Local Government Cost Function: Case Study Analysis for Slovenian Municipalities

The appropriate creation and size of local jurisdictions are important for achieving efficiency gains in local government goods and services provision. In general, the size of local government units should effi ciently combine scale and congestion effects in order to minimise local authority costs. The theory predicts four different potential effects of local government size on its costs: linear negative effect, linear positive effect, non-linear U-shaped effect and non-linear inverted U-shaped effect. In the first case, the bigger local government means lower costs, whereas in the second case, the bigger local government means larger costs. In the third case, costs of local government units fall at the beginning, however they start to rise after certain size of local government is achieved, which implies some “optimal” size of local jurisdictions. The last case shows that costs of medium-sized local units are the largest, as they have not experienced the economies of scale yet, but they still experience congestion effects. Consequently, the main purpose of the paper is to investigate the relationship between local government size and costs, empirical analysis being based on the data for Slovenian municipalities for the year 2011. The results reveal that the average costs function for Slovenian municipalities is U-shaped, and the estimated least-cost size of the municipality implies that the current number of municipalities is not optimal. Besides, the average cost efficiency of Slovenian municipalities is approximately 25% above estimated best-practice frontier. JEL Classification: H11, H21