Theory of Public Finance in a Federal State

By Dietmar Wellisch | Go to book overview

CHAPTER 7
Efficiency and the Degree of
Household Mobility

In Chapter 6, we explained that perfect interregional household mobility may serve as an incentive mechanism for regional governments to abstain from strategic behavior and to internalize all interregional externalities. However, this efficiency result hinges on strong assumptions. We have assumed that only one group of perfectly mobile and identical households lives in the federal state, and that regional governments maximize the utility of a representative resident. Deviations from these assumptions are impediments to an efficient allocation.

There are at least five deviations from this basic model that merit discussion here owing to previous study in the literature and because they either better characterize the situation in federal states or describe the behavior of regional governments at least equally well. First, regions might maximize a utilitarian welfare function consisting of the sum of residents' utilities (Bentham welfare function). Second, there could be several types of mobile households, with all members of one type identical and perfectly mobile but with types differing with respect to preferences and endowments. Third, households could have identical preferences yet differ in their endowments; for example, native residents living in a region usually own a larger fraction of the regional property than nonnative households living in the same region. Fourth, all households may not be equally mobile; there are contributions in the literature studying the extreme scenario of two groups of households-one group with perfectly mobile members and the other with immobile members. Finally, the different degrees of household mobility can also be modeled by costly migration, where migration costs may differ among households.

We will briefly refer to some of the contributions using these alternative assumptions and discuss the consequences of such deviations from the basic model of Chapter 6; a more formal analysis of some deviations can be found in Mansoorian and Myers (1997). If regional governments maximize a utilitarian social welfare function of the Bentham type and the population is mobile (see Gordon 1983), then the value of their objective function increases directly with a rising number of residents. As a consequence, each region wants to have

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