The Economics of Amalgamation

Small municipalities in Nova Scotia are asking tough existential questions. Earlier this year three towns voted to dissolve within a five week window: Springhill, Bridgetown, and Hantsport. Hantsport’s decision came as surprise, given their relatively healthy municipal finances, but as one supporter of the motion put it, the decision to amalgamate represented a “forward-looking” and “strategic” choice for the councilors. The trends foreseen by Hantsport come down to basic economics. In particular, two interrelated economic concepts stand out to explain why so many of Nova Scotia’s small towns are facing increasing cost pressures.

Economies of Scale

The kind of services provided by municipalities are all subject to economies of scale to varying degrees: as the scale of service grows, average or per capita costs fall until reaching a sweet spot, beyond which more scale creates rising average costs. Economies of scale are key to understanding the differing levels of market concentration by industry, and is similarly applicable to analyzing the size and concentration of political units.

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A simple way to demonstrate economies of scale in municipalities is to look at how per capita costs of basic services differ depending on scale. For example, providing a town in Nova Scotia with police and fire services, along with other administrative and counsel expenditures, costs on average $683 per capita annually. Scaling these same services up to the county level reduces the per-capita costs of every category, and cuts the annual total nearly in half to $350 per capita. Costs begin to rise again for CBRM and HRM, but never reach the highs of the town average.

These trends align with the academic literature on the subject. Most studies of Canadian municipalities find that economies of scale are mmaximized for police and fire services between a population of 20 and 50 thousand. Out-migration is, therefore, especially damaging to towns below this population range.

The Cost Disease

The cost disease is a concept that was first observed in connection to the arts. The economist William Baumol noted that musical performers were becoming more and more expensive to hire, despite little to no improvement in their productivity. One had to pay more in order to entice the musically skilled away from high productivity growth sectors of the time, such as manufacturing.

The cost disease is a defining feature of our times, as creeping changes in relative cost, and in particular rising costs of labour, force old practices and structures to break down. For instance, having home servants was once commonplace, but today is associated with luxury. For a similar reason, it’s often cheaper to buy a new home appliance than to call in a technician. In schools, teacher salaries continue to rise without matching productivity growth, too, leading to the infeasibility of the small school model and driving organizational consolidation.

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Residential Tax Burden = Total residential tax revenue ÷ Total dwelling units

The cost disease leads to similar consolidation pressures for municipalities. Nova Scotia’s municipal districts tend to have the fastest growing residential tax burdens for two reasons. First, relative to towns, they have smaller tax burdens to begin with, so a given increase implies a faster growth rate. In absolute terms, towns have the largest tax burdens by a long shot. Second, municipal districts have more mandatory expenditures, such as the education contribution, that they have little control over.

There are no short cuts to fighting the cost disease. The options can be grouped into two types: we can either accept much higher proportions of GDP going to cost diseased areas or we can find ways to adapt to changing cost structures by restructuring organizations, boosting labour productivity and finding labour-saving technologies.

Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

One thought on “The Economics of Amalgamation

  1. Pingback: Free Exchange | Three Case Studies of the Municipal Fiscal Crisis

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