The Regional Resource Curse (online)

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The Regional Resource Curse: The impact of resource-linked revenue flows on development outcomes across Indonesia

Transcript of The Regional Resource Curse (online)

Page 1: The Regional Resource Curse (online)

The Regional Resource Curse:

The impact of resource-linked revenue flows on development outcomes across Indonesia

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Table of Contents: Abstract ................................................................................................................................................. 4 Acknowledgements .......................................................................................................................... 5 List of Acronyms ................................................................................................................................ 6 1. Introduction: .............................................................................................................................. 7

Background ..................................................................................................................................... 7 The issues arising from decentralization ............................................................................ 8 Research Question .................................................................................................................... 10 Purpose & Scope ........................................................................................................................ 10 Structure ....................................................................................................................................... 12

2. Literature Review ................................................................................................................. 13 The Resource Curse .................................................................................................................. 13

Structuralist ............................................................................................................................ 14 Rent-seeking ........................................................................................................................... 14 Institutional............................................................................................................................. 15

A Subnational Resource Curse? ........................................................................................... 17 A Localized Dutch Disease? .............................................................................................. 18

The apparent benefits of fiscal decentralization .......................................................... 21 Managing resource revenue flows at the subnational level ..................................... 24

3. Methodology ........................................................................................................................... 28 Quantitative analysis ................................................................................................................ 28

Case study selection ............................................................................................................. 29 Qualitative analysis ................................................................................................................... 30 Data sources ................................................................................................................................ 31

Resource-linked revenue flows....................................................................................... 31 Economic growth .................................................................................................................. 31 Development outcomes...................................................................................................... 32 Institutional quality ............................................................................................................. 32

4. The impacts of resource revenue flows ....................................................................... 34 Revenue flows ............................................................................................................................. 34 The impact of revenue flows ................................................................................................. 38

Economic and socioeconomic impacts......................................................................... 38 Impacts on governance and institutional quality .................................................... 41

5. The influence of institutional factors ............................................................................ 44 Case studies.................................................................................................................................. 44

East Kalimantan .................................................................................................................... 45 West Papua .............................................................................................................................. 48

Institutional structures & governance practices .......................................................... 51 Fiscal discipline ..................................................................................................................... 52 Development planning ....................................................................................................... 54 Investing in investment process ..................................................................................... 57

Importance of institutional quality .................................................................................... 58 6. Conclusion ............................................................................................................................... 60

Areas for future research: ...................................................................................................... 62 Summary ....................................................................................................................................... 64

Appendices ........................................................................................................................................ 65 Appendix A: Meta-analysis of the literature on the subnational resource curse (Cust & Viale, 2016) .................................................................................................................. 65

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Appendix B: Provincial map of Indonesia (Geocurrents, 2016) ............................. 67

Bibliography ..................................................................................................................................... 68

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Table of Figures: Figure 1: Major mechanisms of the resource curse at the national level ................ 16 Figure 2: Organizing framework for resource curse literature ................................... 21 Figure 3: Indonesia's natural resources revenue sharing regime .............................. 35 Figure 4: Indonesian provinces ranked by average annual natural resources

revenue sharing ..................................................................................................................... 36 Figure 5: Top 30 Indonesian municipalities by average annual natural resource

revenue sharing ..................................................................................................................... 37 Figure 6: Resource revenue flows vs. economic growth ................................................ 38 Figure 7: Resource revenue flows vs. poverty rates ........................................................ 39 Figure 8: Resource revenue flows vs. change in poverty rate ...................................... 39 Figure 9: Resource revenue flows vs. Human Development Index............................ 40 Figure 10: Resource revenue flows vs. changes in the HDI ........................................... 40 Figure 11 & 12: Resource revenue flows vs. governance .............................................. 43 Figure 13: Natural resource revenue flows by type - East Kalimantan.................... 47 Figure 14: Economic and socioeconomic indicators - East Kalimantan .................. 48 Figure 15: Average of economic governance index and sub-indices – East

Kalimantan - 2007 ................................................................................................................ 48 Figure 16: GRP by industry - 2014 (constant 2010 prices) - East Kalimantan ..... 48 Figure 17: Natural resource revenue flows by type – West Papua ............................ 50 Figure 18: Economic and socioeconomic indicators – West Papua ........................... 51 Figure 19: Economic governance index and sub-indices – West Papua – 2011 .. 51 Figure 20: GRP by industry - 2014 (constant 2010 prices) – West Papua.............. 51 Figure 21: Actual revenues & expenditures of autonomous regions (million IDR)

– East Kalimantan ................................................................................................................. 54

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Abstract

The trend towards fiscal decentralization across the developing world has

seen sizeable revenue transfers from central to regional governments. This is

particularly evident in resource-rich countries such as Indonesia, where the

revenue generated from resource extraction is distributed to subnational

governments in the regions where extraction occurs. Whilst these revenue flows

are meant to promote development outcomes, some research suggests that they

can have the opposite effect and undermine development outcomes via the

revenue channel of a subnational resource curse. This paper investigates the

impacts of resource revenue transfers on development outcomes across

Indonesia’s regions by identifying the correlations between these revenue flows

and a range of development indicators. It then performs a comparative case

study of the provinces of East Kalimantan and West Papua to determine what

factors contribute to some resource-rich regions recording superior

development outcomes to others. This research finds that resource revenue

flows do indeed have a positive correlation with improved development

outcomes. However, it also suggests that these revenue flows can undermine the

quality of a region’s governance and institutional structures. The comparative

case study then suggests that this institutional quality is a key factor in

determining which regions record superior development outcomes. Hence

whilst resource revenue flows can have a positive impact on development

outcomes, this impact is heavily dependent on initial institutional quality. In

regions where institutional quality is low, resource revenues may not have as

positive an impact, and they may even undermine institutional quality further.

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Acknowledgements

In putting together this thesis I received plenty of assistance from a range

of different sources. Firstly, I would like to thank Andy Sumner who supervised

my work and provided guidance throughout the process. I would also like to

thank Pierre-Louis Vezina and Dharendra Wardhana who assisted me in

sourcing data and were happy to discuss the intricacies of Indonesia’s economy.

Beyond that I would like to thank the entire IDI (or should I say DID) department

and KCL organization, for their support and guidance throughout the year. I also

want to thank my fellow students in the International Development program,

who provided advice, proofreading and a welcome distraction when needed, in

particular Lauren Kienzle and Chris Chagnon for their notes and comments.

Finally I would like to thank and acknowledge Rachel, who put up with me

spending far too much of my time at the library, but also made it very easy for

me to forget about my thesis for a while whenever necessary.

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List of Acronyms

Note that some of the acronyms used in this paper are originally from Bahasa

Indonesia and hence the acronym may bear little resemblance to their

translation

BPKP – Financial and Development Supervisory Agency

BPS – Central Bureau of Statistics

DAK – Special Allocation Fund

DAPOER – Indonesia Database for Policy and Economic Research

DAU – General Allocation Fund

DBH – Revenue Sharing Fund

EGI – Economic Governance Index

GDP – Gross Domestic Product

GRP – Gross Regional Product

HDI – Human Development Index

IDR – Indonesian Rupees

IGI – Indonesian Governance Index

LNG – Liquid Natural Gas

NRGI – Natural Resource Governance Institute

RPJMN – Medium-term Development Plan

RPJPN – Long-term Development Plan

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1. Introduction:

Background

The resource sector has historically played a significant role in

Indonesia’s economy. Indonesia is a sizeable producer of oil & gas, coal, gold and

other resources, with natural resource rents accounting for an average of 14% of

GDP over the period since 1967 (World Bank, 2016b). Oil & gas have been

particularly significant contributors to the Indonesian economy. Despite being a

net importer of oil, oil rents accounted for 8% of GDP over this same period, with

the petroleum industry contributing 18% of total government revenues in 2011

(Natural Resource Governance Institute, 2016). However, Indonesia is not

entirely resource-dependent. It has been mostly successful in diversifying its

economic base and promoting growth and development since President Suharto

came to power in 1967. Over this period, which includes the sharp contraction

that accompanied the 1998 Asian Financial Crisis, Indonesia has averaged annual

GDP growth of over 6% (World Bank, 2016b). It has also recorded significant

gains in social indicators, with poverty rates having fallen and health and

education indicators improving. Its Human Development Index (HDI) value for

2014 reached 0.684, ranking it 110th out of 188 countries. Indonesia’s HDI has

steadily risen since 1980 and it is now considered to be in the medium human

development category (UNDP, 2015).

Proponents of the ‘resource curse’ theory would argue that Indonesia’s

natural resource endowments should have made Indonesia’s successful

development path more challenging. They would argue that Indonesia’s natural

resources raised the risk of ‘Dutch Disease’ and deindustrialization, whilst

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hollowing out its political institutions and promoting corruption and poor

governance. However, Indonesia has mostly been able to avoid the effects of the

resource curse, instead using commodity exports and in particular the

commodity booms of the 1970s and 2000s, to support its development efforts

(Hill, 1997, 2000). Indonesia followed an orthodox and relatively disciplined

suite of macroeconomic and fiscal policies, which enabled it to manage and

sterilize many of the possible negative impacts of the resource curse (Eifert et al.,

2002, Eifert et al., 2003, Garnaut, 2015, Hill, 2000, Usui, 1997). The centralized

nature of the Suharto regime was a key factor in enabling the government to

exercise control and manage the economy effectively during these initial stages

of development (Hill, 2014, Thee, 2012).

The issues arising from decentralization

However, in 1999 the Indonesian parliament revised laws 22/1999 on

local government and 25/1999 on the intergovernmental fiscal relationship. This

began a sizeable decentralization program that granted greater power over

legislation and public finances to the country’s subnational governments1. A

significant part of this was the sharing of natural resource revenues. Transfers

from the Central Government to subnational governments make up nearly 70%

of subnational budgets and 30% of central government expenditure (Hill, 2014:

107), with oil & gas revenue sharing accounting for 11% of the total balancing

fund transfer in 2010 (Agustina et al., 2012: 14). The provinces of Aceh, Papua

and West Papua have each been afforded special autonomy from the Central

Government and all contain significant endowments of oil & gas. As a result, they

1 Throughout this paper ‘regions’ will refer to any subnational grouping or area (ie; provinces, districts, islands etc.) Municipalities will refer to regencies and cities. Provinces and districts refer to those specific levels of government respectively

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have demanded more generous sharing arrangements and are more dependent

on resource revenues to finance government spending, receiving 70% of oil &

gas revenue originating from their provinces, compared to 15.5% for oil and

30.5% for gas in the other provinces (Agustina et al., 2012: 14).

Whilst fiscal and administrative decentralization can, in theory, improve

the delivery of public services by making them more tailored and responsive to

the needs of those who use them and encouraging competition in governance

practices and business conditions between subnational units (Oates, 1972,

Stigler, 1957, Tiebout, 1956), revenue flows to subnational governments can also

run the risk of making these regions more vulnerable to a ‘subnational resource

curse’. Although Indonesia was mostly successful at avoiding the resource curse

at the national level thanks to good governance and effective institutions, these

are likely to be in much shorter supply at the subnational level. Many of

Indonesia’s provinces and districts are still relatively young and their

institutional structures remain in their infancy. Also despite its apparent

benefits, decentralization can even weaken governance practices and promote

corruption (Prud'homme, 1995, Treisman, 2002).

