The Impact of State Restructuring on Indonesia's Regional Economic Convergence [1 ed.] 9789814620383

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The Impact of State Restructuring on Indonesia's Regional Economic Convergence

The ISEAS – Yusof Ishak Institute (formerly Institute of Southeast Asian Studies) was established as an autonomous organization in 1968. It is a regional centre dedicated to the study of socio-political, security and economic trends and developments in Southeast Asia and its wider geostrategic and economic environment. The Institute’s research programmes are the Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), and Regional Social and Cultural Studies (RSCS). ISEAS Publishing, an established academic press, has issued more than 2,000 books and journals. It is the largest scholarly publisher of research about Southeast Asia from within the region. ISEAS Publishing works with many other academic and trade publishers and distributors to disseminate important research and analyses from and about Southeast Asia to the rest of the world.

The Impact of State Restructuring on Indonesia's Regional Economic Convergence ADIWAN FAHLAN ARITENANG

I5EA5

YUSOF ISHAK INSTITUTE

First published in Singapore in 2016 by ISEAS Publishing 30 Heng Mui Keng Terrace Singapore 119614 E-mail: [email protected] Website: All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the ISEAS – Yusof Ishak Institute. © 2016 ISEAS – Yusof Ishak Institute, Singapore The responsibility for facts and opinions in this publication rests exclusively with the author and his interpretations do not necessarily reflect the views or the policy of the publisher or its supporters. ISEAS Library Cataloguing-in-Publication Data Aritenang, Adiwan Fahlan. The Impact of State Restructuring on Indonesia’s Regional Economic Convergence. 1. Structural adjustment (Economic policy)—Indonesia. 2. Economic policy—Indonesia. 3. Decentralization in government—Indonesia. 4. Indonesia—Economic conditions—Regional disparities. 5. Southeast Asia—Economic integration. 6. Indonesia—Economic conditions—1966–1997. 7. Indonesia—Economic conditions—1997– I. Title. HC447 A71 2016 ISBN 978-981-4620-37-6 (soft cover) ISBN 978-981-4620-38-3 (e-book, PDF) Typeset by Superskill Graphics Pte Ltd Printed in Singapore by Markono Print Media Pte Ltd

For Dad and Mom, this book is impossible without your love, intellectual support and endless prayers.

CONTENTS List of Tables x List of Figures xi Preface xiii Abbreviations xvii 1. Introduction Research Background Regional Development: The Theoretical Debate Research Location: Indonesia, Batam and Bandung The Structure of the Book 2. State Restructuring and Regional Convergence: A Review of Theories and Debates Regional Development Debate: Convergence or Divergence? State Restructuring Impact The Institutional Shift Effect: The Case of Creative and Manufacturing Districts District Performance Model: An Analytical Framework The Institutional Shift in State Restructuring: The Case of Indonesia 3. Indonesia and Its Regional Development Since the 1980s: An Inheritance from the New Order Regime The Lineage of Regional Critical Antecedent Institutions: The New Order Regime Critical Juncture and Inherited Institutions Regional Divergence: Reproduction of Regional Institutions

1 2 4 7 10

13 14 19 29 33 37

45 46 54 57

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Impact of State Restructuring on Indonesia’s Regional Economic Convergence

4. Dynamics of Regional Economic Convergence 72 Research Data Description 73 Regional Economic Distribution Indices 73 Geographical Patterns of Regional Convergence 77 Spatial Distribution and Concentration of Manufacturing Industry 89 Regional Economy Dynamics in the AFTA and Decentralization Period 96 5. Decentralization and the ASEAN FTA Impact on Regional Economic Convergence Studies on Indonesian Regional Economic Convergence The State Restructuring Impact: Econometrics Model and Data Construction Empirical Analysis and Findings Discussion

99 100 101 109 122

6. The Institutional Effects on Regional Policies and Development: A Historical Institutionalist Perspective 129 The Tale of Two Sectors: Manufacturing and Creative Industries 130 The Manufacturing City: Batam 135 The Creative City: Bandung 146 The Effects of AFTA in Regional Development 157 Institutional Impact of Decentralization and AFTA in Regional Development 157 7. State Restructuring in Indonesia: Towards a Balanced Regional Economic Development Current Impact of State Restructuring The Future Policy for State Restructuring

162 162 166

Appendices Appendix A Regional Inequality Measurements 173 Appendix B The b Convergence Research Model 178 Appendix C Convergence Model: Traditional and Spatial Econometrics 181 Appendix D Tariff Data Construction 184

