The Effect of Regional Institutional Quality on Entrepreneurial Flourishing in Decentralized Indonesia
Authors
Andree Surianta
Krisna Gupta
Indonesia’s manufacturing sector is characterized by a "hollow middle" phenomenon, where micro-enterprises dominate but struggle to upgrade to small or medium scales despite significant government commitment to entrepreneurship and reindustrialization. This paper investigates the extent to which regional institutional quality influences entrepreneurial outcomes within Indonesia’s decentralized governance structure. Specifically, it seeks to determine whether local institutions foster opportunity-driven entrepreneurship (ODE) or produce subsistence necessity driven entrepreneurship (NDE), instead. The study utilizes a unique dataset combining the Regional Competitiveness Index (IDSD) with manufacturing/industrial micro and small enterprise (IMSE) statistics across Indonesian provinces and districts for the years 2022 and 2023. Employing Ordinary Least Square (OLS) and Poisson Maximum Likelihood (PML) estimators, the analysis tests the impact of regional competitiveness pillars—such as institutions, market size, labor market, and business dynamism—on the number of firms, informality, profitability, and wages. The findings reveal that market size is the only factor consistently and positively impacting all entrepreneurial outcomes. In contrast, institutional and labor market qualities often show negligible or negative correlations with the outcomes. Notably, weaker institutional settings are associated with a higher prevalence of informal IMSEs, suggesting that local institutional gaps inadvertently encourage necessity-driven activities. The results indicate that current pro-MSME programs may function more as social safety nets than as drivers of industrial productivity. The paper concludes that to foster entrepreneurial flourishing, policymakers should prioritize simplifying institutional complexity and improving access to markets and inputs over handing out direct business subsidies.
