Decentralization, Mobility Costs and the Soft Budget Constraint

In this paper we study how labor mobility affects the relative desirability of decentralization vs. centralization in addressing soft budget constraint problems. In our framework, the State is in charge of the decision of refinancing a loss-making “strategic” enterprise in a centralized setting. In a decentralized setting, the region where the firm is located takes the decision of whether to continue or stop the activity of the unprofitable firm. However, the possibility of migration of those previously employed in the strategic firm to a neighboring region, shifts part of the burden of the bail—out decision onto the destination region’s shoulders. As a result of labor mobility, the stake of each region in the refinancing process is endogenously determined and depends upon such things as the costs of mobility and the number of job openings in the region of immigration.