Abstract
This paper first analyzes a fiscal-policy game between two jurisdictions connected by mutual migration and obtains two main results. (i) As the mutual migration intensifies, both jurisdictions in the Nash equilibrium choose more public consumption, less public investment and more total spending, and finance the total spending entirely with debt. (ii) While the Nash equilibrium without any restriction on local government debts is characterized by too much public consumption, too little public investment and excessive debt, the first-best allocation can be achieved through Nash play by imposing the restriction that public consumption should only be financed by a contemporary tax and not by borrowing. These two results are shown to remain valid in an alternative model. The paper then goes on to analyze a model with one-directional migration and obtains results on how migration affects the fiscal policies of both the jurisdiction of migration destination and the jurisdiction of migration origin. Finally, there are a series of robustness checks to investigate the importance of various assumptions regarding the underlying environment.
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Notes
The focus of our analysis is therefore on the “horizontal fiscal externalities” through inter-jurisdiction migration, compared to analyses of “vertical fiscal externalities” that have a focus on the fiscal-policy interactions between a national government and a sub-national government (Besley and Rosen 1998, Dahlby and Wilson 2003, and Aronsson 2010).
While this restriction says nothing about how the spending on public investment should be financed, both jurisdictions will opt for financing public investment exclusively with debt in the Nash equilibrium.
For discussions of debt limits imposed by various national/federal governments, see Bird and Slack (1983), Aronson and Hilley (1986) and Mathews (1986). See also Huber and Runkel (2008) and Dai et al. (2019a) for justification of regional debt limits as a mechanism design tool for a federal government in the implementation of optimal interregional redistribution in the presence of asymmetric information on the region type. As such, the reason for imposing debt limits on local government borrowing is to guarantee incentive compatibility in these studies, whereas it is to correct for migration-induced fiscal externalities in the present paper. As argued by Stiglitz (2019), the presence of externalities could justify such policy/institutional design.
Since the present paper focuses on analyzing the strategic policy interactions of local governments induced by between-jurisdiction migration, intergovernmental grants or interregional transfers implemented by the center, as usually analyzed in the fiscal federalism literature, are assumed away. This is why our benchmark case focuses on two identical jurisdictions.
Note that the main results of the paper obtained under mutual migration between two identical jurisdictions – those results in Sects. 2 and 3 and most subsections of Sect. 5—still hold when \(G_{1} \;{\text{and}}\;G_{2}\) are publicly-provided “public” goods (with an appropriate interpretation of functions \(g_{1}\) and \(g_{2}\)). This is the case because the number of residents in each jurisdiction remains constant after the process of mutual migration. Nevertheless, the results obtained under one-directional migration in Sect. 4 may be subject to considerable modifications when publicly-provided goods are non-rival “public” goods instead of “private” goods. This qualification also applies to Sect. 5.4 where mutual migration is endogenous.
In Sect. 5, we consider a more general lifetime utility function \(u(c_{1} ,G_{1} ) + v(c_{2} ,G_{2} )\), where the standard time-separability is maintained, but the private consumption and the publicly-provided good in the same period are allowed to be non-separable.
In Sect. 5, we consider a more general situation where \(G_{1}^{A}\) is durable with various degrees.
Note that emphasizing the investment nature of \(G_{2}^{A}\) and incorporating both \(G_{1}^{A}\) and \(G_{2}^{A}\) as two separate components of government spending in period 1 is a distinctive feature of this paper that allows us to obtain results that are not obtainable in some earlier studies. For example, Schultz and Sjostrom (2001) combine \(G_{1}^{A}\) and \(G_{2}^{A}\) into a single government spending in period 1, which prevents them from getting the opposite comparative statics results for \(G_{1}^{A}\) and \(G_{2}^{A}\) with respect to an increase in migration intensity, as well as the optimal differential treatments of \(G_{1}^{A}\) and \(G_{2}^{A}\), regarding the use of debt financing, in the implementation of the first-best allocation.
In Sect. 5, we relax this assumption to allow some share of one jurisdiction’s debt to be held by residents of the other jurisdiction. It is shown that the symmetric Nash equilibrium is characterized by the same set of conditions regardless of how much cross-jurisdiction debt holding is allowed.
In Sect. 5, we allow the probability of migrating to another jurisdiction to be a function of both the difference in the level of publicly-provided goods in period 2 and the difference in the debt level between the two jurisdictions. We show that the comparative statics results on the symmetric Nash equilibrium are qualitatively the same as those obtained in this section.
By maximizing the expected lifetime utility of the representative individual, we effectively assume that a regional government’s objective is to maximize the welfare of its original residents (the natives), regardless of where they end up later in life. This is consistent with the modeling assumption in this paper that all the fiscal decisions in a region are made in the first period. An alternative regional goal is to maximize the welfare of its current/future residents, regardless of their origin. In some sense, the former regional goal is from a “public choice/voting” perspective, whereas the latter regional goal is from a “benevolent government” perspective. See Cremer and Pestieau (2004) for a discussion of alternative regional objectives when labor is mobile. Leite-Monteiro (1997) and Dai et al. (2019a) also adopt maximizing the natives’ welfare as a regional government’s objective.
Also note that implementation of this optimal debt restriction, namely debt financing should not be used for public consumption, may run into practical problems since some government spending may simultaneously contribute to public consumption and public investment. The issue of durable public goods is formally addressed in Sect. 5.2.
As demonstrated in this section, a game with these features turns out to be mathematically manageable, even though some derivations can be quite involved. In contrast, a more general fiscal-policy game with non-identical jurisdictions and two-way migration would be intractable because of the many interdependent endogenous variables.
When n > 1, migration is from a country with a larger population to a country with a smaller population (e.g. from China to Canada or India to Australia). When n < 1, on the other hand, migration is from a country with a smaller population to a country with a larger population (e.g. from Puerto Rico or Mexico to the (Mainland) U.S.).
\(\beta\) is typically treated as a preference parameter with more patient individuals having a larger value of \(\beta\), but it may also include a longevity component in which a lower mortality rate corresponds to a larger value of \(\beta\).
The assumption of complementarity between c and G is somewhat restrictive because it does not allow the two goods to be substitutes. On the other hand, this assumption is satisfied by most often-used utility functions and greatly simplifies the technical aspect of the analysis in this section.
Note that \(G_{2}\) is strictly dominated by \(G_{1}\) if \(\theta \ge 1\). So we only consider \(\theta \in [0,1)\) to give a role to \(G_{2}\).
The distinction arises from the fact that durability generates intergenerational spillovers as emphasized by e.g. Conley et al. (2019) and Dai et al. (2019b). As a result, the optimal public financing institution must correct for both the inter-jurisdictional spillovers induced by migration and the intergenerational spillovers that the durability of local public goods entails.
Since the out-migration in jurisdiction B is at the same time the in-migration in jurisdiction A, the model here includes both endogenous out-migration and endogenous in-migration. Focusing on endogenous in-migration alone, Gordon and Guerron-Quintana (2019) show that it is possible that in-migration can tame the desire to overborrow.
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Dai, D., Jansen, D.W. & Liu, L. Inter-jurisdiction migration and the fiscal policies of local governments. J Econ 132, 133–164 (2021). https://doi.org/10.1007/s00712-020-00715-7
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DOI: https://doi.org/10.1007/s00712-020-00715-7