A Conceptual Note on Scale Economies, Size Economies and Scope Economies in Australian Local Government

Abstract

The notion that ‘bigger is better’ has underpinned municipal structural reform policy in Australia and led to its heavy reliance on amalgamation. Several advantages are believed to flow from larger councils, including scale economies and scope economies. However, a surprising feature of the debate over amalgamation is not only the paucity of empirical evidence supporting the idea that ‘bigger is cheaper’, but also the marked degree of conceptual confusion between size economies, scale economies and scope economies. This article seeks to ameliorate this confusion by carefully distinguishing between these theoretically distinct concepts in the institutional context of Australian local government.

Keywords:

• Amalgamation
• local government
• scale economies
• scope economies

Acknowledgement

The authors would like to thank two anonymous referees for helpful comments on an earlier draft of the article.

Notes

1. A substantial international empirical literature exists on the question of scale economies in local government. By contrast, very little research effort has been directed at the problem in Australia. Byrnes and Dollery (2002) not only summarise both empirical literatures, but also criticise the validity of extant Australian studies. Chicoine and Walzer (1985) provide a useful synopsis of the related empirical evidence on structure and expenditure in local government (see specially their Table 2.1). It should also be pointed out that empirical work that has been done on economies of scale and municipal consolidations is flawed in respects other than their understanding of economies of scale, scope and size. For example, studies on economies of scale generally use population as the proxy for output and expenditures as the proxy for costs. But population is not a good measure of output. Two municipalities with the same population, for instance, may have very different outputs for a particular service because of demographic differences. Expenditures are not a good measure of costs in part because the pattern of expenditures may reflect differences in local government wealth and preferences. In other words, the local government fiscal base is likely correlated with population size so that larger expenditures do not necessarily mean that costs are higher. These criticisms can be found in Byrnes and Dollery (2002).

2. In more formal terms, an economy of scale is said to exist when an increase in output reduces the cost per unit of the good or service produced. If cost is given by a cost function (C) that depends on the quantity of output (Q), then an economy of scale is given by: C(Q1+Q2, 0 < C(Q1, 0)+C(Q2), 0).

3. In more formal terms, an economy of scope is said to exist when the production of two outputs by a single producer is cheaper than the production of the same quantity of these outputs by two separate producers. If cost is given by a cost function (C) that depends on the quantity of two outputs (Q1) and (R1), then an economy of scale is given by: C(Q1, R1) < C(Q1, 0)+C(0, R1).