Thus, if Indonesia’s subnational governments already exhibit poor

governance practices, then the significant revenues that are distributed to them

may not have the intended positive effect. This ‘revenue channel’ is a key

mechanism through which a subnational resource curse can arise (Caselli and

Michaels, 2013, Cust and Rusli, 2014, Cust and Poelhekke, 2015). So instead of

resource revenues helping promote development in Indonesia’s resource-rich

regions, they could instead be wasted by ineffective subnational governments or

even undermine development efforts.

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Research Question

The question that this paper hopes to answer is:

What are the impacts of natural resource-linked revenue transfers – specifically

focusing on those related to oil & gas – on development outcomes in Indonesia’s

regions, and why do some resource-rich regions perform better on these indicators

than others?

Purpose & Scope

In answering this question, this dissertation seeks to identify whether

resource revenue flows to subnational governments in Indonesia are correlated

with more positive development outcomes than experienced by those regions

that do not receive such flows. It will then look more closely at the experiences of

specific regions to ascertain what factors influence the effectiveness of these

revenue flows. The focus will primarily be on formal budgetary institutions and

how they influence a region’s absorptive capacity and its ability to effectively

utilize resource revenues.

By better understanding the impact that resource revenue distributions

to subnational governments have on development outcomes, this dissertation

hopes to contribute to the literature on the subnational resource curse,

specifically via the revenue channel. In doing so this paper aims to emphasize

that the benefits of fiscal decentralization are conditional on the institutional

structures and governance capabilities of subnational governments. It is hoped

that these contributions will be useful in advising the policy choices of

government at all levels when managing natural resource revenue flows.

In order to achieve these goals, this dissertation will limit its scope to the

revenue channel of the subnational resource curse. It will focus on the impacts of

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revenue flows to subnational governments that are linked to non-renewable

natural resource revenues. In doing so this paper will exclude discussion of

renewable resources such as those in agriculture, forestry and fisheries. To

tighten its focus on the revenue channel to government, this paper will also limit

its analysis to the oil & gas industries. The extraction of these resources

traditionally provides the largest revenue windfalls to government and these

sectors are most commonly linked to the resource curse.

As the revenue channel is the primary focus of this paper there will be

less emphasis given to the other mechanisms through which a subnational

resource curse can arise, such as ‘localised Dutch disease’. Whilst it is recognized

that these factors can have an equally significant impact on development

outcomes as do revenue flows, discussion of these factors in Indonesia has been

well covered in the literature (see Cust and Rusli, 2014). Attempts to control for

these factors and to isolate the impacts through the revenue channel have been

made in the selection of the case studies.

Indonesia has been chosen as the country of analysis for this paper as it

provides a natural experiment into the effects of resource revenue flows on

development outcomes at a subnational level. Firstly, it is a relatively resource-

rich nation that is still classified as a lower middle-income country. It is also a

comparatively decentralized nation, both geographically and politically. Since the

1999 reforms, subnational governments have much greater political and

administrative autonomy, as well as access to sizeable resource revenues

through a national revenue sharing regime. These traits make Indonesia an ideal

area of research for this paper as its subnational governments offer a number of

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prospective case studies with varying flows of resource-linked revenues,

different levels of development and a range of levels of governance quality.

Structure

As an introduction to the topic, this paper will begin by outlining the difficulties

that can arise from significant resource revenue flows to subnational

governments in a decentralized Indonesia. Chapter 2 will perform a thorough

review of the literature concerning the resource curse, as well as referencing the

literature on fiscal decentralization and public fiscal management. Particular

attention will be paid to how revenue flows can impact on development at the

subnational level. Chapter 3 will outline the multi-staged and multi-method

approach of the paper as well as providing detail on the data sources used.

Chapter 4 will use quantitative analysis to identify what impacts natural

resource revenue transfers have on development outcomes in Indonesia.

Chapter 5 will then present a comparative case study of two provinces to

understand what factors make some resource-rich regions outperform others.

Finally, Chapter 6 will summarise these findings and how they relate to the

research question, providing concluding remarks.

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2. Literature Review

This paper aims primarily to contribute to the existing literature on the

resource curse by approaching the topic from the less well-researched

subnational perspective. The specific area of focus will be the ‘revenue channel’

through which revenue flows related to natural resource extraction can

undermine institutional quality and development outcomes. This paper also

hopes to draw on and contribute to the literature on fiscal decentralization and

public fiscal management by investigating what impact they have on the

effectiveness of resource revenue flows in promoting development outcomes.

The Resource Curse

Whilst the possible negative implications of a booming resource sector

have been discussed as early as the 1950s (Hirschman, 1958, Prebisch, 1950), it

was Richard Auty (1993) who coined the phrase ‘resource curse’ to refer to the

apparent negative relationship between countries’ natural resource wealth and

dependence and their economic growth (Auty, 1990, 1991, Gelb, 1988, Wheeler,

1984). Sachs & Warner (1995, 2001) later formalized this relationship

empirically through a number of cross-sectional studies. Whilst the curse does

not always apply and there are some that still contest the conventional theory

(Brunnschweiler and Bulte, 2008, Davis, 1995, Stijns, 2005), it has now come to

be mostly accepted as a stylized fact by many academics in the field, albeit with a

number of caveats. The primary mechanisms through which the resource curse

occurs can be broadly classified into three categories: structuralist, rent-seeking

or institutional (Torres et al., 2013).

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Structuralist

The most influential of the structuralist mechanisms is ‘Dutch Disease’,

which refers to the impact that natural resource endowments can have on the

real exchange rate and consequently on a country’s external competitiveness.

Attracting foreign investment and domestic inputs into the booming resource

sector can overvalue the real exchange rate and raise input costs across the rest

of the economy. This can, in turn, weaken the competitiveness of export-

competing sectors and encourage de-industrialization. The resulting

concentration of economic activity and wealth in the resource and resource-

related sectors can lead to increased unemployment and inequality as these

sectors tend to have minimal labour requirements. Due to the volatile nature of

the resource sector and the positive externalities that can be associated with

other export-competing sectors such as manufacturing, a subsequent downturn

in the resource sector can then leave the economy significantly weaker as many

sectors have been ‘hollowed out’. This can then lead to a lower long-term growth

rate than is experienced in countries without a significant resource sector

(Gylfason, 2001, Sachs and Warner, 2001).

Rent-seeking

The rent-seeking mechanisms are more concerned with the perverse

incentive structure that a strong natural resource sector can create for economic

actors. By increasing the returns to rent-seeking activities in the resource sector,

other economic activities that tend to be more beneficial to long term economic

growth and development become less appealing. This can lead to actors

expending more effort in rent-seeking activities, such as lobbying governments,

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than they do in pursuing activities that are more productive in the long-term,

such as undertaking entrepreneurial activities or pursuing an education

(Gylfason, 2001, Robinson et al., 2006, Torvik, 2002).

Resource wealth can also encourage corrupt behaviour as the potential

returns to such behaviour are increased by the readily available rents provided

by the resource sector (Leite and Weidemann, 2002, Papyrakis and Gerlagh,

2004). Conflict, both of the violent and political variety, can also arise as groups

compete for control over the easily obtainable rents associated with the resource

sector. (Bannon and Collier, 2003, Collier and Hoeffler, 2005, Ross, 2012). These

perverse incentives can thus undermine a country’s long-term growth prospects,

as well as weakening its institutional structures.

Institutional

Finally, the institutional mechanisms of the curse refer to when natural

resource endowments have a detrimental impact on institutional quality,

encouraging poor governance practices and subsequently promoting negative

economic and social outcomes (Collier and Goderis, 2008, Ross, 2001, 2012).

Many of the rent-seeking mechanisms such as increased corruption and conflict

can also undermine and weaken a country’s institutions and governance

practices, which can have long-lasting and wide-ranging effects on a country’s

development.

However, it is also recognized that strong institutions and good

governance can help a country avoid the resource curse, or at least temper its

effects (Lane and Tornell, 1996, Mehlum et al., 2006). This institutional school of

thought often views strong institutions and good governance as the ‘cure’ to the

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resource curse, pointing to countries such as Norway and Australia, which

display sound macroeconomic management and a strong rule of law alongside a

range of healthy democratic institutions, as proof that resources need not be a

curse if the right institutions are in place (Acemoglu et al., 2005, Acemoglu and

Robinson, 2006, Mehlum et al., 2006, Torres et al., 2013).

Figure 1: Major mechanisms of the resource curse at the national level (Torres et al., 2013)

The Revenue Channel

A significant channel through which rent-seeking and institutional

mechanisms can operate is the ‘revenue channel’ (Cust and Poelhekke, 2015,

Torres et al., 2013). This refers to the impact that revenue flows to government

can have on economic and political institutions. When governments lack the

capacity to manage the substantial revenue flows that are often associated with

the resource sector, these flows can undermine political institutions and

incentivize poor governance practices (van der Ploeg, 2011). They can encourage

weak fiscal management by the public sector, realized in insufficient savings,

excessive borrowing and unnecessary or ineffective public spending, as

Structuralist

•Dutch Disease - overvalued real exchange rate leads to deinustrialization

•Crowding-out of other economic activities

•Exposing the economy to increased volatility

•Loss of positive externalities - 'learning by doing'/productivity gains

Rent-Seeking

•Reduced incentives for entrepreneurial behaviour or pursuit of education

•Increased conflict in pursuit of rents

•Rent-seeking activities prioritised over more economically productive activities

Institutional

•Undermining democratic institutions

•Incentivising increased corruption

•Deteriorating standard of governance

•Revenue Channel

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politicians tend to take an overly optimistic and short-sighted view of the impact

of resource revenues on public finances (Atkinson and Hamilton, 2003,

Mansoorian, 1991). This can lead to inefficient spending practices and a bloated

public sector, which becomes particularly troublesome when revenues decline

thanks to the volatility that is typically associated with resource-linked revenue

flows (Bleaney and Halland, 2009).

Significant revenue flows also offer a sizeable financial or political reward

for those who control them, encouraging both violent and political conflict as

actors compete to control these revenues (Arellano Yanguas, 2011). This can

encourage increased corruption, which further weakens the efficacy of

government investment and undermines political institutions (Caselli and

Michaels, 2013). However, whilst substantial revenue flows can undermine

institutions, this impact is again conditional on the initial quality of institutions.

High quality institutional structures can temper the negative effects from

resource-linked revenue flows and help ensure that they have a positive impact

(Atkinson and Hamilton, 2003, Bleaney and Halland, 2009, Davis et al., 2003,

Eifert et al., 2003). It is this ‘revenue channel’ of the resource curse and the

impact that institutions have in managing it that will be the focus of this paper.

A Subnational Resource Curse?

Whilst there is a wealth of research concerning the natural resource curse

at a national level, there is significantly less discussion of this phenomenon at the

subnational level. What research there is into a subnational resource curse

mostly focuses on the local proximate effects of resource extraction as opposed

to areas defined by political boundaries (Arellano Yanguas, 2011, Caselli and

Michaels, 2013, Cust and Rusli, 2014). These studies identify four primary

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outcomes from resource extraction that can act as transmission mechanisms for

a resource curse at the subnational level. These are: (1) increased employment in

the resource sector and the subsequent demand for labour, (2) increasing

income generation, (3) increases in local tax revenues, and (4) environmental

consequences and land tenure issues (Fleming and Measham, 2013).

The environmental and land tenure issues are beyond the scope of this

paper and hence will not be covered here. However, using the above framework,

the increased employment and income effects can be categorized as primarily

structuralist mechanisms. At the same time, the effects of the boost to local tax

revenues fall across both the rent-seeking and institutional categories, creating a

‘subnational revenue channel’ that can hamper development outcomes.

