Open Trade, Closed Borders Immigration Policy in the Era of Globalization

Open Trade, Closed Borders Immigration Policy in the Era of Globalization Margaret E. Peters University of Wisconsin Madison November 9, 2011 Prepared for the 2011 Annual Conference of the International Political Economy Society Please do not cite without the author s permission Abstract This paper argues that immigration policy cannot be studied in the absence of trade and capital policy. Trade is a substitute for immigration for both policymakers and firms. Opening trade forces firms to become more productive, move overseas, or close their doors; all three choices reduce firms incentives to push for open immigration and allows policymakers to move immigration policy closer to the ideal policy of the rest of their constituents by restricting immigration. Opening capital reinforces this effect by increasing the probability that firms will move overseas in response to trade openness instead of remaining at home. The paper tests this theory on a new dataset on the immigration policy of 19 states from the late 18th century through the early 21st century. There is a powerful, robust and enduring relationship between trade and immigration in the dataset. Trade openness leads to greater immigration restrictions and this relationship is made stronger when we examine capital openness as well. Department of Political Science, University of Wisconsin Madison, 110 North Hall, 1050 Bascom Mall, Madison, WI 53706; maggie.peters@gmail.com

Introduction Explaining immigration policy has never been easy for political economists. Immigration policies of states seem to vary in inexplicable ways: at times states are very open to immigrants while at other times they are very closed. Moreover, policy is episodic. States seem to ignore the flow of people for a generation and then, with seemingly no change in economic circumstance, close their border. Moreover, policy is no more predictable when we look across nations as opposed to across time. Democracies policies have varied as much as those of nations where citizens appear to have less voice. While the conventional wisdom is that social forces are the key variable in explaining the ebb and flow of border measures, these forces have only sometimes been met with action on immigration policy. At times, including the late 1910s and early 1920s in the United States, cries for immigration reform have been met with policy change. Recently, these same cries to secure our borders have gone largely unheard by the US federal government. What, then, explains these shifts in policy? Unfortunately, our usual political economic explanation for this puzzle the distributional costs and benefits from openness are inadequate. According to the simple two-factor, two-good Stolper- Samuelson model, openness through the movement of people, goods or capital affects prices and wages in the same way, benefiting the abundant factor while hurting the scarce factor. 1 Economic theory, however, tells us little about which policy or policies the state should choose when it decides to pursue openness. Openness in any one of these policy areas, theoretically, should produce the same effects as being open through any other policy or through any combination of policies. Nonetheless, it appears that states rarely choose to be open on all three-policy areas. In the 19th century, most labor-scarce states those states that were most likely to face immigration pressures were open to immigration and capital but not to trade. In contrast, most of these same states have been much more open to trade since the 1950s and to capital since the 1980s than to immigration. Economic theory, however, does not seem to explain these choices between different policies. Political analysts have been no better than economists at providing a clear explanation for the choices that states make regarding immigration policy. When observing this puzzle, many scholars (e.g Freeman 1995, Zolberg 1989, 2006) have turned to culture to explain the policy choices of states, often invoking some type of prejudice as an explanation for why nations will close their economies to immigrants. Yet, these theorists assume that prejudice is constant in most nations. Since immigration policy varies, social theories of this sort may be descriptively true but not helpful 1 The Stolper-Samuelson model of trade builds on the Ricardian model of comparative advantage by allowing countries to have different endowments. In the simple model, there are two countries, one relatively abundant in labor and the other relatively abundant in capital. When these two countries trade with each other, they export the good that uses the abundant factor intensively and import the good that uses scarce factor intensively. Owners of the scarce factor suffers a real decrease in the returns to their factor as domestic production moves out of the good that uses the scarce factor intensively and into the good that uses the abundant factor intensively. In contrast, the abundant factor will see a real increase in the returns to their factor. Similarly, opening borders to the movement of labor or capital will lead, respectively, labor to move from the labor-abundant country to the labor-scarce country and capital to move from the capital-abundant country to the capital-scarce country. Movement of factors, therefore, also increases the real returns to the abundant factor while decreasing the real returns to the scarce factor. 2

