# _<u>Conceptual Measurement of Size Economies</u>_

Both conceptual and empirical analysis can be used to examine whether size economies can be expected to result from consolidation. Hirsch (1968) provides a useful categorization of local government services according to their potential to reap size economies. Horizontally integrated services are ones that use separate production plants at the same level of the production process to produce the same service, and include education and police and fire protection. Once a municipality has reached the size where it can use the individual plants efficiently, economies of size are limited for these services, as increases in population and land area simply require more production plants. For example, if the target student-teacher ratio in a primary school is 25 students per teacher, adding a small number of students may produce very small size economies as more students are added to existing classrooms, but ultimately more teachers must be hired and new classrooms must be procured and few economies result. Hirsch thought that 80 to 85 percent of government expenditures are dedicated to horizontally integrated services but an analysis of 1999 U.S. local government data suggest that the share may be 65 to 70 percent today.

Vertically integrated services are those that require production at several different stages, and these appear to represent about 15 percent of government expenditures. Vertical services include water and electricity, both of which require production of a service and distribution of the service to users. Economies of size are more likely in _production_ of the services, as treating more water at the same facility could result in lower per unit costs. However, it is important to keep in mind that amalgamation not only creates a larger population but also a larger land area and gains from treating more water may be offset by the added cost of distribution over a wider geographic area.

Circularly integrated services are goods and services that complement each other in production, and are therefore best produced in close proximity. These services can be complementary in the sense that resources can sometimes be shared in their production. Central administration is a good example of circularly integrated services and these services in total account for slightly less than 10 percent of municipal costs in the U.S. Size economies from consolidating administrations are possible as long as it is politically feasible to discharge redundant personnel and the added costs of managing a larger administration do not offset size gains.

In a test of the Hirsch hierarchy, Ladd (1994) recently argued that those services entailing large capital costs (often vertically integrated services), such as sewage plants or transportation systems, are more likely to benefit from greater size. Services that are more labor intensive, such as most horizontally integrated services including fire protection and education, are apt to have constant or even increasing per capita costs as the number of people served increases. Ladd examined the effects of population growth in the U.S. and found evidence that per capita spending rises with population in the city, but primarily because of effects from increased population density. Increased density causes higher costs because of the horizontally integrated services, greater congestion of 10