Part I Immigration Theory and Evidence

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1 Part I Immigration Theory and Evidence The economic theory of immigration primarily has sought to explain why people leave one country in order to live and work in another country. A second purpose of the economic theory of immigration has been to clarify the economic consequences of immigration, such as the welfare of people in the source and destination countries. Since people are workers, consumers, and innovators, the economic consequences of immigration on both the source country and the destination country are complex. The analysis of the many positive and negative effects on both the demand and supply sides of the source and destination economies helps to explain why immigration is a controversial issue in so many countries. Modeling Immigration As discussed in the first chapter of this section of the book, economic incentives to immigrate are related to a great variety of push, pull, stay, and stay away factors. Given the complexity of immigration, many different models of immigration have been developed. In preparation for this detailed examination of the many economic models of immigration, we introduce here the labor market model of immigration that many economists have used to explain and analyze immigration. This model is the one that appears most often in economic textbooks that deal with immigration. In its simplest representation, this model assumes that immigrants are only workers, and their only effect is to change the supply of labor in the source and destination countries. Clearly, this model introduced here does not do justice to the complexity of immigration. However, you are well advised to devote a few minutes to learning this model because most economic models of immigration effectively build on this popular labor market model.

2 22 Part I Immigration Theory and Evidence The Basic Labor Market Model of Immigration The typical demand curve for labor is known in the labor economics literature as the value of the marginal product of labor (VMP L ) curve. The VMP L curve is the product of the marginal physical product of labor, MP L, and the marginal price of the output, P, or VMP L ¼ MP L P (I.1) VMP L thus represents the value of the additional output produced when one more unit of labor is used in the production process. Because the marginal product of labor declines as more labor is hired, the VMP L curve is downward-sloping. The shape of the supply curve for labor is not as obvious, however. An upwardsloping supply curve implies that the quantity supplied increases when the price rises. Certainly, the opportunity costs of leisure and nonpaying home activities rise as wages rise, and, all other things equal, a higher wage will tend to make workers substitute work for leisure. But higher wages also increase the income received by labor, and this positive income effect may very well lead people to acquire more leisure even if the opportunity costs go up. Thus, if the income effect of higher wages outweighs the substitution effect of increased opportunity costs of not working, the supply of labor curve will be backward-bending, as the curve labeled C in Fig. I.1, not upward-sloping as the more familiar-looking supply curves labeled A and B. There is indeed evidence that the income elasticity of supply is negative. Only a century ago, in today s high-income countries industrial workers routinely worked 12 h/day, 6 days/week. Today, the 40-h workweek is the norm, except where even shorter workweeks have been mandated. Recently, France legislated a 35- h workweek. In the simple labor market model, we depict the labor supply curve as a perfectly vertical line. We do this to simplify the graphs. Be reassured, however, that even if we draw the labor supply curve as upward- or backward-sloping, the conclusions reached are not qualitatively different from what this class of models reaches in the literature while assuming a perfectly vertical supply of labor curve. Fig. I.1 The labor supply curve

3 Part I Immigration Theory and Evidence 23 Fig. I.2 The labor market In a competitive labor market, the wage is equal to the value of the VMP L curve where it intersects the supply of labor curve. The area under the VMP L curve, the demand curve for labor, represents the total value of output produced in the economy using all the factors of production, namely, labor, and all the other factors employed along with the labor. The area under the marginal curve represents the sum of all the marginal values, or the total value. With labor supply equal to S L, total output is equal to the areas A plus B in Fig. I.2. The total value of output is split among labor (area B) and the other factors (area A). At the wage w, total labor income is equal to the rectangle B. The remaining output, area A, accrues to the other factors of production such as capital and land that labor uses to produce the output. Since we are interested in the broad consequences of immigration across both the source and destination countries, we will often examine a two-diagram graphic labor market model of immigration such as in Fig. I.3, which explicitly shows the labor markets of two countries. Suppose that the supply and demand curves for labor are different in two countries, let s call them Poland and Germany, and wages are 10 euros/h in Germany and 10 zloty in Poland. If the exchange rate between euros and Polish zloty is, say, equal to 1 euro ¼ 5 zloty, we can translate the zloty wage into euros. Or, suppose Poland joins the euro area at the exchange rate of 5 zloty for 1 euro. Then, in euro terms, wages are five times higher in Germany than they are in Poland, as compared to The wage difference will tend to cause Polish workers to move to Germany. This immigration will cause the supply curve for labor to shift to the left in Poland and to the right in Germany. Figure I.4 depicts a possible outcome. Immigration is shown to have shifted the supply curve inward in Poland and outward by an equal amount in Germany, causing the wage to rise to 3.00 in Poland and fall to 8.00 in Germany. In the absence of any psychological or economic costs or explicit restrictions of any kind, we might expect more immigrants to go to Germany until the supply curves shift enough to where the wages become equal in the two countries. Figure I.4, however, depicts the more realistic situation where migration

