Literature on institutional perspectives stresses the importance of participatory process, and the degree of political participation, which differs between countries and regions, is influenced by the initial welfare condition reflected in, among others,

4 The extent and severity of accountability problems and local capture ("L") depend on the following factors: (1) Pre-existing distribution of power at the local level, e.g., allocation of social and economic power within communities; (2) Lobby and campaign contributions by wealthier or more influential groups; (3) Fairness and regularity of elections; and (4) Transparency in local decision-making processes. Establishing these conditions may require institutional and bureaucratic reform, yet it is precisely this type of reform that is most difficult to conduct. Overcoming institutional factors is always more difficult than choosing which policy to take, as it is complex, involving a strong path-dependence. Absence of this reform, a higher local capture will almost certainly produce lower benefits of decentralization (Azis, 2020b).

the human development index (HDI) and the level of poverty and income inequality. A larger share of poor people implies a smaller fraction of informed voters or lower political awareness, i.e., upward mobility, where those at the upper end tend to raise political awareness more significantly than those at the lower end (concavity hypothesis). The quality of public services and "W" can be constrained by low awareness, lack of critical voices, and absence of check-and-balance. Hence, of several factors determining the effect of "L" on "W," three stand out: the initial welfare condition ("S"), people's participation ("P"), and the size of local budget ("F").5 The implied mechanisms could result in either a persistent/wider gap, or a smaller/narrowing gap between rich and poor regions. The interplay of all the above factors will determine the welfare outcome (Azis, 2020b).

As discussed in the preceding chapter, applying the IMD framework in several districts throughout Indonesia confirms the importance of participation ("P") in determining the way the local capture affects welfare. In some LDR, the initial condition matters more than the availability of local budget, highlighting the persistence of low (high) welfare influenced by poor (good) initial condition. It also confirms the presence of "negative local capture" and "positive local capture" in a path dependence fashion. When the dynamics of influences are taken into account, the importance of available fund in some regions is higher than that of the initial condition. Hence, the IMD helps explain why some LDR or backward regions remain less-developed or backward even after numerous efforts were made to make improvements, while other LDR or backward regions could thrive. The fact that people's participation "P" and the size of local budget "F" vary across regions suggests that interactions between institutional change (decentralization) and economic factors indeed explain the widening welfare gap (dualism) between regions. The nature and extent of those interactions reflect the prevailing institution.

Insofar the 'quality' factor (participation) and the 'quantity' factor (local budget) are key to welfare progress, the quality of local leaders (denoted by "Q" in Fig. 3.2) determines the achievement of welfare. Obviously, better local leaders enable greater welfare achievement. Translating this into types of local leaders, Fig. 3.3 displays the typology based on the 'quantity' (column) and 'quality' (row) components of IMD. In the context of promoting efforts to improve MSME competitiveness, the typology suggests that even if we assume there is no corruption among local leaders and officials, their ability and capacity to motivate people's participation could determine the welfare outcome. From the discussions withMSMEs in some regions, cases where local authorities (perceived as 'local leaders') fail to motivate participation of local residents and MSME are numerous. As shown in Fig. 3.3, in such circumstances even with no corruption the outcome will be of the 'incomplete progress.'

5 The initial level of a region's overall conditions "S" is supposed to capture both the traditional 'quantity' measures (income, education, poverty, employment, etc.), and 'quality' or institutional measures (social capital such as trust, collective actions, tradition, habit, enforcement, etc.). The resulting "W" will determine the subsequent level of initial condition "S," that is, the steady-state level of initial welfare is influenced by any perturbations in the system that lead to changes in "W," from which "S" in the subsequent period is in turn affected.

Notes: "L" denotes local capture, "F" is local budget, and "H" represents the quality component that includes local capture, initial conditions ("S"), and people's participation ("P") Source: Azis (2010), Azis (2013), and Azis (2020a).

**Fig. 3.3** Typology of local leaders based on IMD framework. *Notes* "L" denotes local capture, "F" is local budget, and "H" represents the quality component that includes local capture, initial conditions ("S"), and people's participation ("P"). *Source* Azis (2010, 2013, 2020a)

Returning to the distinction between formal and informal institution, we often put more emphasis on formal institution when formulating policies and undermine the enforcement of those policies as part of informal institution. In some cases, when a policy with good intent is not sufficiently enforced, local communities may impose social control through neighborhood trust to ensure that the good intent can be materialized. On the other hand, they may not be able to overcome obstacles sanctioned by a higher authority. Since the quality and capacity differ between communities, the net-result and performance also differ. In poorer regions, the informality of social arrangement may put them in a more difficult position to counter the weak enforcement of a policy. This could prolong, if not worsen, the existing dualism.

In addressing dualism between small and large businesses, high transaction costs are at the center of the institutional problems faced by many MSMEs. Transaction costs could range from expenses incurred in business activities such as advertisement, management, finance, and public relations, to the costs of getting permits which is time-consuming and often involving payment or transfer of bribes and kickbacks.6 In some cases, personalized transactions are the rule rather than the exception. All these costs tend to be more burdensome for small businesses that have small and unsecured assets and lack of formal documents, making them to remain informal and small as they cannot afford to pay those costs. The persistence of informality

6 The well-known Coase theorem suggests that only at zero transaction costs an efficient outcome can prevail (Coase, 1960). However, Coase's solution to lower such costs by establishing clear property rights to facilitate the smooth functioning of markets is less related to the problems commonly faced by MSMEs in most developing countries.

contribute to their productivity and competitiveness, which diminishes the chance for MSMEs to get credits and/or weaken their incentives to expand.

Other than transactions costs, problems associated with institution entail another intangible factor which by no means less important. To the extent institution define the incentive structure of societies, given a certain incentive structure a system will be in equilibrium if the implied regularity of behaviors of individuals or society to follow the rules are best-responses to the beliefs and internalized norms formed by the implied regularity of behaviors (North, 1993,2005). One of the consequences is, policies can fail to achieve their objectives if the institution in which those policies are elements of is not in equilibrium (Grief, 2006). To a large extent, the behaviors of individuals or society reflect their social capital, and institution has a strategic role in influencing and shaping that social capital. It is this social capital that jointly determine the effectiveness of policies to improve MSME performance. The survey reported in the next chapter is based on a framework specifically designed by positioning social capital and its interactions with policies at the center of the analysis. That framework is discussed below.

## **Social Capital**

While methodologies about MSME development and promotion have not been well developed, and received a lack of consensus, there is a widespread agreement that 'survival' and 'self-realization' are among the important aspects of small business activities. Self-realization makes them capable of stimulating entrepreneurship, innovation, and productivity (Parrilli, 2007). More importantly, self-realization can strengthen social bonds and enlarge the circle of social relationships, which is an important feature of social capital. From this perspective, social capital can enhance the opportunity of self-realization and allow MSMEs to gain the benefits of it.

Insofar the networks of relationships among individuals in a society are formed based on the prevailing institution, they constitute social capital which maintains the relationships.7 Thus, institution and social capital can influence the behaviors of those who make the policy (or are responsible to enforce it), as well as the community affected by it. In this sense, enforcement is part of institution, and so is the response guided by the social capital of the affected communities. Any policy intended to foster regional growth and reduce interregional inequality could suffer from weak enforcement due to poor design, as well as from unexpected public response if the policy is not in line with the need, characteristics, and networks of relationships exist in the region. The disconnect makes policy ineffective. Similarly, policy measures to help MSMEs can fail due to irreconcilable response if the design of those measures does not make them compatible with the real needs, local values, and characteristics of MSMEs. For small businesses in particular, the goal achievement often critically depends on the prevailing institution and social capital.

7 Although social capital is not the same with institution, it can contribute to their development.

Putnam's description of social capital is loaded with important implications. He referred social capital to "features of social organization, such as networks, norms, and trust, that facilitate coordination and cooperation for mutual benefit" (Putnam, 1993). Three terms are particularly relevant for our analysis: cooperation, coordination, and trust. The degree of trust is positively related to the probability of cooperation and coordination. For our purpose, we add another element of cooperation, that is, participation, and treat the whole as a system of collective action.

Collective action and participation in social activities are significantly lower in regions and localities that suffer from high inequality (Alesina & La Ferrara, 2000). The propensity of individuals, regions, or small businesses to join groups, associations, or cluster, to cooperate in various collective actions is negatively related to inequality. Higher dualism tends to lead to lower social capital, and in turn lower cooperation and collective actions. To the extent collective actions generate externalities, both positive (e.g., public goods) and negative (e.g., commons), observed dualism is the net result of such externalities.

Since cooperation and collective action are critical for the success of almost all organizations, large and small, it is important to understand how they are formed. Figure 3.4 displays the general framework of how different factors interact and lead to cooperation and collective action, and in turn influence MSME competitiveness. While the basic mechanism is applicable to most cases, the intensity and ranking of importance of the relevant factors as well as the potential benefits from cooperation

**Fig. 3.4** Cooperation, collective action core relationship, and policies. *Source* Author's own creation

may vary according to a set of "structural variables," the types of which depend on the context and issues at hand (Ostrom, 2010).8 In our survey, we use fourteen categories but not all of them can be classified as structural variables. Those categories essentially represent different characteristics of the respondents (the left side of Fig. 3.4).

For cooperation to happen, trust is an important prerequisite. As a central component of social capital, trust can determine the strength of social ties and hence cooperation too. An MSME may cooperate in a cluster because it has come to embrace a norm (a worldview) of being prepared to trust other MSMEs. This exhibits a courage to cooperate, because one player trusts that others are also going to cooperate. In most cases, however, the process of formation of social capital is sensitive to the political and social forces as a result of the prevailing institutional arrangement.

If social capital associated with a set of largely informal relationships can lead to cooperation for collective action, then trust and reliance may become both, a condition and an outcome of it. The question is, how social capital—or more specifically trust—is formed? Under general circumstances, trust arises from received reputation, the process of which is influenced by existing institution. Given an individual's reputation, different institutional arrangement results in different length of time required for others to trust (reciprocity), and different intensity of the trust (upper part of Fig. 3.4). Also, current reputation may be influenced by past reputation (another type of reciprocity). Unlike many studies on corporate reputation, here the pursuit of a better reputation is not an end in itself, rather a precondition that could eventually aid individuals to earn trust from others.9 Nonetheless, in cases related to cooperation among MSMEs, reputation factor can contribute to trust building, although the influence may evolve in different directions; in some cases it causes trust to disappear, in others it makes individual trust advance into a stronger mutual trust. In short, there are complex linkages among variables at multiple levels that could affect individual reputations, trust and reciprocity, and that may lead to cooperation.

What is the essence of cooperation? Strictly defined, cooperation is a situation whereby a group of individuals act together to a common end. Although it is often connotated as a good thing, cooperation is not always socially optimal. Collusion among firms that generate private benefits at a huge social cost (negative externalities) is a noted example. But in the efforts to improve MSME performance, cooperation is a positive thing to have, although the nature and size of the benefits depend on the type of cooperation, e.g., voluntary or compulsory. Individuals who decide to cooperate may do so either voluntarily, or forced and mandated by others (through government regulation). In general, there are usually positive externalities to voluntary cooperation and negative externalities to coerced cooperation. At any rate, it

8 Many formal game-theoretic models generated a list of "structural variables" that often affect the likelihood participants will be able to achieve outcomes greater than the deficient Nash equilibrium.

9 In the business strategy and marketing literature, the relation between trust and reputation is anything but consensual. Some argued that reputation is a consequence of trust (Walsh et al., 2009) and others suggested that reputation is an antecedent of trust (Doney & Cannon, 1997; Keh and Xie, 2009).

is important to distinguish these two features when discussing key components of cooperation.

