Development Economics (Fall 2023)

Prof. Iwan Jaya Azis

.

Vetry Yoel Halomoan

2206065045

Homework #4
1. Role of Social Capital in MSMEs Policies
It has be found that many policies intended to help micro, small and medium enterprises
(MSME) in Indonesia have failed to meet the objectives. One of the key reasons is
because of the incompatibility of those policies with the prevailing social capital.
a. Among the three key components of social capital, which one do you think is the most
important in affecting the productivity of MSME
Answer:
Social capital consists of three components: networks, trusts, and norms. Among the
three key components of social capital, I think network is the most important component
in affecting the productivity of MSMEs. Networks refer to the interconnecting
relationships between people and are considered crucial for the productivity of micro,
small, and medium enterprises (MSMEs). The network component of social capital
emphasizes the importance of both vertical and horizontal associations between people
and the relations within and among organizational entities such as community groups
and firms. There are some keypoints on why network is the most important social capital
component. Firstly, MSMEs owner who has strong networks got access to wider
information and resources. Secondly, effective networks foster a culture of knowledge
sharing and collaboration among MSMEs. Secondly, networks facilitate the formation of
joint ventures and partnerships between MSMEs, allowing them to pool resources, share
expertise, and expand their reach. Thirdly, strong networks of MSMEs can effectively
advocate for their interests and influence policies that support their growth and
development. In Indonesia, where social capital is deeply embedded in business
practices, the impact of networks on MSME productivity is particularly pronounced.
Strong networks can help MSMEs navigate the complex business landscape, access
essential resources, and leverage collective strength to achieve their goals. Therefore,
 enhancing the network capabilities of MSMEs is crucial for promoting their growth and
success. This can be achieved through initiatives that foster networking opportunities,
provide training on effective networking strategies, and promote the formation of
business associations and support groups. By strengthening the network fabric of
MSMEs, Indonesia can harness the power of social capital to drive economic growth and
prosperity.

b. For MSME definition in Indonesia, what is the difference between the definition under
Law Number 20, 2008 and that under the ’Omnibus Law’ (officially known as Law No.
11/2020 on Job Creation), and indicate the top 3 largest MSMEs in Indonesia in terms of
1) Units; and 2) Employment.
Answer:
The definition of MSMEs under the law number 20, 2008 classified by the total of both
turnover and asset sizes. Firstly, a business classified as micro when the total assets is
below Rp 50 million and the turnover is below Rp 300 million. Secondly, if the total
assets is between Rp 50 million to Rp 300 million and total turnover of Rp 300 million to
Rp 2.5 billion, the business classified as small. Thirdly, a business classified as medium
business when it has assets of Rp 500 million to Rp 10 billion and total turnover of Rp.
2.5 billion to Rp 50 billion. Meanwhile, ‘Omnibus Law’ in 2020 changes the criteria of
MSME with micro businesses is for those with maximum assets of Rp 1 billion, small
business is for those with assets between Rp 1 billion to Rp 5 billion, and lastly medium
business for those with assets over Rp 5 billion but below Rp 10 billion.
 The top 3 largest MSME in Indonesia in terms of 1) Units by sector is: Agricultural
(35,68%), Trade(28,67%), Manufacturing (10,62%). and 2) Employment: Trade
(31,41%), Accommodation (80,8%), Watr (66,9%)

2. Productivity
To the extent the growth of labor productivity in Indonesia during the last several years
has been persistently declining, and that the productivity growth can be decomposed
into “within” and “structural”,
a. Which of the two has contributed the most to the declining growth trend, and explain the
meaning of it?
Answer:
If you look at the data obtained from the World Bank, "structural changes" contribute to
the downward trend in labor productivity compared to "within" this is explained in the
following table:

