Local authorities should be allowed to produce their genuinely local public goods without state regulation. It may be justifiable to regulate functions that involve significant costs and benefits across the municipal borders. The VATT Institute for Economic Research proposes that the appraisal of municipalities' obligations should be based more than before on how the division of local and state functions is seen from an economic viewpoint.
Municipalities' functions can be divided into the provision of local public goods and functions that have externalities. The VATT research report, which is published today, proposes that local authorities should be allowed to produce local public goods without state regulation, because the local authorities are best informed about the service level wishes of their inhabitants. Instead, if the functions involve significant advantages and disadvantages across municipal borders, regulation may be justified. This is because local decision-makers take into account only their own inhabitants' wellbeing, not that of other municipalities' inhabitants. Based on this distinction, an evaluation framework was developed in this research in order to examine the advantages and disadvantages of municipalities' obligations.
The state regulates local authorities' activities by means of imposing a number of obligations, such as the requirement of occupational qualifications. Consistent assessments of these obligations can be made only based on structured information about the division of local and state functions. According to VATT, it would be important to make use of economic argumentation and impact assessments more than before.
The research also examined the effectiveness of municipal regulation through empirical examples. The first example concerned recommended maximum class sizes in basic education and the special government aid aimed at the reduction of class sizes. The regulation of basic education can be justified because of the cross-border impacts. The results suggest that the special aid is related to a smaller share of larger classes in a municipality. Furthermore, smaller classes in the upper comprehensive seem to lead to higher grades in basic education certificates.
Another example focused on the impacts of the five-year dismissal protection of municipal workers that was implemented in the municipal mergers of 2007 and 2009. Based on the results, removal of the protection against dismissal did not have a significant impact on the number of municipal personnel or costs.
The last section of the research utilised a game theoretic model to examine what kind of funding mechanism would incentivise municipalities to reliably reveal the real magnitude of their externalities. According to the model, the externalities between municipalities can be internalised through the central government transfer mechanism even so that placing these incentives on municipalities would not lead to costs for the state.
The project was carried out by a research group at VATT and the report is a part of the implementation of the Government's 2015 plan for analysis, assessment and research.
Publication (in Finnish)
More information on the government analysis, assessment and research activities tietokayttoon.fi/en
Inquiries: Antti Saastamoinen, Senior Researcher, tel. +358 295 519 500, antti.saastamoinen(at)vatt.fi, Tuomo Suhonen, Senior Researcher, tel. +358 295 519 507, tuomo.suhonen(at)vatt.fi, Janne Tukiainen, Senior Researcher, tel. +358 295 519 451, janne.tukiainen(at)vatt.fi
