State capacity failure and the illusion of MSME-led development

The growth of Micro, Small and Medium Enterprises (MSMEs) and declining unemployment rates are widely regarded as indicators of successful economic development. However, these trends may conceal underlying structural problems, particularly limited formal job creation and increasing dependence on the informal economy. This study examines how patterns of MSME growth may indicate constraints in state developmental capacity to generate productive formal employment and contribute to the illusion of MSME growth, a condition in which expanding MSME numbers and declining unemployment create the appearance of development success despite persistent structural labor-market vulnerabilities. Using a qualitative comparative design, this study analyzes secondary data from Bandung, Surabaya and Pontianak, including publications from Statistics Indonesia, the Ministry of Cooperatives and SMEs, local government documents and other official reports. The data were analyzed thematically and comparatively to examine patterns linking MSME expansion, formal employment capacity and labor-market dynamics. The findings suggest that increasing MSME numbers do not necessarily indicate stronger regional economic capacity but are consistent with limited formal employment opportunities that encourage necessity entrepreneurship. Based on these findings, the study proposes the Urban Employment Transformation Capacity (UETC) Model and introduces the concept of the illusion of MSME growth, contributing to development governance literature by questioning the use of MSME growth as an unqualified indicator of development success.