Democracy and Financial Governance of Regional Economic Growth

Wahyu Sugeng Imam Soeparno

and Wahyu Ario Pratomo

Program Studi Ekonomi Pembangunan, Universitas Sumatera Utara, Jalan Prof TM Hanafiah, Medan, Indonesia

Keywords: Economic Growth, Democracy, Financial Management, Regional.

Abstract: The research focused on how the influence of democratic variables and regional financial governance on

economic growth in Indonesia. The scope of the study uses data and information at the provincial level in

Indonesia. A total of 34 provinces selected as study locations with observational periods ranging from 2010

to 2018. The results of panel data regression using the fixed-effect method, after going through the chow and

haussmann tests. Variables of democracy and regional financial governance are significant influence the

economic growth of provinces in Indonesia, where all variables (including control variables) have a positive

influence on economic growth. The individual impacts in a cross-section shows that there are 13 provinces

significant economic growth and 21 provinces are experiencing slowing economic growth.

1 INTRODUCTION

Economic growth determined by several factors such

as natural resources, human resources, capital, and

technology. It also can be supported by the presence

of democracy and good government institutions. Hall

(2010) in the research "Institutions, Capital and

Growth", concluded that the allocation and

productivity of capital in driving economic growth is

highly dependent on state institutions. This research

found that an increase in physical and human capital

in economic growth only occurred in countries with

good institutions.

Good institutions reflected in a fully functioning

democracy. Kaldor and Vejvoda (2002) stated

democracy as a set of formal institutions,

redistribution of power, and life's grip. Dozens of

developing countries in the world have fallen into

poverty because there is no independence in

democracy, and the transparency of government

institutions in running the government (Goetzmann,

1999). On the other hand, democracy can cause the

government to stalemate in policymaking. The same

experience also occurred in China, which carried out

market reforms but distortions occurred in its political

regime (Batiz, 2002).

Proper regional financial management will be

able to optimize local government spending so that it

can encourage economic growth in a region. Regional

financial management is carried out economically,

efficiently, and effectively or meets principles the

value of money and participation, transparency,

accountability, and justice will be able to encourage

economic growth (Arsa, 2015).

Decentralization is an alternative to centralized

system which considered undemocratic.

Decentralization is deemed to be capable of bringing

development policies more in line with the needs, and

able to increase community economic growth.

Rondinelli and Cheema (1983) related

decentralization with economics development that

through decentralization and local government could

run more effectively and efficiently.

The relationship of democracy, governance, and

economic growth has become an exciting study theme

that has long attracted the attention of intellectuals.

This theme has become a standard issue in academic

debate among political scientists and economists,

which gave birth to a variety of views and conclusions

(John Helliwell 1992, Robert Barro 1997, and Dani

Rodrik 1997). Therefore, democracy is expected to be

able to accelerate economic progress to achieve

people's welfare.

The progress of democracy in Indonesia

manifested in decentralized governance and regional

financial autonomy has been running for more than 2

(two) decades. For this reason, it is fascinating to do

a study of the influence of democracy and local

financial governance in driving economic growth in

Indonesia. Thus, the results of this study will provide

a conclusion whether democracy and proper regional

608

Imam Soeparno, W. and Pratomo, W.

Democracy and Financial Governance of Regional Economic Growth.

DOI: 10.5220/0009327606080613

In Proceedings of the 2nd Economics and Business International Conference (EBIC 2019) - Economics and Business in Industrial Revolution 4.0, pages 608-613

ISBN: 978-989-758-498-5

financial governance have a positive influence on

economic growth in Indonesia.

2 LITERATURE REVIEW

2.1 Economic Growth

Economic Growth is a process of changing a

country's economic conditions on an ongoing basis

towards better conditions for a specified period.

Economic growth interpreted as a process of

increasing the production capacity of an economy that

increase in national income. The existence of

economic growth is an indication of the success of

economic development in people's lives.

Economic growth in a region interpreted as a

process of increasing output per capita in the long run.

In that sense, three aspects need to underlined, there

are namely process, output per capita, and long term.

Regional economic growth is related to per capita

output, meaning that two things must be considered,

namely total output (GDRP / GRDP) and population.