A Localized Dutch Disease?

The research into the effects of increasing employment demand and

rising incomes stems from the economic literature investigating the labour

market effects of demand shocks, particularly those related to significant

investment projects (Cust and Poelhekke, 2015). Studies in this field identify a

positive impact on incomes in regions where major investment projects take

place (Carrington, 1996, Michaels, 2008), and the observation holds for

investment in the resource sector (Aragon and Rud, 2013, Cust and Poelhekke,

2015). Those that are directly involved in the sector receive employment and

likely an increase in income. This will often also attract migration flows to the

region to satisfy the demand for labour, promoting growth in the local economy

(Marchand, 2012, Weber, 2012). This growth can spill over to other industries

that benefit from the increased demand for goods and services that growth in the

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resources sector brings (Black et al., 2005). Aragon & Rud (2013) even suggest

that the backwards linkage channel of increased demand for local inputs can

have a stronger positive impact than if the funds were redirected via government

spending. Thus there is evidence to support the conventional economic

viewpoint that significant investment in resources extraction and the

accompanying positive demand shock can provide an economic and welfare

boost to the immediate surrounding area.

However, this economic boost is not always widely felt and can have

negative indirect consequences. The resource sector is often characterised as an

‘enclave activity’ (Hirschman, 1958), meaning that it remains relatively

disconnected from the local economy. Those who are not directly involved in the

booming industry often miss out on the economic benefits. Instead, the positive

economic effects are often conditional on individuals’ proximity to extraction

activities and the capacity of local markets to absorb and cater to the increase in

investment (Cust and Rusli, 2014).

Labour and housing shortages can quickly emerge if the population and

housing stock is insufficient, pushing up wages, rents and land prices. Whilst this

will benefit some, it can hit those at the lower end of the income scale who are

unemployed or don’t own their own home especially hard, leading to increasing

inequality and possibly pushing some households into poverty as the costs of

necessities increase. Consequently, in the same way that a booming region

attracts migrants hoping to share in the boom, it can also see others leave the

region as they are unable to share in the benefits that it brings. This most

commonly results in men moving to the region and women leaving, resulting in a

‘boomtown effect’ with an increasing share of men making up the population.

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This is correlated with negative social outcomes such as increased violence,

crime and substance abuse (Stedman et al., 2012). Through these mechanisms,

the increasing employment opportunities and income that accompany a boom in

the resources sector can also lead to more negative socioeconomic outcomes.

This sort of input cost inflation can also reduce the competitiveness of

other industries in the region and crowd them out in much the same way as is

experienced at the national level, creating a ‘localised Dutch disease’ (Cust, 2014,

de Haas and Poelhekke, 2016, Kilkenny and Partridge, 2009, Rolfe et al., 2007)2.

The weakening of other industries can lead to reduced positive externalities,

such as reduced ‘learning by doing’ in the case of a declining manufacturing

sector (Matsuyama, 1992). The result can be a less diverse local economy with

employment focused in the resource and resource-related industries. This can, in

turn, reduce the incentives for further education and entrepreneurial behaviour

as economic actors opt to undertake rent-seeking activities in those industries as

opposed to other more productive activities (Glaeser et al., 2015, Gylfason,

2001). The weakening of other industries and the hollowing out of a region’s

economy can become particularly damaging when commodity prices fall or

resource reserves run out and the resource sector contracts, with the negative

impacts of a bust often outweighing the positive impacts of the boom (Black et

al., 2005, Cust, 2014). Thus the expected economic benefits of increased

investment in resource extraction in the short-run may end up being outweighed

by negative outcomes over the longer term.

2 Note that the localized Dutch disease is often limited to a relatively close proximity to mining activities, with Cust (2014) finding that labour market effects are limited to roughly a 15km radius, whilst de Haas & Poelhekke (2016) find constraints to doing business within a roughly 20km radius, with firms outside these areas experiencing fewer constraints.

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Cust & Viale (2016) surveyed the existing literature on a subnational

resource curse and were unable to definitively prove the existence of a curse.

They listed a number of studies that supported the existence of a subnational

resource curse, some that opposed it, and some where the outcomes were

deemed conditional on institutional quality, the distance from extraction sites, or

the level of government (see appendix A). However, Cust & Viale did find that

existing studies suggested “that resource revenue transfers to subnational

governments have, in most cases, negligible or even negative effects on local

socioeconomic outcomes” (2016: 19). This highlights that the revenue channel of

the resource curse may have added significance at the subnational level and calls

for more research into what factors can influence the effectiveness of revenue

flows in promoting development outcomes. It is by targeting this gap in the

literature that this paper hopes to make its contribution.

Figure 2: Organizing framework for resource curse literature

The apparent benefits of fiscal decentralization

The theory supporting fiscal decentralization argues that local

governments are more informed of their constituencies’ needs and are thus

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more accountable and responsive to them (Oates, 1972, Stigler, 1957, Tiebout,

1956). In response to this theory as well as to rising democratization and

growing pressure from local groups, there has been an increasing devolution of

revenues and revenue-raising capacity to subnational governments across the

developing world (Agustina et al., 2012, Cust and Poelhekke, 2015). This trend is

particularly evident in relation to resource-linked revenues, as resource wealth

is perceived as belonging to the community as a whole (Segal, 2012, Wenar,

2007). This argument has been taken up by native groups and subnational

governments to lobby for a greater share of the revenues generated by resource

extraction in their regions. The growing acceptance of this viewpoint in

Indonesia is particularly evident in its decentralized resource revenue

distribution regime and the sizeable shares of revenues that accrue to the

provinces of Aceh, Papua and West Papua (Agustina et al., 2012). This can

provide substantial revenues to subnational governments that can underpin

public-led development efforts.

However, these apparent benefits are not always realized. The literature

on the resource curse highlights the possible negative impact that fiscal

decentralization can have via the revenue channel, such as promoting rent-

seeking behaviour, undermining institutions (Caselli and Michaels, 2013), and

encouraging political and violent conflict (Arellano Yanguas, 2011). Gonzalez

(2012) argues that the benefits of fiscal decentralization are dependent on the

relative bargaining power of the subnational units and their ability to generate

revenues. A powerful centre can impose costs on subnational units and promote

a more ‘needs-based’ distribution mechanism, which can benefit the less

developed and more fiscally dependent regions. However, when subnational

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units wield more power and influence, distribution mechanisms can become

more ‘preference-based’, with revenues being directed according to political

considerations rather than developmental ones (Gonzalez, 2012). In a more

decentralized environment where subnational governments wield more power,

this ‘preference-based’ approach is more likely, which can undermine

developmental outcomes.

This ‘preference-based’ approach is apparent in the distribution of

resource revenues in Indonesia. The Central Government was willing to grant the

provinces of Aceh, Papua and West Papua higher proportions of oil & gas

revenues and greater autonomy than other regions in order to prevent them

from seceding (Agustina et al., 2012, Le Breton and Weber, 2003). The

phenomenon of pemekaran has also seen new districts being formed as

subnational governments attempt to secure access to the revenues from local

resource wealth (Hill, 2014). This highlights the perverse incentive that fiscal

decentralization has created in Indonesia. Although distributions to regional

governments via the ‘general allocation fund’ (DAU) are aimed at allocating

finances according to a more needs-based model and evening out horizontal

imbalances, there remains significant fiscal inequality between regions, with an

increasing income disparity evident between the resource-rich and -poor states

(Brodjonegoro and Asanuma, 2000, Duek and Rusli, 2010). This contest between

the ‘preference based’ and ‘needs-based’ approaches to revenue distribution pits

political considerations against social ones and can thus limit the positive

impacts of fiscal decentralization (Agustina et al., 2012, Le Breton and Weber,

2003, Spolaore, 2010).

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Hence the benefits of fiscal decentralization are not always fully realized.

Arellano & Acosta (2014) investigated the distribution mechanisms of resource

revenues in some Latin American countries, but did not conclude whether a

more centralized or decentralized approach promoted better social and

institutional outcomes in this context. Olivera et al. (2010) and Caselli & Michaels

(2013) used differing contexts to argue that the decentralization of resource

revenues to the extractive regions can often fail to promote the desired

outcomes and contribute to increased rent-seeking behaviour and weakened

institutions. Thus whilst fiscal decentralization promises much, the evidence in

less-developed countries suggests that any benefits are heavily conditional on

the context and institutional structures within which such decentralization takes

place. By performing further research into this area concerning the case of

Indonesia, this paper hopes to shed further light on the importance of

institutional structures in helping realize the benefits of fiscal decentralization.

Managing resource revenue flows at the subnational level

In the case of particularly sizeable revenue flows or particularly small

regional economies, revenue flows can make up a vast proportion of total

subnational budgets, with total transfers from the Central Government

accounting for over 60% of government budgets in some Indonesian districts

(Agustina et al., 2012: 14). This can lead to subnational budgets becoming

dependent on revenues raised externally, such as resource-linked revenues, and

regional economies being dominated by the public sector (Bauer, 2013).

The literature on subnational resource revenue management outlines five

key challenges that can arise as a result of these sorts of resource revenue flows:

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1. The unpredictability of revenues can undermine forecasting and

planning efforts by governments.

2. The volatility of revenues can result in wasteful spending, poor-

quality investments, an uncertain business environment and

slower non-resource sector growth.

3. When resources are exhausted or the sector experiences a

downturn, the local economy can suffer considerably.

4. Insufficient capacity for government to effectively scale up

spending and investment in response to the windfall.

5. Increased rent-seeking behaviour within both the public and

private sectors and an increased risk of corruption (Bauer,

2013).

To help manage these challenges Bauer (2013, emphasis added) proposes

a three-pronged approach of:

1. Implementing fiscal rules that can constrain government spending

decisions and smooth revenue flows.

2. Adopting development planning that takes a longer-term and more

strategic view of how best to spend revenues to achieve the desired

development outcomes.

3. Investing in the investment process via implementing efficient public

financial management practices in order to improve a government’s

capacity to absorb and effectively spend revenues.

These responses are mostly formal institutional measures and fit well

with the general view in the resource curse literature that the negative impacts

of resource extraction can often be avoided through the adoption of strong

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26

institutional structures. However, such institutional structures often do not exist

at the subnational level or are still in their infancy, and this is particularly true in

Indonesia (Hill, 2014). Public financial management practices at the subnational

level are often much less advanced than those at the national level, weakening

their ability to manage the sizeable revenue flows they receive. Having weaker

institutions can thus make subnational governments more vulnerable to the

revenue channel of the resource curse. In such cases, fiscal decentralization is

more likely to result in the suboptimal outcomes outlined by Bauer (2013).

In specifically responding to the revenue channel, Bauer’s (2013)

proposals draw heavily from the literature on public financial management,

espousing elements of aggregate fiscal discipline and allocative & operational

efficiency (Scartascini and Stein, 2009, Schick, 1998). Bauer’s approach is more

focused on formal institutional structures such as fiscal rules and budgetary

process, but the modern public expenditure management (PEM) approach

emphasizes the importance of political and informal institutions alongside

formal rules in ensuring optimal budgetary and development outcomes

(Scartascini and Stein, 2009). This more holistic approach is particularly

important in understanding budgetary practices in regions where formal

institutional structures may still be in their infancy and informal practices may

be much more influential, such as subnational governments in under-developed

areas. Whilst the arrangements for revenue allocation are seen as particularly

influential in the modern PEM approach, this paper will treat those

arrangements as a given due to space constraints and will remain focused on

how governments manage the revenues they do receive.