Contents

Appendix E Tariff Impact Appendix F Decentralization and AFTA Indices Appendix G Historical Institutionalism Research Methodology

ix

185 187 188

References 191 Index 207 About the Author 218

LIST OF TABLES 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9

Provincial GRDP: Shares of National Totals Provincial GRDP per Capita Rate of Theil Index Districts GDP per Capita Variation of Log, Theil Index, and Gini Coefficient Real GRDP per capita Spatial Distribution of Manufacturing District with Largest Share of Total Manufacturing, by Province Concentration of Manufacturing – National Level (Herfindahl Index) Concentration of Manufacturing – Provincial Level (Herfindahl Index)

80 82 83 84 88 90 92 93 94

5.1 Statistics of Variables in Economic Growth 5.2 Absolute and Conditional Regression 5.3 Fixed Effects Regression of per capita GRDP Growth

108 110 116

E.1 AFTA CEPT Tariff Impact Based on Total Firms in 1993 and 2005 E.2 AFTA CEPT Tariff Impact Based on Industry ISIC 1993 E.3 AFTA CEPT Tariff Impact Based on Industry ISIC 2005 E.4 Effects of Trade Tariff

185 186 186 186

LIST OF FIGURES 1.1 Map of Indonesia 1.2 Map of Batam and Bandung

5 9

2.1 Neoclassical Output Growth 15 2.2 Framework of Decentralization Impact on Regional Disparities 20 2.3 Models of Historical Institutional Analysis and Economic Performance 34 2.4 Institutional Research Methodology 36 3.1 Budgetary Processes in Indonesian Post-Decentralization 4.1 Lorenz Curve GRDP per capita and GRDP per capita (Non-natural Resource) 4.2 Lorenz Curve GRDP per capita, 1993 and 2010 4.3 Dispersion of per capita Provincial Incomes, 1971–2010 4.4 Inter-district Inequality per capita GDP, 1993–2010 4.5 GRDP Province and District Inequality index, 1993–2010 4.6 Inter-district Inequality per capita GDP, 1993–2010 4.7 Theil Index of GRDP per capita, 1995–2010 4.8 Coefficient Variation of GRDP per capita, 1993–2010 4.9 Coefficient Variation of GRDP per capita in Java and Sumatra, 1993–2010 5.1 The b Convergence between Log Annual Change of Real GDP per capita and Initial GDP per capita (1993–2010) 5.2 Districts Growth Rate between 1993–97 and 2001–10 5.3 Districts Initial GRDP per capita, 1993 5.4 Districts Growth, 1993–2001 (Standard Deviation)

62 75 76 76 77 78 78 85 86 87 111 112 119 120

xii

5.5 5.6 5.7 5.8

Impact of State Restructuring on Indonesia’s Regional Economic Convergence

Districts Districts Districts Districts

Initial GRDP per capita, 2001 Growth, 2001–10 (Standard Deviation) GRDP per capita, 2010 Growth, 1993–2010 (Standard Deviation)

121 122 123 124

PREFACE The idea for this research began one morning in 2007 when I was reading an offer for a PhD scholarship in a local newspaper. I immediately informed my father, Dr Wendy Aritenang, the then General Secretary of the Indonesian Transportation Ministry. After an extensive discussion, later that night he encouraged me to study the impact of both decentralization and ASEAN FTA on Indonesian regions as a topic for my PhD research. Despite his civil engineering background, he has a wide and in-depth expertise on decentralization and free trade agreements as a result of more than thirty years of experience in the government. Consequently, the PhD thesis and this book benefit much from short and distance discussions with him in London, Jakarta, Batam, Bandung and Singapore. The thesis and this book are definitely an intellectual production of a father and a son. This book derives from my PhD thesis at the University College London, United Kingdom. In writing the thesis, I would like to express my sincere and deep gratitude to my supervisor Dr Jung Won Sonn. I appreciate all his knowledgeable contribution, support and critiques at every stage of the writing. His guidance extensively helped me in understanding my thesis and integrate each part to form the thesis. I also owe my gratitude to my thesis co-supervisor Professor Nick Phelps whose ideas and knowledge helped deepen my research. I am fortunate to have Professor Andres Rodriguez-Pose of the London School of Economics and Political Science (LSE) as my thesis external examiner. As a leading scholar in the research topic, his expertise and advice greatly helped with the intellectual amendments. I would also like to express my gratitude to Dr Nikos Karadimitriou as the internal examiner who gave invaluable suggestions for the improvement of the thesis. I would like to thank the Ministry of Communication and Informatics, Republic of Indonesia for their support in the form of a scholarship for

