public administration and development

Public Admin. Dev. 35, 347–359 (2015)

Published online 8 December 2015 in Wiley Online Library
(wileyonlinelibrary.com) DOI: 10.1002/pad.1741

DECENTRALISING TO VILLAGES IN INDONESIA: MONEY (AND

OTHER) MISTAKES
BLANE D. LEWIS*
The Australian National University, Australia

SUMMARY
Nearly 15 years after embarking on its large-scale decentralisation programme, Indonesia has decided to extend its efforts to the
village level. Decentralising to villages is intended to improve service delivery performance at the lowest administrative tier and
reduce social inequality and poverty. A number of potential difficulties with the design of Indonesia’s nascent village decentral-
isation initiative have already become apparent. Methods used to allocate funds to villages are particularly problematic. Oddly,
fund distribution procedures insist to a large extent on equal per village allocations, despite the significant heterogeneity of
villages. And they ignore other sources of revenue to which villages have access. In the event, village revenues will be very
inequitably distributed: villages with high levels of poverty will receive less money than they need and villages with access
to significant funding from oil and gas revenues will receive more than required. Also, village service responsibilities are
unclearly defined, village financial management systems are inadequately prepared to handle large increases in funding, and
mechanisms to monitor and control village spending are underdeveloped. These difficulties will severely constrain the achieve-
ment of official objectives and create further challenges for reformers in their attempts to combat corruption at the subnational
level. Copyright © 2015 John Wiley & Sons, Ltd.

key words—decentralisation; villages; funding allocation methods; Indonesia; East Asia

INTRODUCTION
The decentralisation of responsibility for financing and providing services from central government to local
governments is expected to improve local own-source revenue generation, spending, and service delivery. Theoret-
ically, the expected benefits essentially derive from the relative physical nearness of local governments to their
respective constituents. Increased proximity means that local governments are better placed to accurately discern
demand for services, tax and spend effectively and efficiently, and improve service delivery (Smoke, 2001;
Martinez-Vazquez and Vaillancourt, 2011).
Local level political accountability is also ostensibly enhanced with the increased proximity that obtains under
decentralised regimes. Because citizens are physically closer to their local governments they are better able to insist
that their demands for more and better services are met. The increased demand-side accountability therefore
reinforces improvements to local government fiscal and service delivery performance on the supply-side. The
overall result is significantly improved local government performance, in theory (Smoke, 2001; Martinez-Vazquez
and Vaillancourt, 2011; Lewis and Smoke, forthcoming).
Worldwide experience of countries that are decentralising their public sectors suggests, however, that these the-
oretical benefits are not so easily achieved. Practice shows that proximity in and of itself is insufficient to engender
the anticipated advances in local government fiscal outcomes, accountability, and service delivery. The results of a
considerable body of empirical literature on decentralisation indicate that decentralisation outcomes for many
countries have been decidedly mixed and perhaps overall largely disappointing (Smoke and Loffler, 2013).

*Correspondence to: The Arndt-Corden Department of Economics, HC Coombs Building, Room 7132, Crawford School of Public Policy, The
Australian National University, Canberra, ACT 2601, Australia. E-mail: blane.lewis@anu.edu.au

Copyright © 2015 John Wiley & Sons, Ltd.

348 B. D. LEWIS

In 2001, Indonesia introduced a massive effort to decentralise authority over public service delivery to subna-
tional governments, comprising both provinces and districts. Districts have received the majority of new service
obligations; they have been made responsible for public services in all major sectors, including education, health,
and infrastructure. Decentralisation in Indonesia has been mostly focused on expenditures. While central govern-
ment has devolved some authority over what were previously national revenues—most recently the urban and rural
property tax—the delivery of newly decentralised services is primarily funded by intergovernmental transfers
(Lewis, 2003; Lewis, 2014).
Service delivery outcomes under Indonesian decentralisation have been rather mixed. Net school enrolment
rates have increased at primary and (junior and senior) secondary levels but the quality of education, as measured
by Programme for International Student Assessment (PISA) scores for example, remains problematic. Child
immunisation rates and percentage of births attended by a health professional have improved substantially but
progress in reducing both child malnutrition and maternal mortality has stagnated in recent years. The kilometres
of local roads have increased quite significantly, but the quality of those roads has deteriorated considerably
(Lewis, 2014; World Bank, 2012).
In this context, Indonesia has now decided to decentralise to the village level.1 The impetus behind the effort is
to further increase proximity of service providers to citizens and improve on the uneven service delivery perfor-
mance of decentralised units. The village decentralisation process has only just begun, and it is obviously prema-
ture to examine and debate programme implementation outcomes. Still, at this early stage a number of concerns
have already arisen, regarding: inequity of funds allocation, unclear identification of service responsibilities,
inadequately developed public financial management procedures, and insufficient regulatory controls and account-
ability mechanisms. This paper focuses on fund allocation procedures and outcomes, for which relevant informa-
tion is already available and for which suitable analyses can be made. Problems regarding service assignments,
public financial management, and control and accountability are also discussed but in a less detailed manner.
The paper is organised as follows. First, some background material on government and governance structure in
Indonesia and the village decentralisation programme is provided. Second, the data used in the study are described.
Third, village fund allocation methods are reviewed and critiqued. Fourth, village fund misallocations are further
characterised. The final section of the article summarises the main results and draws conclusions.

