An appropriate definition of size

Governments have to cope with problems arising from diseconomies of scale.²⁰It is obvious that the larger a jurisdiction, the less diseconomies of scale pose a problem, since the jurisdiction will reach or exceed opti-mal scale of production for most of the goods provided.²¹

Hence, it goes without saying that diseconomies of scale seem to be an existential problem for VSC from a theoretical viewpoint. Due to problems associated with economies of scale, the provision of public goods is one of the most important challenges for VSC, at least when we define public goods broadly by including intangible public goods like, e.g., security, sovereignty and representation in international politics and economics.

17 The economic consequences of a differentiation between provision and production costs for VSC have been laid out in detail in Gantner and Eibl (1999).

18 Note that there are a lot of local public goods which do not show considerable de-grees of publicness according to empirical studies. For an overview see Reiter and Weichenrieder (1997); the classic papers are Borcherding and Deacon (1972) as well as Bergstrom and Goodman (1973).

19 FOCJ = functional, overlapping, competing jurisdictions.

20 Marshall (1922) introduced this term to the literature. It means that one is providing goods on an inefficient scale, thus qactual< qefficient.

21 Note that in the case of a larger jurisdiction, e.g., over-usage, congestion and hetero-geneity, costs pose considerable problems. However, we do not consider these phe-nomena for the moment and assume that it is possible for larger countries to simply establish more than one provision agency in the case of qactual> qefficient.

Contingent on the results in the following empirical chapter – where we try to answer the question of whether diseconomies of scale really play a role in the public sector – the extent of diseconomies of sca-le might be a good starting point for an appropriate definition of VSC.

Specifically, we are interested in the extent of diseconomies of scale in the production and provision of public goods, or, in other words, in the deviation from cost-optimal production. Note that publicly provided goods are one of the main characteristics of countries from a public eco-nomics viewpoint. Assuming that our theoretical considerations are em-pirically confirmed, a workable definition of country size should consist of three major features:

– (a) A VSC is a country with full sovereignty and international reco-gnition.

Feature (a) is necessary, since the aim here is to investigate public sector peculiarities of small countries.²²Concepts of sovereignty (in economics as well as in international law and political science) have been developing over the last decades because of the process of in-ternationalization. One possible traditional definition of full sover-eignty is associated with constitutional independence, which means that countries are fully sovereign if their constitution is not part of a larger constitutional arrangement. A sovereign country is not sub-ordinate to another country, but necessarily equal to it by interna-tional law. The country’s legal, executive and judicial powers are the supreme authority within its jurisdiction, which is what we would call in economic terms a territorial monopoly (James, 1986; Jack son, 1990). Of course, recent developments especially within the Euro -pean Union do not comply with this traditional view of sovereign-ty. International courts also considerably restrict sovereignty for many countries in the world. One either can conclude that coun -tries like Germany or France are not sovereign any more, which does not make much sense, or accept the fact that a generally valid distinction between fully sovereign and not fully sovereign coun-tries is difficult and that there is a continuum for a possible cut-off

22 We will however also have a look at the differences between independent VSC and autonomous regions later on.

point. Note that subordination of sovereign countries under supranational and international organizations and courts is still voluntary to a certain extent.

A distinction between four different notions of sovereignty by Krasner (1999) is very helpful here. He distinguishes between inter-dependence sovereignty(the ability of a government to control ac-tivities within and across its borders), domestic sovereignty(refers to the organization of authority within the country), Westphalian sovereignty(refers to the independence of external authority struc-tures) and international legal sovereignty (the recognition of one country by another/others). The only notion which provides for a clear cut-off point between countries with full sovereignty and other territories, is the last one. International legal sovereignty implies the right to sign treaties with other countries and to join international organizations. Our term «full sovereignty» is thus equivalent to international legal sovereignty, although there are some jurisdictions like the Taliban regime in Afghanistan, where it is difficult to decide whether they are fully sovereign according to this standard.²³Such rare borderline cases do not pose a problem for our analyses in the following chapters and there is no need to go into greater detail here.