xiv

Impact of State Restructuring on Indonesia’s Regional Economic Convergence

funding this research. Additionally I would also like to thank the Agency for Assessment and Application of Technology (BPPT) that has supported me to pursue this doctorate degree. The intellectual development of the PhD thesis is also a result of formal and informal discussions with friends at UCL Bartlett School of Planning, UCL Enterprise Society 2009, Indonesian Student Society in the United Kingdom and colleagues at the Indonesian Embassy. Some staff members of the ISEAS – Yusof Ishak Institute contributed towards the completion of this book. It is an honour to have the valuable opportunity to be a Visiting Research Fellow under the postdoctoral fellowship scheme in the institute. The institute provided a fresh and new intellectual environment for me in the area of Southeast Asian Studies. Since the first day of my arrival at the institute, the people have been nothing but welcoming me and ensuring that I settled smoothly. My gratitude goes to ISEAS Director Mr Tan Chin Tiong, Deputy Director Dr Ooi Kee Beng, and Head of Indonesia Study Group Dr Hui Yew-Foong. My sincere thanks to my Indonesia Study Group colleagues for the friendship and mentorship: Dr Aris Ananta, Dr Evi Nurvidya Arifin, Dr Alpha Amirrachman, Dr Ulla Fionna, Dr Alexander Arifianto and Dr Maxensius Sambodo. I would like to express my gratitude to the cooperation and support from the administration office and ISEAS Publishing colleagues: Mrs Y.L. Lee, Mr Ng Kok Kiong, Ms Rahilah Yusuf, Ms Karthi Nair and Ms P.P. Susha. My special thanks to Ms Foo Shu Tieng and Ms Kathleen Azali for proofreading and revising the book manuscript. I am also very grateful for the sincere friendship from other members of ISEAS – Yusof Ishak Institute: Mr Rodolfo C. Severino, Dr Francis Hutchinson, Ms Sanchita Basu Das, Ms Reema Bhaghwan Jagtiani, Dr Rizwana Abdul Azeez. Additionally, I would like to thank my Indonesian colleagues who have contributed to my intellectual journey across Indonesia, the United Kingdom and Singapore: Mr Fiki Satari and Dr Tita Larasati of BCCF; Dr Tatang A. Taufik of BPPT; Professor M. Rizza Sihbudi of LIPI; Professor Tommy Firman and Dr Delik Hudalah of ITB; Professor Yanuar Nugroho, Dr Saharman Gea, Dr Suyanto Mahdiputra, Mr Vishnu Juwono, and Mrs Dessy Irawati in U.K.; and Mr Adhi Priamarizki, Ms Fitri Bintang Timur and Professor Sulfikar Amir of Nanyang Technological University. This PhD thesis itself would not have been completed without financial and spiritual supports from my family — Dad, Mom, Dina and Andi. I am very grateful for their prayers, love, and support from Indonesia.

Preface

xv

For my mother, Dra. Tjut Wanda Lisa, who had countless times visited us in London and Singapore, it is always refreshing and a blessing for your one to two weeks visits. I am also thankful for my family in Riau, Papa, Mama and Rio, for their prayers and support. I would also like to thank Om Mul’s family for their support over the years. My special thanks to my wife, Ayu, who has been very supportive and patient in the four years of my PhD study in London; our daughter, Farah, whose birth became a spirit booster to complete the PhD thesis; and our son, Faris, who was born during my fellowship in ISEAS – Yusof Ishak Institute, as the sunshine in our life who has given new meaning on life and family. Adiwan Fahlan Aritenang Jakarta, January 2016

ABBREVIATIONS AFTA ASEAN Free Trade Agreement ASEAN Association of Southeast Asian Nations BAKOSURTANAL Badan Koordinator Survei and Pemetaan National (Coordinating Agency for National Survey and Mapping) BAPPENAS Badan Perencanaan Pembangunan Nasional (Agency for National Development Planning) BATAN Badan Tenaga Nuklir Nasional (Agency for National Nuclear Energy) BCCF Bandung Creative City Forum BIDA/BIFZA Batam Industrial Development Authority/Batam Indonesia Free Zone Authority BII Batam Intelligent Island BP Badan Pengusahaan Batam (Batam Free Trade Zone Agency) BPPT Badan Pengkajian and Penerapan Teknologi (Agency for the Assessment and Application of Technology) BPS Badan Pusat Statistik (Central Bureau of Statistics) CBO community based-organization CEPT Common Effective Preferential Tariff DAK Dana Alokasi Khusus (Special Allocation Fund) DAU Dana Alokasi Umum (General Allocation Fund) DBH Dana Bagi Hasil (Profit Sharing Fund) DPR Dewan Perwakilan Rakyat (Indonesian Parliament) DPRD Dewan Perwakilan Rakyat Daerah (Indonesian Regional Parliament)

