How Does Fiscal Decentralisation Affect Local Polities? Evidence from Local Communities in Indonesia

How fiscal decentralisation (FD) affects the selection of local leaders remains largely unexplored. We utilise Indonesia’s important fiscal decentralisation to local communities in 2001 to study such issues. Using the 1997 and 2007 Indonesian Family Life Survey (IFLS) data, we observe communities practising majority voting (electoral democracy), consensusbuilding (participatory democracy) and also oligarchy (leaders selected by the local elite). The incidence of democracy (voting and consensus-building taken together) did not increase significantly after fiscal decentralisation. Leader selection by consensus-building declined while that by voting increased. We show that community homogeneity has been an important driver of leader selection by consensus-building. However, after decentralization ethnically diverse communities increasingly opted for choosing leaders by voting. Furthermore, voting (relative to consensus-building) communities registered higher income and development spending after fiscal decentralisation, suggesting the salience of local political entrepreneurship. In a fiscally decentralised environment, enterprising local political leaders can facilitate the aligning of economic interests in ethnically diverse communities, especially if ambient economic inequality is low.