Similar to the case of prisoner's dilemma, rational individuals in a social dilemma problem will take actions that maximize short-term benefits to self but generate lower joint outcomes than could have been achieved. Although in such a situation a better optimal outcome could be achieved if individuals cooperate by selecting strategies other than those prescribed by the Nash equilibrium, in pursuit of an optimal outcome they may end up not cooperating even if it is in their interest to do so (Ostrom, 2007). Hence, cooperation is not guaranteed. It requires an enabling institution that can be furnished by some policies.

Closely related to cooperation is the concept of collective action. It occurs when a group of individuals is required to contribute to an effort in order to achieve an outcome. The central difference—and the relation—between a strictly-defined cooperation and collective action lies in the words 'required to contribute.' In a cooperation, participants act together because they believe by doing so the outcome will be to their benefit, or that it will be better than if the work is done individually. But there is no stated guarantee that such an outcome will materialize; the emphasis is on 'acting together.' Collective action adds a condition that the outcome will be attained if everyone contributes, hence no free-ride. Consider a situation where MSMEs decide to join a cluster.While it may imply cooperation, only if every MSME operators contributes it qualifies as collective actions. This highlights the importance of distinguishing voluntary and forced cooperation. Most studies show that ownership of collective action through voluntary participation makes cooperation more effective.10

It is known in game theory that self-centered individuals can be better-off by being free-riders, i.e., letting others contribute to the collective action while they do not. This is a classical problem of public goods and common resources raised by Olson (1965), where the distinction between excludable goods (benefits can be excluded from individuals who do not contribute) and nonexcludable goods (benefits can be reaped by all, irrespective of contributing or not) is fundamental. Because of free-ride, collective action can run into a problem, especially when it is difficult to exclude non-participants from benefiting the outcome of collective action of others. For cooperation and collective action in MSME, the risk of free-riding is also there. It is therefore necessary to safeguard the virtues of cooperation and collective action by exposing the components that could either eliminate or minimize the possibility of free-ride. Two of such components are 'participation' and 'coordination.' Whether cooperation will effectively improve MSME performance depends on the quality of cooperation, for which active participation and coordination matter (see again Fig. 3.4). Expressing the willingness to cooperate without actually participating in collective action opens up the possibility of free-ride, and cooperation

10 Using the case of cooperative water projects in least developed countries, Grootaert (2001) showed that returns to voluntary projects are greater than returns to similar projects implemented by governments.

without coordination may result in a sub-optimal outcome. Thus, both participation and coordination can potentially remove or minimize the possibility of free-ride.

While trust can initiate participation through cooperation, the reverse may also be true: trust in others is created through regular participation in voluntary associations (Newton, 1999). The implication is, when a norm to trust is absent, participation may help to develop trust; hence the two-way arrow between participation and trust in Fig. 3.4. The type of participation—imposed or voluntary—will determine the nature of that two-way relation. Coordination among members of a cluster can improve individual capacity and potentials through cooperation with other MSMEs, for example in production technique, digital use, and networking. The gained benefits range from monetary (joint purchase of inputs, joint sales) to non-monetary (knowledge, information, experience) category, and the effectiveness to reap those gains depend on the type of coordination, e.g., strictly for business purposes or for other social considerations (e.g., sense of camaraderie, pity, shamefulness) and the nature of coordination (e.g., voluntarily versus imposed). Nonetheless, the resulting benefits are likely larger than if they are obtained without coordination.

What is then the role of policies? Human actors are able to solve—lbeit not all collective action problems on their own without external rules and outside intervention. But for that to happen, institutional arrangements and policies furnishing the enabling environment are necessary. To the extent the ability to cooperate in collective action problems is key for improving MSME performance, it is important to identify which policies and institution discourage opportunistic behavior (free-ride) and which promote cooperation in collective action. Providing the latter should be the emphasis of policy. On the other hand, policy intervention can also be problematic if the basis for reliability falls short; for example, when state-owned enterprise is involved directly with commercial activities that could compete with MSME's activities. Coercion through instructions is another institutional approach that may not be well-received and is likely to create opportunistic behaviors or free-riders.

In the current research, we classify policies to furnish the necessary institutional arrangements into three categories: First, linkages policies aimed at supporting the interactions and cooperation among MSMEs as well as between MSMEs and other relevant parties (large firms, financing institutions, supporting industries); second, structural policies to promote and improve MSME performance, many of which have been tried by the government but may require improvements and better prioritization (e.g., training, promotion, financing); and third, policies aimed at providing MSMEs with a greater access to digital or other technology (green technology).

The framework in Fig. 3.4 and the discussions above suggest that cooperation and collective action have an important role in improving MSME performance, and the interplay between policies and a set of social capital can determine the nature and size of the improvement. Insofar establishing clusters of MSME has been common throughout Indonesia, these clusters serve as some sort of 'vehicle' for cooperation and collective action. However, since the types of cooperation and collective action can influence the outcome, distinguishing the types of cluster is also necessary.

Note that the term "cluster" here is close to the standard and formal definition according to The United Nations Industrial Development Organization (UNIDO), which is "geographical concentrations of inter-connected enterprises and associated institutions that face common challenges and opportunities." A similar definition by Porter (2000) is "a geographically proximate group of interconnected companies and associated institutions in a particular field, linked by commonalities and complementarities." In our case, the relevant emphasis from those two definitions are the terms 'geographical concentration/proximity' and 'common challenges and opportunities/commonalities.' More specifically, MSME clusters refer to the agglomeration of the inter-related MSMEs and the related institutions. Members of a cluster usually produce and sell a range of related or complementary goods and services, and experience the same challenges as well as opportunities. If the ensuing network results in new ideas, initiatives, and innovations, it is said that the clusters are robust (Ceglie & Dini, 1999). It is important and highly relevant to highlight the role of local-own initiatives in problem solving, especially giving the decision-making power to the MSME themselves. Otherwise, the external parties tend to see the situation and problems faced by MSMEs through the lens of their own biases, and not recognizes the real or hidden needs of the cluster members based on their experience. The behavioral biases can range from overoptimism, confirmation bias, and fixation on first solutions, without considering what will or will not work. As demonstrated in Chap. 5, the local community tend to find their own solutions to problems and challenges they are facing. External parties can help facilitate the implementation of such solutions.

The relevant parameters to reflect different perceptions of cluster members are the "structural variables" discussed earlier, such as location (rural–urban, and across regions), size (number of employees), status (success or not, length of operation and BI assistance), technology (digital and green), and market (local, non-local, or exports).

To verify the relevance of the above concept and capture the perceptions of MSEs, we conducted a survey during the period of September–November 2020. The survey involves 121 + MSE as the respondents. The goal is to get the perceptions directly from them over the role of a set of policies, social capital, and the interactions between the two, based upon which the type of cluster deemed most relevant for competitiveness is determined. The trust-based cooperation, in which the key components are participation and coordination, is subsequently analyzed based on the responses/perceptions of respondents.

To set the stage, Fig. 3.5 summarizes the outline of the framework used in the survey. Although in the survey we applied it largely to MSEs, the framework in Fig. 3.4 and the outline in Fig. 3.5 is fairly general and applicable to medium enterprises as well (hence the MSMEs). As discussed earlier, the government policy to establish an enabling institutional arrangement and a set of social capital to induce cooperation for collection action will jointly determine MSME performance, which, in this survey is defined as improved competitiveness. For cooperation and collective action to work more effectively, participation and coordination as the components of social capital are required. The three sets of policy expected able to improve the institutional arrangements are: those intended to strengthen the interactions among MSMEs as well as between MSMEs and other relevant parties, structural policies to

**Fig. 3.5** Summarized framework of the survey. *Source* Author's own creation

improve MSME operations, and policies to enable MSMEs to use better technology (digital and green technology).

The interplay of policies and social capital components works through MSME clusters, some of which are imposed or mandated by the government, some are formed for purely business purposes, and others are used for social and other purposes. Practically speaking, for those who are member of a cluster, the joint-effects of the interplay between policies and social capital are constantly felt and experienced during their day-to-day operation. For those who are not members of any cluster, the choice of cluster type should only reflect what they aspire. It is in this context the perceptions directly obtained from MSME operators are expected to capture both, their true and real conditions and their aspirations.

The technique we are adopting in the survey emphasizes the power of human perceptions acquired by asking the respondents to compare relevant attributes or factors in a pairwise fashion, from which we then derive the corresponding ratio scales.11 Unlike in a standard way of ranking which uses either a simple ordering as in indifference curve (ordinal scales), or absolute physical measure as in most economic indicators (cardinal scales), using ratio scales allows us to evaluate human perceptions in a more balance way. First of all, insofar there is no absolute valuation on every attributes—or on everything in life for that matter—especially when those

11 Perceptions are the ultimate lens through which human beings view reality and operate with versions of that reality. Hence, there is no such thing like "right" or "wrong." What matters is what they perceive and express. In order to understand the real situation and problems faced by MSMEs, we need to know what they actually think and perceive, not the "reality" that others see or want MSMEs to see.

attributes are intangible, each of them has to be evaluated in comparison with other attributes; hence, running a pairwise comparison on relevant attributes is imperative. Secondly, since any ranking of attributes conveys human judgement after considering ("calculating") the pluses and the minuses of those attributes, the revealed choices reflect not only the preference toward one attribute over another but also the weight of that preference. Thirdly, once the preference and the weight of attributes are made, depending on how we structure the framework, we may need to compare the resulting scale of selected attributes that represent the plusses with the scale of attributes that reflect the minuses; that is, the upside (the benefit) needs to be compared with the downside (the cost). When intangible attributes are involved, as in our case, such a comparison cannot be made unless ratio scales are used.

The approach of using ratio scales is fundamental in the Analytic Hierarchy Process (AHP) and Analytic Network Process (ANP), a brief description of which is given in Appendices A.1 and A.2. In cases where there is no feedback effect, using a hierarchy approach to structure the problem is appropriate, and we can apply a method using the eigen-vector based on principal eigen-value of the relevant pairwise comparison matrix. This is basically how the AHP works. But when feedback effects are present as in our second set of survey, in which elements in each level of a hierarchy are interrelated with elements in other levels or other elements in the same level, we need another approach capable of dealing with a system where each pairwise comparison matrix is directly or indirectly linked to other pairwise comparison matrices. This is where the use of the ANP is necessary, for which the so-called 'super matrix' needs to be constructed (see Appendix A.2 for more details). The results from using the ANP has been known to be more stable and robust than those from using the AHP.

## **References**

**Open Access** This chapter is licensed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license and indicate if changes were made.

The images or other third party material in this chapter are included in the chapter's Creative Commons license, unless indicated otherwise in a credit line to the material. If material is not included in the chapter's Creative Commons license and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder.

## **Chapter 4 Mitigating Dualism and Exploiting the Interplay of Policy-Social Capital**

**Abstract** The centripetal forces of agglomeration, reflected among others in the structure of the economy and the nature of interrelations among regions (interregional multipliers), limit the effectiveness of spatial policies. Meanwhile, the importance of social capital is revealed from the MSE survey. Social planners could improve the design of policies by understanding the perceptions and aspirations of MSEs to make any measures more compatible with the prevailing social capital.

**Keywords** Quality of leaders · Hierarchy · Network · Policies · Social capital · Perceptions

#### *Conversation*

*A: "We need to ENLIST local leaders and small businesses to support national policies to reduce inequalities and dualism."*

*B: "Far more importantly, we need to LISTEN to those affected by the policies and the SILENT groups whose silence must not be mistaken for their absence."*

*A: "If a small business operator RELUCTS to use green technology, e-commerce, and e-finance, there is nothing we can do to help."*

*B: "Understanding their behavioral insights and encouraging them to work together in a CLUSTER will raise their propensity to adopt new technology by way of increased communication and interactions."*

*A: "That is why mandating small businesses to form a cluster is not just for DECORATION, but it is meant to facilitate interactions among them." B: "While interactions in a cluster are necessary, active participation and COORDINATION are essential for the collective actions to work effectively."*

*A: "We also used examples of success stories so that small businesses are motivated to replicate because THEY SEE the evidence directly." B: "People do not respond to what THE EYES and ears tell them but what the brain makes them see and hear."*

It is clear from the discussions in the preceding chapter that forces of agglomeration could risk a worsening dualism and inequality. On the other hand, potential benefits of the same forces offer incentives for MSMEs to operate in clusters, in which the effectiveness depends crucially on the interplay of policies and social capital.

One may argue that although Chap. 2 provides a clear evidence of interregional inequality in Indonesia, several factors and events unrelated to agglomeration may have caused the inequality. Disentangling sources of inequality, let alone isolating the effect of agglomeration, may not be empirically feasible. But the centripetal forces of agglomeration are undeniably at work. Other factors influencing the effect of such forces are the structure of the economy and the nature and scale of interrelations among regions, both of which are reflected in the intraregional and interregional multipliers. The first part of this chapter discusses the effect of these factors on growth and inequality between regions in Indonesia, and the second part is devoted to the analysis of survey results based on the framework discussed in the preceding chapter.

## **Interregional Multipliers**

In conjunction with the earlier question about the role of institutional change, a more general question is what kind of policy intervention can effectively counter the forces of agglomeration? The question of interest here is whether redirecting spending towards LDR can be effective to reduce the gap between DR (core) and LDR (periphery). To answer this question, we utilize the information associated with the structure of the regional and interregional economic relations from a series of Indonesia's multiregional input–output (MRIO) tables consisting of five regions: Sumatera, Jawa-Bali, Kalimantan, Sulawesi, and Nusa Tenggara-Maluku-Papua.

The theoretical basis of interregional multiplier rests on the idea that there is some sort of relationship between the national economic activity and the regional economy.1 While standard I-O multipliers capture the direct, indirect, and induced effects of any changes in one sector of an economy upon other sectors, they are unconcerned with the location of the sectors. If the issue of interest is how to reduce the gap between core and periphery, location obviously matters. The location of sectors where the initial changes occur as well as the location of activities affected by those changes determine the net results of interregional inequality. To the extent increased spending in a sector located in a region will obviously boost the growth of that region but not necessarily lower the inequality between regions, in addressing the question whether redirecting investment towards periphery will reduce the gap between core and periphery cannot ignore the mechanisms of interregional multipliers.

Suppose a major infrastructure is to be built. We know that the project will boost growth of the region where the project is implemented as well as the national growth. But what about its impact on the gap between DR (core) and LDR (periphery)? Ignoring this question leaves us with criteria only about the costs and benefits of the project including the overall multiplier effects. Since DR is typically in a better position in terms of existing facilities or infrastructure (logistics, financial services, etc.) and the purchasing power that reflect market conditions, in most cases the decision ends up with DR as the preferred location of the project.  This argument, however, essentially puts growth above inequality, and it completely ignores the relative size of interregional multipliers when it is compared with a scenario whereby the project is built in different locations. That is, what about if the infrastructure is built in LDR?

One way to find out is by comparing two types of multipliers in both locations, the intraregional multipliers and the interregional multipliers in DR (µDR and µDR→LDR) and in LDR (µLDR and µLDR→DR). Even if the infrastructure project is built in LDR, the cross-regional direct and indirect effects of it could be larger in DR than the cross-regional effects in LDR if the infrastructure is built in DR, that is µLDR→DR > µDR→LDR.

1 One of the issues of interest in regional growth theory concerns with the activities in a region that could be the source of regional growth. Focusing on the size of demand as key determinant, the "economic base" theory distinguishes internal and external demand (exports). The postulate is, export is the main driver of regional growth. Hence, the expansion of a sector whose products are largely exported (the "basic sector") will stimulate production of the non-exporting or "non-basic" sector through some sort of multiplier. Another theoretical basis rests on the idea that any dynamic sector located in a certain region, called the "growth pole," will create an impact on local and broader regional economies also through a multiplier.

We can think of a scenario whereby increased demand and production in LDR leads to a larger increase of demand and production in DR. The same applies to the effect of increased income and consumption (part of the final demand) in LDR on DR. It is not uncommon to find that residents in LDR prefer to spend their increased income for products and services produced in DR. At any rate, comparing interregional multipliers is an important step for addressing the question whether a policy to redirect spending towards LDR be effective to reduce the gap between core and periphery. To do so, we essentially conduct two different scenarios of regional investment allocation policy and compare their results. This is different from the "before-and-after" approach used in the discussions of Chap. 2.

Measuring the interrelationships between regions based on the coefficient of interdependence (COI) from Indonesia's MRIO in 2005, 2010, and 2015, without looking at the detailed print the interactions within each region and between regions have generally increased, although by using different measure Anglingkusumo et al. (2014) found that regions throughout the country is far from being integrated. However, looking at the trend by pairs, the economic interactions between Jawa and non-Jawa except Sumatera have declined over the years, and so have the interactions between Sumatera and other non-Jawa regions. Increased interactions are most notable between Sulawesi and other regions.

A different trend is detected between interregional backward linkages and forward linkages; the two have not been moving in the same direction. On the one hand, the benefits from backward linkages received by regions outside Jawa from increased final demand in Jawa have been on the rise; that is, more activities in Jawa demand more inputs from outside Jawa. The opposite trend holds when the increase of final demand is reversed. The demand for inputs from Jawa mostly declines, with notable exceptions if the increase of final demand occurs in manufacturing and "other" sectors in Sumatera, as well as in mining sectors in Bali-NT and Maluku-Papua (Table 4.1). On the other hand, the interregional forward linkages show an opposite trend (growing activities in Sumatera generate greater consumers-oriented activities in Jawa).

Given the above trends, the overall net outcome shows that the benefits accrued to non-Jawa from increased activities in Jawa remains much smaller than the benefits received by Jawa from increased activities in regions outside Jawa. From the perspective of regional investment allocation, this can be interpreted as follows.

Since the interregional multipliers received by regions outside Jawa from adding investment in Jawa are much smaller than the interregional multipliers received by Jawa if the augmented investment is made in outside Jawa (compare the bar charts on the right with those on the left in Fig. 4.1), the cross-region gains enjoyed by Jawa from investing in outside Jawa are greater than the cross-region gains reaped by regions outside Jawa if the location of investment is reversed. As shown in the figure, although fluctuating the gap stood out persistently from 2005 to 2015.2 This

2 By 2015, the largest gains enjoyed by Jawa is when the new investment is made in Sulawesi followed by Sumatera, whereas the largest gains from adding investment in Jawa are enjoyed by Sumatera.

**Table 4.1** Percentage of inputs demanded by non-java sectors from Java 2010 and 2015

*Notes* The value for a sector-region is calculated by dividing the sum of intermediate inputs from Jawa for that sector-region, divided by either total inputs or total intermediate inputs for that sectorregion. Higher value means higher % of inputs demanded by non-Jawa from Jawa. Bold cells in 2015 columns indicate that the value increases from 2010

*Source* Calculated from Indonesia's MRIO tables, 2010, 2015

**Fig. 4.1** Interregional multipliers: Jawa and regions outside Jawa. *Source* Calculated from Indonesia's MRIO tables, 2005, 2010, 2015

may come to a surprise for those who think that investing in outside Jawa at once will automatically reduce the gap between non-Jawa (LDR) and Jawa (DR).

As explained earlier, the main problem lies in the structure of the prevailing economic interrelationships between Jawa and non-Jawa. Depending on the size of the within-region effect (intraregional multiplier), simply reallocating more investment to non-Jawa without altering that structure will not guarantee a reduced gap between the two regions. The difference in the interregional structure combined with the forces of agglomeration are too strong for the policy to counter the divergence.

Altering the structure of a region's economy and the economic interrelationships among different regions is not an easy task. It involves changes in the institutional arrangement that go beyond strictly economic matters. Since the effectiveness of any policy intervention is influenced by how communities respond to the policy, social capital is playing an important role. To be effective, therefore, a policy ought to be designed such that it will be compatible with the prevailing institutional arrangements. Undermining the role such institutional arrangements can leave a well-intentioned policy ineffective, or it can even make the policy backfire.

## **Survey Results and Analysis**

As described through the framework in Chap. 3, understanding the interactions between institutional arrangements and policies could be key for the efforts to improve MSME performance. By emphasizing the need for 'cooperation' and 'collective actions' among MSEs, the main focus of the survey is to delineate the mechanisms by using the perceptions and opinions of MSEs on how such interactions determine the type of cluster deemed suitable for making cooperation and collective actions effective to improve the competitiveness.3

To capture perceptions, we utilize both the AHP and the ANP. The starting point is to distill MSEs' current conditions and their experience and aspirations for cooperation in a cluster. In particular, given the prevailing conditions we wish to capture the respondents' preference towards different types of cluster deemed most relevant for improving their business performance. Three types of cluster are considered: clusters mandated by either local or central government, cluster formed for purely business purposes, and cluster for social and other purposes not directly related to business operations. To adopt a balance approach, two sets of hierarchy are built: one for the upside (benefit) another for the downside (cost). The prevailing conditions are exemplified by a set of factors or elements in each hierarchy: those leaning towards

3 Note that all samples used in the survey are obtained from, and suggested by, the SMEs Development and Consumer Protection of Bank Indonesia. According to the definition adopted by the 'Statistics Indonesia,' which is the country's Central Agency on Statistics (known as BPS or *Badan Pusat Statistik*), based on assets (outside land and building) and the size of sales, only 1 of all samples we used in the survey meets the BPS definition of 'medium' enterprise, i.e., > 500 million rupiah and > 2.5 billion rupiah, respectively. Hence, the survey analysis reported in this chapter applies more appropriately to the case of micro and small enterprises (MSEs).

the benefits of a cluster type (Fig. 4.2) and those towards the cost of such a cluster (Fig. 4.3).

Prior to the survey, during the process of structuring the hierarchies we conducted informal interviews with some MSMEs, from which we learned among others that during the Covid-19 crisis some MSMEs began to produce masks to compensate for the substantial decline in sales of their main products. As many MSMEs are hit hard

**Fig. 4.2** Benefit hierarchy. *Source* Author's own creation

**Fig. 4.3** Cost hierarchy. *Source* Author's own creation

and struggling to survive, diversifying products is one of the changes they feel they have to make. Even among MSMEs who are not much impacted by the pandemic, some decide to do product diversification. But not all MSMEs are in a position to do so, depending on the nature of their business and other binding constraints. Nonetheless, we decided to include 'diversification' as another alternative option along with the three cluster types shown at the bottom level of hierarchies in Figs. 4.2 and 4.3.

Note that the options of cluster type and 'diversification' are intended to represent respondents' preferences which may or may not reflect the current conditions. For example, it is possible that some MSEs who prefer a business-oriented cluster may currently belong to a government-mandated cluster, or not a member of any cluster. Similarly, some who express to prefer diversifying their products may have not done so currently.

In the benefit hierarchy, we begin with the spatial dimension ofMSE by identifying their location of operation, whether they are closer to the market, closer to the inputs and other raw materials, or neither (footloose). The benefits are distinguished into two types, monetary and non-monetary. Under the monetary benefits, given their location the size of sales and the gains accrued from being concentrating in adjacent location (agglomeration economies) are ranked. Under the non-monetary benefits, three advantages are identified, ease to acquire information and knowledge, getting a good standing or status from being involved in the business, and receiving nonmonetary supports from the community and family. By ranking the importance of the above elements in a pairwise fashion, and considering the relations between elements in one level of the hierarchy and other elements in the level below it, the preference of the respondents towards different types of cluster including the most beneficial type is determined (Fig. 4.2).

