This chapter examines the theoretical understanding and discourses regarding the impact of institutional changes. However, current regional development and economic literature neglected to provide an explanation on the divergence of economic performance at the district level. This chapter attempts to provide an exploration of contemporary development theories and debates on the politico-economy, governance, and institutionalism as a way to explain such dynamics in Indonesia. A research framework was then put into place in order to study local development processes.

I first revisited theoretical perspectives on neoclassic theories and followed by the divergence theories section. Then the role of institutionalism in economic geography and the construction of an empirical research framework was discussed. The final section addressed research summaries and emphasizes the importance of place-specific policies to enhance local economic performance.

REGIONAL DEVELOPMENT DEBATE: CONVERGENCE OR DIVERGENCE?

The theories on development convergence were premised on the neoclassical perspectives that economic development is accelerated by an open market and free trade. By allowing labour and capital — the factors of production — to be mobilized to the locations where they can be most efficient, these events would lead to the new spatial and international divisions of labour (Perrons 2004, p. 134).

The neoclassical approach posited the traditional convergence of local economic development (Williamson 1965) (Figure 2.1). In this literature, economic growth was the core subject of economics and focused on the long-term decrease of disparities in income per capita (Pike, Rodríguez- Pose and Tomaney 2006). Economic growth theory postulated diminishing returns condition suggesting that world economy will be convergent as poor regions grow at a higher rate than the developed economies.

The basic idea of neoclassical theory was one of diminishing returns. Early nineteenth century economists, including Thomas Malthus and David Ricardo, introduced the concept of diminishing returns with regards to the process of economic growth. This concept simply explains that economic growth must be quantified in real terms of per capita income to represent real purchasing power per capita.