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Existing studies suggest that resource revenue transfers to subnational

governments are often ineffective or even counterproductive in promoting

development outcomes (Cust and Viale, 2016). This paper aims to identify how

effective such flows have been on development outcomes at the subnational level

in Indonesia. It will then try to understand what factors are influential in

determining the effectiveness of such flows. In doing so it hopes to contribute to

the resource curse literature by providing evidence concerning the existence of a

curse and by identifying strategies of mitigating or neutralizing the revenue

channel of any resource curse. This will also have implications for the fiscal

decentralization literature by highlighting the risks decentralization can pose in

regions lacking the necessary supporting institutions. Finally, this paper also

hopes to contribute to the public fiscal management literature by linking it to the

resource curse literature and highlighting how fiscal management practices can

influence the impact of resource revenue flows on development outcomes.

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3. Methodology

In trying to understand the impacts of resource revenue flows on

development outcomes at the subnational level in Indonesia and what factors

influence these impacts, this paper will adopt a two-stage mixed method

approach:

1. Initially a quantitative approach will be utilized to identify

correlations between resource-linked revenue flows and high-level

economic and socioeconomic indicators. This will highlight trends in

how revenue flows can impact on development outcomes at the

subnational level in Indonesia.

2. The second component of this research will be a comparative analysis

of two provincial case studies. This will involve an investigation of the

specific characteristics, policies and institutions of each case in an

attempt to identify significant differences between the regions. This

will help inform how these factors have influenced the effectiveness of

resource-linked revenue flows in promoting development outcomes.

Quantitative analysis

Simple scatter plot analysis of major variables of interest will be

performed at the municipal level to identify any significant correlations, and to

better understand the relationships between these variables. This analysis will

not be performed at the provincial level due to a lack of observations. The key

variables of interest will be:

Resource-linked revenue flows

Economic growth

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Development indicators

Quality of governance and institutions

Whilst it is understood that this is a relatively simplistic analysis, it is only

meant to provide some guidance to the research. More detailed and robust

quantitative analysis of the impact of Indonesia’s resource sector on its

development at the subnational level has been performed elsewhere (Cust, 2014,

Cust and Rusli, 2014) and the purpose of this paper is not to definitively prove

the existence of a subnational resource curse, but to identify possible

correlations and understand what factors influence the effectiveness of resource

revenue flows in promoting development outcomes.

Case study selection

From this initial analysis a number of prospective cases worthy of deeper

analysis should become apparent. The primary selection criteria will be:

Regions receiving significant resource revenue flows,

Regions displaying particularly impressive or particularly poor

development outcomes, and

Regions displaying particularly impressive or particularly poor

levels of institutional quality.

Although district-level governments are responsible for the lion’s share of

social spending, outspending provincial governments significantly in the areas of

health, education and housing & communities amenities (World Bank, 2009b),

case study analysis will be performed at the provincial level. The World Bank

provides a rich dataset at both the municipal and provincial level through its

‘Indonesia Database for Policy and Economic Research’ (DAPOER), but data is

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30

scarcer at the district level without performing extensive primary research. Data

on institutional structures and budgetary practices is also much more difficult to

find at the municipal and district level. Hence, the initial quantitative analysis

will be performed primarily at the municipal level, whilst the more in-depth case

study analysis will be performed at the provincial level.

Where possible, prominence will also be given to those provinces where

oil extraction activity occurs primarily offshore. This should help control for the

direct economic effects of resource extraction activity on development outcomes

as offshore extraction activities have minimal direct impact on the local

economy. However, it is recognized that it will be impossible to completely

control for this at the provincial level. By selecting provinces where the impact of

backward linkages such as increased employment and income is minimized it

should be easier to isolate the impacts of the revenue channel. This approach

was utilized in Caselli & Michaels (2013) and Cust & Rusli (2014) to reduce the

risk of endogeneity between extractive activities and development outcomes via

direct economic effects.

Qualitative analysis

Once two case studies have been selected, further analysis will focus on

assessing the specific context that has influenced development outcomes in that

province, with special attention paid to the quality of governance and

institutions. A comparison of each province’s institutional structures will be

performed, using Bauer’s (2013) approach to managing the challenges of

significant resource revenue flows as an organizing conceptual framework. By

contrasting the context and institutional environments of the two regions and

identifying the points of difference between them, it should be possible to

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31

identify what factors are most influential in determining how effective resource

revenue flows are in promoting development outcomes at the subnational level

in Indonesia.

Data sources

The majority of the data used will be sourced from the World Bank’s

‘Indonesia Database for Policy and Economic Research’ (DAPOER). This collates

data from the national Indonesian statistical agency (BPS), the Indonesian

Department of Finance as well as utilizing some proprietary World Bank data

series. The majority of the series used will be annual.

Resource-linked revenue flows

To measure resource-linked revenue flows, this paper will use the ‘Total

Natural Resource Revenue Sharing/DBH SDA’ series from the World Bank’s

DAPOER. This series tracks the natural resource linked revenue flows from the

DBH fund, which covers revenues from natural resources and land tax, to

subnational governments. Whilst there are separate series tracking revenue

flows related specifically to oil & gas, the series are incomplete and the latest

data is from 2009. Hence the DBH series is used as an aggregate, with the specific

oil & gas data being used as a complementary series.

Economic growth

To measure economic growth, annual increases in gross regional product

(GRP) are used. The series that excludes oil & gas will be used to gain a better

picture of underlying economic activity and to smooth out the volatility that is

associated with these sectors. At the regional level oil & gas activity can account

for a sizeable proportion of GRP and hence volatility in these sectors can be

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32

particularly significant. A simple average growth rate is taken for the period

2001 to 2013 to give a general picture of each region’s economic performance

over this period.

Development outcomes

To measure a region’s performance in socioeconomic terms the poverty

incidence ratio and the human development index (HDI) series are used. The

changes in these indicators are also tracked to determine a region’s

intertemporal performance in promoting development outcomes.

Institutional quality

To measure institutional quality this paper uses the Economic

Governance Index (EGI), which is calculated using a survey performed by

Regional Autonomy Watch and the Asia Foundation. The EGI measures

governance at the municipal level across a range of indicators covering; ease of

doing business, infrastructure, security, regulatory burdens and corruption

perceptions. It then gives a single indicator aggregating these subcategories, and

ranks the regions accordingly. Whilst not all of Indonesia’s municipalities are

surveyed, the 2011 survey covers 245 whilst the 2007 survey covers 243 out of a

possible 512 municipalities (at the time of writing), with a number of unique

cases in each series. The latest available data is from 2011.

The Indonesia Governance Index (IGI) will be used in conjunction with

the EGI. The IGI measures governance at the provincial level and scores the

government, bureaucracy, civil society and economic society of each province

out of 10 each on participation, fairness, accountability, transparency, efficiency

and effectiveness before giving an aggregate score. Whilst the EGI is more

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33

concerned with the ease of doing business, the IGI is focused on the principles of

good governance across both the private and public sectors. Thus together these

indicators provide a proxy for the quality of governance and institutions across

Indonesia at both the provincial and municipal level.

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4. The impacts of resource revenue flows

Revenue flows

Indonesia’s revenue sharing regime distributes revenues to subnational

governments via three main balancing funds: the general allocation fund (DAU),

the special allocation fund (DAK), and the natural resources and land tax sharing

fund (DBH) (Cust and Rusli, 2014). The most significant of these funds is the

DAU, which accounts for approximately 25% of the Central Government’s annual

budget. Whilst the DAU and DAK are intended to reduce fiscal inequality

between regions by redistributing fiscal resources according to needs, the

resources and land tax fund distributes revenues according to a predetermined

formula, which is more preference based. Figure 3 outlines this distribution

regime, with producing districts receiving a much higher share of revenues than

non-producing districts. It must also be noted that the special autonomous

provinces of Aceh, Papua and West Papua receive 70% of oil & gas revenues

generated by their province, which is a much higher share than other provinces

receive under the general regime. However, this proportion falls to 50% after the

first nine years of the arrangement in Aceh and after the first 25 years in Papua

and West Papua.

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35

Figure 3: Indonesia's natural resources revenue sharing regime (Agustina et al., 2012)

Whilst a stated goal of Indonesia’s decentralization and fiscal distribution

regime was to reduce horizontal fiscal inequality, it has not been particularly

successful in achieving this goal. Instead, interregional inequality has increased,

with disparity in the revenues of the governments of resource-rich and poor

regions becoming more and more evident (Cust and Rusli, 2014). The sheer scale

of resource-linked revenue flows is a key factor in this as for some regions, flows

from the DBH fund can outweigh those of the DAU & DAK funds. Figures 4 and 5

rank the provinces and municipalities in terms of average annual DBH revenue

flows over the ten years to 2012. The top 30 municipalities are shown.

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36

Figure 4: Indonesian provinces ranked by average annual natural resources revenue sharing (World Bank, 2016a)

East Kalimantan leads all provinces in resource revenue flows, receiving

over 2.5 trillion IDR annually, however it must be noted that this includes North

Kalimantan as this province only separated from East Kalimantan in 2012. Riau

and Aceh follow behind, with both receiving over 1 trillion IDR in resource

revenue transfers annually. Riau and East Kalimantan are traditionally amongst

the richest provinces in terms of GRP per capita, recording 260% and 407% of

the national average respectively in 2010, although Papua also recorded a strong

result of 143% (Hill and Vidyattama, 2014: 74). Papua and West Papua also fall

AverageDBHrevenueflows2000-12 Rank Province

Avg.AnnualDBHrevenue

sharing2000-12(millionIDR)

AnnualDBHRevenuesharing

2012(millionIDR)

1 KalimantanTimur 2,518,329 5,268,680

2 Riau 1,426,289 2,564,670

3 NanggroeAcehDarussalam 1,098,070 122,178

4 DKIJakarta 566,130 294,849

5 KepulauanRiau 486,164 910,862

6 SumateraSelatan 453,576 1,127,000

7 PapuaBarat 238,153 384,476

8 Papua 186,925 130,708

9 KalimantanSelatan 185,227 646,337

10 JawaBarat 178,440 315,079

11 Jambi 122,917 358,785

12 Lampung 89,603 145,697

13 JawaTimur 80,995 337,623

14 Bali 55,973 -

15 KepulauanBangka-Belitung 54,716 98,685

16 KalimantanTengah 46,067 131,069

17 JawaTengah 39,496 141,067

18 NusaTenggaraBarat 34,812 22,303

19 MalukuUtara 27,931 50,357

20 KalimantanBarat 24,157 105,357

21 SulawesiSelatan 15,529 9,798

22 SulawesiTenggara 11,300 45,493

23 SumateraUtara 10,743 8,315

24 SulawesiBarat 10,418 25,190

25 SulawesiTengah 7,017 14,426

26 SumateraBarat 6,471 9,769

27 Bengkulu 6,017 17,217

28 Maluku 4,092 -

29 SulawesiUtara 2,321 6,975

30 Gorontalo 1,763 17,796

31 DIYogyakarta 1,385 5

32 Banten 1,308 3,447

33 NusaTenggaraTimur 576 553

34 KalimantanUtara - -

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37

into the top ten thanks in part to their more generous distribution regimes. The

remaining provinces receiving large resource revenue flows are mostly focused

around the islands of Borneo, Sumatra and Java. A map of Indonesia outlining its

provinces can be found in appendix B.