BACKGROUND
Government and governance structure
The Republic of Indonesia is the fourth most populous country in the world with a population of over 250 million
people. It is an extremely socially and culturally varied nation: there are more than 300 ethnic groups, each with its
own language, customs, and form of social organisation. Population and attendant social, political, and economic
activities are dispersed across a collection of nearly 14 000 islands, spanning approximately 5000 km (Lewis, 2014).
Indonesia’s unitary government is divided into five levels of administration: central government, provinces,
districts, sub-districts, and villages. At the end of 2014, there were 34 provinces and 504 districts. Districts are
categorised as either kota or kabupaten, of which there are 99 and 405, respectively. Kota and kabupaten each
contain a mix of urban and rural populations. Kota populations are approximately 90 per cent urban, on average;
kabupaten are mostly rural—only around 25 per cent of their populations are classified as urban. Districts are
further divided into sub-districts or kecamatan; they number approximately 7150. Villages represent the lowest
level of public administration and are of two types: kelurahan and desa. Kelurahan are, for the most part, located
in kota and urbanised areas of kabupaten. Desa are mostly found in kabupaten, although a few are located in the
more rural areas of kota. There are about 8300 kelurahan and 74 000 desa in Indonesia (Ministry of Home Affairs,
2014). Desa population makes up about 65 per cent of the Indonesian total. For the rest of the article the terms desa
and village are used interchangeably, as is the practice in Indonesia.

1
Many other developing countries in East Asia have already decentralised to the village (or commune) tier at least to some extent, including
Cambodia, China, Philippines, Thailand, and Vietnam (Smoke, 2005).

Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 347–359 (2015)
DOI: 10.1002/pad
 DECENTRALISING TO VILLAGES IN INDONESIA 349

Provincial and district parliaments (Dewan Perwakilan Rakyat Daerah, DPRD) have been directly elected since
1999. Executives at both these levels of government were appointed by their respective DPRDs until 2005 when
direct elections of provincial and district heads began. Direct elections were implemented in a gradual manner,
as appointed executives’ terms expired. By the end of 2010, direct elections had been fully phased in (Shahrir et al,
2014). The exception to popular elections occurs when a new province or district is created; in this case the head
and parliamentarians are appointed by the Ministry of Home Affairs until elections can be arranged (Lewis, 2015c).
Sub-districts are essentially deconcentrated units of their districts; their heads are civil servants, and they are
selected by district executives. Kelurahan heads are also civil servants appointed by district heads. Desa executives
are directly elected by citizens (for up to three six year terms), as are members of their councils (Badan Perwakilan
Desa, BPD) (Antlöv, 2003; Antlöv and Sutoro, 2013; Antlöv et al., Forthcoming).
There is a growing body of empirical literature on the impact of executive and parliamentary elections in
Indonesia. Skoufias et al. (2014) find that direct elections seem to have had no impact on human development
outcomes; the authors also demonstrate that in the run-up to elections, district expenditure patterns for those local
governments with incumbents running for re-election shift their spending towards activities that are designed to
encourage votes in their favour. In a study of local government administrative expenditure Shahrir et al. (2014)
show that direct elections have not constrained districts’ spendthrift behaviour and that increasing concentration
of political parties in local parliaments supports wasteful spending. In another article Shahrir et al. (2013) also find
evidence that local incumbents running for re-election reallocate budgets in ways that are designed to increase their
popularity but not necessarily to improve fiscal outcomes. Lewis (2015a) produces evidence to suggest that districts
with directly elected heads provide better public service access than districts with appointed executives and that
increasing political fragmentation in directly elected local parliaments has a negative impact on service outcomes.
At the village level, Martinez-Bravo (2014) demonstrates that villages with citizen elected heads (i.e. desa)
show weaker support for the dominant political party in district elections than do villages with district appointed
heads (i.e. kelurahan). The hypothesised explanation is that because the latter are dependent on district politicians
for continuation of their jobs they are more likely to encourage voters to support the ruling party in district elections
than village elected heads whose positions depend only on their constituents’ support.