xviii

Impact of State Restructuring on Indonesia’s Regional Economic Convergence

DRD DRN FDI FTZ GDP GRDP IPTN ITB KADIN KAPET KPPOD

LAPAN LIPI MERCOSUR MNCs MoF MoHA MoT MPKT MPR MTI NAFTA NEG NIE NIS NTB NGO

Dewan Riset Daerah (Regional Research Council) Dewan Riset National (National Research Council) foreign direct investment free trade zone gross domestic product gross regional domestic product Industri Pesawat Terbang Nasional (Nusantara Aircraft Industry) Institut Teknologi Bandung (Bandung Institute of Technology) Kamar Dagang dan Industri Indonesia (Indonesia Chamber of Commerce) Kawasan Pembangunan Ekonomi Terpadu Komite Pemantauan Pelaksanaan Otonomi Daerah (Committee Monitoring the Implementation of Regional Autonomy) Lembaga Penerbangan dan Antariksa Nasional (Institute of National Aeronautics and Space) Lembaga Ilmu Pengetahuan Indonesia (Indonesian Institute of Sciences) Mercado Común del Sur (Southern Common Market) multi-national corporations Ministry of Finance Ministry of Home Affairs Ministry of Trade Musyawarah Perencanaan Kegiatan Tahunan (Annual Activities Planning Forum) Majelis Permusyawaratan Rakyat (People’s Consultative Assembly) Masyarakat Transportasi Indonesia (Indonesian Transportion Society) North American Free Trade Agreement new economic geography newly industrialized economies new industrial spaces non-tariff barriers non-government organization

Abbreviations

OSS PINDAD PNPM

RIA RCTI SDO TIM TPI TVRI

xix

One Stop Service Perusahaan Industri Angkatan Darat (Army Industry Company) Program Nasional Pemberdayaan Masyarakat Mandiri (National Community Development Programme) regional integration agreements Rajawali Citra Televisi (Rajawali Citra Television) Subsidi Daerah Otonom (Autonomous Region Subsidy) territorial innovation model Televisi Pendidikan Indonesia (Indonesia Education Television) Televisi Republik Indonesia (Republic of Indonesia Television)

1 INTRODUCTION

This book is an attempt to decipher regional district economic disparities during the state-restructuring events that occurred after the entry into the ASEAN Free Trade Agreement (AFTA) in 1992 and the governmental decentralization policy in 1999. Following the financial crisis in 1997, Indonesia’s political arrangement shifted from a centralized regime to a decentralized government system. The new system delegates political, administrative, and fiscal autonomies to provincial and districts level. The decentralization process increased the Indonesian administrative size from 26 provinces with 292 districts in 1997 to 33 provinces with more than 491 districts in 2012.1 This book examines the determining factors for Indonesia’s development from a centralized government regime to the state-restructuring period. This book has adopted an empirical approach by using growth theory and the historical institutionalism approach in order to examine the impact of state restructuring. However, the impact would be determined by institutional capacities and the governance level of local governments to exploit opportunities from state restructuring processes as it would affect the rate of growth and economic development. State restructuring refers to the creation of more logical organization where the state operates more efficient and effective (Young 2002). In this sense, the book defines state restructuring as a politico-economy shift of state organization and operation through two events (AFTA and

2

Impact of State Restructuring on Indonesia’s Regional Economic Convergence

decentralization) that accelerates state management and service delivery through the participation of stakeholders, management of production factors, and state administration to achieve development goals. This study worked with the hypothesis that decentralization and AFTA would provide local district authorities ample opportunities in which to accelerate economic growth through authority over resource allocation and mobility. Furthermore, state restructuring provided opportunities in which to accelerate economic growth through the promotion of property rights and lower transaction cost. The book investigates how the state restructuring policy would affect regional economic convergence and what are the economic growth determinants. The main argument for this book is that state restructuring institutional changes would be able to explain regional economic divergence through path dependence and inherited past institutions within individual regions. The nature of the research question has meant that the study required the use of a variety of quantitative and qualitative analytical methods. The deductive research questions which are utilized in this study were formulated through a critical review of relevant literature and current conditions in Indonesia. This study examines Indonesian regional district development by using the municipality and regency (kota and kabupaten, respectively) as the spatial unit of analysis. The dynamics of regional development in Indonesia should be understood and viewed through statistical analysis before one can begin to discuss the variations in state restructuring effects. The use of both quantitative and qualitative analytical methods enabled a much more comprehensive analysis and enhanced the validity of the research as one method served as a test on the other’s accuracy and veracity (Read and Marsh 2002). The quantitative method, which utilizes an econometric analysis of local endowment, explored the determinants of economic growth. This exploration was crucial in understanding the local economic structure and institutional arrangements as the basis of the qualitative study. The qualitative method featured the use of in-depth interviews in order to clarify the role of local endowments and institutional arrangements in terms of economic growth.

