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Incentive Equivalence with Fixed Migration Costs
Journal of Public Economics , 95(11/12), December 2011, pp. 1292-1301
Abstract: If migration between communities is costless, and if policy makers in each community anticipate the migration response to policy changes, then the interests of the two communities are perfectly aligned. Decentralization is efficient. This incentive equivalence is well-known. However, the first-order approach used in virtually all the literature may obscure the fact that no convexity assumptions need be made about technology or tastes. This fact underscores the relevance of incentive equivalence, even when there are scale economies in the public sector. Here, the consequences of positive migration costs for this incentive equivalence are considered. In contrast with much of the literature, migration costs are assumed the same for everyone. This formulation differs from the more common "attachment to home" assumption of heterogeneous migration costs. Conditional on the direction of migration, interests of different communities are still perfectly aligned. But natives of different communities may prefer different directions of migration, weakening incentive equivalence if local policy makers have the power to induce large changes in migration flows. However, incentive equivalence fails only if economies of scale in population are important, so that communities may be "under-populated".
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