Eliminating the effects of external environmental factors to improve the analysis of local government financial condition: a study in Indonesia

This article proposes an approach to the assessment of the financial condition of local governments by eliminating uncontrollable external environmental factors using cluster analysis. The author found seven clusters of provincial government, 13 clusters of regency government, and seven clusters of city government in Indonesia. The article provides evidence that clustering local government increases the effectiveness of analysis of financial conditions. The academic contribution of this article is generating cluster variables that are more comprehensive and relevant than those presented in previous studies. In addition, findings of this study can be used by authorities to develop local government financial management policies that are fairer.In a heterogeneous external environment, it is irrelevant and unfair if the central government applies a single financial management policy to all local governments. This article provides a solution in the form of a method to eliminate heterogeneous external environmental effects. The conceptual framework developed in this study can be adopted by countries with a high degree of local government heterogeneity to develop regional financial management policies, such as analysing financial conditions or financial management performance, which are more relevant, fair and accurate.