Convergence Analysis of Economic Growth in East Java

Je jak Vol 11 ( 1 ) ( 2018 ): 151 - 161 DOI: doi.org/10.15294/jejak.v11i1.9643 Bv JEJAK

Jurnal Ekonomi dan Kebijakan http://journal.unnes.ac.id/nju/index.php/jejak

Sri Karima Amalia1, Dwi Budi Santoso2, Sasongko3

123Universitas Brawijaya

Permalink/DOI: doi.org/10.15294/jejak.v11i1.9643

Received: October 2017; Accepted: January 2018; Published: March 2018

Abstract Convergence and divergence of economic growth is a regional economic issue. The concept of convergence occurs when areas with poor economies tend to grow faster than areas with a rich economy whereas divergence occurs otherwise. East Java has a high economic growth but has a high inequality between districts/municipalities as well. Based on the concept of the inverted U- shape of the Kuznets curve, the East Java situation thus indicates that East Java is at the starting point of economic development. Therefore, it is necessary to develop high economic growth with low inequality through acceleration of convergence by knowing the level of convergence of economic growth and acceleration factors of economic growth convergence of East Java. This study uses panel data from 38 districts/municipalities in East Java between 2005 and 2014 by adopting the model Barro & Sala-i-Martin (1992) then the model specification in answering research objectives are sigma convergence, absolute convergence, and conditional convergence. The estimation results show that in East Java economic growth is convergent at a low level so that efforts need to accelerate the convergence that can be reached through 5 (five) development policies, (i) equalization of basic infrastructure such as access equity (ii) equal distribution of energy availability, (iii) equalization of investment, (iv) equal distribution of labor force, and (v) equality of labor productivity.

Key words : Acceleration of convergence, Divergence, Economic growth

How to Cite: Amalia, S., Santoso, D., & Sasongko, S. (2018). Convergence Analysis of Economic Growth in East Java. JEJAK: Jurnal Ekonomi dan Kebijakan, 11(1), 151-161. doi: https://doi.org/10.15294/jejak.v11i1.9643

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INTRODUCTION underdeveloped occurs due to underutilization of resources from structural The definition of economic And change factors so that development development proposed by Todaro and Smith requires more than the acceleration of capital (2011) is a multidimensional process involving formation. This theory focuses on the structural fundamental changes in social structures, transformation of the process of economic attitudes of communities and national transformation so that the contribution of the institutions aimed at accelerating growth, manufacturing sector exceeds the contribution reducing inequality and alleviating poverty. of the agricultural sector in the national income. Spatially, each region or part of the region has The main focus of this model lies in the process diverse potential and conditions. Thus, in of labor transfer as well as the growth of output regional economic development, the and employment in the modern sector. The objectives of economic development in process of self-sustaining growth and the general can be imposed in each of the expansion of employment opportunities are different regions in order to achieve equitable assumed to continue until all surplus labor is distribution of development across regions absorbed into the modern industrial sector. reflected through the acceleration of growth, Furthermore, additional labor can only be reduction of inequality (convergence), and obtained from the agricultural sector at a higher poverty alleviation in each region. cost arising from the decline in traditional sector At the beginning of the industrial era, production due to the decline in the labor-to- the average real living standard in the richest land ratio which means that rural marginal countries is no more than three times greater power is no longer zero. This is known as "Lewis than the poorest countries. Currently, the turning point". ratio is close to 100: 1. As Lant Pritchett points In Kuznet's structural model described by out, that developed countries today have the inverted U–shape Curve describing the enjoyed a much higher average rate of relationship between growth and inequality. In economic growth than developing countries the early stages of economic development, there over two centuries, a process known as is a process whereby the rate of economic growth divergence (Todaro & Smith, 2011). This increases with the level of inequality to the point indicates that the regional economic of steady state which will further increase development objectives have not been economic growth with the reduction of achieved because the inequality between inequality. regions is widening (divergence). Furthermore, Kuznet's theory of analyzing In the early stages of economic growth individual inequality developed in the regional there is an inequality caused by the growth economy is known as the process of change in process itself. Based Lewis’s theory of the socio economic system pioneered by Gunnar development there are two sectors of growth, Myrdal (1974). There are two strength in that is the traditional sector (agriculture) and economic development, namely the impact of the modern sector (manufacture). In Lewis's the spread of development outcomes from the theory of development hypothesized that center of growth to the sphere of influence