RESEARCH BACKGROUND Since the 1990s, following the decline of oil and gas production, there is a shift of deregulation in the manufacturing sector. At the same time, the

Introduction

3

emergence of manufacturing sector in the ASEAN region accelerates the ASEAN FTA between the association’s member countries. This marks the shift of Indonesia economy towards a non-oil industrialization that lasted until 1997. The Asian Financial Crisis (AFC) that striked Indonesia resulted in the fall of the New Order regime and provided the path of decentralization on politics, economy, and administration. Both events shifted the state management, strengthened regional governments and improved public participation in national development process. At the same time, Indonesia became more involved with the global economy through trade integration and cooperation. Thus, it is important to conduct economic and political analysis at the district level as it is crucial to our understanding of the impact of trade liberalization and decentralization on economic growth disparities. The implementation of AFTA and decentralization led to a shift in the decision-making process from government-centric to multi-stakeholder governance (Jessop 2002) and also economic growth only in certain regions, which Brenner (1999) called “the spatial selectivity of special regions”. Regional disparities are more pronounced in developing countries due to higher political and social issues discontent in these lagging countries (Rodríguez-Pose and Gill 2006). This is illustrated with persistent economic growth divergence among districts in Indonesia. Despite a decade of decentralization in which the Indonesian central government transferred significant political and administrative authority to the district level, government services and public reform have barely improved (von Luebke 2009). Instead, von Luebke’s study demonstrated that there was a continuity of non-transparent and elite-centric agreements on public employment, government contracts, and party list positions despite decentralization efforts. One reason for this lack of development was the persistent sociopolitical challenges. In the local jurisdiction, for instance, there has been a significant increase in the number of provinces and districts due to the decentralization process. Supporters of this regional administrative division argue that as the geographical area is too large with poor infrastructure, decentralization as it is has failed to provide access to health and education services for people in remote areas (Fitrani, Hofman and Kaiser 2005). Other reasons for further regional administrative division were made on the basis of religion, ethnicity, and bureaucratic and political rent seeking (Booth 2011; Fitrani, Hofman and Kaiser 2005).

4

Impact of State Restructuring on Indonesia’s Regional Economic Convergence

Another issue is how direct elections have been criticized as monopolized by local elites. At the early stages of the government decentralization process, there were a number of former civil servants who successfully won elections at the district levels. Since the decentralization process started in 2001, 70 per cent of the new regional heads were bureaucrats and the general public by 16 per cent. Meanwhile, only 10 per cent of the regional heads secured a second term and only 12 per cent of the regional heads were from the Armed Forces (Malley 2003). These leaders were seen as part of the New Order regime which continued to exploit resources for self-enrichment or wealth accumulation to boost status rather than regional development. On the other hand, AFTA is expected to accelerate Indonesia’s industry and trade competitiveness. However, the literature predicts that trade liberalization would increase imports in lagging countries and thus ineffective industries will struggle to compete with cheaper and higher quality imported products. Furthermore, Rodríguez-Pose and Gill (2006) argued that trade liberalization increased the development gap for regions that were lagging in manufacturing industries as these industries tended to be located near industrial complexes and urban areas. At the local level, the effect of this trade liberalization becomes more significant when the size of regions is considered. In Indonesia, with more than 400 districts and each with different local economic structure, the effect of trade liberalization will be widely varied (Feridhanusetyawan and Pangestu 2003). Logically, districts with a large economic base and higher trade rates will gain wider market access from trade liberalization, while poorer regions with less efficient products will struggle to penetrate the market and compete with other regions. Thus, poorer regions potentially become market destination for import products. This is similar to Ramasamy’s argument (1994) that in the early stages of AFTA, the agreement might increase inter-ASEAN imports to 60 per cent.

REGIONAL DEVELOPMENT: THE THEORETICAL DEBATE This section frames the theoretical debate in which the empirical studies are presented in this book. To examine the equalization of regional development, we approximate using regional convergence. Regional convergence refers to the declining gap of regional economic growth due

(}

Introduction

FIGURE 1.1 Map of Indonesia

N South China Sea

~

/ PACIFIC OCE

~

,