Village decentralisation framework

Law 6/2014 provides the broad legal framework for extending Indonesia’s system of decentralised governance and
service delivery to desa. (Kelurahan have so far been excluded from the scheme, although they may get their own
programme in the near future.) Government Regulation (GR) 43/2014, GR 60/2014, and GR 22/2015 (which
amends certain sections of GR 60/2014) provide more detailed implementing guidelines for Law 6/2014. Accord-
ing to law and regulation the multiple and explicit objectives of the village decentralisation programme are to
formally recognise the long-standing rights and duties of villages, strengthen service delivery at the lowest
administrative level of government, and reduce social inequality and poverty.
The legal and regulatory framework provides only a somewhat general indication of service responsibilities of
desa. It notes that village authorities are to include traditional or “origin-based” authorities, delivery of public
services that are local (i.e. “village scale”) in nature, and implementation of tasks that may be assigned by central
government, provinces, and/or districts. Districts will be responsible for specifying in a more detailed manner the
kinds of services that fall into the first two categories. The third category of possible village responsibilities remains
unstipulated; these will ostensibly be further indicated in forthcoming government regulations and ministerial
degrees. In addition, regulations insist that at least 70 per cent of village funds must be spent on development
activities and a maximum of 30 per cent may be allocated to salaries and administrative costs. Finally, sanctions
apply if villages spend less than 70 per cent of their total allocations in any given fiscal year; village fund distribu-
tions may be delayed or even cut the following fiscal year. Districts are responsible for guaranteeing that these
spending conditions are met.
A confounding factor regarding village service delivery responsibilities concerns central government line
agency operations at the desa level. Central government will undoubtedly continue to implement activities of

Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 347–359 (2015)
DOI: 10.1002/pad
350 B. D. LEWIS

various kinds in villages, as they always have done. According to decentralisation legislation, central government
should only perform their own proper functions in the regions, not those of subnational administrative units, includ-
ing villages. Experience suggests, however, that some central agencies will persist in carrying out tasks that should
now be executed by villages. Such operations will further blur the lines of service delivery responsibility at the desa
level.2
Law and regulation are rather more precise regarding the revenues to which desa will have access. Village
funding includes: own-source revenues, transfers from districts, and transfers from the central government.3 Desa
own-source revenues comprise income from traditional markets they manage, charges on small scale public trans-
portation vehicles that pass through their jurisdictions, and fees for the issuance of birth and marriage certificates,
among others (Antlöv et al., Forthcoming). Districts are now required to transfer to villages 10 per cent of their
own-source revenues (Pendapatan Asli Daerah—PAD) as well as 10 per cent of all revenue sharing (Dana Bagi
Hasil—DBH) and general purpose grants (Dana Alokasi Umum—DAU) they receive from the central government.
These desa revenues are referred to as Alokasi Dana Desa (ADD).4 Finally, villages will also receive transfers
from central government, which may total up to 10 per cent of aggregate transfers to regions as codified in the
national budget (APBN). These revenues are termed Dana Desa (DD).
Desa own-source revenues are quite small in the aggregate; the latest estimates suggest that such revenues
amount to only around 10 trillion rupiah (Antlöv et al., Forthcoming). Total ADD, on the other hand, is estimated
to be about 40 trillion rupiah for 2015. The implicit assumption of government is that districts will fully comply
with their obligations in this regard, although past experience casts some doubt on this supposition. Even before
Law 6/2014 was promulgated districts were required to transfer a portion of their funds—10 per cent of shared
revenues, general purpose grants, and own-source revenues, all net of salary obligations—to villages. A recent
estimate by World Bank suggests that only about 40 per cent of districts complied with the requirement during
the last several years (World Bank, 2014).
Levels of DD funding are completely at the discretion of the central government. DD for 2015 totals just less
than 21 trillion rupiah.5 This represents about 3 per cent of total transfers to regions. The expectation is that
government will gradually increase DD allocations until they reach the target of 10 per cent of transfers to regions
as indicated in law. GR 22/2015 implies that this may be accomplished by as early as fiscal year 2017.
The large increase in funding for desa budgets may well strain the capacity of current public financial manage-
ment (PFM) systems. Existing village PFM procedures have developed over the course of many years in the
context of relatively limited service responsibilities and comparatively trivial amounts of funding (DFAT and
World Bank, 2014). The transaction-intensive systems may have proved largely adequate in the pre-desa decentral-
isation period but they are unlikely to be well suited or sufficiently robust in the new scaled-up environment. In this
context desa procurement is a special concern. Village procurement procedures are not clearly laid out in regulation
and practices tend to be ad-hoc and lack transparency. Minimal levels of open competition in tendering processes
are not guaranteed (DFAT and World Bank, 2014).
Vertical and (non-electoral) horizontal accountability mechanisms may also be deficient in the new framework.
The extent to which districts will enthusiastically embrace significant new desa monitoring and control functions is
unclear, for example. For local governments, these fresh responsibilities constitute an unfunded mandate, which is
being forced upon them at the same time that they are being asked to provide additional funding from their own

2
Central government has two official channels through which projects in subnational administrative jurisdictions may be implemented:
dekonsentrasi and tugas pembantuan. The former are organised through provinces and should be used only for routine (non-physical) activities;
the latter are co-administered by villages and are meant to be employed strictly for capital (physical) works. Both types of activities are funded
by central line agency budgets; funds do not flow into lower level government budgets. See Lewis (2015) for further discussion and an analysis
of the impact of such activity at the district level.
3
Provinces may also transfer funds to villages, although they are not required to do so.
4
Strictly speaking, ADD comprises only 10 per cent of revenue sharing and general purposes transfers; the term is defined here to include 10 per
cent of own-source revenues as well, for convenience.
5
In the original planned APBN prepared by President Susilo Bambang Yudhoyono, at the end of his second term in 2014, DD allocations to-
talled 9.066 trillion rupiah. President Joko Widodo increased the allocations to 20.766 trillion rupiah as part of a budget amendment prepared
by his administration immediately upon taking office in January 2015.

Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 347–359 (2015)
DOI: 10.1002/pad
 DECENTRALISING TO VILLAGES IN INDONESIA 351

budgets. And while villages have a 10 year long involvement with implementing poverty reduction efforts
(Program Nasional Pemberdayaan Mandiri, PNPM) that contain strong social accountability mechanisms, the
degree to which this mostly positive experience will be transferable to more extensive village decentralisation is
unclear. One particular concern in this regard is that the continuing engagement of PNPM facilitators, who
organised and led horizontal accountability efforts, has not yet been fully resolved (DFAT and World Bank,
2014). A second worry is that no provisions have yet been made for external audits of desa executed budgets.6
Unclear service assignments, fast growing and relatively large budgets, inadequate public financial management
procedures, and questionable control and accountability mechanisms cause particular concern about the potential
for corruption at the village level. Corruption has been a significant problem among Indonesian subnational
governments since decentralisation began in 2001 (Henderson and Kuncoro, 2004; Henderson and Kuncoro,
2011). According to the Ministry of Home Affairs, between 2004 and 2014, 290 provincial and district heads
and 2960 DPRD members were implicated in graft cases (Jakarta Post, 27 September 2014). Recent empirical
research demonstrates the deleterious effects of corruption on service delivery in Indonesia. Suryadarma (2012)
argues that the positive impact of local government spending on education outcomes disappears for districts with
significant levels of corruption. Lewis (2015b) provides evidence to suggest that districts with very large revenues
perform worse on a wide range of sector outcomes, the hypothesis being that rising corruption crowds out needed
expenditure on services. Such unfortunate experiences among kabupaten/kota need not be replicated at the village
level, of course, but they do raise alarms.

DATA
The empirical analysis below employs data on village population, poor population, land area, and geographical dif-
ficulty, all aggregated at the district level. Data on village population and area come from the Village Development
Survey (PODES), carried out by the Central Bureau of Statistics (BPS). Data on village poverty are not publically
available and so the district poverty rate is used to derive the village poor population; the district poverty rate comes
from BPS’s Household Income and Expenditure Survey (SUSENAS). Geographical difficulty is measured by the
Ministry of Finance (MoF) construction cost index (which the ministry also uses to proxy geographical difficulty in
the allocation of village funds).
The examination also uses data on transfers from districts to villages from district budget sources: own revenues
(PAD), shared tax and non-tax revenues (DBH), and general purpose grants (DAU), which together form the basis
for ADD. Data on these fiscal variables come from MoF. The most recent, complete, and reliable data available for
the three variables are for 2012; values have been inflated to 2015 terms, in order to be consistent with the timing of
village allocation funds, by using the government’s implicit GDP price deflator. Village fund allocations for 2015—
both original and revised—have been provided by MoF. Summary statistics on all variables employed in the various
empirical investigations carried out below are provided in the appendix.

VILLAGE FUND ALLOCATIONS

DD is distributed via a two-step procedure. First, MoF allocates DD to districts7 and, second, districts on-grant
those funds to villages within their jurisdictions. This section of the article focuses on examining DD allocations
from central government to districts. (No information is yet available on the methods districts use to distribute
funds to the villages in their jurisdictions, although they are required by regulation to use an approach that is similar
to the central-district allocation procedures.)

6
Olken (2007) shows that audits of village projects in Indonesia can successfully constrain corruption. Lewis (2015c) provides evidence suggest-
ing that districts with comparatively good external audit outcomes deliver services more efficiently than local governments that do not fare so
well on external audits.
7
419 districts will receive DD in 2015.

Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 347–359 (2015)
DOI: 10.1002/pad
352 B. D. LEWIS

15
10
Percent
5
0 100 200 300 400 500 600
District village fund allocations per village (millions of rupiah)

Figure 1. Original district village fund allocations per village.

