its inception in 1999, and consistently re-used in the 2004 revision, is “Law on Fiscal
Balance between Central and Regional Governments” my emphasis. The first principle
of this law is that that fiscal balance is a consequence of division of tasks between central and regional governments article 2. This means that regional governments are entitled
to receive money from the central government for doing their tasks. Thus, for Indonesia, the goal of fiscal decentralization is not primarily to improve efficiency in the delivery of
public goods and services, or to smoothen the functioning of market principles, but to ensure equitable redistribution of fiscal resources among regions.
To conclude this section, we can say that according to Riker 1964 Indonesia is using a de facto federal system, but according to Weingast 1995 the federal system
being used does not work to preserve markets. Why does Indonesia choose this position, and what are its outcomes? The following section will start by analyzing the situation and
structure that led Indonesia to come to this preference, and then continues with modeling the outcomes of such situation and structure.
II.3. A Game Theoretical Exploration of Decentralization in Indonesia
The good at the center of discussion regarding fiscal decentralization is public money. To understand the “nature of the good,” we need to analyze the rivalry and
excludability attributes of such good Schmid 2004, Ostrom 2011. If the central government did not exist, and rules governing the distribution of money to regional
governments were not present, the following is how we could see the good. First, public money is non-excludable to regional governments. This is because norms
and expectations push it to be distributed to the regional governments, and no existing regional government can be denied of their rightentitlement to the money. Second, the
money is rivalrous, in the sense that one regional government’s use of the money would directly reduce the amount of money left available for other regional governments. This
way, public money can be regarded as a common pool good.
Alternatively, public money could also be considered non-rivalrous, in the in the sense that one regional government’s consumption would not immediately reduce the
amount left available for other regional governments. This is because of the sense that there is a continuous supply of “easy money” generated from natural resources. This way,
public money can also be considered – arguably – as a public good. This nature of public
money in Indonesia, as something that lies somewhere between a public good and a common pool good, creates a widespread norm that money is no object. The source of
the money may not be limitless, but the perception is that there is enough of it for everyone.
The law that stipulates regional governments’ entitlement to the public purse is also driven by a deep trauma with movements for independence in a number of regions
in Indonesia, one of which resulted in secession of Timor Leste in 1999. Around the end of the Soeharto rule, a number of Indonesian regions, such as Aceh and Papua, were
also in conflict with national interests and were at the peak of their demands for independence. It is no coincidence that these regions are highly endowed with natural
resources oil, gas, and mining. The response to these demands has been to give these
regions a “special autonomy” status, which is a compromise between national and regional governments. Special autonomy allows these regions to keep a substantial part
of their natural resource earnings in return for pledge of allegiance. This compromise reflects public pressure for the central government to distribute fiscal resources and
ensure there is no grudge among the regional governments that could lead to separatist tendencies. The incentive structure as presented above makes pushes the central
government to apply a “soft budget constraint” on regional governments. Rather than face threats of secession, or face public accusation that the central government is not
redistributing wealth, the central government would rather distribute money loosely, even if it means that regional governments under-perform in their public responsibilities.
Now that regional governments have substantial amount of fiscal resources with very few strings attached, would they actually use the resources to improve public goods
and services, and invest in things that will generate the local economy? The question remains difficult to answer since the incentive structure at the local level still does not
provide enough pressure for regional governments to perform their duties well. Based on a survey of citizen satisfaction with public services in 2007, Lewis 2010 highlighted a
curious case of high citizen satisfaction despite having to cope with sub-standard
services. This runs counter to Tiebout’s 1956 theory that given enough resources and autonomy, the local government would deliver better and more relevant public goods and
services since they are under closer scrutiny of the local citizens. Why is the public not demanding more from their local governments?
A possible explanation is that there is “very low expectation about service delivery” Lewis 2010. The public may not be aware of the vast amount of resources available at
their local government’s disposal, and has no benchmark on what a good public service should be like. Given this condition at the local level, the incentive structure encourages
regional governments to shirk, instead of work, on their responsibility. Indeed, shirking is easier than working, but if political pressure is present, local officials may choose to work
because shirking may cause them to lose the election the next time around. With no citizen pressure, regional governments have incentives to shirk.