In the cost hierarchy (Fig. 4.3), we begin by identifying whether transaction costs are less or more burdensome than operating costs. There are three types of transaction costs to be considered, transport costs, costs associated with bureaucracy (e.g., to get license or permit, and to receive government supports and assistance), and social costs (e.g., community dissatisfaction due to pollution of all sorts and other negative externalities). Operating costs consist of cost of inputs and raw materials, cost of capital in terms of difficulty to access and interest rates, labor costs in terms of quality and wages, and utility costs including rent. Their locational preference is subsequently ranked. However, unlike in the benefit hierarchy, this time the respondents will make the ranking based on the prevailing cost structure, implying that they may feel it would have been less costly if they move either to a closer-to-market location or to a closer-to-inputs location, or they may feel that the current location is more preferable. Given such a preference, the ranking of cluster type is subsequently made.

By comparing the ranking of the type of cluster including 'diversification' from the benefit hierarchy and that from the cost hierarchy, we can deduce the true (net) preference of the respondents. This is done by taking the ratio of the resulting weights assigned to each option from the benefit hierarchy and those from the cost hierarchy. The most preferred choice is the one with the highest ratio.

The following are the summarized results from the survey based on the benefit/cost framework above. Given their current location, most urban-based MSEs are of the opinion that monetary benefits are greater than non-monetary benefits, where sales increase is considered the most important of all. The exceptions are for MSEs in Kalimantan who rank agglomeration economies to be more important than sales. A relatively high concentration of MSEs in low-density yet large area of Kalimantan may have been the reason why the gains from agglomeration are perceived greater than the gains from sales.

Unlike their counterparts in urban areas, majority of rural-based MSEs feel they obtain non-monetary benefits more than monetary benefits. The most important nonmonetary benefits is the ability to acquire information. It is likely that in terms of making profits most rural-based MSEs have been doing less well compared to urbanbased MSEs, but their persistence to improve, including through learning from new information, make them more resilient. There are quite a large number of rural-based MSE (62%) who consider that monetary benefits are smaller than non-monetary benefits. The spectrum ranges from male-owned, with education lower than average, household size is smaller than average, not yet successful, having a large number of employees, operate longer than the average period, using digital technology, not yet a member of any cluster, located in Jawa, Sulawesi, and operate in trade and services. Given the above prevailing conditions, the type of cluster that aII categories of MSEs feel most beneficial is the business-oriented one (as an example, see the testimony from woven fabric MSM in Tidore in Appendix A.6).

On the cost side, all MSEs express that operating costs are more burdensome than transaction costs, and majority (30 out of 41 categories) believe that the costs of inputs and raw materials are most burdensome. The categories that consider costs of capital are more taxing consist of rural-based, age lower than average, education lower than average, household size is smaller than average, not yet successful, operate longer than the average, received supports from BI for a longer period than average, member of larger cluster, located in Sulawesi, Sumatera, and operate in the agriculture sector. Only MSEs in Kalimantan feel that the cost of labor is most burdensome. Again, this is likely due to the region's low population density that makes the cost of labor relative higher than in other regions (see the testimony of MSME rendang in West Sumatera and MSME red chili in Lhokseumawe in Appendix A.6).

Given the above, majority of MSEs perceive that the type of clusters not strictly intended for business purposes would be costly, especially if they are meant to serve only for social function. On the option of diversification, MSEs in Jawa, rural-based MSEs, and those operating in the agriculturaI sector feel that diversification is not a viable option. They even consider it as the costliest of all options. In the eyes of MSEs that have already used digital technology and those that operate in trade and services sector, the costliest option is to have a government-mandated cluster. There seems to be a strong perception among MSE in this category that such a cluster allows government controls and intervention that could hinder their business.

It is interesting to note that if we consider only the results from the benefit hierarchy, a government-mandated cluster is actually ranked second from the top (by more than half, or 26 out of 41 categories). Hence, it is also highly preferred by the majority. However, given the potential costs of the option, a number of MSE categories (as mentioned above, the digital technology users and trade sector MSEs) feel at the same time that it is too costly. These both categories rank governmentmandated cluster as the costliest option. This example demonstrates crucially the reason why we always need to consider the upside and the downside of perceptions when trying to acquire human preferences. At any rate, after considering the overall results from the benefit and the cost hierarchies, the benefit/cost ratio show that the majority of respondents pick business-oriented clusters as their top preference. Note again that this choice is irrespective of the clusters they are currently member–or not member–of.4

The reason why diversification does not seem to be preferred by most MSEs despite the difficulties caused by the Covid-19 crisis is because the nature of their business does not make such an option feasible. Rural-based MSEs, Jawa-based MSEs, and MSEs operating in the agricultural sector are particularly not in favor of diversification. For them, the possibility to do so is second to none.

Having revealed MSE's preference towards the type of cluster given the prevailing conditions, we now investigate the role of policies and social capital by unravelling their perceptions towards the relevant components, as well as the feedbacks or internal and external interrelations (the inner dependence and outer dependence) of these components. The previous approach cannot be used when feedbacks or interrelations are present. Therefore, we use a network system to allow for the feedback effects to operate (using ANP instead of AHP). As mentioned earlier, the ranking derived from using the ANP is more stable and robust than using the AHP. Figure 4.4 depicts the framework of the network.

To the extent both policies and social capital influence the effectiveness of a cluster for engaging cooperation and collective action, respondents are first asked to rank and weigh the importance of a set of policies and components of social capital. The framework of the network is structured such that the resulting ranking is eventually linked to the type of cluster. The results may or may not be different from the earlier ranking derived from using a hierarchy approach.

As described before, three categories of policies are selected based on their potential in providing–jointly with social capital—an enabling institutional arrangement. In the first category (linkages/interactions), there are four components deemed relevant to support cooperation and collective actions: policies to facilitate and enhance interactions among MSEs and between MSEs and larger firms/industries, policies to link MSEs with financial institutions, and policies to enable MSEs to access and use the product and services of supporting industries (e.g., packaging, logistics).5 Interactions among these policies are also considered, because in practice the effects of one

4 Two minor exceptions are: MSEs who generate highest benefit/cost ratio for diversification (urbanbased, located in Kalimantan, Papua, and Sumatera), and MSEs whose benefit/cost ratio is highest for the government-mandated cluster (those operated by older people).

5 A survey on 1000 MSMEs across 9 major cities in Indonesia conducted in 2018 shows that MSMEs that joined a multi-service tech platform providing access to transport, payments, food delivery, and logistics find their partnership useful in raising their transaction volume and revenue. Moreover, majority MSME also viewed that the merchant management technology of the tech platform played

**Fig. 4.4** Interplay of policies and social capital: A Network of feedback and interrelations. *Source* Author's own creation

policy can influence–and be influenced by–the effects of other policies. For example, larger firms may help provide the financing facility and cooperation between several MSEs, and the presence of supporting industries allows several MSEs to jointly utilize the industries' products and services. Such internal effects are denoted by circling arrows at the top of each policy box in Fig. 4.4.

Similar effects, albeit with a different degree of completeness that may also include feedback influences, are applied to the structural category of policy consisting of measures to strengthen the administrative and accounting capacity, policies to promote MSE, to assist MSE to improve the production process and product design, and to increase MSE's access for low-cost financing. The feedback effects occur, for example, between promotion and product design where the preparation for promoting events may lead MSEs to come up with a new or modified design (e.g., matching

an important role in accelerating and improving MSME growth and competitiveness in the digital era (Lembaga Demografi FEB-UI, 2018).

with the taste of consumers), on the other hand the new design may change or refocus the type and content of the promotion.

In the category of technology policy, no feedback links are expected. There are four components in the category: digital payment, e-commerce including the use of social media, e-finance, and green technology. It is important to note that policy categories can be interrelated in one way or another. In the case of technology policy, for example, it is both affecting and affected by some components in the linkage policy, but is only affected by some components in the structural policy category. More crucially, they are all interrelated with the social capital components. These particular interrelations capture the core structure of systemic framework in our survey. The working of the interplay between policies and social capital determines the type of cluster where cooperation for collective action is expected to improve MSE performance.

As has been discussed earlier, there are two categories of social capital influencing the nature and quality of cooperation for collective action: participation and coordination. Under the participation category, there are four types to be ranked: participation mandated by regulation, participation for strictly business affairs, participation for acquiring information, and participation for social interactions. Related to this classification is the categorization under coordination, which also consists of four components similar to those under participation: coordination mandated by regulation, coordination for purely business purposes, coordination for transparency (where the role of information and communication is key), and coordination for social interactions purpose.

Similar to the policy categories, there are interactions among–and feedbacks between–all these components (see circling arrows above the participation and coordination boxes in Fig. 4.4). However, those interactions should be interpreted differently from the earlier case. For example, if individuals have chosen to participate in a cooperation for strictly business purposes, they may also wish to participate—or already participated–in different cooperation (through a different cluster) for other purposes, say, acquiring information or having social interactions. Which between the two is most preferred reflects how the business-oriented participation "influences" their preference towards participating for other purposes. On the other hand, if individuals have participated in a cooperation for, say, a social interaction purpose, they may wish to participate—or already participated–in another cooperation that is strictly business oriented. This example represents the interactions and feedback effects in the relations between participation for business purpose and participation for social interaction purpose.

Due to this distinctive nature of relations, and the possibility that MSEs participate in more-than one cooperation, we structure the internal feedbacks within the social capital categories in way that is depicted in Fig. 4.5. Similar explanations can also be used for the coordination category (Fig. 4.6).

Using the frameworks in Figs. 4.4, 4.5 and 4.6, results of the systemic survey are as follows. The first stage is to determine the respondents' views towards the importance of policies viz social capital. This stage is used to test the hypothesis that

**Fig. 4.5** Interactions within 'participation:' feedback in near completeness. *Source* Author's own creation

**Fig. 4.6** Interactions within 'coordination:' feedback in near completeness. *Source* Author's own creation

'policy' dominant scenario (policy is more important than 'social capital') does not suffice to ensure MSE improvement.

Results of the survey reveal that a slightly less-than half of the respondents in our sample consider 'policy' matters the most–more so than 'social capital'–in affecting MSEs' efforts to improve competitiveness. Among the other half who do think that it is not 'policy' that matters the most, about one-third are of the opinion that both 'policy' and 'social capital' are equally important (equally weighted), and one-sixth (17%) consider 'social capital' is more important than 'policy.' Two things influence these results: the structural variables discussed earlier (see again Fig. 3.6), and the spatial dimension (regions).

Different characteristics of respondents (structural variables) give different results of judgement. For example, shown in Table 4.2, among MSEs operating in the agricultural sector, a considerably large share (64%) believe that social capital and its interplay with policy play a much more important role than policy-dominant scenario in influencing MSE performance. Another characteristic showing a large portion of MSE who believe that relying on policy more than social capital does not suffice to improve performance is the size or number of employee. More than 60% MSEs with a relative large number of employee hold such a view. Two other characteristics having high shares are related to the use of digital technology and the number of children in the family. MSEs that do not use digital technology and those whose operators have a relative large number of children are also of the opinion that policy-dominance cannot be effective to improve MSE performance; the corresponding shares are 57% and 56%, respectively.

