When Regional Policies Fail

Throughout the developing world, many countries have created special economic zones to attract investment and spur industrial growth. In some cases, these zones are designed to promote development in poorer regions with limited market access and lower quality infrastructure, an example of a "big push" development strategy. In this paper, we study the effects of Indonesia's Integrated Economic Development Zone (KAPET) program. This program provided substantial tax-breaks for firms that locate in certain districts in the Outer Islands of Indonesia, a country with large regional differences in per-capita income and a history of policies to promote inclusive growth. We find that along many dimensions, KAPET districts experienced no better development outcomes, and in some cases fared even worse, than their non-treated counterparts. If anything, the strongest finding is that firms in KAPET districts paid lower taxes, but these tax reductions neither encouraged greater firm entry, increased migration, nor raised local measures of output or welfare. Overall, the KAPET program does not appear to have achieved the intended outcome of promoting growth in lagging regions. While there are many possible reasons that the KAPET program failed, our findings suggest caution in spending scarce resources to subsidize development in lagging regions.