According of classical economists, four factors

that influence economic growth there are the

population, number stocks of capital goods, land area

and natural wealth, and the level of technology used,

even though they realize the economic growth

depends on many factors. The classical economists

focused their attention on the effect of population

growth on economic growth (Sukirno, 2010). One of

them is the classical theory put forward by Adam

Smith. Adam Smith's argumen assumes that

economic growth rests on population growth. With an

increase in population, there will be an increase in

output. Adam Smith's theory is in his book entitled

"An Inquiry Into the Nature and Causes of the Wealth

of Nations" (Simanjuntak 2013). Growth in output or

results to be achieved is influenced by the following

3 (three) components including: (1) natural resources,

(2) labor (population growth), and (3) total inventory

2.2 Democracy

Literally, democracy comes from the Greek language

δημοκρατία (dēmokratía) means "people's power",

which is formed from δῆμος (Dêmos) "people" and

κράτος (Kratos) "power" or "authority" in the 5th

century BC to refer to the Greek city-state political

system, one of which was Athens. This word is an

antonym of ἀριστοκρατία (aristocratic) "elit

authority." According to Abraham Lincoln,

“Democracy is a government of the people, for the

people, and by the people.”

According to KBBI, Democracy has two

meanings, namely: (1) Democracy is a form or system

of government in which all people participate in

governing, namely through the intermediaries of their

elected representatives. (2) Democracy is an idea or

view of life that prioritizes equal rights and

obligations, and fair treatment for all citizens.

In general, there are two forms of democracy,

namely:

1. Direct Democracy

Direct democracy is a form of democracy in

which every citizen votes or opinions in determining

a decision. In this system, each person represents

himself in choosing a policy so that they have a direct

influence on the political situation that occurs. The

direct democratic system used in the formation of

democracy in Athens were when there was a problem

that to be solved, it cause the all to discuss it. In the

modern era, this system becomes impractical because

in general a country's population is quite large and

gathering all people in one forum is difficult. Besides,

this system requires high participation from the

people while modern people tend not to have time to

study all the country's political problems.

2. Representative Democracy

In representative democracy, all people elect

representatives through general elections to express

their opinions and make decisions for them. The

principles and the prerequisites for the establishment

of a democratic state have accommodated in the

constitution the Republic of Indonesia. The principles

of democracy, can be reviewed from the opinion of

Almadudi who came to be known as the "pillar of

democracy." According to him, the principles of

democracy are :

a) People's sovereignty

b) Government based on approval from the governed

c) Majority power

d) Minority rights

e) Guarantee of human rights

f) Free, fair and honest elections

g) Equality before the law

h) Reasonable legal process

i) Constitutional government restrictions

j) Social, economic and political pluralism

k) Values of tolerance, pragmatism, cooperation,

and consensus

The characteristics of democratic government has

become an order that is accepted and used by almost

all countries in the world. The aspects of a democratic

government are as follows:

a) The involvement of citizens (people) in political

decisions, both directly and indirectly

(representative).

Democracy and Financial Governance of Regional Economic Growth

609

b) The existence of recognition, appreciation, and

protection the fundamental rights of the people

(citizens).

c) The existence of fair rights for all citizens.

d) The existence of an independent judiciary and

judicial authority as a law enforcement tool

e) There is freedom and independence for all

citizens.

f) The existence of a press (mass media) that is free

to convey information and control government

behavior and policies.

g) There is a general election to elect the people's

representatives who sit in the people's

representative institutions.

h) The existence of free, honest, fair elections to

determine (elect) state, government leaders and

members of people's to be representative the

institutions.

i) Recognition differences in diversity (ethnicity,

religion, class, etc.).

2.3 Conceptual Framework

Speaking of economic development and democracy,

Immanuel Walerstain (1974) classifies countries in

the world into three categories, namely core, semi-

periphery, and periphery. Core countries are

characterized by developed countries that have a

democratic system and do industrialization to sustain

the country's economy. Semi-periphery countries are

in the middle position whose economic conditions are

far better than periphery countries but are still below

the core countries. Whereas periphery countries are a

group of developing countries which are generally

undemocratic. In global competition, the political

system adopted by the core countries has always been

an example of development for semi-periphery

countries. Democracy is further said to have a

positive correlation with improving the welfare of a

country seeing the success of many core countries

with the democratic system that it practices.

In connection with the explanation above, the

writing of this article departs from doubts about the

work of Lipset (1959) entitled Political Man. Lipset

stated his hypothesis that democratization is directly

proportional to a country's economic growth. The

more democratic a country, is better the country's

economic growth. Logically, within the framework of

a democratic political system, each development

stakeholder will be more free to voice his aspirations

to improve development. The result of construction

will be better because it takes the interests of the

people as required by a democratic political system.

Almond and Powell (1966) seemed to justify the

Lipset hypothesis (1959). In his theory of capability

of system politics then states that each political

system has different abilities in handling inputs and

outputs. But it can be said that democratic systems

have a higher sensitivity to dealing with welfare

issues. The critical question is, can democracy

guarantee the welfare of a country? Considering

today, many countries do not adhere to freedom or do

not meet democratic criteria but can experience rapid

economic improvement.