Figure 5: Top 30 Indonesian municipalities by average annual natural resource revenue sharing (World Bank, 2016a)

The majority of the municipalities in the top thirty come from the

provinces of Riau and East Kalimantan, with South Sumatra and North

Kalimantan also featuring often, whilst North Aceh and Papua both had only one

entry in the top 30. Kutai Kartanegara Regency in East Kalimantan holds a

sizeable lead as the municipality receiving the highest DBH revenue flows,

recording over 4.54 trillion IDR in 2012, the latest year of available data, which

was worth almost $350 million USD at the time of writing. Data on the revenues

related to oil and to gas is only available for a small number of years, the latest of

Rank Municipality Province

Avg.annualDBHrevenue

sharing2000-12(millionIDR)

AnnualDBHrevenuesharing-

2012(millionIDR) Primarily

1 KutaiKartanegara,Kab. EKalimantan 2,080,978 4,544,510 gas

2 Bengkalis,Kab. Riau 1,423,166 2,826,030 oil

3 Siak,Kab. Riau 813,807 1,348,620 oil

4 RokanHilir,Kab. Riau 749,969 1,206,170 oil

5 MusiBanyuasin,Kab. SSumatra 650,770 1,578,600 gas

6 KutaiBarat,Kab. EKalimantan 496,756 1,136,260 gas

7 KutaiTimur,Kab. EKalimantan 494,358 - gas

8 Kampar,Kab. Riau 469,815 1,017,890 gas

9 Paser,Kab. EKalimantan 456,854 1,011,960 gas

10 Berau,Kab. EKalimantan 410,168 963,166 gas

11 Nunukan,Kab. NKalimantan 366,089 852,293 gas

12 Bulungan,Kab. NKalimantan 355,278 848,478 gas

13 Samarinda,Kota EKalimantan 352,671 893,486 gas

14 Natuna,Kab. Riau 346,944 874,101 oil

15 PenajamPaserUtara,Kab. EKalimantan 332,377 847,960 gas

16 Tarakan,Kota NKalimantan 293,893 841,030 gas

17 Bontang,Kota EKalimantan 289,029 - gas

18 Pelalawan,Kab. Riau 274,727 511,271 oil

19 AcehUtara,Kab. NAceh 268,951 273,134 gas

20 Pekanbaru,Kota Riau 268,501 466,496 oil

21 IndragiriHilir,Kab. Riau 264,352 247,134 oil

22 Balikpapan,Kota EKalimantan 260,647 542,371 gas

23 RokanHulu,Kab. Riau 258,537 485,531 oil

24 Dumai,Kota Riau 254,689 361,393 oil

25 Malinau,Kab. NKalimantan 241,499 - gas

26 IndragiriHulu,Kab. Riau 226,919 490,505 oil

27 KuantanSingingi,Kab. Riau 221,949 470,214 oil

28 Mimika,Kab. Papua 217,803 260,895 -

29 MuaraEnim,Kab. SSumatra 160,452 428,950 oil

30 MusiRawas,Kab. SSumatra 157,594 378,390 gas

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38

which is 2009, but these account for the vast majority of DBH fund revenue

flows. The municipalities are fairly evenly split between those which primarily

draw their revenue flows from oil and those that draw them from gas, although

natural gas is becoming increasingly important and most regions draw at least

some revenues from both sources.

The impact of revenue flows

Each municipality’s revenue flows were then plotted against a range of

development indicators to identify the relationships between resource revenues

and measures of economic growth, social outcomes and governance. These

relationships are shown in figures 6 to 12.

Economic and socioeconomic impacts

Figure 6: Resource revenue flows vs. economic growth (World Bank, 2016a)

Figure 6 highlights a moderate positive correlation between resource

revenue flows and economic growth rates over the past decade. Whilst this does

not support the concept of a resource curse via the revenue channel, it is

unsurprising that additional revenue flows promote economic growth.

Expenditure of these revenues would provide a direct boost to economic activity,

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

0 500,000 1,000,000 1,500,000 2,000,000 2,500,000

Avg.annual%GRPgrowth(2001-13)

excl.oil&gas

Avg.annualDBHrevenuesharing2000-12(millionIDR)

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39

whilst high revenue flows will also indicate the presence of extractive industries

in the municipality, which would have a positive economic impact via backward

linkages (Cust and Rusli, 2014). Hence, this correlation shows that the regions

receiving higher resource revenue flows tend to exhibit stronger economic

growth patterns, providing no suggestion of a negative economic impact via the

revenue channel.

Figure 7: Resource revenue flows vs. poverty rates (World Bank, 2016a)

Figure 8: Resource revenue flows vs. change in poverty rate (World Bank, 2016a)

0

5

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PovertyIncidence(%)2013

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0 500,000 1,000,000 1,500,000 2,000,000 2,500,000%pointfallinpovertyincidence2002-13

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Figure 9: Resource revenue flows vs. Human Development Index (World Bank, 2016a)

Figure 10: Resource revenue flows vs. changes in the HDI (World Bank, 2016a)

Figures 7 to 10 show the relationship between revenue flows and social

indicators such as the poverty incidence rate and the Human Development Index

(HDI). Whilst Figure 7 shows a reasonable negative correlation between revenue

flows and the poverty rate, suggesting that revenue flows do have some effect in

reducing poverty, Figure 8 shows little correlation between revenue flows and

changes in the poverty rate. However, if regions with greater resource revenue

flows tend to have lower rates of poverty incidence then this would leave less

scope for these regions to record falls in poverty. Thus the lack of correlation

40

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0 500,000 1,000,000 1,500,000 2,000,000 2,500,000

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0

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4

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8

10

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0 500,000 1,000,000 1,500,000 2,000,000 2,500,000

IncreaseintheHDI(2004-13)

Avg.annualDBHrevenuesharing2000-12(millionIDR)

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between revenue flows and changes in the poverty rate may be partly explained

by some convergence in poverty rates as those with initially higher poverty rates

play catch-up. Evidence of convergence in poverty rates at the subnational level

was found by Ilmma & Wai-poi (2014), with initially poorer regions recording

nearly 1% faster poverty reduction over 2003-10. This suggests that resource

revenue flows have indeed had some impact in reducing poverty in the less

developed regions, although their impact appears to have been a relatively

modest one.

Figure 9 uses the HDI as a means of measuring development outcomes

and shows a much stronger and positive correlation between revenue flows and

development outcomes. This is likely due to a more direct link between public

expenditure in areas such as education and health and the HDI as an indicator.

However, when plotted against changes in the HDI in figure 10 the correlation

disappears, though this may again be due to convergence in poverty rates. Thus

these relationships suggest that resource revenue flows have had some success

in reducing poverty and promoting an improvement in development outcomes,

and provide little suggestion of a revenue channel of the resource curse at the

subnational level.

Impacts on governance and institutional quality

Figures 11 & 12 then show resource revenue flows plotted against the

EGI, which is used as a proxy for the quality of governance and institutions at the

municipal level (The IGI doesn’t provide municipal-level data). Data from both

the 2007 and 2011 survey are used as this includes regions that would otherwise

not be captured if only the latest survey was used. These scatter plots show a

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42

noticeable negative correlation between revenue flows and the quality of

governance, which fits with the literature suggesting that revenue flows can

weaken governance and undermine institutional strength (Collier and Goderis,

2008, Ross, 2001, 2012).

Although this scatter plot analysis is insufficient to draw any definitive

conclusions concerning the existence of a subnational resource curse via a

revenue channel, it does provide some evidence to support such a claim. Whilst

revenue flows do appear to have a positive impact on development outcomes,

they also appear to have a sizeable negative impact on the quality of governance

within a region. Thus whilst the revenue channel of the resource curse may not

have a direct impact, it could negatively affect development outcomes via its

impact on governance and institutional quality, as the existing literature

suggests. If this is true then the positive direct impact of revenue flows may well

have been limited by the negative impact on institutional quality, and the

effectiveness of resource revenue flows may have been much higher if

institutional quality was stronger.

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Figure 11 & 12: Resource revenue flows vs. governance (KPPOD, 2007, 2011, World Bank, 2016a)

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0 500,000 1,000,000 1,500,000 2,000,000 2,500,000

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5. The influence of institutional factors

Case studies

In order to understand why some resource-rich provinces display better

development outcomes than others this paper will now undertake a more

detailed investigation of two case studies. Whilst many of Indonesia’s provinces

could provide suitable case studies, the specific contextual factors of particular

provinces contributed to some of them being deemed unsuitable for further

analysis. East Kalimantan and Riau rank first and second in resource revenue

flows but they also share many similarities in development indicators and

institutional structures making a comparative case study between the two

somewhat pointless. Riau also has strong links to Kuala Lumpur and Singapore

thanks to its geographical location, which has been a boon to the province’s

development by promoting industrial growth. Hence, between the two, East

Kalimantan was deemed more suitable to studying the impact of resource

revenue flows. Aceh was also disregarded as the 2004 tsunami had a significant

negative impact on the province and particularly its socioeconomic outcomes,

which would skew its results. Jakarta was also not considered as its role as the

capital and economic centre of Indonesia again made it a unique case where the

impacts of resource revenue flows would be difficult to isolate and identify.

Consequently, the provinces selected for further investigation are East

Kalimantan and West Papua. These were selected because whilst both have

significant oil & gas sectors and have received sizeable revenue flows over the

past decade, they have recorded relatively contrasting outcomes in the economic

and social indicators under investigation. By comparing these provinces and

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45

their institutional structures this paper hopes to identify what factors have been

most influential in ensuring the effectiveness of resource revenues in promoting

development outcomes. Both provinces are relatively sparsely populated and

share a mostly rural character. They are also both coastal, with strong links to

offshore oil & gas projects, which helps to minimize the direct economic impact

of extraction activities, allowing a sharper focus on the revenue channel, as

outlined earlier.

East Kalimantan

East Kalimantan lies on the eastern coast of the island of Borneo. To its

west it shares a land border with Malaysia. Although in 2012 the province

separated into North and East Kalimantan, the latest year of data available is

from 2012 and hence this analysis will treat North Kalimantan as part of East

Kalimantan. East Kalimantan now consists of six regencies and three cities, with

four regencies and one city having been split off to form North Kalimantan. The

province is relatively rural and remote and is the second least densely populated

in Kalimantan; the least densely populated is North Kalimantan (World Bank,

2016a).

Whilst it does not affect the data used in this paper, the formation of

North Kalimantan may significantly alter results for East Kalimantan in the years

since 2012. North Kalimantan’s municipalities tend to have higher poverty rates

and are more rural and remote. A closer investigation of the impact of the

formation of North Kalimantan province is beyond the scope of this paper, but

would provide a rich opportunity for future research.

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46

East Kalimantan’s resource revenues primarily come from natural gas,

with revenue transfers from the as industry averaging nearly 1.75 trillion IDR

per year from 2005 to 2009, compared to 630 billion IDR per year from oil (see

figure 13). The resource and resource-linked manufacturing sectors account for

a massive 62% of GRP, highlighting the importance of the industry to the region

(see figure 16). However, since this is 2014 data it does not include North

Kalimantan, so it may even understate the importance of the resource sector. Its

resource-linked revenue flows through the DBH fund well surpassed any other

province as shown in Figure 4 (World Bank, 2016a). A significant source of these

revenue flows come from resources in the Kutei basin, such as the Mahakam

block, Indonesia’s largest gas block, and the East Kalimantan block (Indonesia

Investments, 2016). East Kalimantan will also benefit from the Indonesia

Deepwater Development Project when it comes online. This highlights the

significance of offshore extraction and production activities to the province’s oil

& gas sector.

