Decentralization Synergies and their Welfare Effects in Indonesia

Decentralization has dramatically altered governance in developing countries. However, the empirical evidence on its welfare effects has been limited and ambiguous. I argue that this ambiguity is due to a misidentification of different types of decentralization – namely administrative, political and fiscal – and their synergies. In order to test this claim, the paper employs a unique Indonesian panel of village level outcomes and a difference-in-differences estimation strategy with village level fixed effects. I show that use of a näıve specification that only considers political or administrative decentralization as separate treatments while neglecting their synergies leads to an omitted variable bias problem. Results from a more complete specification suggest that districts that have both types of decentralization display significantly greater welfare improvements compared to those that face only political or administrative decentralization or no decentralization at all. I also provide evidence on improvements in governance.