Abstract
This study investigates the dynamic relationship between fiscal decentralization, local government size, and regional economic growth in Indonesia. Integrating fiscal federalism theory with the Armey curve framework, the study examines whether decentralization reshapes the scale of subnational governments and how this influences growth outcomes. Using balanced panel data from 26 Indonesian provinces over the period 1995–2020, the analysis employs dynamic panel estimators based on the Generalized Method of Moments (GMM) to address endogeneity, persistence, and unobserved heterogeneity. The results reveal a nuanced relationship between fiscal decentralization and government size. Greater revenue autonomy is associated with a contraction in government size relative to regional output, while both local own-source revenue and intergovernmental transfers contribute to fiscal expansion. The findings also provide evidence of a nonlinear relationship between government size and regional economic growth, consistent with the Armey curve hypothesis. Public expenditure supports growth at lower levels but exhibits diminishing marginal returns beyond a threshold. The estimated turning point suggests an indicative optimal government size of approximately 31.9% of GRDP, although this value should be interpreted cautiously given institutional heterogeneity across regions. This study contributes to the literature by providing subnational evidence on the decentralization–government size–growth nexus within a large emerging economy. The findings highlight the importance of fiscal governance and expenditure quality in shaping decentralization outcomes and suggest that improving the design of intergovernmental fiscal frameworks may be more important than targeting specific expenditure levels.