Empirical Study of Effects of Local Financial Structure on Regional Economic Growth (Studies Conducted in Regencies in the Province of East Java, Indonesia)

Abstract

Fiscal decentralization in Indonesia has officially been implemented since 2001. This led to a fundamental change in the relationship regulation of central government and local government, particularly in the financial balance between central government and local government in Indonesia. Implementation of the fiscal decentralization is the beginning of the transformation of the local financial structure which is reflected in the regional budget. Theoretically, the fiscal decentralization affects the regional economic growth because local government has been authorized with regional autonomy. The research aims to test the effect of changes of the local financial structure triggered by the fiscal decentralization on the regional economic growth in the regencies in East Java. The research involved 25 regencies in East Java, with the data taken for 8 years from 2005 to 2012 using Johansen cointegration test, Granger causality test, and vector error correction model. The first hypothesis shows that there is a significant cointegration relationship (long-term balance) between the autonomy ratio and regional economic growth ratio in East Java. This means that there are a balance relationship and movement equality in the long term between the local financial structure and regional economic growth in East Java. The results of the second hypothesis test show that there is only one-way causality relationship which is significant; the local financial structure affects the regional economic growth of regencies in East Java. These findings indicate that change in the local financial structure will cause change in regional economic growth, but change in the regional economic growth does not lead to change in the local financial structure.

Keywords: Local Financial Structure; Economic Growth; Fiscal Decentralization; Regional Autonomy; Causality; Cointegration

Australian Academy of Accounting and Finance Review, vol 3, issue 2, April 2017, pp 85-97