Note further that many of our results can be applied, mutatis mutandis,to other small jurisdictions, be they federal units (Bun des -länder, Länder or Kantone²⁴) or – as mentioned above – small terri-tories with an extraordinary degree of autonomy, like, e.g., the Channel Islands, Gibraltar and Niue. To generalize, jurisdictions without full sovereignty (thus not fulfilling (a), but complying with the two following features), asymptotically obey our approach to a possible definition of VSC with monotonically increasing degree of sovereignty. Nevertheless, international legal sovereignty is a prere-quisite to be considered as a VSC in this study.

23 Especially countries or authorities which are only recognized by some other coun-tries are difficult to assign. Fortunately, there are not many such cases.

24 These are the names of the federal units in Austria, Germany and Switzerland, res-pectively.

– (b) The set of public goods provided by the VSC is comparable to the set of public goods provided by other sovereign countries.

Feature (b) assures that we only deal with jurisdictions which pro-vide a broad set of public goods.²⁵ Note that this feature does not require that a certain share of the provided public goods be produ-ced in-house. There are of course differences in the perception of what the core of a country’s activity and the minimum requirement in terms of publicly provided goods of a sovereign country are.

These differences are partly due to distinct ideological and histori-cal backgrounds of continental European countries on the one hand and Anglo-Saxon countries on the other hand. However, it is easy to list a few goods which are provided by any federal government.

Note that we again do not say anything about the provision arran-gement, especially whether those few goods should be provided in-house or whether their production should be sourced out either to other jurisdictions (internal or foreign) or to private enterprises. A country’s government is supposed to at least guarantee their provi-sion.

The following list of important public goods, though probably not exhaustive, would be widely agreed upon: internal security, external security, an executive branch (government and administration), a le-gislative branch (some kind of parliament), a judicial system (courts and prisons), international representation, financial and monetary systems, education, a health system, a system of social security as well as infrastructure building and maintenance.

– (c) A considerable part of the publicly provided goods exhibit dis economies of scale in their production if they are produced in-house.

The definition power of this feature is contingent on the results in the following chapter. A country is theoretically expected to exhibit diseconomies of scale in the production of many publicly provided goods in order to be labeled a VSC. In other words, a VSC should not be able to reach optimal scales of production for most (or all) of the above-mentioned public goods and/or the deviation from the

25 Note that we only require the goods to be provided, not to be produced in-house.

cost-optimal number of consumers, i.e. inhabitants, should be large.

Thus, the VSC should have a cost disadvantage, which we have been referring to as «diseconomies of scale». The number of inhabitants is strongly correlated with feature (c). The fewer inhabitants a coun-try has, the more public goods will exhibit diseconomies of scale if they are produced in-house. Hence, feature (c) of our approach to define country size considers the number of inhabitants implicitly, but the focus is on the related problem of public good provision.

Our definition approach is – not surprisingly – inappropriate for arri-ving at a set of VSC without imposing some restrictions on (b) and on (c). Those would clearly have to be arbitrary, since there is no natural cut-off point. However, features (a) – (c) neatly attest to the fact that the problem of diseconomies of scale is prevalent in all jurisdictions (at least for some publicly provided goods) and that the study of VSC is only one promising approach to studying the extent of diseconomies of scale, its effects and the possible ways to diminish its adverse effects.

Note that our approach also justifies, as briefly mentioned above, definitions relying on the number of inhabitants due to the clear corre-spondence between the extent of diseconomies of scale and the popula-tion of a country (see Definipopula-tion 2).

After testing in Chapter 3 for the empirical content of our ap-proach, where the focus is on the critical feature (c), we will come back to our analysis at the end of Chapter 3. We then can conclude whether our approach to defining VSC here is helpful and valid.