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(spread effect), while the impact of the in regional income disparities and inter-region backwash effect is negative, that is the productivity leading to their rapid growth. A absorption of labor and capital from rural spread effect analysis can reduce inequality areas to urban areas, will cause a gap inter- according to the concept proposed by Barro & urban and inland areas are getting bigger. Sala-i-Martin (1992) causing convergence while Regional inequalities within a country are the backwash effect can cause divergence. rooted on a noneconomic basis. Myrdal The convergence concept occurs when argues that if everything is left to market areas with poor economies tend to grow faster power without being impeded by any policy than areas with rich economies so that poorer intervention then all economic activities regions tend to catch up rich regions in terms of within a developing economy tend to be per capita income levels or products. The profitable, which generally cluster in certain concept of convergence is divided into 3 (three) regions or territories. If these developed areas namely sigma convergence, absolute grow by harming other stagnant areas it will convergence, and conditional convergence. exacerbate regional inequality. Economic Sigma convergence occurs when there is a development in an increasingly developed decrease in per capita income dispersion over country leads to a higher impact as well as time. Absolute convergence occurs without transportation, communication, better considering growth factors whereas conditional education, and an increasingly dynamic convergence occurs by considering growth relationship between ideas and values. factors. East Java is one of the provinces in Therefore, the role of the government in Indonesia that has inequality issue of regional reducing the level of inequality with the aim economic growth. According to Regional of weakening the impact backwash effect and planning agency of East Java Province (2015) and strengthening spread effect is very important. Central Bureau of Statistics (2012), East Java's Gunnar Myrdal (1957) states that the main economic growth in Java tends to be high even causes of regional inequality are strong above the national economic growth. In 2011, backwash effects and weak spread effects in underdeveloped countries. Furthermore, according to Mrydal (1957) the non- egalitarian role of government will lead to regional inequality as well. Therefore, the role of the government in reducing the level of inequality with the aim of weakening the backwash effects and strengthening the spread effects is very important. Barro & Sala-i-Martin (1992) define Indonesia's economic growth of 6,35 percent convergence as a process of economic growth while East Java Province of 6,44 percent. of countries or regions, reducing differences Figure 1. Economic Growth in Indonesia and or disparities in income, productivity, wage East Java levels, and other indicators. In other Source : Primary Data, Processed barrwords, poorer regions can catch up with the developed regions because of the decrease

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However, based on the index of the model specification in answering research inequality using the Williamson Index objectives are: calculated based on the Central Bureau of Statistics (2012) data, high economic growth in East Java Province is followed by high ...... (1) inequality as well.

Absolute Convergence ( ) lnY = β0 + β1 ln yi,t0 + εi...... (2) Conditional Convergence where the policy factors of development affect growth ( ) lnY = β0 + β1 ln yi,t0 + βi Xi+ εi...... (3)

The development of conditional Figure 2. Economic inequality with convergence from Barro is influenced by the Williamson Index in Java Island policy of economic development Source : Primary Data, Processed β1 = f (Policy) = α0+αi Xi...... (4) If linked with Kuznet's inverted U– So the conditional convergence equation in shape curve, East Java's high economic growth is followed by high inequality, East Java is at this research is: the start of development (starting point of lnY = β0 + α0ln(yi,0)+ αiln(yi,0)Xi + development) which has not reached the βi Xi + εi...... (5) steady state peak of Kuznet's inverted U– Is the per capita growth rate, 풍풏(풚풊,ퟎ) is the shape curve. initial per capita income, 푿풊 is a factor affecting

