Increased integration of labour and capital markets creates
significant challenges for the welfare states of modern Europe. Taxation of
capital and labour that finances extensive programs of cash and in-kind
redistribution creates incentives for capital owners and workers to locate
in regions where they obtain favorable fiscal treatment. Competition
among countries for mobile resources constrains their ability to alter the
distribution of income and may lead to reductions in the size and scope of
redistributive policies. Mobility of labour and capital is imperfect,
however. Recent trends indicate that labour and capital are neither
perfectly mobile nor perfectly immobile, but rather adjust gradually to
market conditions and economic policies. This paper presents an explicitly
dynamic analysis showing that governments can achieve some redistribution
when it is costly for factors of production to relocate. As the costs of
factor mobility fall, however, the effectiveness of redistributive policies
is more limited, and governments have weaker incentives to pursue them.
Liberalised immigration policies, EU enlargement, and other steps that
promote integration of the factors markets of Western Europe with those of
surrounding regions thus present a challenge to policymakers if they also
wish to maintain fiscal systems with extensive redistribution.