Corruption in Indonesia

Bribes paid by firms in Indonesia arise principally from red tape, in particular licenses, imposed by local government officials. Red tape generates direct revenues (fees) plus indirect revenues in the form of bribes. The expected value of the latter is capitalized into lower salaries needed by localities to compensate public officials. Localities in Indonesia are hampered by insufficient revenues from formal tax and transfer sources to pay competitive salaries to officials and meet public service expenditure requirements, because local tax rates are capped by the center and inter-governmental transfers are limited. Thus the direct and indirect (bribe) revenues from local red tape are critical to local finances. The paper models how inter-jurisdictional competition for firms limits the extent of locally imposed red tape and how greater sources of inter-governmental revenues reduce the need for red tape and corruption. The paper estimates a large reduction in red tape in better funded localities. For countries such as Indonesia that are in the midst of decentralizing government functions, the impact on corruption is tied to fiscal arrangements and the ability of localities to legitimately fund activities. The paper then estimates the relationships between red tape, bribes, and time devoted by firms to dealing with corrupt officials.