Internationally Mobile Factors of Production and Economic Policy in an Integrated Regional Union of States

Abstract

There is a general class of model used to examine the expenditure and tax strategies adopted towards mobile factors by states that are members of regional unions (eg., federations, confederations or common markets). We develop a variant of this model, extended to allow for imperfect factor mobility between the region and the world, and characterize a game between states in which tax and expenditure policies are the strategies. It is shown that a Nash equilibrium to this game exists (though there may be multiple equilibria). We also argue that, unlike previous results, states have an incentive to levy non-zero taxes, or subsidies, on the migrant factor (with the precise mix of strategies depending on the degree of factor mobility). Generally, the strategies adopted lead to an inefficient supply of the factor to the region, as well as an inefficient distribution across member states.