Theory of Endogenous Institution and Evidence from an In-Depth Study in Indonesia

We study how endogeneity between welfare and institutions recommends the efficacy of subtle institutional reforms that must be exogenous. We use evidence from a field study conducted in five Indonesian districts, and build a model that illustrates how initial socioeconomic conditions and quality of institutions generate certain institutional attributes, such as a particular level of local capture (that is, gaining of influence over institutions, and hence over policy, by local elites), local leadership and participation. These institutional attributes, which evolve with changing welfare, create self-reinforcing processes in the long run that could be either vicious, virtuous or neutral. The policy question we investigate is how to break a vicious cycle between low welfare and low institutional quality. Reform must be exogenous and multi-dimensional, requiring welfare and institutions to be mutually reinforcing. In the context of post-decentralization Indonesia, any multi-dimensional institutional reform must include not only policies to strengthen local institutions, but also policies to increase welfare