Therefore, in order to create high regional economic growth, and 휷ퟏ= 휶ퟎ is the economic growth followed by a decrease in convergence rate. inequality level, strategies are needed in if positive means divergence, and negative creating and accelerating convergent regional means convergence, 푹푶푨푫 is a road economic growth in East Java through infrastructure, is the ratio of the length of the identification of economic growth patterns road is good and medium per capita, 푬푳푬푪 is (convergence rates) and policy factors that electrical infrastructure, is per capita electricity accelerate the process of convergence of sold ratio, 푰푵푽푬푺푻 is a third-party funds, 푺푴푷푻 growth Economy in East Java. is the percentage of the population who RESEARCH METHODS graduated high school and university, 푼푴푲 is the Minimum Wage Value districts / This research is quantitative using panel municipalities, 푨푲 is the labor force level, data in the period of 2005 - 2014 in 푷푹푶푫푻푲 is the ratio of output value per worker, districts/municipalities in East Java with 29 and 푮푶푽 is the ratio of total government districts and 9 municipalities. By adopting expenditure per GDP. the model Barro & Sala-i-Martin (1992) then

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푛푌 = 훽0 + [훼0 + 훼1(푅푂퐴퐷)푖푡 + 훼2(퐸퐿퐸퐶)푖푡 + 훼3(퐼푁푉퐸푆푇)푖푡 + 훼4(푆푀푃푇)푖푡 + 훼5(푈푀퐾)푖푡 ( ) ( ) ( ) ] ( ) ( ) + 훼6 퐴퐾 푖푡 + 훼7 푃푅푂퐷푇퐾 푖푡 + 훼8 퐺푂푉푆푃퐸푁퐷 푖푡 + 휖푖 푙푛 푦푖,푡0 + 훾1 푅푂퐴퐷 푖푡 + 훾2(퐸퐿퐸퐶)푖푡 + 훾3(퐼푁푉퐸푆푇)푖푡 + 훾4(푆푀푃푇)푖푡 + 훾5(푈푀퐾)푖푡 + 훾6(퐴퐾)푖푡 + 훾7(푃푅푂퐷푇퐾)푖푡 + 훾8(퐺푂푉푆푃퐸푁퐷)푖푡 + 휀푖

The policy factor interacted with By conducting the model selection test

풍풏(풚풊,ퟎ), if a negative value means a policy from panel data through chow test and hausman factor that can accelerate convergence, and if test, the model suitable for absolute convergence it is positive means to slow down and conditional convergence is using fixed effect convergence. method (FEM) method in answering the Furthermore, the convergence velocity research objectives. denoted by 풔 can be obtained by the equation Based on the calculation results that the

풔 = −퐥퐧(ퟏ + 휷ퟏ)/횻, where Τ denotes the coefficient of variation in value decreased from number of years beginning and end of the 1,656 in 2005 to 1,350 in 2014. The calculation study period. While the time taken to result which can be seen in figure 1 can be eliminate half of income imbalances at the concluded that in East Java there is a beginning of the period is half life, 흉, with the convergence of sigma that is the decrease of equation 흉 = 퐥퐧(ퟐ)/퐥퐧 (ퟏ + 휷ퟏ) (Paas et al. income dispersion per capita between regency / 2007). In determining the best model is done municipalities in East Java during period of 2005- chow test and hausman test. 2014. The chow test compares common and fixed characteristic data, while the hausman test compares the fixed and random characteristic data. For fixed character data model (FEM) or LSDV, for random characteristic data used random effect model (REM) or ECM, while for common characteristic data is done least squares method. Figure 1. Sigma Convergence RESULTS AND DISCUSSION Source : Primary Data, Processed

This research uses absolute Absolute convergence is a natural convergence and conditional convergence. convergence that occurs without the influence of Absolute convergence is a natural policies and growth factors. This means that convergence that occurs without the regions with low initial per capita incomes have influence of policies and growth factors high economic growth so they can catch up with whereas conditional convergence occurs areas with high initial per capita income. This is because it is influenced by policies and factors indicated by the value of the coefficient 훽1 = 훼0 that affect growth. which is negative.

