Indonesia is rapidly moving from a highly centralized system of government to a largely decentralized one (World Bank 2003a). Law No. 22/1999 on Regional Governance devolves most functions except for national defence, international relations, justice, police, monetary policy, religion, and finance. The local governments are obliged to perform a set of key functions, including health, education, environmental and infrastructure services, and can perform any function not explicitly reserved for the centre or the provinces. The province has only a minor role, mainly in coordination, and backstopping rural regencies and urban municipalities that cannot yet perform their functions. The province will also continue to perform deconcentrated central tasks, including supervision, on behalf of the central government.
Law No. 25/1999 sets out a revised inter-governmental fiscal framework. Through the introduction of a general allocation grant (dana alokasi umum, DAU) and stipulations on shared taxes and local tax bases, the system significantly increases financing for local governments. Moreover, it also moves largely away from the former system of subsidy for autonomous regions (Subsidi Daerah Otonom, SDO), and presidential instruction (Instruksi Presiden, INPRES) grants characterized by a high degree of earmarking and centralized control. Regional governments are now responsible for local public service delivery in areas previously executed directly by the central government through its deconcentrated regional agencies and civil servants. The deconcentrated agencies in the decentralized sectors have been largely merged into the local government apparatuses (pemerintah daerah, PEMDA), and over half of Indonesia's civil service — 2.1 million people — have been transferred to the local governments. While government spending has been regionalized to a substantial degree, taxation remains largely centralized and the regions depend in their financing on central government allocations.
The on-going decentralization process will bring about a fundamental change in the organization and functioning of Indonesia's government. It will also bring in new actors that are, at least in principle, accountable to their local electorate. The question that arises is how these changes will affect the quality of governance in general and the level and structure of corruption in particular. While it is far too early to give definite answers, we can identify the channels through which decentralization will affect the quality of governance and the extent of red tape and corruption in the regions. Moreover, there is some preliminary evidence on some changes in corruption following the devolution of authority towards lower levels of government.