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

Against farm subsidies

Many countries, especially those in the West, support their farmers with generous agricultural subsidies. In 2011, for example, Canada spent $6.9 billion on them. These programmes, however, create inefficiency and lead to morally questionable outcomes.

Farm subsidies artificially reduce the cost of farming. In other words, farmers produce more in jurisdictions with subsidies than those without, i.e. subsidized farmers produce more than what would otherwise be profitable under purely competitive market conditions.

For instance, consider a developed country without farm subsidies. Farmers would use land that allows them to earn as much, or more, money than they could by renting it to the highest bidder. If this country introduced agricultural subsidies, farmers would purchase or rent additional land, since it would increase their revenue from the additional land above its market price (which, all things equal, was uneconomical before subsidization). Under competitive conditions, farmers would not utilize the additional land, whereas providing subsidies encourages them to do so.

Now, imagine a farmer who plans to purchase land in one of two countries. He must choose between Country A, which has extremely fertile land, and Country B, which has only passable land. If the cost of doing business and renting land were equal in both countries, he would likely choose Country A. However, if Country B offered subsidies that compensate him for utilizing less productive land, then he may opt to operate there, instead. In other words, agricultural subsidies are inefficient, in that they encourage farming on land that could be useful for building shopping malls, restaurants, or movie theatres. Moreover, subsidies create inefficiencies between countries with different agricultural policies.

These subsidies are more pervasive in the developed world than in its developing counterpart. Farmers in poorer countries are unable to compete with farmers in richer countries that offer artificially low factor prices resulting from lavish subsidies. As a result, these subsidies encouraging production in areas that are not especially suitable for agriculture, while discouraging production in areas that are suitable for farming. It is in the interest of developing countries to end agricultural subsidies, as it would allow them to expand their agricultural industries, which currently underperform due to subsidies in rich countries, and would alleviate rural poverty by boosting production and prices. Currently, however, richer countries “dump” their subsidized products in poorer countries, not only deteriorating their ability to generate economic activity, but also creating a dependency trap. From the perspective of richer countries that provide billions in annual subsidies, it is more efficient to stop transferring wealth to their agricultural industry and, instead, purchase foodstuffs from abroad.

Agricultural subsidies additionally affect wealth distribution at the domestic level. Policymakers fund the subsidies using tax revenue, which they transfer to farmers and landowners that tend to be wealthier than most; in 2011, the average income of a farm family was $93,426. That is, they redistribute wealth from the general population to a small group of wealthy individuals and firms. Indeed, contemporary “farming” is much different from its predecessor: most “farmers” are wealthier individuals and many farm operations involve large firms that use factories.

Farm subsidies also have a tendency to remain politically relevant–the special interest group behind farm subsidies is very powerful. It is politically expedient for governments to stay these benefits, as they require little funding per capita, yet, provide massive benefits to a small group. In other words, the cost of fighting these subsidies exceeds to cost of providing them in the first place. Moreover, when subsidies increase, this group begins to sense that they can generate more profit by lobbying the government than by actually producing foodstuffs or agricultural commodities.

Lastly, the farming lobby provides a massive obstacle to potential trade deals. In 2007, for instance, American and European governments’ objected to limiting their agricultural subsidies, which threatened the World Trade Organization’s Doha talks. India and Brazil, the countries proposing that western farm subsidies recede, in turn, refused to open their markets.

Proponents of agricultural subsidies typically defend their position by arguing that they benefit farmers and increase food security. However, in world of institutionalized trade relationships, there is little reason why any country should strive for food autarky at the expense of efficiency. Additionally, the age of rural poverty in rich countries is essentially over: farmers whom subsidies support tend to be quite wealthy. For these reasons, and those mentioned above, all states would be wise to stop subsidizing agriculture.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute

Airfare Must Descend

Since the first commercial passenger flights at the turn of the 20th century, aviation has advanced global integration in many ways that few other technologies have. By transporting people around the world in a quick and efficient manner, modern aircraft has allowed for cultural diffusion and economic globalization.

However, Canada’s ability to forge stronger connections with other countries is somewhat threatened by its restrictive airline regulations, which not only protect domestic airlines, but also limit competition from foreign operators. These stipulations ensure high operating costs for airlines and reduce options available to consumers (compelling them to pay higher prices), pleasing neither business nor the public.

There are, for instance, two especially prohibitive and protectionist rules mandated by the federal government that facilitate inefficiency in the Canadian aviation market. First, the Canadian Transportation Agency (CTA) requires Canadian ownership of domestic carriers. Second, Canada’s “cabotage” laws decree that only Canadian airlines may transport passengers between airports within Canada. As a result, two firms dominate Canadian airspace: Air Canada and West Jet. Together, these companies control roughly 90 per cent of Canada’s aviation market.

It may seem as though these regulations would have a savings effect, since insulating Canadian carriers from foreign competition allows them monopoly access to flights within the country. However, the Canadian market is not large enough to support these firms under the current regulatory framework and new airlines could scarcely hope to achieve economies of scale, which would reduce costs and prices in the end. Yet, by facilitating competition via foreign carriers, the federal government could ensure lower fares, if not efficiency gains.

More importantly, if other countries scrapped their cabotage regulations, which restrict the ability of foreign airlines to flying between two points within a country, international competition would likely drive both prices and costs down and Canadian airlines could access new markets. Nevertheless, unilaterally abolishing these restrictions would still push down the costs and prices associated with air travel.

Increased competition from foreign carriers would additionally reduce Air Canada’s political influence. The Canadian airline’s market share affords it lobbying power without much of a counterweight. In fact, some associate Ottawa’s decision to reject Emirates Airlines from operating direct flights between Toronto and Dubai to Air Canada’s political influence.

Supposing the federal government eliminated cabotage regulations, the high cost of operating in Canada would preclude many foreign airlines from entering the Canadian market. In 2012, for instance, the Conference Board of Canada claimed that about five million Canadians opt to cross the American border by land to fly from airports in the United States. They concluded that high labour compensation, fuel costs, aircraft prices, airport fees, and navigational expenses explain why Canadian flights are, on average, 30 per cent higher in price compared to equivalent flights operated from the United States.

Higher costs in Canada have already encouraged many foreign airlines to exit. JetBlue, a low-cost American carrier, refuses to fly to and from Canadian cities, despite having a license, as high costs prevent it from making any profit without sacrificing their low-price airfare.

What is the result of Canada’s strict aviation rules?

The Frontier Centre for Public Policy found that for 5400KM flight, Canadian consumers pay $1,499.62, whereas American’s pay $934.72. (Europeans paid $525.72).

Reducing the rents charged to airports and the mess of taxes and surcharges placed on flights would assuredly reduce costs. However, in order for lower costs to translate into reduced prices, the federal government must eliminate barriers to entry. This would allow new firms to undercut the cost of existing ones, placing downward pressure on prices. Thus, by cutting costs and enabling competition, Ottawa could make flying more accessible for consumers and businesses while increasing choice for flyers.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute