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

19
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.

20
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

22
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

23
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).

24
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:

25
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

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.

27
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.

28
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

29
 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

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

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

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

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.

34
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.

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.

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
flows 2000-12 Rank Province
Avg. Annual DBH revenue
sharing 2000-12 (million IDR)
Annual DBH Revenue sharing
2012 (million IDR)
1 Kalimantan Timur 2,518,329 5,268,680
2 Riau 1,426,289 2,564,670
3 Nanggroe Aceh Darussalam 1,098,070 122,178
4 DKI Jakarta 566,130 294,849
5 Kepulauan Riau 486,164 910,862
6 Sumatera Selatan 453,576 1,127,000
7 Papua Barat 238,153 384,476
8 Papua 186,925 130,708
9 Kalimantan Selatan 185,227 646,337
10 Jawa Barat 178,440 315,079
11 Jambi 122,917 358,785
12 Lampung 89,603 145,697
13 Jawa Timur 80,995 337,623
14 Bali 55,973 -
15 Kepulauan Bangka-Belitung 54,716 98,685
16 Kalimantan Tengah 46,067 131,069
17 Jawa Tengah 39,496 141,067
18 Nusa Tenggara Barat 34,812 22,303
19 Maluku Utara 27,931 50,357
20 Kalimantan Barat 24,157 105,357
21 Sulawesi Selatan 15,529 9,798
22 Sulawesi Tenggara 11,300 45,493
23 Sumatera Utara 10,743 8,315
24 Sulawesi Barat 10,418 25,190
25 Sulawesi Tengah 7,017 14,426
26 Sumatera Barat 6,471 9,769
27 Bengkulu 6,017 17,217
28 Maluku 4,092 -
29 Sulawesi Utara 2,321 6,975
30 Gorontalo 1,763 17,796
31 DI Yogyakarta 1,385 5
32 Banten 1,308 3,447
33 Nusa Tenggara Timur 576 553
34 Kalimantan Utara - -

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. annual DBH revenue
sharing 2000-12 (million IDR)
Annual DBH revenue sharing -
2012 (million IDR) Primarily
1 Kutai Kartanegara, Kab. E Kalimantan 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 Rokan Hilir, Kab. Riau 749,969 1,206,170 oil
5 Musi Banyuasin, Kab. S Sumatra 650,770 1,578,600 gas
6 Kutai Barat, Kab. E Kalimantan 496,756 1,136,260 gas
7 Kutai Timur, Kab. E Kalimantan 494,358 - gas
8 Kampar, Kab. Riau 469,815 1,017,890 gas
9 Paser, Kab. E Kalimantan 456,854 1,011,960 gas
10 Berau, Kab. E Kalimantan 410,168 963,166 gas
11 Nunukan, Kab. N Kalimantan 366,089 852,293 gas
12 Bulungan, Kab. N Kalimantan 355,278 848,478 gas
13 Samarinda, Kota E Kalimantan 352,671 893,486 gas
14 Natuna, Kab. Riau 346,944 874,101 oil
15 Penajam Paser Utara, Kab. E Kalimantan 332,377 847,960 gas
16 Tarakan, Kota N Kalimantan 293,893 841,030 gas
17 Bontang, Kota E Kalimantan 289,029 - gas
18 Pelalawan, Kab. Riau 274,727 511,271 oil
19 Aceh Utara, Kab. N Aceh 268,951 273,134 gas
20 Pekanbaru, Kota Riau 268,501 466,496 oil
21 Indragiri Hilir, Kab. Riau 264,352 247,134 oil
22 Balikpapan, Kota E Kalimantan 260,647 542,371 gas
23 Rokan Hulu, Kab. Riau 258,537 485,531 oil
24 Dumai, Kota Riau 254,689 361,393 oil
25 Malinau, Kab. N Kalimantan 241,499 - gas
26 Indragiri Hulu, Kab. Riau 226,919 490,505 oil
27 Kuantan Singingi, Kab. Riau 221,949 470,214 oil
28 Mimika, Kab. Papua 217,803 260,895 -
29 Muara Enim, Kab. S Sumatra 160,452 428,950 oil
30 Musi Rawas, Kab. S Sumatra 157,594 378,390 gas

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. annual DBH revenue sharing 2000-12 (million IDR)

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
10
15
20
25
30
35
40
45
50
0 500,000 1,000,000 1,500,000 2,000,000 2,500,000
PovertyIncidence(%)2013
-15
-10
-5
0
5
10
15
20
25
30
0 500,000 1,000,000 1,500,000 2,000,000 2,500,000
%pointfallinpovertyincidence2002-13

40
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
45
50
55
60
65
70
75
80
85
90
0 500,000 1,000,000 1,500,000 2,000,000 2,500,000
HumanDevelopmentIndex-2013
0
2
4
6
8
10
12
0 500,000 1,000,000 1,500,000 2,000,000 2,500,000
IncreaseintheHDI(2004-13)

41
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

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.

43
Figure 11 & 12: Resource revenue flows vs. governance (KPPOD, 2007, 2011, World Bank, 2016a)
40
45
50
55
60
65
70
75
80
0 500,000 1,000,000 1,500,000 2,000,000 2,500,000
EconomicGovernanceIndex2007
40
45
50
55
60
65
70
75
80
85
0 500,000 1,000,000 1,500,000 2,000,000 2,500,000
EconomicGovernanceIndex2011

44
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

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.

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

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)
Total DBH revenue Gas Oil

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
East KalimantanHDI 73.26 73.77 74.52 75.11 75.56 76.22 76.71 77.33
Poverty Rate (%) 11.41 11.04 9.51 7.73 7.66 6.77 6.68 6.38
GRP % growth p.a. (excl. O&G) 12.6% 9.6% 7.0% 6.6% 10.8% 13.1% - -
Land access &
security of
tenure
Business
licensing
Local govt.
business
interaction
Business
development
program
Capacity &
integrity of the
Regent/ Mayor
67.74 66.41 62.92 50.57 59.88
Transaction cost
Local
infrastructure
Security &
conflict
resolution Local regulation
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%
East Kalimantan
Agriculture Mining, oil & gas
Mining related manufacturing Other manufacturing
Construction Wholesale & retail trade
Transportation & storage Public Administration & defence
Education Health & Social Work
Other

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

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)
Total DBH Revenue Gas Oil

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
Papua BaratHDI 66.08 67.28 67.95 68.58 69.15 69.65 70.22 70.62
Poverty Rate (%) 41.34 39.31 35.12 35.71 34.88 31.92 28.2 27.14
GRP % growth p.a. (excl. O&G) 7.4% 8.6% 9.3% 7.7% 6.8% 13.5% - -
Land access &
security of
tenure
Business
licensing
Local govt.
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 &
integrity of the
Regent/ Mayor
Economic
Governance
Index
80.36 68.11 70.49 65.03 63.78
West Papua
10%
21%
29%
3%
11%
6%
2% 8%
2%
1%
7%
West Papua
Agriculture Mining, oil & gas
mining related manufacturing Other manufacturing
Construction Wholesale & retail trade
Transportation & storage Public Administration & defence
Education Health & Social work
Other

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

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

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 -

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

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,

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

58
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

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.

60
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

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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