Most MSEs (64%) that have been receiving assistance from BI for a longer-thanaverage period also believe that policy dominance is not sufficient. Looking into more details, the share of those having such a view who are both members of a cluster and receiving BI assistance is over 70%. To the extent most MSE assisted by BI-KPWs have performed well (in most cases better than those not assisted by BI-KPWs), we find this result particularly interesting. The criteria and procedure adopted by BI-KPWs to select MSE, and the comprehensive approach they use in assisting them have clearly contributed to the improved performance of those MSEs, making them understand better about the importance of social capital.

Among policy categories, majority MSE prefer linkage policy to help create and strengthen the interactions between MSEs and other relevant parties. Within social capital, coordination is considered most important partly because the majority of respondents are already actively participating in a cluster but still lack of coordination required to make the cooperation effective. For MSEs who strictly rank policy higher than social capital, the linkage policy is ranked the highest, with the exceptions of those whose owners have a large number of children, have a long relationship with BI, exporting, and those operating in the agricultural sector. According to these MSEs, policies related to technology is most important.

Among MSEs who strictly prefer social capital, the results are split equally, i.e., half prefer participation and another half prefer coordination. Only MSEs not using digital technology, exporting, member of a cluster, and operating in trade and services sector consider participation more important than coordination. Hence, while in average coordination is viewed more important than participation, for MSEs whose opinion is strictly leaning towards social capital the importance of participation exceeds that of coordination. A complete list of the ranking of policy and social capital categories broken down by "structural variables" (different characteristics of respondents) is displayed by spider charts in Fig. 4.7a–n.

The spatial/regional dimension is equally important. In contrast with urban-based MSE, the number of those in rural area who believe that policy dominance will not suffice far exceeds the number of those who believe otherwise (56% vs. 44%). By

**Table 4.2** Distribution of perceptions towards the importance of policies and social capital

**Fig. 4.7** Ranking of policy and social capital components: MSE characteristics. *Source* Compiled Survey results

**Fig. 4.7** (continued)

regions, MSEs with higher share that hold such a view are in Jawa, Sulawesi, Papua, Maluku and NTT. Figure 4.8a, b display the spatial/regional dimension of the ranking of policy and social capital categories.

Among different policies, both urban-based and rural-based MSEs prefer linkage policy, followed by technology policy. Between the two categories of social capital, the need for coordination is ranked slightly higher than for participation. By regions, MSEs in all provinces except Sumatera unanimously put the policy to strengthen linkages at the top and technology policy at the second. In the case of MSEs in Sumatera, the prioritization is reversed: technology policy at the top, followed by policy for linkages.

Next is the ranking of components. Within policy for linkages, majority MSE prefer measures to improve interactions between MSEs and larger firms. However, almost one third of all categories put policies to develop and strengthen supporting industries at the highest priority, followed by policies of linkages with larger firms. The need for supporting industries like packaging and logistics to help MSE cannot be overstated. During informal discussions with survey participants, this issue was raised

**Fig. 4.8** Ranking of policy and social capital components: spatial/regional dimension. *Source* Compiled Survey results

repeatedly by them with some concrete examples. They emphasized the importance of such industries to secure and improve the supply chains, especially for MSEs operating in outside Jawa where transportation costs are expensive (see the testimony of MSE red chili in Lhokseumawe and MSE rendang in West Sumatera, in Appendix A.6).

Within structural policy, most MSEs clearly view promotion policy as the most important. Even those who do not rank it at the top, put it as the second priority. Among them are MSEs in rural areas, member of any cluster, located in Jawa, operating in the agricultural sector, and not using digital technology. For them, policies that are aimed at improving the product, process and design are more important than promotion; that is, improving quality is better than increasing quantity (sales).

In terms of technology policy, majority MSEs prefer measures to enable MSEs to use e-commerce for sales and improving access to inputs. Note that many of the respondents in our survey do not have/use digital technology. Lack of a reliable internet connection is one of the reasons. If utilization of digital technology is to be encouraged, some MSEs prefer to use it for payment purposes (e-payment). Even for that to happen, having a reliable internet connection is necessary. This was expressed particularly by MSEs with limited access to technology (no digital), those operating in trade and agricultural sector, and MSMEs located in Kalimantan and Sulawesi. A complete list of ranking of the components in each policy category for MSEs grouped according to the "structural variables" is displayed in Appendices A.3 and A.4.

Within the coordination category of social capital, the perceptions of majority MSEs lean towards transparent coordination in order to make cooperation and collective action effective. This is due to the fact that exchange of information among members are highly valued, which is also consistent with the results from the ranking of components within the participation category, where majority put searching for information at the top. For the second choice, the results vary between coordination for business purposes and for social interactions (informal coordination), although most lean towards the latter. However, by regional dimension the difference of perceptions is quite stark. Urban-based MSEs believe that the most important kind of coordination is the business-oriented one, whereas their counterparts in rural area are of the opinion that the main purpose of coordination is to get information, hence transparency is valued the highest. Again, this is consistent with the ranking under the component of participation where searching for information is put at the top priority. By regions, the only MSEs that value business-oriented coordination as the most important are those in Kalimantan. Other MSEs in the rest of the country choose coordination for transparency and for social interactions. What is also very obvious is that, virtually all MSEs do not favor coordination mandated or conducted through government regulation.

The strong perceptions of most respondents towards transparency in coordination and searching for information are also expressed during the informal discussions after the survey. Many participants even made a request for BI to help organize zoom sessions like the one we had during the survey, in which MSEs operating in various sectors in different regions can communicate and interact with each other so that they are able to acquire information useful for their operations.

Having revealed their perceptions regarding the degree of importance of all components under policy and social capital, as well as the interplay between the two, respondents are eventually asked to rank the types of cluster deemed most relevant for cooperation and collective action to improve their performance. It turns out the preferred choice of most MSE remains the same as in the previous benefit/cost framework, i.e., a cluster for strictly business purposes. The exceptions are MSEs run by younger individuals, having relatively large number of employee, currently not a member of any cluster, and operating in handicrafts, handbags, woven fabric or tenun, furniture, perfumes, etc. These MSEs put government-mandated cluster at a highest rank. All in all, most MSEs under study are of the opinion that given the pre-conditions and interplay of policies and social capital, joining a cluster for a strictly business interest would be most fitting for improving competitiveness.

## **Sensitivity Analysis**

The robustness of the survey results described above is tested by a series of sensitivity analysis discussed in this section. The way we conduct the analysis is by changing (mostly raising) the weight of each element in the component in every level of the hierarchy and check whether or not the final ranking of the elements in the final component at the bottom of the hierarchy change. The charts showing the full results are displayed in Appendix A.5.

In the benefits hierarchy, the ranking of the results is not sensitive to the existing location ofMSE (the first level of the hierarchy in Fig. 4.2). On the other hand, the type of benefits, monetary or non-monetary, matters. If we focus only on the monetary benefits, the final ranking of perceptions shows the government-mandated cluster being the most preferred choice. As the weight of monetary benefits gets bigger, however, the new ranking replaces the government-mandated with business-oriented cluster at the top. This is somehow expected; when the focus of MSEs strictly on monetary revenues or profits, they also tend to emphasize only the business side of joining a cluster. The reverse outcome, however, applies to non-monetary benefits. The more the MSEs feel that such benefits are more important than monetary benefits, the more they prefer to join the government-mandated than business-oriented cluster since such a cluster is expected to offer other benefits through government-assisted programs beyond just pure business benefits. What about the sensitivity of each element under those two types of benefits? Checking the final ranking of all scenarios after assigning greater weights to all elements (one at a time), we found no change in the ranking whatsoever, implying that the results from the benefits hierarchy are robust.

On the cost side, the sensitivity of operational costs and transaction costs is extremely small. Raising the weight of each does not alter the outcome that a cluster for social purposes is viewed by the MSEs to be the costliest. Even if we augment the weight of every single element under those costs, and also under the location component at the third level of the hierarchy, such a conclusion remains intact. The only exception is when the weight of closer to inputs location ("what if" type, rather than the actual location) is raised to maximum, in which case a diversification of product becomes the costliest for them, presumably due to market uncertainty surrounding the diversified products.

The robust results under the benefits and costs hierarchies above make the final ranking of the benefits/costs ratio remains the same as in the survey results, i.e., joining a business-oriented cluster being the most preferred choice.

Next is the sensitivity analysis for the survey results based on the systemic framework that involves a network. Note that since a network is designed to capture the feedback effects, there is no such thing as the "bottom level" as in a hierarchy; it essentially reflects a system where "everything depends on everything," and hence the ultimate target to look at in conducting the sensitivity analysis depends on the specific goal that we are interested in. The analysis presented in the preceding section has made it clear that the specific goal being adopted is the type of cluster (the top part of Fig. 4.4). Looking at all the runs from augmenting the weight of each component in every category, there is no single case showing that the ranking of cluster type is altered; the business-oriented cluster remains the most preferred choice. The results of the systemic survey are therefore very robust.

Yet, more information can be acquired from the sensitivity analysis of a network system. Take the case of technology policy for e-finance. Even though businessoriented cluster continues to be at the top ranking when we raise the weight (or the importance) of e-finance, the size of the weight actually declines from 0.440 to 0.406, whereas the weight of government-mandated cluster increases from 0.319 to 0.389 (the weight of social-oriented cluster declines, i.e., from 0.241 to 0.205); see Appendix A.5 for the details. Given the fact that the analysis in the preceding chapter has shown that e-finance policy is viewed by majority of MSEs to be less important compared to the other types of technology, this suggests that intensified efforts to boost the use of e-finance among MSEs requires a strong support and assistance from the government, for which government-mandated clusters are seen to be more appropriate to have. It is difficult to expect MSEs' shifting to e-finance technology without government's assistance, more so than their shifting towards e-commerce.

On the other hand, in the case of policies to create linkages with other MSEs, the analysis in the preceding chapter has shown that most MSEs see the importance of such policies. Yet, the sensitivity analysis also shows that raising the weight of those policies will make government-mandated cluster to take over business-oriented cluster as the most-preferred choice. Cognizant of the fact that an important message from the analysis is for policy makers to understand the perceptions and aspirations of MSEs as part of understanding the prevailing social capital, this suggests that government's assistance and supports are needed to foster closer linkages among MSEs.

## **References**

Anglingkusumo, R., Werdaningtyas, H., Rakhman, R. N., & Munandar, H. (2014). Integrasi Internal Perekonomian Indonesia: Sebuah Kajian Awal, unpublished paper. DKEM Bank Indonesia.

LD-FEB-UI. (2018). *GOJEK's Impact on the Indonesian Economy in 2018*. Lembaga Demografi-FEB-UI.

**Open Access** This chapter is licensed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license and indicate if changes were made.

The images or other third party material in this chapter are included in the chapter's Creative Commons license, unless indicated otherwise in a credit line to the material. If material is not included in the chapter's Creative Commons license and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder.

## **Chapter 5 Case-Based Evidence and Local Custom**

**Abstract** How do institutional arrangements and social capital work, and do cases on the ground corroborate what has been conceptualized? Some case-based evidence of MSMEs in different regions provide clues to that question. The role of trust and local solution to achieve a particular goal, including fostering environmental-friendly activities, is highlighted. The evidence also helps permeate the practical and moral thinking of the issues related to MSME operations influenced by local customs and customary laws.

