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This article evaluates economies of scale in local public spending in Chile, emphasizing the country's geographical features and high fiscal heterogeneity. We leverage balanced panel data for ten years and 307 municipalities in order to estimate the population level at which a reduction in the average cost of local public goods provision occurs and to differentiate between levels of market potential. We follow a theoretical model of cost efficiency that considers spatial interactions and spillover effects among neighboring jurisdictions. Our findings suggest that Chilean municipalities reach an optimum population level at around 700,000 inhabitants, which is high considering that only two cities qualify. When differentiating for levels of economies of scale according to levels of market potential, municipalities with a low potential reach their optimum at around 28,000 inhabitants, those with a medium potential reach it at approximately 124,000, and those with a high potential reach it at approximately 680,000. • Few cities reach Economies of scale in local public spending in Chile. • First nature influences the distribution of population and Economies of Scale. • Optimum level of population varies according to the market potential of each city. • Policies must consider the effect of first nature on population distribution. [ABSTRACT FROM AUTHOR]

We explore how spatial interaction affects the strategic use of municipal income when deciding between 1) an optimal long-run expenditure strategy versus 2) using the current income to finance current activities, a phenomenon known as the permanent income hypothesis. Even when this hypothesis is grounded in temporal logic, insufficient attention has been given to the impact of spatial dependence on this type of budget decision. Therefore, we present two reasons why spatial interaction adds new insight to this discussion. First, subnational governments located inside larger functional areas have lower average costs due to the population concentration, allowing for coordination between jurisdictions to achieve more power of negotiation and to potentially exploit economies of scale. Second, local government decision-making is not independent of other jurisdictions as municipalities would constantly evaluate the others' actions regarding local tax effort, spending, and debt. While this spatial consideration remains a challenge for theoretical modeling, we offer empirical evidence to evaluate how robust the permanent income hypothesis is when geography is incorporated. Our empirical approach uses dynamic panel data with spatial dependence on debt, expenditure, and the error term. To evaluate our hypothesis, we exploit panel data from 320 Chilean municipalities between 2008 and 2020 and use two sources of income: non-matched grants via mining windfalls and horizontal fiscal transfers among cities. The evidence indicates that jurisdictions make backward-looking decisions regarding spending; that is, there are no significant differences between the short and long run. The results for debt, however, are not robust. Policy pertaining to the use of public resources should consider the spatial dependence between municipalities which should be a crucial factor in budgetary decision-making. • We analyze the permanent income hypothesis when geography is incorporated. • We pursue the causal effect of horizontal transfers and mining windfalls on budgetary decisions. • Jurisdictions make backward-looking decisions regarding spending. • Spatial dependence between municipalities is a crucial factor in budgetary decisions. • Results call for policies regarding the use of public resources considering spatial dependence. [ABSTRACT FROM AUTHOR]