East Kalimantan is a relatively strong performer in socioeconomic terms.

It has a relatively low poverty incidence ratio, with 6.77% of the population

living in poverty in 2013 compared to the national ratio of 11.4%. East

Kalimantan’s HDI rating has steadily improved to reach 77.33 in 2013, which is

again well above Indonesia’s national result of 68.4. The province’s economic

growth rates have also tracked well above the national level, with an average

real growth rate of 8.6% p.a. from 2001 to 2011, compared to 5.4% at the

national level (World Bank, 2016a).

Finally, whilst the EGI does not provide indicators at the provincial level,

the 13 East Kalimantan regencies and cities that it does cover averaged a rating

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47

of 59.44, (although this data was only available in the 2007 edition of the report

(KPPOD, 2007)). East Kalimantan scored particularly well in terms of measures

of doing business such as regulation, transactions costs and licensing, but was

less impressive in terms of local infrastructure and the capacity and integrity of

the local regent or mayor, which measures corruption perceptions. The IGI told a

similar story for East Kalimantan, giving it an overall score of 5.66 and ranking it

22nd out of 33 provinces. It scored slightly below average in terms of

government, bureaucracy, and economic society, although it ranked above

average in terms of civil society (Kemitraan, 2012)

For the purposes of this paper, East Kalimantan can be viewed as

somewhat of a success story. It has achieved strong results in both its economic

and socioeconomic indicators and its sizeable revenue flows have not prevented

it from recording reasonable results on governance indices. Hence it will be

viewed as the positive case in this comparative case study.

Figure 13: Natural resource revenue flows by type - East Kalimantan (World Bank, 2016a)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

2000200120022003200420052006200720082009201020112012

Naturalresourcerevenuesharing

(millionIDR,realizationvalue)

TotalDBHrevenue Gas Oil

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48

Figure 14: Economic and socioeconomic indicators - East Kalimantan (World Bank, 2016a)

Figure 15: Average of economic governance index and sub-indices – East Kalimantan - 2007 (KPPOD, 2007)

Figure 16: GRP by industry - 2014 (constant 2010 prices) - East Kalimantan (World Bank, 2016a)

West Papua

West Papua is a province in the far east of Indonesia. It covers New

Guinea’s western coast, with two peninsulas and a number of smaller islands.

The province was formed in 2003 out of the western portion of Papua and has

special autonomous status as part of the decentralization reforms. It is the

second least populated province in Indonesia, behind the recently created North

Kalimantan, and similarly to East Kalimantan is relatively remote and rural in

nature. The province is currently comprised of 13 regencies and cities, with two

of these regencies having been established as recently as 2010. The province has

2006 2007 2008 2009 2010 2011 2012 2013

EastKalimantanHDI 73.26 73.77 74.52 75.11 75.56 76.22 76.71 77.33

PovertyRate(%) 11.41 11.04 9.51 7.73 7.66 6.77 6.68 6.38

GRP%growthp.a.(excl.O&G) 12.6% 9.6% 7.0% 6.6% 10.8% 13.1% - -

Landaccess&

securityof

tenure

Business

licensing

Localgovt.

business

interaction

Business

development

program

Capacity&

integrityofthe

Regent/Mayor

67.74 66.41 62.92 50.57 59.88

Transactioncost

Local

infrastructure

Security&

conflict

resolution Localregulation

Economic

Governance

Index

69.40 54.18 64.14 79.91 59.44

East

Kalimantan

7%

50%12%

6%

7%

5%3%

2%

1%

0%

5%

EastKalimantan

Agriculture Mining,oil&gasMiningrelatedmanufacturing OthermanufacturingConstruction Wholesale&retailtradeTransportation&storage PublicAdministration&defenceEducation Health&SocialWorkOther

Page 50: The Regional Resource Curse (online)

49

also experienced some violent and political conflict due to a widespread

independence movement across both West Papua and Papua.

The available data shows that West Papua’s resource revenues

overwhelmingly come from oil (see Figure 17). However, the available data is

only to 2009 and the massive Tangguh LNG project began producing in that year.

Hence it is likely that gas has made a significantly larger contribution in recent

years and will continue to do so in the near future. The majority of oil & gas

projects across West Papua are offshore fields, limiting the direct economic

impacts that they have on the neighbouring communities. West Papua also

receives sizeable revenue flows through special autonomy funds (Agustina et al.,

2012) and thanks to these funds alongside flows from the DAU & DAK funds in

2009 it became the fiscally richest of all Indonesian provinces (World Bank,

2009b).

However, in socioeconomic terms West Papua is one of the weakest

performing provinces in Indonesia. In 2013 its poverty rate was 27.14%, and

whilst this is a vast improvement on the 41.34% recorded in 2006 it remains

well above the national average and is one of the highest rates in the country,

second only to the Papua province. Notably the province’s HDI of 70.62 is slightly

above the national level and has steadily improved over the past decade,

suggesting that the province’s development has not been as poor as its poverty

rate implies. Economic growth over the decade to 2011 has been solid, with real

GRP growth excluding oil & gas averaging 7.9% p.a. Again this outpaces the

national growth rate but it lags behind provinces like East Kalimantan, despite

the prospect for significant catch-up growth in West Papua. When oil & gas are

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50

included this growth rate strengthens considerably to 10.9% p.a., with

particularly strong growth rates recorded in 2010, 2011 and 2012.

In terms of governance West Papua actually outperformed East

Kalimantan on the EGI. Whilst the measures covering business conditions, such

as regulation, land access, and business development etc. were relatively similar

across the board, West Papua performed much more strongly on the measures

concerning infrastructure, security and corruption perceptions. Yet West Papua

was deemed the 2nd worst performing province by the IGI, recording a score of

4.48. It scored particularly poorly in the areas of government and bureaucracy,

with accountability and transparency identified as particular weak spots

(Kemitraan, 2012). The negative impact of this weak government sector is

amplified by the fact that 8% of West Papua’s GRP is accounted for by public

administration (World Bank, 2016a), which is well above the national average of

3.5%.

Figure 17: Natural resource revenue flows by type – West Papua (World Bank, 2016a)

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

2000200120022003200420052006200720082009201020112012

Naturalresourcerevenuesharing

(millionIDR,realizationvalue)

TotalDBHRevenue Gas Oil

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51

Figure 18: Economic and socioeconomic indicators – West Papua (World Bank, 2016a)

Figure 19: Economic governance index and sub-indices – West Papua – 2011 (KPPOD, 2011)

Figure 20: GRP by industry - 2014 (constant 2010 prices) – West Papua (World Bank, 2016a)

Institutional structures & governance practices

The literature suggests that by implementing formal institutional

measures, such as: strong fiscal rules, adopting a long-term development

planning scheme and investing in the investment process, governments should

be able to improve the effectiveness of public spending and minimize the

negative impacts of sizeable revenue flows (Bauer, 2013). The next section will

investigate how successful East Kalimantan and West Papua have been in

implementing such measures.

2006 2007 2008 2009 2010 2011 2012 2013

PapuaBaratHDI 66.08 67.28 67.95 68.58 69.15 69.65 70.22 70.62

PovertyRate(%) 41.34 39.31 35.12 35.71 34.88 31.92 28.2 27.14

GRP%growthp.a.(excl.O&G) 7.4% 8.6% 9.3% 7.7% 6.8% 13.5% - -

Landaccess&

securityof

tenure

Business

licensing

Localgovt.

business

interaction

Business

development

program

Local

Regulation

73.40 60.46 62.14 33.36 84.51

Transaction

cost

Local

infrastructure

Security&

conflict

resolution

Capacity&

integrityofthe

Regent/Mayor

Economic

Governance

Index

80.36 68.11 70.49 65.03 63.78

WestPapua

10%

21%

29%

3%

11%

6%

2% 8%

2%1%

7%

WestPapua

Agriculture Mining,oil&gasminingrelatedmanufacturing OthermanufacturingConstruction Wholesale&retailtradeTransportation&storage PublicAdministration&defenceEducation Health&SocialworkOther

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52

Fiscal discipline

Since the majority of development spending occurs at the district level, it

is difficult to gain a clear picture of what fiscal rules exist to constrain

government spending. However, at the national level, Indonesia has displayed

admirable restraint in its fiscal policy, dramatically reducing its debt through the

2000s thanks to a strong commitment by government, fiscal rules that cap the

fiscal deficit, and debt ratios at 3% and 60% of GDP respectively, and of course

the booming commodity sector and strong economic growth. These fiscal rules

cover general government expenditure and have generally been interpreted as

limiting the Central Government deficit to 2.5% of GDP and regional

governments’ cumulative deficit to 0.5% of GDP (Carter et al., 2016). Thus there

exists a binding fiscal rule at the national level that impacts on all regions.

The resource revenue distribution mechanism outlined earlier also

qualifies as a binding fiscal rule on regional government budgets. The

mechanism that determines the flow of resource revenues to subnational

governments is fixed and all governments are aware of this mechanism,

providing a degree of certainty. However, there remains significant volatility in

revenue flows thanks to the nature of resource revenues and their dependence

on volatile commodity prices and production quantities. Whilst both East

Kalimantan and West Papua are aware of the revenue distribution schemes that

determine their share of DBH fund revenues, West Papua’s special autonomous

state means that it receives a much more sizeable share of oil & gas revenues.

Although this boosts its revenue flows, it also makes it more dependent on the

volatile revenue flows associated with the resource sector, which in turn can

hamper attempts at budget forecasting and development planning. Thus West

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53

Papua can be seen as having a more volatile revenue flow than East Kalimantan.

Carter et al. (2016) argues that volatile budgets coupled with fiscal rules limiting

the size of deficits has contributed to underspending on infrastructure as capital

spending becomes a ‘residual’ item which can be abandoned in order for budgets

to continue complying with fiscal rules. Thus, West Papua’s more volatile

revenue flows can be seen as a contributing factor to its greater infrastructure

gap, as identified by the World Bank (2009b).

One area where East Kalimantan outperforms West Papua is in terms of

the transparency of its public financing. On their respective provincial statistics

pages, East Kalimantan provides significantly more detailed data covering

revenues and expenditures by type and region, domestic and foreign investment

projects, development programs and foreign aid flows, whilst West Papua only

provides basic annual details of its revenues and expenditure by type. East

Kalimantan’s provincial government website also provides numerous reports on

its budget plans and their implementation. Despite this, both East Kalimantan

and West Papua were deemed ‘poor’ in terms of government transparency in the

IGI (Kemitraan, 2012), due to the difficulty in accessing government budgetary

and fiscal documents.

The data that East Kalimantan made available included annual revenues

and expenditure at the municipal level showing that over the five years to 2011

East Kalimantan’s regions significantly underspent their revenues. Whilst this

was not apparent in every year, with expenditure outpacing revenues slightly in

2008 and 2009, the surpluses easily outweighed the deficits over this period (see

figure 21). Relative to revenues, expenditures remained roughly steady (BPS,

2016). This highlights a degree of fiscal discipline from East Kalimantan’s

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54

municipalities as they did not simply elect to spend all their revenues in the

years that they accrued in, which often results in pro-cyclical spending patterns

and encourages economic volatility. This suggests that East Kalimantan’s fiscal

rules do not encourage unnecessary spending from municipalities who fear

losing access to revenues if they don’t use them, thus promoting more

responsible spending habits. Unfortunately, such data was not available for West

Papua.

