Reallocation of workers from declining sectors to more productive ones constitutes one of the most important challenges for all economies in transition. The challenge is particularly great in the Russian Federation, where, as a result of Stalinist industrialization policy, many regions have been dominated by a small number of large firms, which have proven to be unfit for the challenges posed by the transformation of the economic system.

One would expect workers to leave regions with weak job markets in order to find jobs in the flourishing metropolitan areas and in regions with better job prospects. In fact, the degree of interregional migration in the Russian Federation is very low. As a consequence, several geographically segmented labor markets have emerged. Unemployment and vacancy rates vary substantially across regions. In some regions, for instance, there is one job vacancy for four people seeking a job, while in others the ratio is 1 to 100. Remarkably, these ratios have been very stable over the last few years. Moreover, rather than converging, regions appear to be becoming more distinct. In some regional labor markets, profitable firms report a scarcity of qualified work force, particularly, skilled blue collar workers. At the same time, unprofitable companies in declining regions are hoarding workers with sought-after qualifications. The consequences are not only that profitable firms find it harder to fill vacancies but also that workers are forgoing promising job opportunities.

Why are workers not migrating across regions? While unqualified workers may lack outside options, it is surprising that highly qualified workers stay at their firms. Many firms have discontinued the payment of (monetary) wages, thus increasing the incentives for workers to migrate to more prosperous regions.

Our article provides a rationale for why workers stay at their firms and why firms appear to pay wages in kind and in the form of fringe benefits, such as housing, food, and health care, rather than in cash. We argue that the phenomena of slow labor reallocation, in-kind compensation, and wage arrears emerge as a consequence of firms’ strategies to attach wealth-constrained workers to the firms. Search costs of finding a new job are particularly high in the Russian Federation, because labor exchanges are inefficient and housing markets in the metropolitan areas of Moscow and St. Petersburg (where jobs opportunities are greatest ) are poorly developed. Moreover, many cities limit geographical mobility by imposing additional administrative barriers to entry. By paying wages in kind and through fringe benefits rather than in cash, firms make it harder for workers to leave the region. Because most of the goods and services provided cannot be converted into cash, workers cannot raise the cash needed to finance the costs associated with moving to another region. They thus forgo opportunities to move to more rewarding jobs.

From the viewpoint of firms, attachment strategies can be profitable for two reasons. First, they may facilitate investments in workers that pay off only if the workers stay at the firm. Payments in kind can reduce or even eliminate the risk of a worker leaving. They consequently facilitate investments such as the reorganization of task assignments within the firm. While attachment may be locally efficient, it can impose negative externalities on the productivity of firms in another region that would like to hire the worker. Second, attachment may allow firms to exploit workers, since it eliminates workers’ outside options.

We show that whether or not exploitation occurs depends crucially on the structure of regional labor markets. Interestingly, exploitation is not constrained to the case of monoposonistic regional labor markets, as one might expect. Even if there is competition in the regional labor market and workers can raise the cash needed, situations can emerge in which all firms attach workers through fringe benefits and in-kind payments. In this case, the worker is locked into the region and does not receive any compensation for the opportunities he or she forgoes. This result is in line with work on wage arrears that shows that an important determinant of a firm’s decision not to pay wages is the existence of other firms in the same region that have accumulated wage arrears.

We test our theory with data from the Russian Longitudinal Monitoring Survey, the largest Russian household survey. We find that workers who receive part of their salary in kind have a significantly lower probability of moving than workers who receive their wages in cash. We examine a number of policy implications of our analysis, in particular the importance of payment of wage arrears and the abolition of obstacles to migration.