in poverty indicators. It relates district performance in reducing poverty to characteristics of the decentralization program implemented in Indonesia since 2001.

We argue that the system of governance for managing Indonesia's ‘big bang’ decentralization lacks key institutional requirements, notably adequate performance measures and an effective framework of constraints, as reflected in the shortcomings in the system of controls for central government oversight of local governments (World Bank 2006). Moreover, the division of responsibilities between the different levels of government is unclear, clouding the lines of accountability required to improve service delivery. An additional challenge stems from the uniform implementation of decentralization regardless of regional differences. This is a problem in a country as diverse as Indonesia, where each region differs in local government capacity and available resources. All these factors have undoubtedly had an effect not only on the implementation of the national poverty reduction strategy, but also on the development of local poverty reduction initiatives.

A review of experiences in 19 countries conducted by the OECD Development Centre finds that decentralization has led to improvements in poverty reduction in only one-third of cases (Jütting, Corsi and Stockmayer 2005). The authors argue that lower middle-income countries that have literacy rates above 80 per cent, and whose political processes are relatively open, are more likely to experience decreases in poverty following the adoption of decentralization measures. Overall, they conclude that decentralization is more likely to have a positive impact on poverty if there is an adequate commitment by the central government to the decentralization process, if the actors involved have the requisite (financial and technical) capacity, and if checks and balances are established at the local level to prevent rent seeking and corruption.

OVERVIEW

Like many large countries, Indonesia has a geographically fragmented labour market. Physical and economic contrasts between and within the major islands govern patterns of employment, wages and unemployment. The labour market still bears the signs of a dualistic division, dating from colonial or even pre-colonial times, between densely populated, poorer Java–Bali and most of the more land-abundant Outer Islands. Rapid national economic growth based on both export-oriented development and resource booms altered that historical pattern during the Soeharto years. The process became more complicated in the post-Soeharto democratic reform era after Indonesia's radical decentralization. Manufacturing stagnated in Java, while in the Outer Islands better governance and the return of revenue to resource-rich provinces provided more opportunities in some regions than in others for human resource development and economic diversification.

The widely varying rates of poverty discussed by Ilmma and Wai- Poi (Chapter 5) and Sumarto, Vothknecht and Wijaya (Chapter 12) are reflected to a large extent in differences in labour productivity across island groups and provinces. Labour productivity in Jakarta and East Kalimantan is more than twice the national average, whereas in Gorontalo and East Nusa Tenggara it is less than half. Most people in the former two provinces work in the formal sector in services, mining and manufacturing. In contrast, high levels of poverty and low labour productivity in the latter two provinces are closely associated with a concentration of employment in agriculture and the informal sector.

At the same time some indicators, such as inter-regional migration, suggest quite high levels of integration for a country of Indonesia's size and spread. There are also signs of convergence in labour productivity among some provinces and regions, as poorer provinces shed agricultural workers.1 Remarkable similarities across the country in trends towards greater formalization and improvements in unemployment rates and wages also suggest a degree of integration in the national economy. This has meant that some of the worse-off provinces have not been left behind. Nevertheless, in other provinces, high rates of population growth, low levels of schooling and associated low levels of outmigration have kept much of the workforce trapped in low-productivity agriculture.