The argument of Lipset (1959) seems to be

meaningless when many developing countries are

separated from the occupation and stand as a new

state, and generally follow the modernization, in the

end, it is not as stated. Modernization gave birth to

prosperity which led to democratization in Western

Europe, North America and Australia, but this was

not same case with Singapore, China, and South

America countries which did not give to democracy

but gave to authoritarianism. These countries have

relatively fast economic development accompanied

by reasonably even distribution of income. Lee Kuan

Yew (former PM of Singapore) in his Thesis said that

"Democracy will damage the economic growth and

development of a country." This hypothesis is applied

in Singapore and proven to have very high economic

growth until now. Perdana (Iksan, 2015) explained

Thesis Lee that to achieve higher welfare, the people

must be willing to sacrifice a little civil liberties and

political rights. Singapore, which maintains a very

open market economy and attracts a lot of foreign

investment, does not protect civil liberties such as

freedom of speech and expression. If society has

reached a high standard of living, independence and

democracy are no longer a necessity. Furthermore,

Asian values which form the essence of Lee's

argument, believe that there is a cultural tendency to

comply with higher authority and hard workers to

enable East Asian countries to create liberal economic

policies without democracy.

Unlike the case with North (1990) which says that

theoretically, running an authoritarian government

requires high costs and is very inefficient.

Inefficiency results in weak economic performance.

Also, democracy is considered more able to allocate

resources efficiently. But Huntington (1968) says the

opposite that democracy is inefficient. In a

democracy, the decision-making process can seem

slow. Democratic governance also has the potential to

be subject to populist pressure while authoritarian

governments can make decisions with a long-term

orientation.

EBIC 2019 - Economics and Business International Conference 2019

610

3 METHOD

This study uses panel data, namely a combination of

cross-section and time-series data. Hsiao and

Klevmarken (Baltagi, 2008) list several beneﬁts from

using panel data. These include the following:

a) Controlling for individual heterogeneity.

b) Give more informative data, more variability, less

collinearity among the variables, more degrees of

freedom, and more efficiency.

c) Better able to study the dynamics of adjustment.

d) Better able to identify and measure effects that are

not detectable in pure cross-section or purely

time-series data.

e) Allow us to construct and test more complicated

behavioral models than purely cross-section or

time-series data.

f) More accurately measured and unlike the problem

of nonstandard distributions.

The data used from 34 provinces in Indonesia

with a period of 2010-2018. The variables used in this

study are gross regional domestic product at constant

price 2010 as dependent variables. While the

independent variables are index of democracy, BPK’s

opinion on financial statement, human development

index, and percentage of labor to working. The data

used in this research is secondary data. Data obtained

from the Central Statistics Agency (BPS).

The method used is panel data regression with the

following equation:

Y = α+β

+ β

Opinion

+ β

HDI

+ β

Labor

+ɛ

(1)

“Y” is gross regional domestic product at constant

price 2010, “ID” an index of democracy, “Opinion”

is BPK’s opinion on financial statement, “HDI” is

human development index, and “Labor” is a

percentage of labor to working. Whereas “I” is the

province in Indonesia (33 regions), and “j” is the time

studied (2010-2018).

Equation (1) is estimated by the Chow Test and

Hausman Test to get the appropriate model. Some of

the models chosen to Pooled Least Square (Common-

Effect), Fixed-Effect, or Random-Effect. It estimated

by using Eviews 9.

4 RESULTS AND DISCUSSION

4.1 Choosing Appropriate Model

Choosing the appropriate model whether using

Pooled Least Square/PLS (Common Effect) or Fixed

Effect Model (FEM) is by using the Chow Test.

While choosing a model whether using the Fixed

Effect Model (FEM) or Random Effect Model (REM)

is by using the Hausman Test.

Table 1: Estimated Results of Chow Test and Hausman

Test.

Test Hypothesis P-

Value

Conclusion

Chow

H0: PLS

H1: FEM

0.000

Reject H0

(

Usin

FEM

)

Hausman

H0: REM

H1: FEM

0.015

Reject H0

(Using FEM)

From the estimation results, as shown in table 1,

it can be concluded that the most appropriate model

to use is the Fixed Effect Model. This study assumes

that all variables change at a constant level over time.