**Keywords** Case evidence · Local solution · Circular economy · Local custom · Customary law

## *Conversation*

*A: "Small businesses must follow government policy to SHARE responsibility in the community."*

*B: "Treating them as equal partners and HEAR their views would have worked better for the community."*

*A: "Small businesses are too WEAK to find a solution to their problems."*

*B: "Given proper environment, they could WAKE up to the challenge and come up with a solution of their own."*

*A: "When land conflict associated with customary law arises, it is difficult to deal with indigenous communities as their VOICES RANT ON." B: "There is nothing better than listening to them and putting ourselves in their*

*shoes in order to resolve the conflict through honest CONVERSATION."*

Thus far, we have shown the analysis of how interactions of policies, institution, and social capital affect MSME performance. The survey discussed in the preceding chapter is intended to validate the framework developed in Chap. 3. Yet, the actual relationship between policy making, institution, and MSME performance is admittedly more complex than what is conceptualized through the scientific approach. The spillover is various and, to some extent, unforeseeable. To the extent the application of scientific approach demonstrated through the survey is our generalization endeavor of using data and people perceptions as a piece of evidence, it is only natural to ask: "how do institutional arrangements and social capital actually work to affect small businesses operations?" More specifically, "do cases on the ground corroborate what has been conceptualized?".

Enter the case-based evidence

This is what this chapter is intended to discuss. It basically presents some examples of cases throughout different regions in Indonesia. Like any case studies, case-based evidence is often regarded too soft a piece of proof for scientific inquiry. It has a lack of generalizing power and provides only limited justification to scientific hypotheses. Yet, as an epistemic strategy in social science, case-based evidence can help permeate practical and moral thinking. Presented below, the apparent simplicity of historical narratives and life experience of micro and small enterprises (MSEs) are revealing and instructive. The role of trust, social bonding, compatibility of local values, norms, and the power of local solutions come to the fore. Hence, these examples complement what has been discussed in the preceding chapters.

The Section 'Example of Cases' is drawing the case-based examples of MSE situations from different regions. The narratives consist of 'stories lived and told' involving real characters (albeit with abbreviated names), dispute resolutions and challenges within the existing institutional arrangement. They also reflect the prevailing social capital. The Section 'Customary Law and Social Capital' discusses the effect of local customs and customary law on MSE operations by using selected examples from MSEs operating in communities that uphold indigenous customs. Insofar around 1000 ethnic groups exist across Indonesia's 17,000 islands, where 50–70 million people are considered members of indigenous communities (*masyarakat adat*), it is essential to explore the extent to which customs (*adat*) and customary laws (*hukum adat*) affect MSEs operations.

## **Example of Cases**

## *Inflation Control Through Trust and Local Norms: Rice Farmers in Manggarai Barat, East Nusa Tenggara*

In an attempt to control inflation and keep the rice price stable, in 1968 the Indonesian government established a special agency called Bulog. The agency was tasked to manage the nation-wide set of local agency and warehouses at the district level (Dologs). During a surplus season, they are expected to buy rice from farmers' cooperative and private traders in order to avoid prices falling below the floor level. During a dry season, they are tasked to ensure that rice prices do not exceed the predetermined ceiling level. This is done by unloading and selling rice in the market. The policy was intended to protect farmers when price is low and shelter consumers when price is high. Obviously, the effectiveness of it depends on the supply of rice that Dologs have in their storage. The problem is, since the offered price is lower than the market price, farmers are not motivated to sell rice to Dologs, and this can constrain their operation, hampering the efforts to keep the inflation low (rice price has the largest weight in the consumer price index). More seriously, it can disrupt peoples' access to affordable basic food, especially in regions that often experienced fluctuations in rice production.

A case in point is in Manggarai Barat district, East Nusa Tenggara. Given that the policy requiring farmers to sell rice to Dologs often failed to meet the target, an individual hired by BI (let's just call him Mr. Y) with a long history and knowledge about local culture came up with an innovative idea. Having understood well the characters of local farmers, he used an approach that he labeled 'a community-based program of inflation control' (*gerakan inflasi berbasis masyarakat*). At first, he made some personal contacts and established close communications with the rice farmers who were members of MSE clusters in such a way that they gradually developed trust towards him. This was done by treating the farmers as equal partners rather than as rice sellers. This trust building—an important component of social capital was critical in ensuring that any proposed solution would be accepted by the MSE members. From the subsequent discussions, it was found that farmers actually had surplus and capacity to sell some of the rice to Dologs, albeit with a consequence of receiving lower margin, even after considering various risks of harvest failure (due to drought, flood, pest, or other diseases). It became clear that a lack of communication and mutual trust was the key factor that caused the past efforts failed.

It was at this stage that the awareness and understanding of local culture play a critical role. Realizing the importance of telling stories for the local people to speak up and reveal their frank opinions, Mr. Y used precisely such an approach and steered the narratives towards engaging them to show their social responsibility by helping others. He also understood that timing was important. Therefore, he tried to execute the plan during the Muslim fasting month (*Ramadhan* period), when the spirit of giving and sharing is usually high. Indeed, religion can be an important source of social capital in some communities, as it provides a framework for morality and serves as the general principles of behavior. In essence, what Mr. Y tried to do was to match the community's norms and social capital with the inflation policy.

Having done all the right things, however, the real challenge was in the implementation. Since Bulog and Dologs are parts of the government apparatus, administrative bureaucracy in dealing with them is at times challenging. To overcome this perennial problem, members of MSE themselves initiated a solution, i.e., organize a meeting with all the relevant stakeholders, including the local government, in order to get supports and approvals from them. Long story short, the farmers finally sold some of the rice to Dologs, supporting Dologs' operation to keep the local inflation low. A combination of Mr. Y's approach to acknowledge local wisdom and to adopt local peoples' own-initiative helped make the inflation control policy more effective. From the regional development perspective, price stability is one of the conditions for improving peoples' standard of living, and lower local inflation also contributes to lower national inflation.

Example of Cases 83

Transporting rice in Manggarai Barat, East Nusa Tenggara

## *Meeting Challenges with Trust and Own Solution: Breadfruit Business in Manokwari, Papua, and Coffee Business in Aceh*

Breadfruit is one of the superior local products in Papua. Although not a major staple, it is an important supplementary crop for food security and variation in diets. Long recognized for its potential to alleviate hunger in tropical climates, this underutilized Oceanic staple crop is widespread in Papua, grown readily in lowland alluvial plains and fans below altitudes of 1500 m (with rainfall above 1500 mm annually).1

In Manokwari, West Papua, a working group led by a woman entrepreneur, Mrs. IP, formed an MSE specializing in breadfruit chips (*keripik sukun*) by mixing it with locally grown taro leaves. Employing 15 women, the group was part of a church's woman organization or '*persekutuan wanita gereja*.' They produced the breadfruit

1 Some of breadfruit plants are wild, others are cultivated. When it is dried, its nutrients are concentrated, making it a high-protein flour alternative. They can also be used for medicine, timber, fuelwood, canoe construction, clothing, rope, wrapping and adhesive. Different countries use breadfruit to produce different products, e.g., chips in Costa Rica, French fries in Puerto Rico, and tostones (fried green plantains) in the Caribbean.

chip in a workshop located in a site provided by the church pastor with whom they had a good relation. BI supported the training components (for processing, marketing, and book-keeping), and provided subsidy for equipment and to cover the costs of packaging (which is all done in Jawa). The MSE performed well, able to sell their products not only within the region but also outside the region, and it served as a source of income for local women.

But things changed dramatically when their relationship with the newly appointed pastor went sour. They were told that they could no longer use the workshop site. The well-known Papua creed, *tak kenal maka tak sayang* ("don't know thus don't like" or "out of sight, out of mind") explains why such an unfortunate situation can arise. Upon the initiative of the group leader, along with the newly recruited women some members decided to form a new group/cluster. BI supported the group by providing a production house. Receiving trust from the existing and new members, the leader and other initiators found no obstacles in recruiting members for the new cluster.

Yet, the group failed to find a synergy, and productivity was below the capacity. One of the main reasons for low productivity was too few workers attended the workshop in the production house (high absentee rate). A lack of skill among new members was another factor, although they gradually solved this problem through training supported by BI. But it was the low attendance that soon became the most serious obstacle, especially when they received a large order from inside and outside the region. Many of the women had to stay home to attend children and family's need. In some cases, they did not get the permission from their husband to leave home. Clearly, this was a case of MSE failing to perform well not because of classical problems such as a lack of financing, high input costs, difficulty in marketing, or inadequate technology. Instead, it was a time-management issue.

After a long series of discussions, the MSE members themselves came up with a solution. They decided to adopt a pre-scheduled working time system, where members have the option to come to work only during certain pre-scheduled hours/days per week, and payments are made according to the time they spent in the production house.

This case demonstrates that, given the prevailing local norms, i.e., family custom and local creed, when the MSE had to face an unexpected challenge they themselves could find the solution. The external party, in this case BI, only helped by facilitating the process to ensure that the system would work. It is also important to note that the establishment of the new cluster was made possible due to the trust towards the leader and among members.

In some cases, however, an own solution also emerged out of frustration. Together with other MSEs in Aceh, a relatively successful small coffee business run by Mr B had been trying to convince the local authority to help facilitate with a packaging machine. The reason was simple, many MSEs could not compete because there was no good packaging facility available in the region. Most of them had to send their products to Jawa, or they had to buy the materials from Jawa for the packaging. As a result, the additional and high transport costs made their products less competitive. Only after many attempts were made that a packaging machine was finally purchased by the local authority. It turned out, however, the machine was unsuitable for the kind of packaging required by most MSEs. The authority purchased a wrong machine without consulting with the MSEs. Out of frustration, Mr. B solved his problem by selling the products directly through various stores after packaging in Jawa, and subsequently made a plan to relocate the main part of his business to Jawa and manufacture the products there (at the time of this writing, the plan is temporarily postponed due to the Covid-19 pandemic). This is only one of so many examples demonstrating how the incompatibility of policy with real conditions/problems faced by MSEs made the well-intended policy ineffective, if not wasteful, and how the MSEs had to manage to find the solution by their own. At the end, the power of agglomeration forces in attracting activities to move to the developed region (Jawa) proved its strength.

Women entrepreneurs promoting their breadfruit chips in Manokwari, Papua

Quality control of the coffee made by a local SME in Aceh

## *Replication Through Trust, Local Solution, and Policy Announcement: Cattle Growers in Kupang, East Nusa Tenggara*

Among farming communities throughout Indonesia, welfare progress is often measured by indicators such as how many agricultural produce they plant, harvest, and sell, or how many animals and livestock they own/raised for their meat, fibre, milk, eggs, or other products. Efforts to help MSEs in such communities used this as an entry point. In a cattle-growing community, government programs often took the form of giving calves or cattle. In many cases, the program failed because it overlooked the importance of feeding capacity as a precondition. Either the productivity deteriorated due to low quality of cattle and other products, or they ceased the cattle-growing business altogether by selling the cattle. Only in cases where an integrated approach was used or made by the government as a precondition for receiving assistance that the productivity could improve.

Two important issues are notable. First is on sustainability. One of the method's most important features of circular economy is the integrated production of animal and crop where nutrients from agriculture produce are recycled from animal feed to animal proteins to manure to soils and back to animal feed. The circular nature of the process is featured by nutrients added to the farm when animals, feed and fertilizer are used/purchased, offsetting nutrients leaving the farm (as meat and milk). The key is how to exploit the interaction. The second important issue is with regards to replicability. Past experience has shown that replication of even a good practice is not an easy task, since it involves changing people's mindset.

Through the skill and ability of its leader, Mr. DA, a cattle growing cluster in Kupang, East Nusa Tenggara, implemented a circular economy and tried to persuade other cattle growers to replicate it. After trying several approaches to no avail, an initiative came up from the cluster members themselves. They decided to conduct sales and cattle trading inside the farm and invite general public to attend. Expecting to have an impact, the result turned out quite impressive: some farmers in and outside Kupang were motivated to go into cattle growing business by replicating/adopting the circular economy method. This example once again shows that local communities themselves, not outside experts, are capable of finding an innovative solution.