The explicit intent of MoF is to allocate village funds based on the principle of equity. In this context, officials
have defined equity to be a function of the number of villages within a district as well as the fiscal needs of those
villages. Fiscal needs are defined as the amount of money villages require to discharge the tasks they have been
assigned to carry out. As the number of villages in a district increases and/or as the fiscal needs of those villages
rise, DD allocated to districts should grow.
The initial method for allocating DD to districts was elaborated in GR 60/2014. The regulation begins by
defining fiscal needs of villages in district i, VFNi, as follows.


αh PROXY hi GDI i
VFN i ¼ DDT * ∑ * (1)
h PROXY hT 100

DDT is total village funds (from the APBN); PROXYhi represents various village fiscal needs proxies, where
h = village population, village poor population, and village area, all for district i; α are the weights of the proxies,
which sum to one;8 PROXYhT is the total value (i.e. across all districts in the country) of proxy h; and GDIi is the
geographical difficulty index for district i (based on construction costs, where 100 is the base value).
DD allocations for a district within a particular province p, DDip, are then derived as follows.
0n 1
∑ VFN ip
Bi C
DDip ¼ B @ V p A*V i
C (2)

Vp and Vi are the number of villages in province p and district i, respectively, VFNip represents village fiscal
needs of district i in province p and n is the number of districts in province p. Equation (2) is applied to all districts
that will receive DD, province by province.
Upon release of the regulation and the derived DD allocations, many central government officials (both inside
and outside MoF) and national parliamentarians complained vociferously. The major expressed criticism related to
the variation in per village allocations, which objectors found to be “excessive”.9 Figure 1 shows the frequency
distribution of DD district allocations per village. The standard deviation of per village allocations is 131.8.
In the face of such strong disapproval, MoF reconsidered its allocation mechanism. Allocation procedures were
subsequently revised and a new government regulation codifying the changes was issued—GR 22/2015.10 The
amended distribution system, and the one actually used to make DD allocations for fiscal year 2015, can be
expressed as follows.

8
The original weights for population, poor population, and area were 30 per cent, 50 per cent, and 20 per cent respectively.
9
The fixation on per village allocations may be a function of how the programme was originally promoted by politicians to the public. During the
recent presidential elections both candidates (Joko Widodo and Prabowo Subianto) supported the village decentralisation initiative. The popular
refrain, used occasionally by both candidates, was “satu desa, satu milyar” which may be translated as “one village, one billion rupiah”.
10
Interestingly, changes to the allocation formula were made by MoF even before district and village officials had a chance to formally offer their
views on the procedures.

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 DECENTRALISING TO VILLAGES IN INDONESIA 353

40
30
Percent
20
10
0
200 300 400 500 600

District village fund allocations per village (millions of rupiah)

Figure 2. Actual district village fund allocations per village.


  

DDT αh PROXY hi
DDi ¼ 0:9* *V i þ 0:1*DDT * ∑ (3)
VT h PROXY hT

VT is the total number of villages in the country; h (i.e. in PROXYh) now comprises village population, village
poor population, village area, and the geographical difficulty index;11 and all other terms have been defined above. 12
As can be seen in the formula, the new distribution mechanism allocates 90 per cent of total DD to districts
based on equal amounts per village. The remaining 10 per cent of funds are distributed as a function of village fiscal
needs, as now defined.
The new formulation does indeed have the desired effect of reducing the variation in per village allocations. The
frequency distribution of the actual DD allocations per village is shown in Figure 2. The standard deviation of
allocations in this case is 27.7.
Two main criticisms of the above formulation can be made. First, the focus on per village allocations seems
inappropriate. Villages are very heterogeneous, especially in terms of the principal characteristics that determine
their fiscal needs. Figure 3 illustrates village heterogeneity as related to the fiscal need variables, as indicated by
MoF. It shows frequency distributions of population, poor population, and land area per village and that for the
district level geographic difficulty index, which is applied to all villages with in a district.13 Allocating funds on
a per village basis is clearly inequitable from a fiscal needs perspective.
The second criticism is that the allocation formula does not take into account other revenues to which villages
have access. Villages have their own-sources of revenues and they receive other transfers from districts (ADD), as
already mentioned. The latter revenues are large in the aggregate and they vary significantly across districts.
Figure 4 shows the frequency distribution of estimated per capita ADD transfers from districts to villages in
2015. The standard deviation of estimated per capita transfers is 651 490. Such transfers vary from 21 625 rupiah
to 6 426 576—that is, by a factor of nearly 300. Obviously ignoring these other sources of village revenue in the
distribution of DD is untenable from an equity point of view.
Under the assumption that equity is the main concern in the allocation of village funds, then a preferred distri-
butional mechanism might focus on the equalisation of fiscal needs net of fiscal capacities across villages within
districts. MoF has a long experience with such fiscal equalisation methods, which it uses to determine allocations
associated with its large general purpose grant (DAU) to both provinces and districts (Shah et al, 2013). A simple
fiscal equalisation transfer, of the kind with which MoF is familiar and that employs readily available data, to
distribute village funds can be expressed in the following two equations.