Figure 21: Actual revenues & expenditures of autonomous regions (million IDR) – East Kalimantan (BPS, 2016)

Although neither province can really be said to display particularly

admirable standards of fiscal governance, East Kalimantan’s formal structures

appear slightly superior to West Papua’s. Both provinces’ budgets face national

fiscal constraints, but East Kalimantan has proven more successful in publishing

its budgets, albeit only slightly in the views of the IGI. West Papua is also

hamstrung by its greater dependence on volatile revenue flows, which limits its

ability to effectively forecast future revenue flows.

Development planning

Adopting a longer-term approach to development planning is a key factor

in ensuring that government expenditure is as effective as possible in achieving

the desired development outcomes. The literature highlights the importance of

accurate budget forecasting capabilities in enabling governments to effectively

plan ahead (Bauer, 2013), however neither East Kalimantan or West Papua have

demonstrated strong capabilities in that area. What budget data each region

Surplus

2007 2008 2009 2010 2011 2012

Revenues 4,642,674 6,127,503 5,348,926 7,041,086 9,760,624 11,816,602

Expenditures 4,113,195 6,356,384 5,429,283 5,979,389 3,108,349 -

Surplus 529,479 (228,881) (80,357) 1,061,697 6,652,275 -

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55

does provide is mostly backwards looking, and Indonesia’s governments have

exhibited a tendency to be overly optimistic in terms of their revenue forecasts, a

tendency most governments share (Carter et al., 2016). Consequently, significant

improvement in both provinces’ budget forecasting capabilities would help to

underpin a more successful and longer-term approach to development planning.

However, there does exist a national long-term development plan

(RPJPN) covering 2005 to 2025. This is made up of four medium-term

development plans (RPJMN) which span five years each, the latest of which

covers 2015 to 2020. These development plans highlight key strategic directions

for economic and social development, and provide guidance to regional

governments in how to pursue these development goals. West Papua’s detailed

development plan for 2016-20 is made available on its government website,

whilst East Kalimantan only provides a relatively general 10-point development

agenda.

Regardless of these plans, both provinces have experienced difficulties in

achieving their stated aims. For example, in West Papua, public administration

accounts for 8% of the province’s GRP, well above the national average of 3.5% ,

and spending on public wages accounts for 4.5% of provincial expenditure (BPS,

2016). This fails to consider such spending at the municipal and district level,

with anecdotal evidence suggesting that administrative waste is even higher at

this level (Carter et al., 2016). This demonstrates that a significant proportion of

West Papua’s revenues have gone to administrative functions as opposed to

development or welfare programs, which suggests inefficient government

practices or significant patronage spending (Mietzner, 2014, World Bank, 2009a:

66). This has occurred as capital spending on infrastructure’s proportion of

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56

provincial expenditure has fallen from 43% in 2008 to 17% in 2014, despite a

sizeable infrastructure gap being identified across the province, and improved

infrastructure being a key goal of the current development plans (BPKP, 2014,

Carter et al., 2016). Although total capital expenditure in West Papua has risen, it

has been unable to keep pace with demand and the increase in revenues,

highlighting a lack of absorptive capacity in the region’s bureaucracy. This is

supported by the particularly low score of 3.55 given to the province’s

bureaucracy by the IGI, with inconsistency between the priorities of the RPJMN

and the province’s accountability report highlighted as a significant factor

(Kemitraan, 2012). Thus despite its best attempts, West Papua’s development

planning and bureaucratic capacities are holding it back, as evidenced by its poor

governance indicators and underwhelming socioeconomic indicators.

Although East Kalimantan also faces its own difficulties in achieving its

development goals, it has proven somewhat more successful. This is not only

evident in its superior socioeconomic indicators outlined earlier, but in its ability

to better direct its spending efforts to match its development strategies. East

Kalimantan is ranked in the top four by the IGI for commitment to education,

health and poverty reduction based on its spending in the provincial budget

(Kemitraan, 2012). Comparatively West Papua fell as far as 9th in these rankings

despite it having access to greater revenue flows through the DAU, DAK and

special autonomy funds. East Kalimantan also recorded a stronger result for

bureaucracy from the IGI of 5.52, scoring particularly highly in the areas of

effectiveness (9.34) and efficiency (8.50) (Kemitraan, 2012). Thus despite a

much less significant development plan, East Kalimantan has so far been able to

better pursue its development goals thanks to a better functioning bureaucracy,

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57

as evidenced by its spending habits and its superior results in terms of

socioeconomic indicators.

Investing in investment process

Perhaps the most important strategy for Indonesia’s subnational

governments in attempting to ensure that the expenditure of resource revenues

is most effective in promoting development outcomes is ‘investing in the

investment process’. By implementing efficient public financial management

practices provinces can build up their capacity to effectively and efficiently direct

expenditures and achieve their desired development goals. This makes a strong

investment process a key part of ensuring the effective spending of resource

revenue flows.

As discussed earlier, both provinces have performed poorly in terms of

making government and budget documentation available. This lack of

transparency at the subnational level and the erratic nature in which statistical

and budgetary information is made available undermines the investment

process by creating uncertainty over government legitimacy. This is evidenced in

the EGI’s ‘capacity and integrity of the regent/mayor’ index, with both provinces

ranking below the national average (KPPOD, 2007, 2011). In West Papua the IGI

found it particularly difficult to access financial documents and regulations on

investment and noted the absence of a Public Complaints Unit for health,

education, poverty alleviation and the Provincial Revenue Office as bureaucratic

shortcomings in the province. It also highlighted the lack of consultation with

civil and economic society by government and an inability to pass legislation as

planned, as weakening the investment climate. These factors contributed to a

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relatively inefficient and ineffective bureaucracy, with the province scoring 6.60

and 4.27 on these measures respectively (Kemitraan, 2012).

Despite facing similar difficulties to West Papua in terms of transparency,

East Kalimantan was deemed to have a much more efficient and effective

bureaucracy, scoring 8.50 and 9.34 on these measures. East Kalimantan also

lacks Public Complaints Units for health, education, poverty alleviation, yet it has

outperformed West Papua significantly in the IGI’s measures (Kemitraan, 2012).

Thus a major difference between East Kalimantan and West Papua appears to be

not the types of policies implemented, but the quality with which they are

implemented. A possible reason for East Kalimantan’s relatively more effective

bureaucracy could be the relative youth of West Papua as a province, as East

Kalimantan’s bureaucracy would be much more experienced.

Importance of institutional quality

Both West Papua and East Kalimantan have made efforts to implement

the policies and principles that the literature proposes to underpin effective

fiscal management. However, the quality of these efforts as measured by the EGI

and IGI varies significantly between the two provinces. Hence, this variation in

institutional and bureaucratic quality appears to be the most significant

difference between the two cases and a determining factor in why the province

of East Kalimantan has recorded stronger development outcomes. This supports

the literature’s assertion that the impact of resource revenue flows is dependent

on the quality of institutions. In situations where initial institutional quality is

high, then resource revenues have a more positive impact, but if initial

institutional quality is low, then this impact will be more muted. When these

findings are viewed alongside the findings in Chapter 4 that revenue flows are

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59

negatively correlated with the quality of regional governance, it suggests that

resource revenue flows can also have a negative impact on development

outcomes via their negative impact on the quality of institutions. Thus this

paper’s findings support the existence of a revenue channel of the resource

curse, however this impact is heavily dependent on the initial quality of

institutions.

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6. Conclusion

This paper’s findings suggest that natural resource-linked revenue

transfers can indeed have a positive impact on development outcomes at the

subnational level in Indonesia, with revenue flows exhibiting a positive

correlation with economic growth and the HDI as well as a negative one with

poverty rates. However, the research does also suggest that revenue flows can

have a negative impact on the quality of governance at a subnational level. A

comparative study of the provinces of East Kalimantan and West Papua then

found that the existence of specific formal budgetary institutions such as those

espoused by Bauer (2013) appeared to explain little of the difference in

development outcomes between the two provinces. Rather it was the quality of

these institutions that appeared most impactful, with the superior bureaucratic

quality of East Kalimantan providing the most convincing argument to explain its

superior development outcomes. In this case, in those regions with greater

institutional quality, resource revenue flows will provide a greater positive

impact on development outcomes than in those regions with weaker institutions,

highlighting the importance of initial institutional quality in determining the

impact of resource revenue flows. Thus this paper’s findings do provide some

evidence in support of the revenue channel of the resource curse, suggesting that

resource revenue flows can undermine development outcomes via weakening a

region’s institutional quality, although this impact is contingent on initial

institutional quality. However, there remains scope for other variables not

explored here, such as informal institutional structures, historical and

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61

geographical factors, to play a significant role in explaining the variance in

development outcomes across Indonesia’s regions.

A significant implication of these findings is that it supports the argument

that fiscal decentralization efforts across Indonesia can have a positive impact on

development outcomes. It does however also suggest that more should be done

to strengthen bureaucratic quality and capacity at the subnational level in order

to enhance the effectiveness of revenue flows in achieving development

outcomes. This paper’s findings also provide support to the modern public

expenditure model (PEM) approach to public fiscal management, outlined by

Scartascini & Stein (2009). The insufficiency of formal budgetary institutions for

promoting efficient and effective governance in Indonesia’s provinces suggests

that the more holistic approach advocated by PEM could be more potent in

strengthening bureaucratic quality and achieving development goals. This could

influence the policy approaches of Indonesian government and NGOs, providing

guidance in their future attempts to support development efforts.

These findings contribute to the literature on the resource curse by

providing evidence in support of the existence of a subnational curse via the

revenue channel. Whilst this does not definitively prove or disprove the

existence of a curse, it does provide another example to fit alongside the existing

field of literature. The focus on the revenue channel in particular sets it apart

from existing investigations of the resource curse, which tended to focus on

economic linkages and proximity effects. The paper also provides another voice

in support of fiscal decentralization, by showing the positive correlation between

such efforts and development outcomes across Indonesia. This optimism is

tempered by the finding that governance quality appears to be a key factor in the

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62

superiority of East Kalimantan’s development outcomes in comparison to West

Papua. By further highlighting the importance of governance and institutional

quality, as well as a more holistic approach to fiscal management, this in turn

makes a contribution to the literature on public fiscal management.

Areas for future research:

Indonesia is a vast and heterogeneous archipelago and hence any

research concerning it will have difficulty covering all the aspects of any one

element of its economic and social development. Accordingly, there exists

significant scope for further research to support and build on the findings of this

paper.

Whilst this paper used only secondary sources for its research, its

findings could be significantly strengthened by the collection of new primary

data. This could shed more light on the institutional structures of the case

studies of East Kalimantan and West Papua, and would be particularly effective

in investigating the influence of informal institutional structures and other

factors such as the provinces’ cultural, geographical and historical contexts. This

could also allow more research to be performed at the district level, where the

majority of development spending occurs. Districts such as Blora and

Bojonegoro, where NGO-led programs aimed at improving revenue management

have been introduced, would provide significant opportunities for further

research.

