Theory of Endogenous Institution and Evidence from an In-Depth Study in Indonesia

We study how endogeneity between welfare and institutions might make institutional reform more subtle. We use evidence from an in-depth field study conducted in five districts in Indonesia and build a model that illustrates how initial socioeconomic condition as well as past institutions generate institutional complexes, including the degree of local capture, local leadership, and participation level. By endogenizing the degree of local capture, we show how cooperation between local leaders and local elites could positively or negatively affect welfare depending on the initial socioeconomic conditions. These institutional complexes that evolve with welfare create self-reinforcing progresses in the long-run. In the context of Indonesia in the post-decentralization period, exogenous shocks, such as an introduction of central government's enforcements on both strengthening local institutions and increasing welfare are needed