Labor Market Integration in the Presence of Social Capital

and participants at a World Bank seminar, for useful comments. The views expressed here are mine and do not necessarily reflect those of the World Bank or its affiliated organizations. iii ABSTRACT Labor market integration is typically assumed to raise welfare in the absence of distortions because it allows labor to move to where returns are highest. This result is examined in a simple general equilibrium model in the presence of a common property resource, social capital. Based on evidence that social capital raises productivity and falls with labor mobility, the main findings are: i) Labor market integration imposes a negative externality and need not raise welfare; ii) the welfare impact is more beneficial (or less harmful) the greater the difference in endowments between the integrating regions; iii) whether positive or negative, the welfare impact is larger the closer the social capital of the integrating regions and the lower the migration costs; iv) trade liberalization generates an additional benefit—over and above the standard gains from tradeby reducing labor movements and the negative externality associated with them, and is superior to labor market integration; and v) the creation of new private or public institutions in response to labor market integration may lower welfare. The welfare implications are shown to depend on two parameters of the model, the curvature of the utility function and the private migration cost.