in predicting variation in policy. What is missing from both the economic and political theories is a discussion of the structural constraints that policymakers face when choosing an immigration policy once they open their economies to the free movement of goods and capital. I argue that the dynamics of immigration policy formation differ depending on the openness of the economy to the movement of goods and capital. When trade and capital are closed, immigration policy follows interest group politics. Firms serve as the bulwark against anti-immigration groups, leading to a more open immigration policy. When capital and goods are free to move, the dynamics become more complicated because openness decreases firms need for immigrant labor while also increasing their ability to influence policy. This paper argues that, in the long run, policymakers cannot simultaneously open their markets to goods, capital and people because these flows are interdependent. Opening trade and capital allows some firms to take their capital to labor rather than bring labor to capital, taking their tax revenue and jobs with them and leads other firms to close by subjecting them to competitive pressures, taking their tax revenues and jobs as well. Policymakers fear the consequences of losing tax revenue and jobs as it could affect their chances of staying in office. They seek ways to keep these firms at home. But the incentives that policymakers give firms to remain at home are politically unpopular. The policymaker must balance her desire for tax revenues and jobs with her constituents preferences if she is to stay in office. This creates a dynamic where either firms are made less mobile and more competitive, through capital and/or trade restrictions, while immigration is opened or where firms are allowed to exit the state or close their doors and immigration policy is restricted. By allowing firms to move overseas or close, policymakers remove the main bulwark firms against anti-immigration groups and, therefore, face an incentive to close immigration policy. Thus, in the long run, capital, trade and immigration cannot all be open. One of the major obstacles to research on immigration has been the lack of longitudinal crossnaitonal data. While there have been a few studies that have coded immigration policy over time (Albarracín 2003, Timmer and Williamson 1998), these studies have been focused on a limited number of countries and years. In response to this lacuna, this paper assembles a new dataset of de jure immigration policy across 19 countries over the last 200 years. After introducing the data, I argue that the data suggest that states should be categorized into four categories settler states, European liberal democracies, export-oriented industrializers and autocracies that vary in what type of policies they use to regulate their borders and their openness to immigration. The data show that the 19th century was a period of general openness; although, countries increasingly sought to control immigration as the years went on. The Interwar period was a time of general closure, but there were some side and back doors left open for some, mostly Northern European, immigrants. After World War II, some states opened their doors to immigrants again, only to begin closing them again at the end of of the 20th century. What accounts for this increase in restrictions? I argue that trade policy can explain the pattern of increased immigration policy restriction across all states. I test the relationship between trade policy and immigration policy and find a robust and enduring negative relationship between these 3

two policies. Trade policy cannot be separated from immigration policy because trade policy is a substitute for immigration policy. When trade is closed immigration is open and when trade is open immigration is closed. The relationship is made stronger with the inclusion of capital openness. This finding is supported if we examine policy in the 19th century or today, if we examine each state s trade policy and if we include a variety of control variables. While the dataset was created to test the relationship between trade, capital and immigration policy, it also provides the opportunity to test alternative hypotheses offered by scholars. I find that most of the relationships hypothesized by these theories are not supported when tested using this data. One theory, the fiscal argument, does help to explain the variation in immigration policy in the post-world War II era in OECD states. The paper continues as follows. I begin by further explicating the constraints that openness to trade and capital place on the policymaker s ability to use immigration policy. Next, I discuss the alternative explanations in the literature. Third, I introduce the new dataset of the immigration policy of 19 states from 1783-2010. Fourth, I test the relationship between trade, capital and immigration policy and examine the evidence for the alternative explanations. Finally, I conclude. The Constraints that Policymakers Face In this section, I use a model of firm lobbying over immigration policy similar to the model developed for trade policy by Grossman and Helpman (1994). While there are several groups in a polity that could affect immigration policy firms, labor, people who dislike immigrants for cultural reasons (nativists), taxpayers and immigrants themselves I examine the preferences of firms because they are the main source of pro-immigrant sentiment in the polity. Native labor dislikes immigrants because immigrants compete with them for jobs and push wages down (which is exactly why firms like immigrants). 