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Estimated Results of East Java Absolute Conditional convergence occurs because it Convergence 2005 – 2014 shows in appendix 1. is influenced by policies and factors that affect Based on the estimation result, it is known growth. Low initial per capita income areas may that the coefficient value of 훽1 = 훼0 is negative catch up their preoccupation with high initial per value of -0.09. This means that in East Java capita income areas through policies issued by there is an absolute convergence with time to the government so that inequality may be eliminate all inequalities for 144.54 years. reduced. Conditional convergence model The pace of convergence occurs at 1% considers several factor which affect regional per year with half time needed for region with economic growth and shows that regional steady least income per capita to be equal with the state is determined by different structure. region with highest income per capita Based on the estimation result, it is aprroximately 72,27 years. Moreover, the known that the coefficient value 훽1 = 훼0is regions with high income per capita tends to negative value equal to -0.619959. It means that have low income per capita growth. While in East Java there is conditional convergence regions with low income per capita have high with time to eliminate all inequality over 22,40 income per capita growth. Therefore, income years. Furthermore, it can be concluded that the per capita convergence is possible in East Java. existence of government policy factors can accelerate the convergence of economic growth There is a difference in per capita in East Java. Policy factors that can accelerate the income between 2005 and 2014. These convergence of economic growth in East Java differences can affect the speed of the include per capita road infrastructure, per capita conferences in East Java. In 2005, Regency of power infrastructure, investment capital, labor Tuban and Bojonegoro were districts with low force growth, and labor productivity growth. per capita income but in the year 2014 turned East Java is a province that has a high rate into a district with high per capita income. of economic growth as well as a high level of Bojonegoro regency has high economic inequality. Based on the calculation of growth due to government policy and public williamson index among regions in Java Island, welcome in developing natural resources in East Java has the highest level of inequality. the form of oil can cause the economy to grow Based on these facts indicate that East Java is in well. the early stages of economic development. Municipality of Kediri have high GDP Therefore, it is necessary to make the high per capita, but have lower growth. In fact its economic growth followed by decreasing the growth is below the average growth rate of level of inequality. A decrease in inequality East Java. While the region with low GDP per occurs when areas with low per capita incomes capita and above average growth of East Java can catch up with high-income areas through a are Regency of Bojonegoro, Jombang, convergence process. Based on the estimation Lamongan, Lumajang Madiun, Nganjuk, results, East Java has a convergent economic Ngawi, Pacitan, Tuban, as well as growth pattern with a low level and takes 144.54 Municipality of Batu. Therefore, it is possible years to eliminate all inequality. Furthermore, by to converge per capita income in East Java. using conditional convergence, or by using

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policy instruments the time of convergence every 1 unit of road infratucture added, income can be accelerated in East Java. per capita growth will increase as much as Results shows several factors 0.316869 unit. Road services both in quality and influencing income per capita growth, which quantity in poor areas will tend to accelerate are road infrastructure per capita, electrical convergence in rich areas as it will facilitate the infrastructure per capita, capital investment, mobilization of both economic activity, people, regional minimum wages, labour forces, as and goods and will reduce transportation costs in well as labour productivity. On the other hand order to increase the economic growth of poor factors that aren’t influencing income per areas. Likewise with the provision of quality and capta growth are education level and quantity of electricity infrastructure will government expenditure. accelerate convergence. Maryaningsih, Among the policy factors that can Hermansyah, & Savitri (2014) stating that hard accelerate the convergence of economic infrastructure, power, roads and port loading growth in East Java include per capita road and unloading have a positive and significant infrastructure, per capita power impact on boosting per capita income. infrastructure, investment capital, labor force Investment capital can accelerate growth growth, and labor productivity growth. While and accelerate convergence. Based on the factors that aren’t influencing the neoclassical theory, investment capital becomes convergence are education level, labour force, one of the most important to increase in output and government expenditure. growth. Barkley, Henry, & Bao (1996) revealed Road infrastructure is a transport that for spillover investment is to invest urban network that connects the economic activities funds in rural areas. Increased investment capital of various regions into one, and therefore in poor areas will have more impact on growth allows rapidly growing areas to encourage the acceleration than in rich areas. economic growth of the poor regions by the Amongst emprirical research employ effects of diffusion, thus showing a positive physical capital and have positive significant spillover effect. Xueliang (2008) noticed the effect on economic growth is Jajri and Ismail fact that the development of transport (2010) who found that capital reserve and capital infrastructure can promote the migration of per labour ratio have important role in economic activity between regions. It contributing towards economic growth connects the economic activities of the andlabour productivity. WhileResosudarmo and various regions into one, and therefore allows Vidyattama (2006) claims that physical capital a rapidly growing area to encourage regional accumulation is an important factor in economic growth to slow down by the effects promoting regional growth in Indonesia. of diffusion, thus demonstrating a positive Maryaningsih, Hermansyah, and Savitri spillover effect. (2014) states that physical capital reinforced with This variabel positively affect income investment have positive significant effect and per capita growth (0.316869) on 1% leve of confirm the hypothesis that investment is among significance. That is to say this variable the main factor of economic growth stimulant in accelerate income per kapita growth. For Indonesia.

