Using the Theil population-weighted method for per capita GDP and the variance in a shift-share analysis on labor productivity, we conduct a comprehensive interregional income inequality decomposition analysis on Indonesia before and after the 1998 economic crisis.
Interregional income inequality is largely determined by the interregional inequality in the productivity differential component due to the region's specific sector-by-sector productivity differentials—the result of investments accumulated in technology, public infrastructure and human capital. Although the interregional inequality in the productivity differentials show a declining trend throughout the period under observation, they should have decreased further, considering the active implementation of policies aimed at balanced regional development. However, the results are still far below the target levels because of the effects of economic agglomeration. An examination of non-productivity factors shows that the interregional inequality in the employment rate has become the dominant factor after the crisis, whereas the active population rate was dominant before. The widening of the interregional employment gap is a new concern for Indonesia. The relative decrease in urban employment rates in 2003-2006 and the predominance of inequality in higher educational attainments within the urban sector reported by Akita and Miyata[5]suggest a growing deterioration in the labor market efficiency in urban regions.
JEL Classification: D63, O40, R11, R58