Analyzing firm location decisions: is public intervention justified?
This paper develops a two-region model of firm migration where moving is costly and firms have market power. In this setting, the decentralized equilibrium generates excessive inertia in firm movement relative to the 'first best' solution. Because the decentralized solution is inefficient, the widespread notion that inducing firm movement between regions yield no net social gain does not necessarily hold. That is, firm migration does not amount to a 'zero sum.' Moreover, given the presence of inertia, and contrary to the prevalent view, we show that targeted subsidies that alleviate moving costs can lead to a 'second best' outcome. We also show that once a dynamic dimension is considered, moving cost subsidies, while potentially welfare improving in a present value sense, may nevertheless generate transitional welfare costs in the short run. Consequently, it may be especially misleading to mainly consider contemporaneous conditions in evaluating regional incentive programs.
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