Municipal amalgamation and economies of scale

Observation : Municipal amalgamation does not necessarily yield economies of scale1

Across many countries, especially in Europe, the last 50 years have seen a dramatic wave of municipal mergers, often motivated by a quest for economies of scale. The main motivation has therefore been economic – to reduce costs by capturing economies of scale.

These reforms have redrawn the local government map, with smaller units merging together to form larger ones. Across the developed world, this trend has affected states of all types – from decentralised federal states to regionalised unitary systems – and countries of all sizes.

Yet theoretical arguments and empirical research appear to show that these reforms have failed to yield economies of scale. Potential savings in, for example, administrative costs from such mergers are likely to be offset by opposite effects for other domains.

Moreover, it is difficult to empirically assess supposed economies of scale because amalgamations never happen by chance and, as such, each merger has its own unique features. Consequently, the findings of such research may not be universally applicable. In most cases, amalgamation decisions are made by central government or directly by local government leaders. In both cases, the characteristics of the merged entities can differ, making any assessment even more complex.

This finding raises questions about the rationale behind a global movement that has already restructured local government on almost all continents, driven by reformers with several objectives in mind, including reinforcing democracy and building local government capacity.

Economies of scale are only one of the likely consequences of increased jurisdiction size, although such gains are by no means certain. Such benefits may be offset by the loss of effects that favour smaller units – greater ease of local monitoring, more effective accountability mechanisms, or greater Tiebout-style competition for mobile voters and capital (local services).

At the same time, the savings from economies of scale will depend on the initial and post-amalgamation sizes of the units and will also vary across the types of public services supplied, which have different cost functions. The net benefits are likely to be indeterminate.

Lastly, jurisdiction size is determined by a variety of factors, which also affect the cost of public services. Moreover, regional subcultures and local political histories will influence both jurisdiction size and also levels of corruption and bureaucratic efficiency. As such, there is no strong correlation between jurisdiction size and public service spending.

Danish municipal reform:

In 2007, the Danish local government system underwent a major reform. In total, 239 municipalities – primarily all municipalities with fewer than 20,000 citizens – were merged together to form 66 new units. A further 32 municipalities remained intact (Mouritzen 2010).

The 2007 reform had two main elements. The first was a reshuffle of functions across tiers, involving income tax assessment, disabled services, rehabilitation, health promotion, primary education for children with special needs, environmental protection and regional roads.

For several reasons, the Danish reform is particularly well-suited to test the effects of increasing jurisdiction size because Danish municipalities play important roles in managing schools, child care, infrastructure, environmental regulation, social spending and culture.

An analysis of this local government reform shows that cost savings in some areas of the country were offset by deterioration in others, while for most public services jurisdiction size did not matter at all.

In other words, Danish local government reforms failed to yield any cost savings in the delivery of public services such as schools, roads and infrastructure. There were no clear and systematic effects from amalgamations. In line with the findings in Blom-Hansen, Houlberg and Serritzlew (2014), administrative costs declined, as did spending on road maintenance per kilometre of road in the merged units. It is impossible to say, however, whether these savings represent greater efficiency in service delivery.

However, the economies of scale in administration and road maintenance were offset by increased management/delivery costs in local programmes and projects. In most policy areas – including elder care, schools, daycare and caring for children with special needs – jurisdiction size did not matter at all. The conclusion, therefore, is that there is no optimal jurisdiction size (Dahl and Tufte, 1973; Treisman, 2007).

Local jurisdiction size: theory and empirical surveys

The optimal scale of local government jurisdictions – or of government jurisdictions in general – has been debated since the time of Plato. However, without knowing the particular mix of tasks assigned to local governments and their technologies, it is impossible to predict whether, on balance, enlarging municipalities will have positive or negative effects.

In both the private and the public sector, returns of scale are thought to increase for two main reasons (Boyne, 1995; 47-70). First, there are fixed costs associated with providing various kinds of public service, so the marginal cost will fall with output, at least up to a certain point. Some public goods have elements of non-rivalry in consumption, so the marginal cost is zero. Second, increasing the scale of service provision makes possible a more fine-grained division of labour, yielding the associated benefits of specialisation.

However, above a certain level, such benefits of larger size are offset by problems of communication and control. As output grows, so does the need to transmit information through more layers of management. Large production processes offer suffer from bureaucratic congestion (Williamson, 1967). Consequently, production processes normally exhibit first increasing, then constant, and finally decreasing returns to scale.

In short, even setting aside Oates’ (1972) argument that scale economies are offset by less precise matching of services to local tastes, the existence of economies of scale does not imply any direct or universal prescriptions for the design of local government systems, except perhaps in the case of certain single-purpose service providers. For municipalities – or other multi-purpose entities – there is simply no good reason to expect that larger size will generally lead to cost savings.

A second argument in favour of amalgamations is that larger jurisdictions may be able to capture not just economies of scale but also economies of scope. It may be more efficient to produce certain related services – say, sewerage and recycling of water, cf. Dollery and Fleming (2006) – jointly than to produce them separately.

However, the relationship between economies of scale and scope is far from clear. They may complement each other or conflict. But they may also be unrelated (Dollery and Fleming 2006). Given this, we should not expect increased size to lead to cost reductions for this reason either.

1 Article: “Jurisdiction Size and Local Government Policy Expenditure: Assessing the Effect of Municipal Amalgamation”, American Political Science Association, 2016