Overcoming Cost-Inefficiencies within Small Municipalities: Improve Financial Condition or Reduce the Quality of Public Services?

A common finding of studies evaluating cost-efficiency in the provision of local public services is the existence of economies of scale in the production of such services. How can smaller, less efficient local authorities overcome this position of disadvantage? According to economic theory, they should either obtain supplementary funding or otherwise reduce the quality levels of the services provided. The aim of the present study is to evaluate the relations among different dimensions of municipal performance. The above concepts are analysed in a sample composed of 923 local authorities in Spain, each with fewer than 20 000 in habitants, using a data envelopment analysis model adapted for the particular characteristics of the local environment and repeating the analysis for two different periods, 2000 and 2005, in order to increase the consistency of the results obtained. Empirical analysis shows that the financial management and the productive efficiency of small local authorities are not interrelated, with the more cost-efficient bodies (especially for quality-related costs) being the least efficient as regards their financial condition. Moreover, our analysis of cost-efficiency for the smaller municipalities shows that revenues must be increased in order to obtain a similar level of quality to that of larger authorities.