The way to advocate a new thing also matters. Providing a concrete evidence that the new method will give the biggest benefit to the locals around the farm can be effective. This has been shown by the organic horticulture farm owned by Mr. GS (also in Kupang). His persistence to make the farm thrives and educate farmers inside and outside the region about organic farming has been working well, for which he won the 2018 'Young Agripreneur Ambassador' award.

Similarly, the way a new policy is announced can make a different impact. For example, in regions where communities are relatively poor and not too accustomed with the concept of cluster, announcing 50 ha minimum land required for cattle growing without informing the possibility of doing it through a cluster tends to receive a cold shoulder. None of the local farmers can afford to meet the set limit individually, and not all of them have a full understanding about why 50 ha is required. The risk is therefore real that the well-intended policy can be dead on arrival. Clearly, a policy becomes ineffective if it is announced without understanding the local conditions and constraints.2

2 In some cases, advocation in communities that still rely on faith and superstation also requires drawing the cultural traits of such communities. A notable example is in announcing the risks of natural disaster. The late Mr. Sutopo Nugroho, widely respected spokesman for Indonesia's disaster management agency, could not express it better when asked to reveal the secret of his credibility in educating the public about such risks: "cultural approach works better than just science and technology … if people think that it is punishment from God, it makes it easier for them to recover".

Cattle grower in East Nusa Tenggara

## *Circular Economy, Policy Asymmetry, and Vicious Circle Problem: Rice Farm Cluster in Ngawi, East Jawa, and Banana Chip Producer in Banten, West Jawa*

For a country that produces food waste of up to 300 kg/person annually (2016 data), and the amount of organic waste in the capital city Jakarta is second highest in the world (3233 m3, mostly from the agri-food industry), Indonesia can gain enormous benefits from applying a circular economy farming. Converting the waste into economic value and lowering the greenhouse gas emissions from food waste are among the key benefits. Yet, these potential benefits failed to persuade a large number of farmers to shift to a more sustainable farming. The lure of short-term profits, the asymmetry of policy measures, and a lack of information are all acting as hindrances.

Led by Mr. A, a community of rice farmers in Ngawi, East Jawa, formed a cluster to adopt a circular economy method.3 Their products are organic, as no chemical and toxic residue applied to the soil and plants, and the process produces zero wastes

3 The field research based upon which the narratives are presented here was conducted by one of our research team members, the details of which can be found in Rishanty (2021)

where one-third of the waste is used for cattle feed and two-third for fertilizer. In addition to implementing an environmentally sound method, the productivity of the farm is around 6 tonnes per hectare, higher than the national average and greater than the productivity of government-mandated rice clusters that did not apply a circular economy method.

Numerous obstacles, however, continue to stand in the way of their desire to grow and make progress. The application of the method also fails to spread to other farmers despite various efforts made by the leaders and members of the cluster. The total rice production based on an environmentally sound method throughout the region continues to be low. This has created a vicious circle. The fact that the production is low causes a stigma against promoting it, especially that rice is considered important not only economically but also politically (for food security). Indeed, government supports to the cluster and generally to any efforts to shift towards sustainable farming have been limited. In addition, the development of major infrastructure has resulted in dwindling area of fertile land especially in Jawa, and the provision of subsidy for chemical fertilizer creates an unfair price competition to the circular economy farms. The government assistance to provide irrigation machine to rice clusters in the area also creates a negative effect. Allocating only one unit machine in a cluster with a relatively large number of farmers causes frequent disputes among members—hence the weakening of social capital–over who has the right to use the machine. The design of the policy clearly overlooks the local conditions and reality on the ground.

Efforts to spread the concept of circular economy were also tried by the cluster members through enhancing the skill and knowledge on practical application of circular economy. They distribute the waste to, and share inputs with, other farmers, to strengthen the social bonding. Yet, the progress has been rather disappointing. Given the fact that the whole process of circular economy involves a rather long supply chain, any efforts to spread the method requires an expanded network of collaboration with all stakeholders, including with consumers and public at large.

While breaking a fixed mindset and adopting alternative policies that embrace new development paradigm take time and effort, convincing farmers who has been using traditional method for years and feel that their products can be threatened (cannibalized) by the new method is equally challenging. It requires a cultural approach and the trust from other farmers.4

A rather contrasting situation is experienced by a traditional banana chip maker in Banten, West Jawa. Run by Mrs. AS, a mother of two children, the business is typical of rural small business facing a vicious circle problem. She encounters a combination of challenges. Culturally, she prefers not to borrow money, although given the circumstances the only way to continue the business and support the family is to get an additional capital. On the other hand, she also knows that getting loan is difficult due to limited collateral and she does not have the necessary license

4 The role of culture and social capital in linking process and performance of circular economy is evident in other countries as well. Revealed in Subramanian et al. (2019), the implementation of circular economy in China has been strongly influenced by the coexistence of Confucian and Taoist values among workers.

(known as P-IRT). All these put her in a dilemmatic situation. It is her strong sense of survival to gain self-realization and the desire to send her children to a higher education program that finally forced her to take a bank loan, albeit only of a small amount.

But a series of obstacles continue to block her business progress, ranging from a lack of proper equipment to raise production capacity and improve the quality, limited market and low purchasing power, to a lack of knowledge for using different means of sales including using internet-based e-commerce. The money from the loan was far from adequate to overcome these obstacles and to keep the business afloat, especially during the pandemic. In such a situation, concerns over environmental considerations are off the table. Instead, she had to do cost cutting by using cheap plastic for packaging. With no government support, no steady income, while refusing to default loan, at the end she had to forgo her desire to send the children to school.

It is hard to imagine what solution is available for her when the response to the original problem (the need for capital to expand business) creates new problems of loan repayment and forgone children education, which aggravate the original problem. She had tried all kinds of initiatives to break the vicious circle, but to no avail. This is clearly a case where policy intervention and external assistance are required.

Preparing for transporting products of the community of rice farmers in Ngawi, East Jawa

Drying process in the traditional banana chip makers in Banten, West Jawa

## **Customary Law and Social Capital**

People invest in social capital within their communities by building a network. So do members of MSEs when they form a cluster. They invest in social capital to enable and strengthen collective actions, and to resolve any potential conflicts. In a community with deep-rooted and long history of customs and tradition, as in the case of many indigenous ethnic groups throughout Indonesia that still hold indigenous customs and follow customary law, disputes are settled without invoking the court that relies on local/state law.

A number of studies exploring the link between laws, customs, and social capital reveal that business operations in communities with high levels of social capital tend to comply with a variety of simple legal mandates (Ramseyer, 2015). Obeying traffic rules, participating in neighborhood safety, and paying monthly due for specific needs are few examples of simple legal mandates. Such businesses and communities are less likely to breach or default on their promises. They also tend not to sue when a dispute ensues, and in the case of MSE borrowing money, the creditors less often petition courts for enforcement orders. Debtors in high social capital communities also less often file in court for bankruptcy protection. On the other hand, members of communities and business operations with low levels of social capital are more likely to default on their contracts, and to litigate and petition a court.

For any business activities, large, medium, small and micro alike, rules and laws are very important as they are closely tied to the customs and tradition that prevail in a community. They do not exist in a vacuum. In assigning punishment for the basis for obedience, laws require the support of custom in order to be compatible with the need of communities. On the other hand, customs that are required to produce social accord need the support of rules and laws for members of the community to observe the practice without hurting the interest of others. The question is, when disputes arise in a community that holds strong customs and customary laws, which one to abide to, the state law or the customary law?

The type of court where disputes are heard has a profound influence on the approach to proving or ascertaining customary law. In many situations, if a case is unresolved, they bring it to a higher forum, e.g., from hamlet to village level. If it is still unresolved, they may take it to an even higher level where local/state law is applied. In case it becomes apparent that customary law should be used, however, there is a possibility that the judicial officers in higher level court are either not familiar with the customary law's provisions (in which case a special statutory provision may be made), or they unilaterally impose sanctions that violate customary law. Either way, it could give rise to disharmonious relationship or even conflict, which is obviously unfavorable for social activities or any business to operate.

To avoid such a scenario, some regions decided to formally incorporate key components of the customary law into local/state law. Rejang Lebong district in Bengkulu province is an example. The MSEs we interviewed in that district did not find serious problems related to this matter because local government had issued a regulation (PERDA No 4, 2017) to acknowledge and protect the indigenous communities and their customary law where trial was developed based on the spirit to achieve agreement and trust, and to be conducted in a transparent way (open to public). Even the execution is determined by the agreement of the parties involved. When the decision has been made, the conflicting parties forgive each other, and the execution is done in a ritual session through a joint prayer.

Another clause in PERDA No. 4 that is highly relevant for MSE operations especially in the farm-based activities is on land rights. The regulation explicitly recognizes custom-derived land rights (ulayat) of the indigenous communities, consistent with what is stipulated in Rejang's customary law.5 The rights, known as 'taneak tanaiadalah,' is a traditional type of land tenure that reflects communal rights based on community's custom or tradition. For two decades since the promulgation of Law

5 The area governed by Rejang's customary law where communities adhered to a system of rules from leaders who emerged from within the community is called *petulai* (Siddik, 1980). Historically, it was the area where the tribe known as *suku sembilan* settled in groups before Bengkulu area came under the control of the Majapahit Kingdom, and it was then the Rejang's customary law began to be known. Some speculate that a major change in Rejang's customary laws occurred when after losing a dispute at court, four 'princes' (*pangeran*) of Majapahit fled to the hinterland in search of territory to rule.

No. 5/1979, the indigenous communities lost their customary rights and controls over their land and other assets. Following the decentralization policy in early 2000s, particularly after the issuance of Law No. 22/1999 on regional government (later renewed by Law No. 32/2004), local governments had the opportunity to restore the rights of indigenous communities. Since then, many district governments saw themselves confronted with claims related to such rights. The response, however, varied. Some, including Rejang Lebong, opted to formally integrate customary law with local law, while others did not.

What matters, however, is the implementation. Even in regions where two types of law are integrated, when a choice has to be made the enforcement tends to side with local/state law. Consequently, MSE activities relying on land-use and related resources have to face uncertainty. Such cases often arise when big plantation or mining activities take the land area that is part of the traditionally owned territories of indigenous peoples. Mining, forest and land use management is always tightly close to local custom and law. For indigenous peoples, land is the main source of traditional means of subsistence, and for those running small commercial activities it is the only supporting asset they had. More often than not, disputes over land ended up being resolved by undermining the customary law. The indigenous peoples' rights are respected only to the extent that the state law has formally recognized such rights (normally done by the issuance of formal title).

Yet, the indigenous customs and tradition are generally more favorable from the environmental impact perspective. The case in Kalimantan is a notable example. For generations, Dayak tribes have lived in harmony with nature and used the forest in a sustainable way. Having intimate connection to nature, they have developed a farming system that prevents forests from being destroyed by following the guidance in customary laws before opening forest lands for farming. They plant diverse rather than single crop, and grow tall trees as forest canopies in order to secure plant and wildlife habitat and to cycle necessary nutrients.

Similarly in Rejang Lebong, where forest covers about 75 percent of the entire area, and most members in 65 villages abutting *Sumatera's Kerinci Seblat National Park* are farmers.6 After the government established a national park which also covered the indigenous community land without consulting them in 1999, local farmers changed their polyculture farming to monoculture type (e.g., coffee). Only in recent years the indigenous Rejang rediscovered their heritage by relearning polycultural agriculture practiced by their ancestors. Multiple crops are now grown interspersing coffee bushes with other plants such as kabau and jengkol bean trees (traditionally used in curries and chili sauce), allowing farmers to make money year-round

6 The Park boasts caves, peaks and crater lake (largest in Southeast Asia) where some 370 bird species are found. It is also one of the last homes of the endangered Sumateran tiger (Panthera tigris sumatrae).

instead of one-time shot during the coffee harvest.7 By rediscovering the old tradition, local communities gain not only from higher earnings but also from reduced damages caused by the environmental destruction.

