Paving the Way to Development: Costly Migration and Labor Market Integration

How integrated are labor markets within a country? Labor mobility is key to the integration of local labor markets and therefore to understanding the efficacy of policies to reduce regional inequality. We present a comprehensive framework for understanding migration decisions, focusing on the costs of migrating. We construct and then estimate a spatial equilibrium model where mobility is determined not only by idiosyncratic tastes, but also by moving costs that are origin-destination dependent. We use rich data on the inter-municipality moves of 18 million people together with exogenous variation in the road network caused by the construction of a capital city to identify the bilateral costs of moving between two regions. The mean observed migration cost is between 0.8-1.2 times the mean wage. 84% of the migration cost is a fixed cost, 3.5% depends on the distance between locations, and 9.6% is dependent on the travel time on the road. This imperfect integration of labor markets has two key implications. First, costly migration generates heterogeneity in regional responses to economic shocks. A region 10% more connected will have a 5.6 percentage point higher population elasticity to wage shocks. Second, costly migration changes the incidence of regional shocks. We estimate that 37% of the total incidence of a shock falls on residents, compared to 1% in a model where migration is costless. Our results have important implications for understanding the impact of economic development as well as the impact of place-based development policies.