The Dynamic Analysis of Economic Openness and Regional Economic Growth in Indonesia

Abstract

Economic openness has become a central component of regional development in Indonesia, yet its growth effects remain uneven across provinces because trade exposure, investment inflows, infrastructure, and absorptive capacity vary substantially. This study examines the dynamic relationships among trade openness, foreign direct investment (FDI), their interaction, and regional economic growth across 34 Indonesian provinces from 2015 to 2025. The empirical analysis employs a panel Vector Error Correction Model (VECM), complemented by Pairwise Granger Causality tests, Johansen cointegration tests, impulse response functions, and variance decomposition. The results identify bidirectional causality between trade openness and growth, supporting both the trade-led growth and growth-driven trade hypotheses. A significant two-way relationship is also found between economic openness and growth, indicating that the joint effects of international market access and foreign capital are more informative than either channel in isolation. The Johansen test confirms one long-run cointegrating relationship, while the error-correction coefficient of -0.240885 indicates that approximately 24.09% of disequilibrium is corrected in each period, implying a gradual return to equilibrium over roughly two to three years. Variance decomposition further shows that FDI shocks become the dominant source of long-run growth fluctuations, accounting for 63.82% of the forecast error variance by the tenth period. These findings suggest that regional policy should prioritize the quality, stability, and domestic linkages of FDI, strengthen local absorptive capacity, and integrate trade and investment strategies to promote more resilient and inclusive regional growth.