Merger myths: a functional analysis of scale economies in New South Wales local government.

Author:Fahey, Glenn

    In common with a preponderance of other advanced countries, including both unitary states and federations, Australian local government policymakers have employed municipal mergers as an instrument of structural reform (Dollery, Grant and Kortt, 2012). For instance, during the 1990s the South Australian, Tasmanian and Victorian local government systems all experienced council consolidation. Similarly, mergers occurred in New South Wales (NSW) in 2004, Queensland instituted amalgamation in 2007, the Northern Territory underwent wholesale consolidation in 2008, and more recently Western Australia abortively attempted to forcibly merge councils in Greater Perth. Moreover, a further radical episode of forced mergers is currently underway in NSW under the auspices of the Fit for the Future (FFTF) reform process initiated in late 2011.

    Advocates of amalgamation frequently argue that it represents an efficacious means of enhancing the operational efficiency of local authorities, improving their administrative and technical capacity, generating cost savings, strengthening financial sustainability and increasing strategic decision-making (Dollery and Robotti, 2008; Faulk and Hicks, 2011). In particular, it is widely asserted that larger local government entities will enjoy significant scale economies attendant upon their size in terms of population (Faulk and Grassmueck, 2012). These claims have been stridently contested in both the conceptual and empirical literature, including the argument that substantial pecuniary savings can be secured through scale economies flowing from larger municipal bodies (Sancton, 2000).

    The NSW compulsory council consolidation program, conducted under the FFTF local government reform program, is based inter alia on the premise that the larger local government entities created through forced mergers will exhibit superior performance, due in part to scale economies. However, no empirical evidence has been produced in support of the existence of substantial scale economies in NSW local government. Accordingly, in this paper we test empirically the proposition that significant economies of scale can be reaped in NSW local government by means by municipal mergers using disaggregated 2014 data decomposed by council function.

    The analysis of scale economies on the basis of municipal function is based upon the premise that since municipalities conduct multiple production activities, the relationship between expenditure and size is likely to vary based on each activity. Put differently, economies of scale, if they exist, may be 'service-specific' in that councils do not necessarily exhibit scale in all of their activities. This argument is important in light of the advocacy of amalgamation, since amalgamation implies the existence of unanimous and unambiguous scale economies. Accordingly, we investigate this question empirically using multiple regression, within the context of the current debate over municipal mergers in NSW. Our results are stratified by council type and disaggregated these into each of the 11 municipal functional categories in NSW local government. Finally, we also address the empirical miss-specification of proxy variables for output employed in a majority of empirical studies on scale economies in the public sector.

    A substantial international empirical literature exists on economies of scale at the local level, which includes a number of empirical papers on scale in NSW local government (see, for example, Dollery et al, 2006; Dollery et al, 2012 for recent surveys of this literature). Various problems have been identified with extant empirical work on scale in NSW municipalities, not least the aggregation of all municipal services and the use of population rather than the number of property tax assessments. The present paper seeks to address some of these problems and thereby offer a more accurate method of estimating of scale by municipal function for defined categories of NSW local authorities.

    The paper is divided into five main parts. Section 2 provides a brief discussion of the institutional background to NSW local government and the Fit for the Future structural reform process. Section 3 offers a synoptic account of the empirical measurement of scale economies by scholars in local government. Section 4 presents the empirical strategy followed in the paper and Section 5 outlines the results of the estimation process. The paper ends with some brief concluding remarks in Section 6.


    The largest of the seven Australian state and territory local government systems, NSW local government is comprised of 152 'general purpose councils', 12 'special purpose councils' and the NSW Aboriginal Land Council. The regulatory structure governing NSW local authorities consists of the NSW Office of Local Government (OLG), the NSW Local Government Grants Commission and supplementary bodies, as well as a Local Government Act (1993). In common with other Australian municipal systems, NSW local government is a 'creature of statute' since the NSW Government possesses almost unlimited regulatory powers over local government.

    Relative to most other developed countries, Australian local government fulfils a comparatively limited range of functions, focused largely on 'services to property'. It does not provide many 'services to people', such as education, fire protection and police, which are state government responsibilities. NSW councils provide local infrastructure, including local roads, and local services, such as sewage and solid waste disposal, with some regional councils running local water utilities. NSW local government is funded through property taxes, fees and charges for services, intergovernmental grants, developer charges and various other minor sources. NSW local authorities fall under elected councilors and usually an indirectly elected mayor, who face periodic elections. The operation of councils is conducted by a professional bureaucracy led by a General Manager.

    The forced merger program embodied in the Fit for the Future program is derived from recommendations made by an Independent Local Government Review Panel (ILGRP) appointed by the NSW Government in 2011. In its Final Report Revitalizing Local Government--presented in October 2013--the Panel advocated a radical forced merger program, largely centered in Greater Sydney. It was attacked on several counts, not only because of the absence of any empirical basis for its merger recommendations, but also the poor quality of its commissioned research, particularly Assessing Processes and Outcomes of the 2004 Local Government Boundary Changes in NSW by Jeff Tate Consulting (2013).

    As we have seen, structural reform through municipal mergers has been attempted in all Australian local government systems. It is generally presented in terms of a 'desperate predicament' polemic (see, for example, Hirschman, 1991) and Fit for the Future is no exception. For instance, in his Parliamentary address outlining FFTF, Minister for Local Government Paul Toole (Hansard, 2014b, p. 399) observed that '[W]e cannot continue as we have done in the past' since 'councils are losing $1 million a day and it is not the way of the future'.

    Despite claims by the NSW Government that it was adhering to the recommendations of the Panel, FFTF introduced several new elements into the reform process. For example, the NSW Government subsequently instructed the Independent Pricing and Regulatory Tribunal (IPART) to assess NSW councils' 'fitness for the future'. Under the IPART methodology councils were required to demonstrate that they possessed 'adequate scale and capacity' in addition to ongoing financial sustainability to avoid forced amalgamation. 'Adequate scale and capacity' was not defined but simply characterized on the basis of a set of qualitative criteria largely related to the quality of governance. Furthermore, financial sustainability was subordinated to the amorphously defined 'scale and capacity' criterion such that councils were deemed 'unfit' irrespective of financial sustainability. This has drawn sharp criticism in the scholarly literature (Drew and Dollery, 2015a; Abelson and Joyeux, 2015).

    On the 18th December 2015 the NSW Government announced its proposed mergers: Sydney metropolitan councils would fall from 43 to 25, with non-metropolitan councils declining from 109 to 87 entities. These recommended mergers were to be examined by 'Delegates' appointed by the Office of Local Government as part of a public consultation process commenced in January 2016. Delegates were required to make recommendations to the NSW Boundaries Commission which, in turn, would make its own recommendations to the Minister for Local Government.

    Almost all of the mergers subsequently accepted by the Minister have been contested by the affected local authorities. In addition, many aspects of the merger process have been disputed and are presently mired in high court proceedings. In many cases, these judicial proceedings have not yet been resolved and it is thus not feasible at present to determine how many forced amalgamations will eventuate.

    The FFTF process has generated more problems than it has resolved. For instance, the announcement of an additional $15-20m per amalgamation to merged councils will do little to address the infrastructure maintenance backlog which formed a key aim of FFTF in the first place. Moreover, the uniform allocation of monies across merged councils also will do little to improve municipal fiscal discipline. In addition, over time mergers will imply property tax (i.e. rates) 'harmonization' between amalgamated councils in the newly-merged entities thereby initiating net welfare transfers. Likewise, the NSW Government has announced that the current 'rates trajectory' will remain frozen for four years while IPART reviews the NSW rating system. Over this...

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