Results of the study

Regarding the first objective of the study, it has been found that there are some budget functions that demonstrate specific changes, particularly before elections for both local parliament members and local leaders. A simple approach, a distribution test for the composition of each budget function, has been applied to detect the budget functions utilised for rent-seeking, particularly in supporting incumbents in elections.

Converting the budget composition is the main optimisation strategy, particularly because the total budget amount does not substantially change. The alteration of the budget functions must be reciprocal; the rise in a certain budget function will cause a reduction of other functions. Hence, the following stage was testing the correlations between the functions whose

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compositions changed significantly. A significant correlation between two functions indicated the preferred budget functions for the opportunistic behaviour.

The distribution test has shown that there are five budget functions that significantly change based on legislative elections: public services, security and order, housing and public facilities, education and social protection. Among these functions, it indicated the strategic role of the education function in accomplishing political interests in the lead up to elections. The correlation test has shown that education was negatively correlated with the other four functions.

In relation to local leader elections, among the budget functions with significant change in legislative elections, four budget functions (except for social protection) demonstrate similar shifts. This also confirmed the substantial role of the education function in supporting political interests before local leader elections. The negative correlation found between education and the other three functions reflect the importance of this function in supporting incumbents in influencing voters. It can be concluded that in the year prior to local leader elections, the composition of this budget possibly increases while the other three functions decline, or vice versa.

Regarding the hypotheses, this study has found that local original revenue has a significant impact on rent-seeking. This finding is consistent with that of Abdullah and Asmara (2007), who discovered the existence of rent-seeking behaviour by legislative members using local original revenue. However, this result is contrary to the objective of decentralisation to increase local self-reliance by increasing local capacity (Bird & Smart 2001; Brodjonegoro 2001; Martinez-Vazquez & Searle 2007; Prud'homme 1995; Werner 2012). The result also contrasts with those of previous studies which found that the implementation of decentralisation will benefit by limiting the possibility of opportunistic behaviour because it brings the public closer to the government, particularly in controlling policy.

The other findings confirm that natural resources and population size positively influence the existence of rent-seeking behaviour. The result is in line with Kolstad and Søreide (2009) that demonstrated the utilization of resources for rent-seeking, particularly for political motives. Related to population size, the finding supported Fisman and Gatti (2002) and also Goel and Nelson (2009) that provided empirical evidence of the higher possibility of rent-seeking in higher population area.

The other main finding of this study is that transfers from the central government do not generate a higher possibility of local budgets being dissipated. This indicates that increases

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in these transfers may stimulate local government to be more creative in allocating the budget to productive sectors that can increase local income. This result is not consistent with those of Gemmell et al. (1998) and Dollery and Worthington (2007), who found that transfers from the central government did not encourage local governments in raising local revenue. However, this finding corresponds with Bird & Smart (2001), Brodjonegoro (2001), Martinez- Vazquez & Searle (2007) that stated the benefit of transfers from central government to minimize the fiscal gap among the local governments and also to increase local governments’ productivity.

The other important findings relate to the existence of rent-seeking before elections, both legislative elections and local leader elections. The study has found that legislative elections have a significant effect on the occurrence of rent-seeking. In the year before elections, there has been found to be an increase in the budget amount that is indicated as rent-seeking. A further analysis in association with the rent-seeking in each budget sector has shown that significant rent-seeking indications occurred in three budget functions: public services, housing and public facilities, and health. Although the indications of rent-seeking occurred only in these three budget functions, this represented the behaviour in the overall budget.

However, regarding local leader elections, there is no empirical evidence of an increase in the budget amount utilised for rent-seeking. Nevertheless, a partial analysis in each budget function has provided evidence of this behaviour in two functions: housing and public facilities, and education.

The last finding related to the importance of audits has found that audit reports have a significant influence on limiting the existence of opportunistic behaviour in budget optimisation. In the context of the agency relationship theory, this finding is consistent with the importance of internal mechanisms in controlling agents in order to maximise the benefits. This also supports the recommendation of Human Rights Watch (2007) for local governments to issue reports that trigger good governance in government.

The results of the study provide insights into rent-seeking in local governments. First, in association with the resources used, local government authorities seem to benefit themselves from the revenue collected from local sources, such as local taxes and natural resource revenue. Rent-seekers are seen to avoid utilizing transfers from the central government for this purpose, even though these make the most significant contribution to the local budget.

One of the reasons for this is that the local government prioritizes allocating this budget for operational and routine expenditures, which are relatively fixed, such as staff salaries and

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spending for the maintenance of government assets. It is difficult for local authorities to exploit these resources for private interests.

Different from intergovernmental transfers, local origin and natural resources revenues are more beneficial for local authorities. One of their advantages is that they have complete information about these resources, such as the potential revenue to be collected and the cost of collection, and also they have the power to distribute the funds. Based on agency theory, the agents (the local governments) have more opportunity to allocate these funds to the sectors that will be more favourable for them (Adams 1994).

The second lesson learnt from this study relates to the political reason for rent-seeking. The study has found interesting empirical evidence, since the possibility of rent-seeking occurred at the times before legislative elections only. Further analysis shows substantial increases in some budget sectors, one of which is infrastructure expenditure (housing and public facilities). The finding confirms prior studies that demonstrated the optimization of this sector for opportunistic behaviour (Mauro and Driscoll 1997, Mauro 1998, Tanzi and Davoodi 2006).

It is fascinating that there is no substantial finding of the impact of local leader elections on this behaviour. This indicates that local leaders did not attempt to escalate certain budget sectors to support their interests, particularly during their incumbency for following elections. However, it does not mean that local leaders did not attempt to find opportunities to increase their interests. Kumorotomo (2011) said that the heads of regions are advantaged since they have better information about local resources and have the power to allocate them. They can be more flexible in allocating the budget to the targeted functions during the years of their leadership.

The last important lesson learnt is about the effective role of auditing in limiting rent-seeking behaviour. The existence of this variable, as described in the introduction, is intended to address the gap of the inconsistencies of previous research results relating to the impact of decentralization on improving regional performance. These contrasting studies provided indications of possible misuse of resources in local financial management. Resource allocation decisions are based more on particular interests than on improving regional performance. There are two possible ways to do this;, first, by allocating to less controllable sectors, and second, by increasing excessively the allocation to certain sectors, particularly infrastructure. Consequently, this results in ineffective expenditure for local performance improvement and tends to produce budget wastage. From this perspective, the likelihood of opportunistic behaviour may exist. In the local context of Indonesia, the huge number of

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corruption cases during the implementation of fiscal decentralization indicated the existence of the behaviour (see Rinaldi et al. 2007).

In the context of agency theory, the reality can be explained as the effort of the agents (local governments) to maximize their utility (see Jensen and Meckling 1976, Adams 1994). As this leads to the dissipation of local budgets, the implementation of auditing is required in order to diminish this behaviour. Auditing will force local governments to be accountable and transparent in utilizing their local resources. The results of the study confirm that the implementation of auditing is an effective way to reduce opportunistic behaviour.