Given the above structure, how would the central government and regional governments interact with each other? Would the central government pressure the local
governments using a hard budget constraint, or would they apply a loose, soft budget constraint in the name of redistribution? Would regional governments work to achieve
quality public service and encourage local investments, or would they shirk from these responsibilities? What would the central government do if they knew the incentive
structure facing regional governments, and vice versa?
To answer these questions, I use Game Theory to model the strategic interdependence between central and regional governments, and predict the outcome of
interaction between these two “players”. Game Theory models the rational interests of the players involved, determined by weighing the costs and benefits for each possible
“move” that apply to the player, and making decisions based on such deliberation. The basis for conducting Game Theoretical analysis is a 2x2 matrix that cross-tabulates the
possible actionsmoves of each player, and analyzes four possible combinations of net benefits to either player. Game Theory simplifies many things, arguably down to a
questionably simplistic model. However, it has the ability to de-clutter various aspects that demand attention though they may be in fact inessential. Game Theory is also transparent
and accountable, in the sense that whoever proposes it has to present all the assumptions
used in the model, and leave the reader to decide whether the assumptions make sense and whether the conclusions are consistent with the assumptions.
I present a game theoretic model with two “players”: the central government and regional governments. The two “moves” available to the central government are either to
act hard or to act soft. The two moves available to the regional governments are either to work or shirk. My assumptions for the incentive structure facing central and regional
governments are presented above and open for readers’ inspection.
Regional Governments Work
Shirk Central Government
Act Hard 3 , 1
1 ,2 Act Soft
4 , 3 2 , 4
Figure 1. Game Theoretical model of the interaction between central and regional governments
The central government prefers that regional governments work, rather than shirk. But, whatever move the regional governments make work or shirk, the central government
prefers to act soft rather than hard.
A. If acting hard results in regional governments shirking, then the central government gets 1 point upper right cell. However, even if regional governments still shirk,
the central government would have collected 2 points if it had acted soft lower right cell. Thus for the same possible outcome the risk that regional governments
might shirk, the central government would be better off acting soft.
B. If acting hard results in the regional governments working, the central government gets 3 points upper left cell. But if they could achieve the same results - regional
governments working - by acting soft, the central government gets 4 points lower left cell. So, given the hope that regional governments would work, the central
government still has a dominant strategy to act soft.
The regional governments prefer that the central government act soft, rather than hard. But, whatever move the central government makes act soft or act hard, the regional
governments still have more incentives to shirk, rather than work.
A. If regional governments respond to central government’s hard pressure by
working, then the regional governments get 1 point upper left cell. However, if under the same pressure regional governments respond by shirking, they collect2
points upper right cell. This shows that if the central government acts hard, the
regional governments’ dominant strategy is to shirk. B. If the central government releases the pressure by acting soft, regional
governments gets 3 points for working lower left cell. This move gives more net benefits than if the regional governments had shirked under hard pressure.
However, given the same soft attitude of the central government, regional governments is better off by shirking as it will get them 4 points lower right cell.
So, given the hope that the central government would act soft, the regional governments still have a dominant strategy to shirk.
Both dominant strategies find each other in the lower right cell, resulting in the Nash Equilibrium where regional governments shirk from their responsibilities, and the central
government has a soft attitude towards the situation. This game is commonly labeled as a “harmony game”, albeit an unbalanced one i.e., the scores are not even. It is so-called
because both players have harmoniously-aligned incentive structures which lead them to an equilibrium situation. However, in this case, the equilibrium is detrimental to the
people. Is this the fate of Indonesia under decentralization?What policy measures could be taken
to improve the situation? To answer this question, it is beneficial to review how China - another large, developing, and unitary state
– has implemented MPF.
II.4. Learning from Market-Preserving Federalism in China
