Abstract
Access to public infrastructure is understood to be central to economic growth. Good governments that invest in essential public goods and services (e.g., transport/ communications) realise high rates of return (e.g., Easterly, 2001). Decentralization is identied by many as an important policy reform to improve the delivery of public goods and services in developing countries. Since scal decentralisa- tion provides greater decision-making power to local governments, its impact on public goods provision should, arguably, depend on the quality and nature of local institutions. The relevant local institutions should include not only the processes through which communities make collective decisions regarding public spending, but also the informal institutions which facilitate economic exchange and maintain law and order within the community. We develop a theoretical model of inter- and intra-community trade to argue that communities that have higher levels of mutual cooperation should have a stronger preference for spending on social goods, e.g. schools and health centres, as opposed to physical infrastructure. Using the Indonesian Family Life Survey community-level data from 1997 and 2007, we nd evidence of heterogeneity in public goods spending across communities in the period prior to scal decentralisation, with greater spending on social goods in communities which observe traditional (adat) norms, and less spending on physical infrastructure in communities with a democratic electoral system. Fiscal decentral- isation led to an increase in investments in physical infrastructure, as well as a convergence in spending across communities with di¤erent types of local institutions.