Decentralizing Intergovernmental Grants: Evidence from Indonesia’s Village Fund

We study the impact of Indonesia’s Village Fund, one of the largest and most decentralized intergovernmental transfer programs in the world, which has approximately doubled the budget for village governments across the country. We exploit changes in the fund allocation formula to uncover how local public service delivery reacts to these substantial intergovernmental grants. Our results suggest that the Village Fund grants lead to increases in villages' development as measured by the central government, yet we do not observe any improvements in local educational or health facilities. Instead, we observe improvements in specific basic services provided by villages. These results are consistent with the differential jurisdictional authority over public expenditure of goods and services. Our analyses also indicate that the Village Fund acts as a complement to informal taxation. As informal taxation is often paid by villagers through in-kind labor, greater village funds allow local governments to procure the necessary materials while informal taxation provides the necessary labor for improvements in basic services.

Draft available by request