2 Nativists dislike immigrants for the obvious reason: immigrants are different from natives. Immigrants typically are for an open immigration policy as it allows them to be more secure in their ability to stay in the state and/or bring in friends and family; however, immigrants are not a powerful group. Until they gain the rights of citizens (and, sometimes, not even then), immigrants can be expelled from the country, which limits the political power that immigrants have. Moreover, as they are not citizens and therefore, lack the ability to punish the policymaker, policymakers are less likely to listen to the demands of immigrants. Thus, firms are left as the only powerful group that could be pro-immigration. If the firm is not for immigration then it is unclear who would be for immigration. Given firms important role in immigration policy, I examine how their preferences change due to changes in productivity, trade policy, and capital policy and how policymakers respond to these changes. 2 Unions today have taken a more pro-immigration stance than they had in the past. In part this reflects the realization that in many wealthy states, a segment of low-skill labor is comprised of illegal labor. Unions would rather have these illegal workers brought out of the shadows so that all employers would have to respect minimum wages and safety standards. As such, unions tend to be for a more open immigration policy with stricter enforcement. Second, unions in many countries have been gaining immigrants as union members and therefore tend to represent their interests as immigrants and not just their interests as workers. 4

I begin by assuming that the policymaker can only choose an immigration policy and a tax rate for each firm; later the policymaker will be able to choose a trade and capital policy as well. In the model, firms can lobby the policymaker for a preferred policy by paying a contribution; in general, however, we could think about the contribution as the political capital that the firm is willing to pay for the policy. In essence, by paying a contribution to the policymaker, the firm is paying an extra tax, on top of the tax rate that the policymaker sets. To simplify the model, both the taxes and the contribution are combined into one tax rate. The game is as follows: firms offer the policymaker contributions schedules that lay out the tax rate that the firm will pay for each potential immigration policy the policymaker could make. The immigration policy is modeled as the total number of immigrants allowed into the state in a given year, ρ. The policymaker observes the contribution schedules and chooses a level of immigration that maximizes her utility function, G( ). Firms then maximize their profits, π i, given the immigration policy. Firms may also be unable to make a profit given a tax rate and immigration policy and choose to go out of business. Following Grossman and Helpman, I examine Nash equilibrium with truthful contribution schedules, defined as a contribution schedule that everywhere reflects the true preferences of the firm (1994, 840). A set of contribution schedules and a policy choice is a sub-game perfect Nash equilibrium if the firm does not contribute more for a policy than it would make under that policy; the policymaker chooses the policy that gives her the greatest payoff given the contribution schedules, and that the policy chosen also maximizes the firms payoffs given all the contribution schedules. 3 The first criteria ensure that the firm can actually give the contribution it is offering for a given policy and the second two criteria ensure that neither the policymaker or any of the firms want to deviate from their choices in equilibrium. The policymaker s goal is to stay in office; to do so, she maximizes her utility function, G(w, τ, ρ) = α 1 w(ρ) + α 2 τ i (ρ) + α 3 H(ρ) (1) where w(ρ) is the wage for low-skill labor; i F τ i is the total tax revenue, including contributions that the policymaker receives, from each firm i in the set of all firms F and H(ρ) is a function that measures the cultural benefits (costs) of immigrants. The policymaker places a weight α k [1,3] on each element and the α s must sum to 1. The first term, the wage level, measures how concerned the policymaker must be about jobs and wages of low-skill workers. The second term measures how much the policymaker cares about tax revenue. The policymaker could use the tax revenue as a transfer to give her citizens, in a sense using it to buy votes, or she could keep the revenue for herself, as we might expect an autocrat to do. 4 Finally, the last term is used to capture all the 3 More formally, a policy choice is SPNE if (a) the contribution schedule for every firm is feasible, i.e. the firm cannot contribute more than it would make, (b) the policymaker sets a policy to maximize her welfare given the contribution schedules, (c) the policy chosen maximizes the joint welfare of the firm and the policymaker, given all the other contributions and (d) there exists a policy that would elicit a contribution of zero from firm i, which the policymaker likes as much as the equilibrium policy (Grossman and Helpman 1994, 839, 845). 4 I do not model the total welfare, as in Grossman and Helpman (1994), because I assume that constituents only i F 5