4 24 Part I Immigration Theory and Evidence Fig. I.3 The labor markets before immigration Fig. I.4 The labor market after immigration tends to reduce, but not eliminate, the difference in wages between two countries. In general, there are many stay and stay away factors, such as language differences, moving costs, and family ties, that prevent perfect wage equalization. Who Gains and Who Loses with Immigration? Figure I.4 provides useful insight into why labor migration is a controversial issue in many countries: Even though the overall worldwide gains appear to outweigh the

5 Part I Immigration Theory and Evidence 25 Table I.1 Gains and losses from immigration 1. Poland Owners of other (nonlabor) factors Loss of e + g Remaining workers Gain of e Net change in real income Loss of g 2. Germany Workers originally in Germany Loss of E Owners of other (nonlabor) factors Gain of E + G Net change in real income Gain of G 3. Immigrants Loss of wages in Poland Loss of h Gain of wages in Germany Gain of H Net change in real income Gain of H h World ( ) Net change in Polish real income Loss of g Net change in German real income Gain of G Net change in immigrants real income Gain of H h Net gain Gain of (H + G) (h + g) > 0 various welfare losses, the simple labor market model of immigration shows that some groups suffer welfare losses when people immigrate. Note that as a result of labor migration from Poland to Germany (represented by the shift in supply curves), migrating workers increase their welfare very substantially. More specifically, after the quantity q 0 q workers depart, the supply of labor in Poland falls from S to S 0 and total output falls by the area g + h. The wages of the workers remaining in Poland rise from 2 to 3 euros, and their labor income increases from f to e + f. The other factors earn only d, which is smaller than their former income by the value of the areas e + g. It thus appears that labor gains real income while other factors lose income. The other factors in Poland suffer a net loss in income: The area e that other factors lose is gained by labor, but the area g is completely lost to Poland because the decline in total output, g + h, is greater than the wages that no longer need to be paid to the workers who left (area h). Immigration causes a similar, albeit reversed, redistribution of welfare in Germany. According to Fig. I.4, native labor in Germany sees its income fall from E + F to just F, but other factors enjoy a rise in income from D to D + E + G. The income of Germany s native workers and other factors rises by the net amount of G as other factors gain more than the native workers lose. Output increases in Germany as we move down the labor demand curve in Fig. I.4; this increase is represented by the area G + H. Figure I.4 also shows that the gain in output in Germany is greater than the loss of output in Poland. This must be the case since q 0 q ¼ Q 0 Q and the average height of the areas G + H and g + h, respectively, are 9 euros and 2.5 euros. This rise in the value of total world output is the result of labor moving from a country with a small marginal contribution to the real value of output to a country where labor s marginal contribution to the real value of output is greater. Table I.1 summarizes the distributional results from immigration in Fig. I.4.

6 26 Part I Immigration Theory and Evidence Building on the Basic Labor Market Model According to the simple labor market model of immigration developed here, immigration causes total income in the source country to fall, and total income in the destination country to increase. The immigrants clearly increase their welfare, which is why they were motivated to immigrate in the first place. Notice also that in the example given here, the gains of the immigrants are much larger than the net gain in the destination country. As will be detailed later in this book, there is a large amount of empirical evidence suggesting that, indeed, immigrants capture the greatest part of the immediate gains from immigration. The labor market model of immigration also shows that immigration causes world output to rise, wages to rise in the immigrant source country, and wages to fall in the destination country. Finally, the model seems to confirm what many workers and employers in immigrant destination countries suspect or hope for, which is that immigrants cause wages to decline. This simple model is often used in immigration analysis. But, despite its popularity in the economics literature, the model is an extreme simplification of what actually happens in source and destination countries when people immigrate. All models are simplifications, of course, but there are some obvious extensions that can make the model more realistic. First of all, when labor moves from one country to another, simultaneously there is also an international transfer of a consumer. That implies that consumption expenditures shift from the source to the destination countries, and thus the demand for labor also shifts from the source to the destination countries. And, in the long run, there are likely to be dynamic growth effects associated with the movement of people because (1) immigrants may introduce economies of scale effects and (2) immigrants may turn out to be entrepreneurs, innovators, and inventors. Chapters 2 through 10 of Part I of this book on the economic theory of immigration detail how economists have extended economic theory to take into consideration these additional causes and effects of immigration.

Part I Immigration Theory and Evidence

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