A more robust statistical analysis could also be performed to more

definitively ascertain the impact of revenue flows on development outcomes at

the subnational level. Whilst Cust & Rusli (2014) did perform similar analysis,

their focus was primarily on direct economic effects and thus there still exists an

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63

opportunity here to focus on revenue effects. The inclusion of revenue transfers

unrelated to resource endowments such as flows from the DAU and DAK funds

could also make a significant contribution to the research on fiscal

decentralization and public fiscal management. As more time passes since

Indonesia’s decentralization reforms, the data that becomes available will

provide more evidence and greater opportunities for further research. This will

allow researchers to better track the development of Indonesia’s regions over

time, and relatively young provinces such as West Papua and North Kalimantan

will provide suitable natural experiments to investigate the effectiveness of

relatively young institutional structures.

An element of the resource curse that received little attention in this

paper is its propensity to encourage conflict (Bannon and Collier, 2003, Collier

and Hoeffler, 2005). An investigation of this impact on conflict in Aceh and Papua

would make a significant contribution to the resource curse literature and

understanding the roots of these conflicts. The phenomenon of pemekaran,

where regions seek to split off and form a new province or district, could also be

viewed through this lens as a form of political conflict that is encouraged by the

lure of significant resource revenue transfers.

The modern Public Expenditure Management (PEM) approach espouses a

more holistic approach to understanding public fiscal management, with a key

part of this is being the distribution mechanisms for revenue transfers. Whilst

this paper took the distribution arrangements between Indonesia’s Central

Government and its regions as a given, this relationship provides a rich area for

further research. Understanding the influence of these arrangements on

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64

development outcomes could have considerable implications for future

Indonesian policy and for fiscal decentralization theory in general.

Summary

In conclusion, this paper’s findings suggest that Indonesia’s success in

avoiding the resource curse at the national level has mostly translated to the

subnational level. The sizeable flows of resource-linked revenues from the centre

to Indonesia’s regions appear to have had a positive impact on development

outcomes, despite an apparent negative impact on their quality of governance.

However, the closer investigation of East Kalimantan and West Papua highlights

that even though poor governance has not necessarily prevented revenue flows

from having a positive impact, it may have somewhat weakened their impact.

Thus, Indonesia must continue its efforts to strengthen institutional quality

across the country at the subnational level if it hopes to ensure that its sizeable

resource wealth is as effective and efficient as possible in promoting improved

development outcomes.

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Appendices Appendix A: Meta-analysis of the literature on the subnational resource curse (Cust & Viale, 2016)

Year

Authors

Country

Unit

Eviden

ceof

subnatio

nal

curse

Transm

issionch

annel

Outco

meso

finterest

Directio

nofch

angein

outco

mevariab

le

2013

Alco

tt&

Kenisto

nUSA

Counties

No

Growthoflo

calmanufactu

ringse

ctorp

ositively

associated

with

natu

ralresourceb

ooms

Employm

ent&

wage

sinth

em

anufactu

ringsecto

rPositive

2009Corey

USA

StatesYes

Poorin

stitutio

ns

Growthofgro

ssstateproduct

Negative

ifinstitu

tionsare

weak,p

ositivew

ithstro

ng

institu

tions

2015Cust

Indonesia

Communities

No

Labourm

arketSecto

rofem

ploym

ent

Shiftto

non-trad

ed&reso

urcese

ctor,fro

mtrad

ed&

agricultu

resecto

rs

2006

Papyrakis&

Gerlau

ghUSA

StatesYes

Multip

lech

annels:in

crease

dco

rruptio

n,decreased

investm

ent,sch

ooling&

spendingo

nrese

arch&

developmen

tGrowthofgro

ssstateproduct

Negative

2010Jam

es&Aadl&

USA

Counties

Yes-

Perso

nalin

come

Negative

2010Lib

man

Russia

Regio

ns

YesInstitu

tionalen

vironment

Growthofgro

ssstateproduct

Negative

(ifqualityo

finstitu

tionsislo

w)

2011

Hajko

wicz,

Heyen

ga&

Moffat

Australia

Regio

ns

No

Spendinge

ffects

Qualityo

flifeindicato

rs(householdincome,h

ousin

g

affordability,accessto

communicatio

nservices,

educatio

nalattain

men

t,lifeexpectan

cy,&

unem

ploym

ent)

Positive

2010

Rolfe,Law

rence,

Morrish

&

Ivanova

Australia

Regio

n(Q

LD)

No

Spendinge

ffects

Employm

ent

Positive(d

irect&indire

ctemploym

ent)

2012

Reeso

n,

Meash

am,

Hoskin

gAustralia

States&local

govern

men

t

areas

Conditio

nal

Ineq

uality(in

itiallyincre

ased,butth

endecre

asedasth

e

levelo

fminingactivityw

ashigh

er)

Inequality(G

inico

efficien

t)&gro

ssindivid

ualin

comeb

y

gender

Non-lin

ear(in

equalityin

creaseswith

miningactivity,b

ut

then

decreases).N

egative

effectinth

ecaseoffem

ale

income.

2012Raveh

Canada

Regio

ns

Conditio

nal

Subnatio

nalD

utch

dise

aseGrowthofFed

eralGDP

Negative

2012

Papyrakis&

Raveh

Canada

Provin

ces

Conditio

nal

Localin

flation&alab

or(cap

ital)shiftfro

m(to

)non-

prim

arytradablesecto

rs.

Inflatio

nrate

s&se

ctoralcap

ital&lab

orsh

ifts(factor

movemen

ts)

Positive(h

igherin

flation&sh

iftoffacto

rsawayfro

m

non-prim

arytradablesecto

r)

2007Zhanget.al

China

Provin

ces

Conditio

nal

Propertyrigh

ts(ben

efitscaptured

bygo

vernmen

t&

state-ownedenterp

rises),decreased

competitiven

essof

non-trad

eablesecto

rPercap

itaconsumptio

ngro

wth

Negative

2010Arago

n&Rud

Peru

Regio

n

(Cajam

arca)No

Spendinge

ffects

Householdincome

Positive(sen

sitiveto

distan

ce)

2014Ticci&

Escobal

Peru

Districts

Both

positive

&

negative

effects

Spendinge

ffects&

CSR/In

flowofm

igrants,n

o

improvemen

tinaccessto

socialservices

Employm

ent,co

mpositio

nofe

mploym

ent,in

flowof

migran

ts,localso

cialindicato

rs(schoolatte

ndancein

ruralareas)

Bothpositive&

negative

2011Arellan

oPeru

Districts

Mixe

dSpendinge

ffects,n

ored

uctio

nofp

overty

Regio

nalG

DPgro

wth&welfarein

dicato

rs(poverty

rates,drin

kingw

atercoverage

,sanitatio

nfacilitie

sat

home,sch

oolatten

dance)

Bothpositive&

negative

2007

Zegarra,

Orih

uela&

Pare

des

Peru

Districts

Conditio

nal

Onlyin

rurald

istrictsHouseholdincome(ru

ral&urban)

Positivein

rurald

istricts

2013

Loayza,M

iery

Teran&Rigo

liniPeru

Districts

YesIncrease

dineq

ualityacro

ss&with

indistricts

Socio

economico

utco

mes(h

ouseh

oldco

nsumptio

n,

povertyrate

,literacy)

Positivein

comeso

nso

cioeconomico

utco

mes,b

ut

uneve

ndistrib

utio

n(in

equality

2014

Orih

uela,

Huaro

to&

Pare

des

Peru

District

Yes

Impactso

nwater&

l&fro

mm

iningactivities(o

ld&new

mining)

Conflict&

impactso

nagricu

lture

Positiverelatio

nshipbetw

een

miningactivitieso

n

conflict&

negative

impacto

nagricu

lturesecto

r

2014

Asher&

Novosad

India

District

No

Price

booms,cro

wdingo

uto

fworkersfro

mothersecto

rs

Economicstru

ctureo

fdistricts(gro

wthofeco

nomic

sectors–

agricultu

ral,service

s,etc.)Positivein

townsu

pto

50km

fromth

eminingsite

2014Zuo&Sch

ieffer

China

Provin

ceYes

Crowdingo

uto

fR&D&ed

ucatio

nexpenditu

resEco

nomicgro

wthatp

rovin

celevel

Negative

Page 67: The Regional Resource Curse (online)

66

2014Zuo&Sch

ieffer

China

Provin

ceYes

Crowdingo

uto

fR&D&ed

ucatio

nexpenditu

resEco

nomicgro

wthatp

rovin

celevel

Negative

2006Dube&

Vargas

Colombia

Municip

alitiesYes

Rapacityo

verresource

sConflict

Negative

(increasein

conflictw

ithincrease

inoilp

rices&

windfalls)

2009

Caselli&

Mich

aelsBrazil

Municip

alitiesYes

Municip

alitieswith

oilw

indfallsh

aveworsep

erform

ance

inwelfarein

dicato

rs&se

rviceprovisio

n

Welfarerele

vanto

utco

mes(h

ousin

gquality&

quantity,

supplyo

feducatio

nal&

health

inputs,ro

ad

infrastru

cture,&

welfarere

ceipts).

Negative

2009

Monteiro

&

FerrazBrazil

Municip

alitiesYes

Spendingo

foilro

yaltieshadnosign

ificantim

pactso

n

educatio

norin

health

supplyin

resource

rich

municip

alities

Locald

emocracym

easu

res(e

lectoralo

utco

mes,

beh

avioro

fpolitician

sinpower,e

lecto

ralcompetitio

n&

politicalsele

ction)

Noeffe

ct

2009Perry&

Olive

raColombia

Municip

alities&

regio

ns

Conditio

nal

Oilw

indfallsh

adnegative

effecto

ngro

wthatregio

nal

level,w

eakpositive

atlocalle

vel

Regio

nalG

DPgro

wth&provisio

nofp

ublicservices

(educatio

n,health

,investm

ent),in

stitutio

nalq

uality

Negative

attheregio

nalleve

l,positiveatth

elocalleve

l

2014Cust&

Rusli

Indonesia

Districts&

municip

alities

No

Positive

impacto

flocalgo

vernmen

tspen

dingo

f

resourcereven

ues

LocalG

DP

Positive

2010Arago

n&Rud

Peru

Regio

n

(Cajam

arca)No

Noeffe

ctfromlocalsp

endingo

fresourcere

venues

Householdincome

Noeffe

ct

2011Mich

aelsUSA

Counties

No

Sectoralsp

ecializatio

n,publicsp

ending,sp

illovereffects

Percap

itaincomes

Positive

2010Arellan

oPeru

Districts

YesConflicts&

poorsp

endingo

fresource

revenues

Conflict

Negative

(increasein

conflictw

ithhigh

erresource

revenuetran

sfers)

2011Monge&

Viale

Peru

Districts

YesSpendingo

fresource

revenuesb

ylocalgo

vernmen

tsInflatio

nrate

s&se

ctorallab

orsh

ifts

Negative

(high

erin

flation&sh

iftoflab

orto

municip

al

work,aw

ayfromagricu

lture)

2014

Zambran

,Robles

&Lao

sPeru

Districts

No

Miningre

venuetran

sferstodistricts

Head

countp

overtyratio

&GINIin

dex

Positive(h

igherin

districtsm

iningd

istrictswith

lower

povertyrate

s&high

erin

equality).

2014

Ardanaz&

Mald

onald

Peru

Municip

alitiesNo

Increase

inpoliticalco

mpetitio

n

Efficiencyin

useo

fresource

revenuew

indfallsb

y

municip

alities

Positivew

henreso

urcereve

nuetran

sferswerelarge

.

Source

:Cust&

Viale(2

016)

IndirectEffe

cts

Page 68: The Regional Resource Curse (online)

67

Appendix B: Provincial map of Indonesia (Geocurrents, 2016)

Page 69: The Regional Resource Curse (online)

68

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