potential non-labor market costs and benefits of immigrants, including nativism (cultural costs), cosmopolitanism (cultural benefits), the benefits to immigrants themselves of the policy and the (supposed) fiscal costs of immigrants. If immigrants hurt citizens in the non-labor market, H is negative; if they benefit citizens, H is positive. The first order condition for the policymaker is dg dρ = α w 1 ρ + α 2 α 2 i F i F τ i ρ + α H 3 ρ = 0 (2) τ i ρ = α w 1 ρ α H 3 ρ From equation 3, we see that, in the basic framework, the policymaker will need increased tax revenue (contributions or political capital) in order to open up immigration further. 5 (3) Increased immigration lowers the wage for low-skill workers, making the first term on the right hand side of equation 3 positive and increases the non-labor market costs of migration, assuming that H is decreasing in ρ, making the second term positive as well. As such, the total tax revenue she receives through political capital, contributions or taxation will have to increase for immigration to increase. Similarly, if contributions or political capital (tax revenue) decreases, the policymaker will restrict immigration. Firm Behavior and Immigration Policy under Closed Trade and Capital I begin examining firm behavior when trade and capital are closed (henceforth, under autarky). I assume that capital is immobile across industries but that labor is mobile across industries. The profit function for each firm, i, in the set of all firms, F, is π i = p i q i c i (w(ρ), q i ) τ i (ρ) (4) where p i is the price of the good that firm i produces; q i is the quantity produced; c i ( ) is the cost function, which is assumed to be convex; w is the wage for low-skill workers and τ i ( ) is the tax rate including the contribution schedule that the firm pays for a given immigration policy, ρ. The costs of producing each good i is decreasing in the number of immigrants allowed into the country because increased immigration lowers the wage for low skill workers. 6 In contrast as we saw above, care about the wage effects of immigration or similarly, that they do not realize that immigration has an effect on the overall economic welfare of the state. I do not include prices because the overall effect of immigration on prices and consumers utility is unclear. On the one hand, increased immigration will lead the costs, and therefore the prices, of goods made with immigrant labor to drop; on the other hand, immigrants demand for goods will mean that the price of some goods will rise. Without knowing the consumption bundle of consumers, it is impossible to know how increased immigration will affect consumers and, therefore, the policymaker s utility. 5 I assume that there are diminishing effects of immigration on both the wage and the non-labor market costs of immigration, making both functions concave in ρ. 6 I assume that there is a numeraire good produced with only high-skill labor which sets the wage for high-skill labor, without loss of generality, at 1. This assumption allows immigration to affect only the wage of low-skill labor, which I assume to be the case, as the vast majority of immigrants over time have been low-skill workers. The wage 6

the taxes that the firm pays are increasing in the immigration policy to compensate the policymaker for her loss in utility given an increase in immigration. 7 I assume that no firm has market power; instead, they are all price takers. Because the firms are price takers, in equilibrium, their marginal cost will equal their marginal revenue, the price of good i, or their costs will exceed the price of good i, which will force the firm to close. Assuming that the firm does not close, c w w ρ = τ ρ (5) where c w w is the change in costs due to a change in wages, ρ is the change in wages due to a change in immigration and τ ρ is the change in the tax that the firm pays for a given immigration policy. The labor costs that the firm pays will decrease with an increase in immigration while the taxes it pays will increase. Under autarky firms, therefore, will pay increased taxation for an additional immigration until the additional benefit they receive from the immigrant in reduced costs equals the marginal tax that they will have to pay. The decrease in costs due to increased immigration will be lower for firms that are more productive or capital/high-skill intensive than for firms that are less productive or low-skill intensive because these firms use less low-skill labor or c high productivity w < c low productivity w (6) Because firms are only willing to pay in taxes up to the marginal benefit they receive from another immigrant, firms that need less labor more productive or capital/high-skill intensive firms will be willing to pay less for each additional immigrant than firms that need more labor the less productive or low-skill intensive firms. As the proportion of more productive or capital/high-skill intensive firms in the economy increases, the policymaker will receive less in taxation (contributions or political capital) for the same immigration policy. With less tax revenue, the policymaker will restrict immigration. Further, if we allow for imperfect market competition (oligopoly), more productive and capital/highskill intensive firms in an industry have an incentive to spend political capital to restrict immigration. Firms now have market power and can compete for market share through price (or quantity) competition. Increasing immigration, therefore, conveys an advantage to firms that use more labor because immigration lowers the costs of these firms pay to a greater extent than for more productive or capital/high-skill intensive firms. These less productive and low-skill intensive firms can lower their price and collect a greater share of the market, reducing the profitability of more productive and capital/high-skill intensive firms. More productive and high-skill intensive firms may want to keep their competitive edge by limiting the availability of cheap labor for their less productive and more low-skill intensive competition. Therefore, when the proportion of firms that are more profor low-skill workers will be less than 1; otherwise high-skill workers would take low-skill jobs. 7 For ease of solving the model, I do not allow the immigration policy to affect the price of the good by increasing the demand for the good produced by firm i. If I did include this effect, firms would simply be willing to pay more for each level of immigration as they receive a higher benefit from each immigrant. 7

ductive or capital/high-skill intensive in the economy increases, immigration policy should become more restrictive under either perfect or imperfect competition. This leads to my first hypothesis. Hypothesis 1 As labor productivity and/or capital/high-skill intensity of production increases, immigration policy will become more restrictive. The overall openness of immigration is also likely to be affected by the non-labor market costs of immigrants (H(ρ)). If the non-labor market costs of immigration increase for all levels of immigration (shifting H ρ downwards), the policymaker will need to be compensated with more tax revenue for every possible immigration policy than she was before the increase in non-labor market costs. Firms, therefore, will want fewer immigrants because immigration is more costly, leading to a less open immigration policy. Similarly, if the non-labor market benefits of immigration increase for every possible policy, immigration policy should be more open because firms have to pay less for each immigrant. An increase in nativism or an increase in the welfare benefits that accrue to migrants would shift the non-labor market benefits downwards. An increase in immigrants or their political power, say for instance because they gained citizenship, would lead to an upward shift in the non-labor market benefits of immigration. This leads to my next three hypotheses. Hypothesis 2 As nativism increases, immigration policy will become more restrictive. Hypothesis 3 As the number of immigrants in society increases and/or immigrant rights groups gain more power, immigration policy will become more open. Hypothesis 4 As the fiscal costs of immigrants increase (or are thought to increase), immigration policy will become more restrictive. Finally, the immigration policy will be affected by the weight that the policymaker places on each item in her utility function. If the policymaker places more weight on the wage of low-skill workers (α 1 ), immigration policy should become more restricted. From equation 3, we see that an increase in α 1 increases the taxes that firms have to pay. By equation 5, we know that increasing the tax per immigrant lower the total number of immigrants that the firm wants. By placing more weight on wages, the policymaker makes increasing immigration more costly for the firm because the tax that the firm has to pay for each immigrant increases. One way in which the weight placed on the wage of labor would increase would be if the state democratized or if franchise expanded; both changes in the political system make low-skill workers more important for reelection. Another way in which the weight placed on wages could increase is if organized labor became more politically powerful. 8 As organized labor gains power, they become more important for reelection, leading to a more restrictive immigration policy. Finally, the weights could also measure the policymakers ideological 8 Here I assume that the power of labor organizations is in delivering votes rather than contributions and that labor organizations dislike immigration due to the wage effects. If organized labor can provide contributions for immigration restrictions, it is clear that immigration openness would be more expensive for firms and there would be a more restrictive policy in equilibrium. If organized labor was pro-immigration, then it would be cheaper for firms to buy additional immigrants and immigration policy should be more open. 8