11
This means that GDI is treated like any other expenditure needs proxy; it no longer enters the distribution formula in a multiplicative fashion.
This was done by MoF in order to reduce the importance of geographic difficulty in determining DD distributions, which they felt led to overly
skewed per village allocations.
12
The (final) weights for population, poor population, area, and the geographical difficulty index are 25 per cent, 35 per cent, 10 per cent, and 30
per cent, respectively.
13
The standard deviations of the four distributions are 2 333.7, 299.3, 52.8, and 52.9 respectively.

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DOI: 10.1002/pad
354 B. D. LEWIS

40

40
30

30
Percent
Percent
20

20
10

10
0

0
0 5,000 10,000 15,000 20,000 0 500 1,000 1,500 2,000 2,500
Average population per village Average poor population per village
60

0 10 20 30 40 50
40

Percent
Percent
20
0

0 100 200 300 400 100 200 300 400 500

Square kilometers per village Geographical difficulty index

Figure 3. Village heterogeneity.

80
60
Percent
40
20
0

0 2,000 4,000 6,000

Other district transfers to villages per capita ( thousands of rupiah)

Figure 4. Estimated other district transfers to villages.

VFN IT ¼ DDT þ ADDT (4)

VFNIT is defined as total village fiscal needs, where the superscript I stands for “ideal”14 and is used to differ-
entiate the variable from previously defined village fiscal needs; ADDT is total ADD (i.e. one-tenth the sum of
own-source revenues, shared revenues, and general purpose transfer across all districts). It may also be referred
to as total (ideal) village fiscal capacity. Equation (4) assumes that aggregate village fiscal needs are equal to the
aggregate funds to which they will have access (not including their own-source revenues, which cannot be
estimated).15

14
The term “ideal”, in relation to village fiscal needs, village fiscal capacities, or DD allocations, is used in a broad sense. There are many ways to
operationalise needs and capacities and design equalisation grants, some of which may be preferred to the procedures discussed above. The
“ideal” method discussed here is suggested simply because MoF uses essentially the same technique to allocate general purpose transfers and
data are readily available to operationalise the methods for village funds as well. See Boadway and Shah (2007) for an examination of various
ways to construct fiscal equalisation transfers. See Shah et al. (2013) for a discussion of the ways in which Indonesia could improve upon the
design of its central-subnational equalisation grant.
15
This may not be the case, of course, but without explicit information on village service responsibilities and the cost of delivering such services
the estimate cannot easily be improved upon.

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 DECENTRALISING TO VILLAGES IN INDONESIA 355

Table 1. Inequity of village fund allocations across districts

Gini coefficient

Original allocations 1.17

Actual allocations 1.19
Feasible allocations 0.20
Ideal allocations 0.00
Source: Author’s own calculations.



αh PROXY hi
DDIi ¼ VFN IT * ∑  ½ADDi  (5)
h PROXY hT

DDIi represents the “ideal” DD allocation for district i. The first term on the right-hand side of the equation is
total (ideal) fiscal needs of villages in district i and is henceforth written as VFNIi . The second term on the right-
hand side, ADDi is total fiscal capacity of villages in district i. Village fund allocations to districts are equal to vil-
lage fiscal needs minus village fiscal capacity (both aggregated at the district level)—(ideal) village net fiscal needs.
One potential problem with the above allocation system is that for some districts, ADDi > VFNIi , which implies
the possibility of negative grants. Experience in Indonesia suggests that negative grants are politically infeasible
(Lewis, 2002). But it is a simple matter to add a “hold-harmless” condition to the allocation mechanism to require
that all distributions be non-negative. Operationally, after implementing Equation (5) all negative grants would be
fixed at zero and the aggregate “losses” would be reallocated across other districts as a function of their shares of
non-negative net fiscal benefits.16 Village allocations with the non-negative restriction are hereafter termed feasible
village allocations—VFFi .
The concept of ideal net fiscal needs can be used to evaluate the equity of village fund distributions to districts.
In this context the focus is on the extent to which DD district allocations are sufficient to cover village net fiscal
needs. So the variable of concern is DD district allocations divided by village net fiscal needs at the district level.
Distributional equity can be assessed by examining the Gini coefficient of that ratio across districts.
Table 1 shows the Gini coefficients for the distribution of the ratio of original, actual, feasible, and ideal alloca-
tions to net village fiscal needs across districts. The figures indicate that the original and actual allocations are about
the same in terms of the equality of their distributions. Their Gini coefficients are 1.17 and 1.19, respectively.17
Feasible allocations—with a Gini coefficient of 0.12—demonstrate a very significant improvement over original
and actual allocations from an equity point of view. Ideal allocations are perfectly equally distributed, of course,
because they were constructed to be equivalent to net fiscal needs.

