Indonesia's persistent development gap between its western and eastern regions—reflected in unequal access to education, healthcare, and financial services—continues to pose a structural challenge that cannot be resolved through economic growth alone. Against this backdrop, identifying the most effective policy measures to reduce income inequality has become an increasingly urgent issue that requires empirical rather than merely normative answers.

 

Addressing this challenge, Dr. Paidi, a lecturer at the Faculty of Economics and Business, Universitas Sumatera Utara (USU), conducted a study entitled "Examining the Connection Between Financial Inclusion and Income Inequality in Indonesia," published in the international journal Economies (MDPI). The research examines the determinants of income inequality across Indonesian provinces using dynamic panel data from 33 provinces between 2015 and 2023. North Kalimantan was excluded due to limited data availability during the early years of the study. The data were obtained from official sources, including Statistics Indonesia (BPS), the Indonesia Investment Coordinating Board (BKPM), the Financial Services Authority (OJK), and Bank Indonesia.

 

The 2015–2023 period was selected because it encompasses both the implementation of Indonesia's National Financial Inclusion Strategy (SNKI) and the COVID-19 pandemic, two significant events that substantially influenced income inequality and public access to financial services.

 

The study examined the impact of four key variables on income inequality: the Financial Inclusion Index, the Human Development Index (HDI), foreign direct investment (FDI), and domestic investment. The Financial Inclusion Index was constructed using Principal Component Analysis (PCA), enabling a more comprehensive representation of access to, availability of, and usage of financial services.

 

To identify causal relationships among these variables while accounting for the possibility that current inequality is influenced by inequality in previous years, the study employed the two-step Generalized Method of Moments (GMM), an econometric approach specifically designed for dynamic panel data. The model was subjected to validity and autocorrelation tests to ensure the methodological reliability of the findings.

 

The results reveal that income inequality in Indonesia exhibits a very high degree of persistence. In other words, provinces experiencing high levels of inequality in one period are likely to continue experiencing similar conditions in subsequent periods unless strong policy interventions are implemented. This finding indicates that inequality is shaped not only by current economic conditions but also by long-standing structural factors.

 

The study further demonstrates that expanding access to formal financial services has a negative and statistically significant relationship with income inequality, suggesting that greater financial inclusion can serve as an important instrument for promoting more equitable economic development.

 

Conversely, foreign investment tends to be concentrated in capital-intensive industries and already-developed regions, increasing the risk of widening regional disparities when not accompanied by more inclusive policies. Domestic investment, meanwhile, showed a positive but statistically insignificant relationship with income inequality, indicating that it remains concentrated in relatively developed regions and has yet to function effectively as a tool for economic equalization.

 

These findings provide valuable empirical evidence for designing more targeted financial inclusion policies while offering strategic recommendations for reducing regional development disparities across Indonesia.

 

According to Dr. Paidi, Indonesia's geographical characteristics as an archipelagic nation create unique structural challenges for financial inclusion, particularly in regions where conventional banking infrastructure remains difficult to access. This distinctive geographic context differentiates Indonesia from continental countries and explains why financial inclusion may play a particularly important corrective role within the country's highly decentralized institutional framework.

 

The study's most significant finding concerns financial inclusion itself. The broader the public's access to formal financial services—including savings accounts, microcredit, and digital payment systems—the lower the level of income inequality observed across provinces.

 

Dr. Paidi explained that access to formal financial services enables low-income households to escape dependence on loan sharks and high-interest informal lenders while providing them with the capital needed to develop productive businesses independently. This pattern is consistent with findings from similar studies conducted in developing countries, ranging from Ecuador to several African nations, where formal financial access has proven to be an effective pathway toward more equitable economic development.

 

Meanwhile, the Human Development Index showed a relationship consistent with economic theory: higher levels of education, health, and purchasing power are associated with lower income inequality. However, its effect was not statistically significant within the study period. Rather than suggesting that human development is unimportant, the findings indicate that its impact is more likely to materialize over the long term, particularly given the substantial disparities in educational quality among Indonesian provinces. For example, the gap between Jakarta and Papua remains too wide for improvements in human development to produce uniform equalizing effects in the short term.

 

One of the study's more surprising findings relates to investment. Foreign investment in Indonesia has largely been concentrated in capital-intensive sectors such as heavy manufacturing and mining, industries that generate relatively limited employment opportunities for local communities. Furthermore, these investments are primarily located in infrastructure-rich regions such as West Java, Banten, and Jakarta. Rather than serving as a driver of equitable development, such concentration risks widening the economic divide between investment-receiving regions and less-developed areas.

 

According to Dr. Paidi, these findings do not suggest that foreign investment should be restricted. Instead, investment policies should be redirected toward labor-intensive industries and regions that have historically received limited investment so that economic growth can be distributed more evenly across the country rather than remaining concentrated in already-developed areas.

 

Based on these findings, the study proposes more targeted policy recommendations than the general call to "expand financial access." For example, Indonesia's People's Business Credit (KUR) program should be more specifically directed toward provinces with the highest levels of inequality through dedicated credit guarantee schemes that effectively reach low-income communities.

 

Given Indonesia's archipelagic geography, the research also recommends prioritizing the expansion of financial technology (fintech) services and agent banking initiatives such as Laku Pandai over the construction of additional physical bank branches, as these approaches are considered more efficient in serving remote areas.

 

In addition, large-scale foreign investment projects should be required to establish supply-chain linkages with local micro, small, and medium-sized enterprises (MSMEs) rather than operating as isolated economic enclaves disconnected from surrounding communities.

 

The research demonstrates that financial inclusion should not be viewed solely as a financial sector development strategy but also as a key policy instrument for fostering more inclusive economic growth and reducing regional income inequality in Indonesia. Combined with more equitable human development and inclusive investment policies, financial inclusion has the potential to support more sustainable and balanced economic prosperity throughout the country.

 

Dr. Paidi also emphasized that while the study demonstrates strong statistical correlations based on nine years of data, the findings should not be interpreted as universally applicable causal relationships under all circumstances. He encouraged future research to investigate possible threshold effects—for example, whether financial inclusion becomes significantly more effective in reducing inequality only after a region reaches a certain level of human capital development—and to compare the mechanisms operating in western and eastern Indonesia, where financial infrastructure differs considerably.

 

This study serves as a clear example of how academic research conducted at the Faculty of Economics and Business, Universitas Sumatera Utara, extends beyond theoretical discussions by providing empirical evidence that can directly inform policymakers in their efforts to promote more inclusive and equitable economic growth across Indonesia.

 

Paper Details

• Journal: Economies (MDPI)
• Title: Examining the Connection Between Financial Inclusion and Income Inequality in Indonesia
• Author: Paidi
• Author Affiliation: Faculty of Economics and Business, Universitas Sumatera Utara
• DOI: https://doi.org/10.3390/economies14040122