note that distribution costs, not treatment costs, account for the largest share of expenditures and as a result conclude that cost advantages from consolidation only exist in the most densely populated areas.

Kim and Lee (1998) in a study of urban water service markets in Korea find that consolidating the water districts of the Seoul Metropolitan Region would lead to substantial cost savings. However, the authors note that such gains would not be expected in low population density and lesser-developed areas. The authors conclude that flexibility in designing the best-sized water district and the means of service delivery is a key to low cost provision of water services. They caution that the large potential savings from consolidation in the Seoul region would be substantially eroded if there were significant costs of integrating the water districts or if changes in economic resources such as population or employment occurred. Kim and Lee also note that integration may cause conflict among localities if benefits are transferred without compensation.

Using panel data for French local communities, Garcia and Thomas (2001) find gains to consolidation among 53 privately operated and 3 publicly operated municipal water systems. The marginal gains from consolidation are found to be highest when two systems are merged, with the additional savings diminishing until the optimal level of five is reached. Beyond this point there are diseconomies from consolidating districts, although the cost increases are not significant. Density is an important consideration as creating a combined service district is less profitable in low population density areas. The authors conclude that their model provides evidence that merger of water districts is generally profitable. Interestingly, Garcia and Thomas find that it is more cost effective to produce and pump additional water in response to an increase in demand rather than to provide the water by fixing losses through repairs and maintenance. Provided that water conservation is an important local goal, an alternative to the market mechanism is needed to reduce water losses. Government planning to achieve local environmental goals is discussed further in the regional planning section below.

The above evidence indicates that caution should be exercised when consolidating vertically integrated services for the purpose of realizing cost savings. Economies of size, although likely to occur over a much broader population range than in the case of horizontally integrated services, are not a given. Size economies in the production of vertical services are very probable but distribution costs are nearly as likely to rise. As a result, the potential for economies from consolidation must be examined on a case-bycase basis. The best candidates for consolidation are areas with high population densities and short distances from the service source to consumers. Indeed, at times the distribution costs are so sizable that a proposed merger can be disregarded with little analysis. For example, a recent report on the merits of amalgamation in Latvia (World Bank, 2003) observes that large distances separate the water supply and sewage networks of many small Latvian municipalities. As a result, it is argued that the distribution costs from consolidating these systems outweigh any potential savings from larger scale production. The report also notes that cost savings for purchasing large quantities of 15