CHARACTERISING VILLAGE FUND MISALLOCATIONS

DD allocation errors at the district level, AEi, may be defined as the difference between the allocations that districts
actually receive and the allocations that districts should receive, as expressed in the following equation.

AEi ¼ DDi  DDIi (6)

Equation (6) can be used to calculate village fund allocation errors for the various distribution systems. Table 2
shows the absolute value of allocation errors for each of the distribution formulae discussed above as a per cent of

16
This method assures that no additional funding would be required to implement the hold-harmless condition. It is the same procedure that MoF
has used in the past to operationalise its hold-harmless provision related to general purpose grant allocations. See Lewis (2002) for a detailed
discussion of the relevant techniques.
17
The value of the Gini coefficient is typically between zero and one, where larger values represent greater inequality. When some values of the
variable being measured are negative, as is the case here (i.e. because net fiscal needs may be zero), the Gini can take on values greater than one.

Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 347–359 (2015)
DOI: 10.1002/pad
356 B. D. LEWIS

Table 2. Allocation errors as a per cent of total allocations

Original allocations 69.86
Actual allocations 81.20
Feasible allocations 23.51
Ideal allocations 0.00
Source: Author’s own calculations.

total DD allocations.18 Village allocation errors are highest for actual allocations—81 per cent. Allocation errors
represent 70 per cent of total allocations for the original distribution system and only 24 per cent for the feasible
allocation formula. Allocation errors for the ideal system are zero of course.
Employing the definitions for DDi and DDIi from above and rearranging terms yields the following more specific
formula for village fund allocation errors.

  

DDT   αh PROXY hi
AE i ¼ 0:9* *V i þ 0:1*DDT  VFN T * ∑ I
þ ½ADDi  (7)
VT h PROXY hT

Equation (7) shows that allocation errors are a positive function of the number of villages in a district (Vi) and
village (ideal) fiscal capacities (ADDi); and because VFNIT > 0.1*DDT, allocation errors are a negative function of
the various village fiscal need factors (PROXYh).
Village allocation winners and losers might be defined as those districts for which AEi is positive and negative,
respectively. To investigate more precisely the determination of village fund allocation winners and losers the
following logistic regression equation is estimated.

wi ¼ β0 þ β1 V i þ β2 PROXY hi þ β3 ADDi þ εi (8)

In Equation (8), the subscript i denotes the district; w is a dummy variable that takes on the value 1 if the district
is a winner and 0 if the district is a loser, both defined as above; V is the number of villages in the district; PROXY
is a vector of fiscal needs proxies, i.e. village population, poor population, area, and geographical difficulty index
for the district; ADD is per capita village fiscal capacity for the district; β are the coefficients to be estimated; and ε
is the usual error term. (All variables on the right-hand side of the equation are measured in logarithms, except poor
population, which is measured as a per cent of total population.19)
The logistic regression equation is estimated via maximum likelihood procedures. Results are shown in Table 3.
Estimated coefficients are provided in both log odds and odds ratio forms. Discussion of the output is restricted to
the latter. As expected, given Equation (7) above both the number of villages in a district and village fiscal capacity
at the district level positively influence being a winner (i.e. odds ratios are greater than one); while village fiscal
needs variables negatively affect village winner status (odds ratios are less than one).
More specifically, the output suggests that a 1 per cent increase in the number of villages increases the odds of
being a winner by a factor of 44 and a 1 per cent increase in village fiscal capacity increases the odds of being a
winner by a factor of 24. One per cent increases in village population, village poverty rate, village land area,
and the geographical difficulty index decrease the odds of being a winner by 76 per cent, 22 per cent, 62 per cent,
and 98 per cent, respectively.20
It is common in Indonesia to examine public sector (and other development) outcomes across local governments
grouped by island location, for purposes of constructing regional development policies. A typical categorisation
considers: Java/Bali, Sumatra, Kalimantan, Sulawesi, and Eastern Indonesia, where the latter comprises Maluku,

18
For purposes of this exercise original allocations have been scaled up so that total allocations are equal to those of other systems as well (i.e.
20.766 trillion rupiah).
19
Poor population and total population are highly correlated. Measuring the former as a per cent of the latter avoids problems associated with
multicollinearity.
20
The latter four statistics are derived by taking one minus the relevant coefficient.

Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 347–359 (2015)
DOI: 10.1002/pad
 DECENTRALISING TO VILLAGES IN INDONESIA 357

Table 3. Determining village fund winners and losersa

Independent variables Log odds z stat OR z stat

Log of number of villages 3.777 8.59 * 43.666 8.59 *

Log of village population 1.417 3.07 * 0.243 3.07 *
Per cent of village population that is poor 0.255 6.70 * 0.775 6.70 *
Log of land area 0.969 4.86 * 0.380 4.86 *
Log of geographical difficulty index 3.806 3.09 * 0.022 3.09 *
Log of village fiscal capacity per capita 3.167 4.08 * 23.729 4.08 *
Constant 11.690 0.97 0.000 0.97
Number of observations 419 419
Pseudo R2 0.491 0.491
a
Dependent variables is the winner and loser dummy (loser = 0; winner = 1). Log odds is the log of the odds ratio and OR is the odds ratio. Stan-
dard errors are clustered. * indicates statistical significance at the 0.01 level.

150.0

100.0

50.0

0.0

-50.0

-100.0
Eastern Java/Bali Sulawesi Sumatra Kalimantan

Figure 5. Island group allocation errors as a per cent of total allocations.

West Nusa Tenggara, East Nusa Tenggara, West Papua, and Papua. Broadly speaking Java/Bali and Sumatra are
relatively more socio-economically advanced while Eastern Indonesia (as defined here) is much less well devel-
oped; Kalimantan and Sulawesi are positioned somewhere between the two extremes from a developmental point
of view (World Bank, 2012; Lewis, 2014). Figure 5 shows allocation errors (as a per cent of total allocations) for
local governments by island group. Losers, as defined above, have negative allocation errors, while winners have
positive allocation errors.
The biggest losers are found in Eastern Indonesia. Districts there receive about 70 per cent less than they should,
under the assumptions used in this analysis. Eastern Islands’ losses are largely a function of their relatively high
levels of poverty, large land areas, and substantial geographical difficulty (especially in the provinces of Papua
and West Papua). The most significant winners are located in Kalimantan and Sumatra (especially in the provinces
of East Kalimantan and Riau, respectively). Local governments there receive about twice as much as they should,
on average, according to the definitions employed here. Kalimantan’s and Sumatra’s winnings are because of their
significant fiscal capacities, especially as derived from oil and gas revenue sharing. These results are again sugges-
tive of the inequity of DD allocations as they are currently derived.

SUMMARY AND CONCLUSIONS

Nearly 15 years after embarking on its large-scale decentralisation programme, Indonesia has now decided to
extend its efforts to the village level. Decentralising to villages is intended to improve service delivery performance
at the lowest administrative level and reduce social inequality and poverty. A number of potential difficulties with
the design of Indonesia’s village decentralisation initiative have already become apparent.

Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 347–359 (2015)
DOI: 10.1002/pad
358 B. D. LEWIS

Methods used to allocate funds to villages are particularly problematic. Oddly, current funds distribution
procedures insist to a large extent on equal per village allocations, despite the significant heterogeneity of desa.
And they ignore other sources of revenue to which villages have access. In the event, village revenues will be very
unequally distributed. Villages with comparatively high levels of poverty will receive less money than they need
and villages with relatively greater access to other sources of funding, especially from oil and gas transfers, will
get more than required.
In addition to problems related to the allocation of transfers, village service responsibilities are unclearly
defined, village public financial management systems are inadequately prepared to handle forthcoming large
increases in funding, and mechanisms to monitor and control village spending are underdeveloped. Together these
difficulties will severely constrain the achievement of government objectives and create further challenges for
reformers in their attempts to curtail corruption at the subnational level.
None of these problems is unsurmountable. The allocation of funds could easily be made more equitable—by
government’s own standards—if Ministry of Finance were to adopt procedures that they already employ to distrib-
ute equalisation transfers to subnational level. Difficulties related to service assignments and, especially, public
financial management and monitoring and control may take more time to fully resolve. But some ameliorative
actions can be taken now, the design and implementation of external village budget audits being among the more
noteworthy and urgent.
In the past, Indonesian policymakers have shown an impressive willingness to revisit a wide range of features
associated with their decentralisation framework. The basic legal architecture has been revised twice since 2001
and government has made a number of structural and procedural improvements over the years. Village decentral-
isation policymakers will have to be similarly amenable to reform as they embark on this new and important phase
of administrative and fiscal devolution.

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APPENDIX

Table A 1. Summary statistics

Variable Number of observations Mean Standard deviation Minimum Maximum

Number of villages per district 419 174.1 115.6 5.0 852.0

Village population per district 419 2293.4 2333.7 73.1 19 217.3
Village poor population per district 419 302.1 299.3 30.7 2381.4
Village land area per district (sq kilometres) 419 35.9 52.8 0.0 354.7
Geographical difficulty index 419 112.1 52.8 70.5 461.5
ADD per district (blns of rupiah) 419 82.2 53.3 19.6 604.5
DD original per district (blns of rupiah) 419 21.6 18.7 0.5 133.2
DD acutal per district (blns of rupiah) 419 49.6 31.7 2.8 225.5
DD ideal per district (blns of rupiah) 419 49.6 74.0 426.9 412.9
DD feasible per district (blns of rupiah) 419 49.6 56.1 0.0 369.5

Copyright © 2015 John Wiley & Sons, Ltd. Public Admin. Dev. 35, 347–359 (2015)
DOI: 10.1002/pad