For some MSEs not operating in farm activities, however, they may find the relevance of customary law in contemporary context more limited. Even when the business requires inputs from farm products (e.g., processing), the perceptions towards indigenous customs including the effect of customary law on their operations are no longer strong. This often occurs in communities where the relevance of customary law in contemporary contexts has been increasingly questioned. Younger generation, members of communities who had interactions with outside world, and those with formal education, are usually more inclined to accept new norms and customs. They tend to raise new ideas, and stage criticisms of local customs as they view them impractical.8

Most MSEs who are busy and more concerned with their day-to-day activities also feel that indigenous customs have only little effects on their business operations. This is evidenced from the results of our additional survey using a questionnaire designed specifically to include the role of customary law. Respondents in Rejang Lebong believe that other factors are more important to consider than concerns over the effect of local customs or customary law. An MSE producing palm sugar, led by Mr. SA, expresses their opinion that following the state law is affecting their business more than abiding to the customary law especially when the non-monetary benefits are considered. A business-oriented cluster is most preferred for them. On the other hand, an MSE operating in coffee production, led by Mr. S, perceives that state and customary laws are both contributing positively to their business operation. In terms of cluster type, after considering the benefits and the costs, they prefer to have a government-mandated cluster. Insofar the two types of law in Rejang Lebong have been integrated, abiding to state law and joining a government-mandated cluster are not in contradiction with following the customary law.

7 For example, as reported in Hendry (2017, each of 600 families in Tik Sirong village planted 10–15 of such trees in the coffee groves. Some also planted petai beans, durian, and bamboo. The latter, ubiquitous in the past but disappearing in recent years, has multiple home uses and commercial benefits. It can also shore up soil that might otherwise erode and cause flood (the region suffered from regular floods since 1995).

8 Indeed, customs are not static. As unwritten rules that people follow in a particular culture or society, customs evolved and changed overtime. The way they changed, however, should be put in the historical context of the respective society. As remarked by Siddik (1980), to appreciate the evolution of Rejang customs and customary laws, one needs to understand the history of Rejang tribe.

A small coffee producer in Rejang Lebong, Bengkulu, who sees the importance of both the customary and the state laws in his business operations

A small palm sugar producer in Rejang Lebong, Bengkulu, who are not too affected by the customary law

A similar finding is revealed from our survey in Umi Jaya village, in Sintang district ofWest Kalimantan. Organized and led by Ms. AA, Ms P, and Ms. S, members of a cluster specializing in traditional woven fabric and cloth are of the opinion that following the state and customary laws is most beneficial to their operations. Despite the fact that members of Dayak community where the MSE operates continue to hold their traditional customs and tradition, the effect of customary law on their operation is rather limited. They use the Dayak motifs for their cloth, and they employ local women from the Dayak community. Interestingly, from the cost questionnaire they generally perceive that it would be costly (ranked second costliest) to just strictly abide to customary law. After combining the benefits and the costs, their preferred cluster is one that is strictly for business, not the government mandated type.

The above result is not surprising. MSEs producing woven cloth in this area represent a typical small business operation plagued by classical problems. Their location is remote, far from major urban centers, the infrastructure is poor with limited access to outside information (let alone technology), and the workers' level of education is low. When trying to work on some administrative matters, they have to struggle with bureaucratic hurdles that cost them time and money. Ironically, they usually experience this when trying to participate in a government's offered program. It is difficult to expect their business to grow in such circumstances. While the product of this MSE represents a genuine local value of Dayak customs and tradition, hence unique and rare, their business is paradoxically stagnant. As sales are limited, and the price is unreasonably low despite the fact that we found their products are sold in the international market by a third party at a much higher price, workers are unable to secure steady income. This category of MSEs needs a magic wand that can help to expand the market network of their products.

A woman weaving in a cluster of Dayak woven fabric makers, Umi Jaya village, Sintang, West Kalimantan. They strictly use the Dayak motif for their products and employ women members from the Dayak community

Protecting indigenous local customs in a system with formalized rules, regulations, and legal systems can also be incompatible in a different way: i.e., the latter is not supporting the former. Take the case of MSEs operating in culture-related activities. To the extent culture and cultural heritage are important components of social capital, preserving them cannot be separated from securing the social capital. Indeed, preserving cultural heritage has myriad impacts on social capital. For one thing, it provides space of encounters for social integration and inclusion. But it can also function as a source of identity and local pride, from which members of community may cooperate and engage in collective actions.

An example is the artisan-weaving group pioneered and led by a local woman (Ms. AH) in Nita village of Sikka Regency in Flores island-East Nusa Tenggara. Run all by women, the self-managed group wanted to protect the ancient organic art of ikat weaving, which is a valuable heirloom and part of the region's cultural identity. It exemplifies the rich cultural heritages of the community. In addition to keeping the ancient motifs rich of philosophical values, they also adopt the ancient technique and all materials they use are natural, e.g., the natural colors for dyeing are made from tea barks, leaves, fruits and roots. While the activities provide income for the local women, the emphasis of their work has been on the social, cultural, and philosophical value to preserve the local heritage. Hence, what they produce cannot be considered as a handicraft; the weavers are not craftswomen or handicraft workers, instead they are called *seniwati* (women artist). This may explain why they hardly receive any assistance from local government, as the official policy and assistance outside farm activities are traditionally reserved for MSEs producing handicraft.

Yet, protecting cultural heritage, which is exactly what this cooperation has been trying to do, is an important part of securing social capital. This kind of work by small cooperation or enterprises produces multiple advantages beyond just economic benefits. They deserve attention and assistance beyond those mandated by the customary and commercial laws for MSEs. At the very least, the products of small enterprises of this type need to be protected by the intellectual property law (HAKI or Hak Kekayaan Intelektual).

A woman leader of a self-run artisan-weaving group in the village of Nita, Flores, East Nusa Tenggara, who emphasizes the need to protect the local cultural heritage

## **References**

Hendry, D. (adapted by Melati Kaye). (2017). A return to mixed roots in a Sumatran forest. In *Mongabay Series: Global Forests, Indonesia's Forest Guardians, Indonesian Forests*.

Ramseyer, J. M. (2015). Social capital and the formal legal system: evidence from prefecture-level data in Japan. *Journal of Legal Analysis, 7*(2), 421–466.

Rishanty, A. (2021). *A Study of Transition Towards Circular Economy in Developing Countries at the Firm Level*. Ph.D. thesis. University of Liverpool.

Siddik, A. (1980). *Hukum Adat Rejang*. Balai Pustaka.

Subramanian, N., Gunasekaran, A., Wu, L. & Shen, T. (2019). Role of traditional Chinese philosophies and new product development under circular economy in private manufacturing enterprise performance. *International Journal of Production Research*, *57*(23), 7219–7234. https://doi.org/ 10.1080/00207543.2018.1530467.

**Open Access** This chapter is licensed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license and indicate if changes were made.

The images or other third party material in this chapter are included in the chapter's Creative Commons license, unless indicated otherwise in a credit line to the material. If material is not included in the chapter's Creative Commons license and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder.

## **Chapter 6 Summary**

**Abstract** Counterbalancing the endogenous forces of agglomeration by addressing any institutional bottlenecks, and incorporating a set of design principles to ensure that any proposed policies are compatible with the prevailing institutions are key to resolving dualism and inequalities. In many cases, they are more important than finding the right policies. Alas, reforming policies is far more difficult than reforming institution. Be that as it may, listening and understanding the perceptions of local people and MSME is a necessary starting point.

**Keyword** Structure of relations · Decentralization · Mental bandwidth · Behavioral insights · Policy design

The role of dualism in shaping income distribution is well known. So is the role of spatial dualism in shaping inequality between regions within countries (interregional inequality). The persistence of such inequality is a major policy concern confronting social planners in rich and poor countries alike. Indonesia is no exception. Given its size and archipelagic nature, by international standard the country has a large inequality between regions.

Inequality also exists in business activities, indicated by the performance gap between micro-small-medium enterprises (MSMEs) and large businesses. While across the globe the number of business establishment and unit is dominated by MSME, the figure in Indonesia is roughly more-than 99% and over 96%, respectively. It certainly accounts for the largest share of employment. It is no surprise that a statement like "MSMEs are the backbone of our economy" has been popular and frequently raised by policy makers such that it has become a bit of a cliché. With the outbreak of the Covid-19 that brought the country into recession, the expression goes even further, i.e., "MSME is the source of economic recovery." Official statements and documents to support MSMEs have also been made repeatedly.

There is no deficit of publications and research reports on the issues of interregional inequality and challenges faced by MSMEs. On interregional inequality, a typical analysis focuses on the unequal allocation of investment between regions and the lack of regional capacity in utilizing the greater autonomy especially under a decentralized system. On MSME, many studies spend much time on pounding how inefficient, unproductive and uncompetitive MSMEs are. They typically show a long list of problems faced by MSME, from the issues of financing gap, a lack of management skills, poor information, marketing difficulty, to the problem of limited access to technology. The list is usually followed by the suggested policy measures.

While some of the analysis on investment allocation and the limited capacity of the regions are true, and some of the statements and recommendations about MSME are valid, many are more myth than reality.

The focus of this book, is different. I avoid reinventing the wheel. On interregional inequality, the analysis is more on the role of endogenous forces of agglomeration and the structure of economic relations between regions as part of the prevailing institution. On MSME, it emphasizes their perceptions towards social capital and various policies, as well as the interactions between the two. My primary goal is to raise awareness about the importance of interplay between policies and institution, and to improve the understanding about the elements and mechanisms of their interactions. To the extent the highlighted issues are more institutional in nature, most policy interventions discussed throughout the book are justified because of institutional failure, more than market failure. To fulfil the stated goal, two tasks are performed: diagnose the causes underlying interregional inequality, and delve into problems faced by MSMEs that put constraints on the effectiveness of various policies.

The evidence of interregional inequality and the persistent challenges faced by MSMEs, including the performance gap between small and large businesses in Indonesia are discussed in Chap. 2. Given the fact that numerous policies have been implemented, it is argued that there is indeed a deviation between policies and outcome. The bulk of Chaps. 3 and 4 is devoted to the analysis about why such a gap. While dualistic characteristics of an economy in a large and diverse country like Indonesia may have been expected, persisting inequality poses risks of growing discontent and deepened political divides. It could also weaken the country's growth prospect. Contrary to the classical economic thinking, based on recent empirical evidence the contemporary economic thinking confirm that greater inequality tends to worsen growth.

The fundamental thinking behind the analysis is synopsized in Fig. 6.1. The lure of external economies of agglomeration is too strong of a "pull" factor for policy interventions to counter and reduce the divergence between core and periphery. Yet, the contribution of another factor is no less-substantial, i.e., non-compatibility of policies with the prevailing institution. Policies, rules and regulations (formal institution) at the national and regional levels may have been in place to soften the agglomeration forces and mitigate their effects on inequality. But due to weak enforcement (part of informal institution), they are deemed ineffective. More importantly, other informal institutions are also at work, significantly influence the way the public respond to policies. They could range from bureaucratic and legislative norms, clientelism, paternalism, patrimonialism, habits, traditions, and codes of conduct, all may interact with the prevailing social capital (left part of Fig. 6.1). It is subsequently shown through the institutional model of decentralization in Chap. 3 that the quality of local leaders also matters.