In the table above, we can see that overall productivity growth (3.4 percentage points
per year) from 2010 to 2018 "structural changes" only contributed 1.0 points, which is
only one-third of the overall labor productivity growth. This means that the reallocation of
resources from sectors with low productivity to sectors with high productivity, which is
often referred to as “structural change”, has a relatively smaller role in driving labor
productivity growth. one of the reasons why structural changes make a relatively small
 contribution to overall labor productivity growth is because most Indonesian workers
move from agriculture to the lower class service sector.

b. What do you think is the appropriate policies to reverse such a growth trend?
Answer:
policies to reverse the downward growth trend, are explained as follows;
Increasing Productivity in Manufacturing and High-Class Services, the policies
created must aim to increase company efficiency and facilitate easy access in trying to
increase efficiency. Increasing Export-Oriented Foreign Direct Investment (FDI) can
encourage direct investment, especially in export-oriented manufacturing, and can open
up employment opportunities and higher wages, then increasing export-oriented
manufacturing will increase value added to the economy. Investing in Human Capital
and increasing the number of highly educated workforce to create an attractive talent
pool for innovative foreign companies. Building Physical and Digital Infrastructure,
Investing in infrastructure will help increase productivity because there is easy
connectivity between regions, such as transportation infrastructure (toll roads, arterial
roads). Digital infrastructure can support growth and job creation.

3. Institutional Model of Decentralization

a. Explain what is ‘local capture’ and the key components of IMD, and based upon those
explanations provide the narrative to describe their role in determining the welfare
outcome of decentralization.
Answer:
Local capture describes a scenario where influential local figures exploit decentralization
for personal gain rather than the community's benefit. This may involve diverting public
funds for personal use, securing preferential treatment, or obstructing reforms that
threaten their interests. Such behavior adversely affects decentralization, leading to
increased inequality, restricted access to public services, and an overall decline in
economic well-being. The Institutional Model of Decentralization (IMD) provides a
framework for analyzing factors influencing the success or failure of decentralization
policies. It identifies four crucial components:
1. Autonomy of local governments: The extent to which local governments can
independently make decisions on resource allocation and service delivery.
 2. Accountability of local governments: Mechanisms ensuring local governments
answer to constituents for their actions.
3. Fiscal capacity of local governments: The financial resources available to local
governments for fulfilling their responsibilities.
4. Administrative capacity of local governments: The skills and expertise of local
officials in managing their responsibilities effectively.
Success in decentralization depends on the synergy of these four components. If local
governments possess sufficient autonomy, accountability, fiscal capacity, and
administrative capacity, positive welfare outcomes are likely. Weaknesses in any of these
components increase the risk of local capture, leading to negative outcomes.

The role of local capture and IMD in determining decentralization's welfare outcome:
Decentralization holds promise for improving welfare by allowing local communities to
tailor decisions to their specific needs. However, the risk of local capture threatens these
benefits. Influential local figures may misuse their power, diverting resources for personal
gain and causing increased inequality. The Institutional Model of Decentralization (IMD)
provides a framework to understand decentralization's success or failure. Autonomy,
accountability, fiscal capacity, and administrative capacity are crucial components.
Positive welfare outcomes are more likely when these components are robust. In
situations where local capture prevails and IMD is weak, decentralization tends to result
in negative welfare outcomes. Conversely, when strong IMD mitigates local capture,
decentralization can realize its potential for improving welfare.

b. Given the different types of local leader, how the quality of local leader can influence the
welfare outcome.
Answer:
The impact of decentralization on welfare outcomes is intricately linked to the quality of
local leadership. The effectiveness of local leaders plays a crucial role in shaping
whether decentralization benefits or harms a community. Competent leaders, by
efficiently managing resources and promoting transparency, can enhance service
delivery, encourage citizen participation, stimulate economic growth, and foster social
cohesion. On the other hand, ineffective or corrupt leaders may mismanage resources,
lack accountability, create barriers to economic development, and exacerbate social
divisions. In essence, the quality of local leadership is a determining factor in whether
decentralization realizes its potential to improve overall welfare for the community.