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Regency / Municipality Minimum Wage Education level positively influences slows growth and slows convergence. Obeng insignificantly because there are still educated (2015) argue that increased spending on wages unemployed in East Java. Educated can reduce investment spending by firms. unemployment occurs because the number of This is likely to reduce productivity and registered job seekers is more than the registered production. job vacancy. So growth may be hampered. The As well as the number of fulfillment of attractiveness of educated labor from low- labor that turns out to be less than the vacancy income areas to high-income blood. As a required. This happens because of the result poor areas will lack skilled and inappropriate specifications required by the educated human resources. This is what company so that the fulfillment of labor is not in causes the backwash effect and slow the accordance with the vacancy required. convergence. Districts / municipalities government Minimum wage increase might not be expenditures negatively affect the insignificant the most efficient way to reduce poverty (Card growth of per capita income and acceleration of and Krueger, 1995). This is because the convergence. This is due to similar variations in minimum wage increase is followed by higher government spending that are unable to explain unemployment rate especially for unskilled economic growth and acceleration of labour. convergence in East Java. Dube (2013) claims that the moments to CONCLUSION increase minimum wage is an important factor due to negative corelation between The growth of Barro and Sala-i-Martin minimum wage raise and jobs availability. models can be applied in calculating Increasing minimum wage in turn raise price convergence in East Java. These findings level. Inflation effect of minimu wage raise strengthen Kuznet's theory of the inverse U burden the poor since they spend more relationship between growth and inequality. portion of their income. Therefore the poors East Java's economic growth is convergent are prone to inflation impact of minimum at a low level. This is evidenced by the results of wage raise. the estimate of absolute convergence or natural In neoclassical theory, the labour force convergence where this convergence is not can accelerate growth. This is in accordance influenced by policy factors. Furthermore, this with the results of research which states that low level of absolute convergence needs to be labor force growth can accelerate income per accelerated through policy factors issued by the capita and accelerate convergence in East government so that the reduction of inequality Java. Labor productivity describes the can also be accelerated. endogenous capability of workers and Efforts to accelerate convergence can be technical progress in a region. The results proved through the result of conditional show that labor productivity can accelerate convergence estimation where in East Java there per capita income growth and accelerate is convergence in a shorter time with efforts to convergence. accelerate convergence through government

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APPENDIX

Table 1. Estimated Results of East Java Absolute Convergence 2005 - 2014 Variable Absolute Convergence Model Constanta 1.551196*** Initial Income Percapita (LNYO) -0.095458*** R-squared 0.219878 Adjusted R-squared 0.130458

훽1 = 훼0 -0.095458 Speed of convergence 0.010033 Half - life 72,27 Years Time 144,54 Years

Source : Data Processed

Table 2. Estimation Result of East Java Conditional Convergence 2005 - 2014 Variable Conditional Convergence Model Constanta -12.22859*** Initial Percapita Income (LNYO) -0.619959*** road infrastructure * LNYO -0.001521*** electrical infrastructure * LNYO -6.00E-06** third-party funds * LNYO -0.000387*** SMPT * LNYO -0.0007 UMK * LNYO 0.025804** labor force * LNYO -0.008662*** labor productivity * LNYO -0.023386* government expenditure * LNYO 0.012702 road infrastructure 0.316869*** electrical infrastructure 9.75E-05** third-party funds 0.006057*** SMPT 0.010235 UMK -0.45404*** labor force 0.829089*** labor productivity 1.250564*** government expenditure -0.151574 R-squared 0.835631 Adjusted R-squared 0.80832

훽1 = 훼0 -0.619959 Speed of convergence 0.09 Half - life 11,20 Years Time 22,40 Years

Source : Data Processed