Rethinking Fiscal Decentralization: Public Service Effectiveness as a Transmission Mechanism for Human Development

Abstract

This study investigates the impact of regional government expenditure composition on human development outcomes in West Nusa Tenggara (NTB), Indonesia, with particular emphasis on the mediating role of public service effectiveness. Using balanced panel data from 10 districts/cities during the 2013–2022 period, the study applies fixed-effects panel regression, principal component analysis (PCA), & structural equation modeling (SEM) to examine the relationships among fiscal variables, service effectiveness, & the Human Development Index (HDI). The Hausman test confirms the appropriateness of the fixed-effects estimator, indicating the existence of unobserved regional heterogeneity across districts. The findings reveal that personnel expenditure & social transfer spending, including subsidies, grants, & social assistance, significantly enhance public service effectiveness, which subsequently exerts a strong positive influence on HDI. In contrast, capital expenditure does not show a significant direct or indirect contribution to human development outcomes. The PCA results indicate that overall expenditure composition remains positively associated with HDI despite the limited contribution of certain expenditure categories. Furthermore, SEM analysis demonstrates that public service effectiveness fully mediates the relationship between personnel expenditure & social transfer spending on HDI. These findings contribute to the fiscal decentralization & public finance literature by emphasizing that the developmental impact of local government expenditure depends more on the effectiveness of public service delivery than on the magnitude of spending itself. The study highlights the importance of strengthening institutional capacity & implementing service-oriented budgeting policies in decentralized governance systems.