4.2 FEM Estimated Results

Table 2 shows the specification effects of the Fixed

Effect Model. R-squared value of 0.9997 means that

variations of economic growth in Indonesia can be

explained by index of democracy, BPK’s opinion,

human development index, and percentage of labor,

while the rest are defined by other variables outside

in model. In this case, the model used in this study is

appropriate.

Table 2: Effects Specification of Fixed Effect Model.

ecification Value

R-s

uare

0.999745

Prob.

(

F-statistic

)

0.000000

Table 2 also shows that the probability of an F-

statistic value of 0.00 is smaller than alpha 5%,

rejecting Ho. That indicates an index of democracy,

BPK’s opinion, human development index, and

percentage of labor variables simultaneously affect

economic growth in Indonesia.

This study can prove that each variable, namely

the index of democracy, BPK’s opinion, HDI, and

percentage of labor a significant effect on economic

growth. The index of democracy coefficient of

0.00054 indicates that if the index of democracy

increase for 1 %, it will be increasing economic

growth for 0.00054 % (ceteris paribus). The BPK’s

opinion coefficient of 0.00847 indicates that every

increase in BPK’s opinion by 1 step, economic

growth in Indonesia will rise by 0.00847 % (ceteris

paribus).

Democracy and Financial Governance of Regional Economic Growth

611

Table 3: Output of Fixed Effect Model

Dependent Variable: Log

PDRBHK

Parameter Estimates

Coefficient SE

ID 0.00054* 0.00031

Opinion 0.00847** 0.00242

HDI 0.08563** 0.00118

Labo

0.00508** 0.00169

Constant 5.36895** 0.14085

Note: *Significant at 10%, **significant at 1%.

The HDI coefficient of 0.08563 indicates that

every HDI increase by 1 point; growth economic in

Indonesia will increase by 0.086 % (ceteris paribus).

Meanwhile, the labor coefficient of 0.00508 indicates

that each 1% increase in the labor, economic growth

in Indonesia will increase by 0.0051 % (ceteris

paribus).

Table 4: Cross Effect

ion Effect Re

ion Effect

Aceh -0.172461 NTB -0.156500

Sumatera

Utara

1.123642 NTT -0.345694

Sumatera

Barat

-0.067954

Kalimantan

Barat

0.115203

Riau 1.054282

Kalimantan

Tengah

-0.542802

Jambi -0.097909

Kalimantan

Selatan

-0.156972

Sumatera

Selatan

0.745299

Kalimantan

Timu

0.796098

Bengkulu -1.262410

Kalimantan

Utara

-1.007072

Lampung 0.548355

Sulawesi

Utara

-0.804149

Bangka

Belitung

-1.092479

Sulawesi

Tengah

-0.381732

Kepulauan

Riau

-0.313477

Sulawesi

Selatan

0.573158

Jakarta 1.502388

Sulawesi

Tenggara

-0.645309

Jawa Barat 2.161116 Gorontalo -1.579482

Jawa

Tengah

1.750340

Sulawesi

Barat

-1.194555

Yogyakarta -1.266500 Maluku -1.530172

Jawa

Timur

2.279597 Malulu Utara -1.629099

Banten 0.886296 PapuaBarat -0.347699

Bali -0.451687 Papua 0.950856

If we look at the effect of all variables, namely

index of democracy, BPK’s opinion, HDI, and labor

on economic growth every province in Indonesia,

there are 13 provinces where the democracy and

financial management have a positive impact to

economic growth. Where the biggest positive impacts

were in the provinces of DKI Jakarta, West Java, and

East Java. Meanwhile, there are 21 provinces in

which the democracy and financial management

guide on slowing economic growth for each province

in Indonesia. Where the provinces of Maluku,

Gorontalo, and North Maluku are three provinces

with the biggest impact of slowing economic growth.

5 CONCLUSIONS

This study proves that freedom of democracy and

good financial management have a significant impact

on economic growth in Indonesia. Where the impact

has a positive influence on economic growth in each

province, also affects slowing economic growth in

several provinces in Indonesia. Good financial

management has a greater impact than democratic

freedom on economic growth in Indonesia. these

conditions indicate that transparent financial

governance will stimulate economic conditions for

the better.

For this reason, both the central and regional

governments must create a climate of information

openness and open access so that they can have a

domino effect on economic growth. Keep in mind,

superior human resources also influence economic

growth. This condition can achieved if the

government can provide the best stimulation in the

fields of education, health, and job creation, where it

can have a significant impact on the economic growth

of each region.

ACKNOWLEDGMENTS

We gratefully acknowledge that Universitas

Sumatera Utara supports the present research. The

support is under the research grant TALENTA USU

2019, No. 4167/UN5.1.R/PPM/2019 April 01, 2019.

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