position. Left leaning politicians are likely to place more weight on the wage of labor than right leaning politicians. Conversely, right leaning politicians may place more weight on the non-labor market costs of immigration because they want to appeal to typically conservative nativists, they want to appeal to fiscal conservatives or both. 9 This leads to my next four hypotheses. Hypothesis 5 As the size of the franchise increases or as the state democratizes, immigration policy will become more restrictive. Hypothesis 6 As the power of labor increases, immigration policy will become more restrictive. Hypothesis 7 When left leaning parties are in power, immigration should be more restrictive. Hypothesis 8 When right leaning parties are in power, immigration should be more restrictive. Immigration Policy under Open Trade and Closed Capital Under autarky, firm preferences and their willingness to spend political capital on immigration were driven by their productivity and their capital/high-skill intensity. Opening trade does not affect these preferences. Instead it has two countervailing effects: it increases the influence that firms have over immigration but also increases the proportion of firms that are more productive and capital/high-skill intensive. In the short run which of these effects will prevail will depend on the choices made by the policymaker; in the long run the changing composition of the economy will predominate, leading to a more restrictive immigration policy. I assume that trade openness is exogenous to both the firm and the policymaker, which I relax later. Trade openness could affect firms in two ways depending on whether the trade is opened to countries with different endowments (Ricardo-Viner model) or the same endowments (Melitz (2003) model). I begin by examining what happens to firms that produce tradable goods when trade opens under the Ricardo-Viner model. Firms that produce non-tradable goods are not, by definition, affected by trade. These firms should continue to hold the same preferences as they held under autarky. Under the Ricardo-Viner model, trade openness is modeled as an increase in prices for the tradable goods produced by capital/high-skill intensive firms and a decrease in prices for the tradable goods produced by low-skill intensive firms. As prices for low-skill intensive goods decrease, these firms have to decrease costs or close. There are three ways in which these firms could decrease costs: increase their use of capital and/or high-skill labor, decrease the wage they pay or decrease their tax bill. As we saw above, if firms choose to increase their use of capital and/or high-skill labor, they will be less supportive of immigration and immigration will be more restrictive. Assume there is only one sector i that faces lower profits under trade openness and all other firms receive the same prices. If firms in sector i exit the market, they pay no taxes and provide no 9 We would expect that the policymaker would place more weight on nativists if they were more organized; for example, if there was an anti-immigrant party which was a challenger to the policymaker or could be brought into her coalition. This, of course, assumes that the anti-immigration party arose exogenously; otherwise, we would expect that the policymaker would choose a policy that forestalled the emergence of the anti-immigrant party. 9

jobs, which decreases the wage for low-skill labor. The policymaker now must decide whether it is better for her to give the firm incentives to stay in business or allow the firm to exit the market. Without loss of generality, I assume that policymaker does not offer any tax breaks in addition to offering increased immigration. The policymaker must increase immigration from the level that it was under autarky to keep the firms in sector i in business without getting additional tax revenue. The policymaker will offer increased immigration as an incentive if α 1 w(ρ in ) + α 2 τ i (ρ in ) α 3 H(ρ in ) α 1 w(ρ out ) + α 2 τ i (ρ out ) α 3 H(ρ out ) 10 (7) where ρ in is the immigration policy needed to keep firm i in the market and ρ out is the immigration policy the policymaker would choose if firms in sector i exit the market. If firms in sector i exit the market, the policymaker receives no tax revenue for those firms and equation 7 simplifies to α 1 w(ρ in ) + α 2 τ i (ρ in ) α 3 H(ρ in ) α 1 w(ρ out ) α 3 H(ρ out ) (8) For the policymaker to be willing to increase immigration to keep firms in sector i in business, wages and tax revenue must compensate her for increased immigration. If sector i is large and the price decrease for good i with open trade is small, then the policymaker will be more likely to open immigration to keep sector i in business. As a large sector if firms in sector i close, many jobs will be lost and wages will fall sharply. If the change in prices due to open trade is small, then only a small increase in immigration and a small decrease in wages - will be needed to keep firms in sector i open. Conversely if sector i is small and the price change large, the loss of sector i will result in only a slightly lower wage whereas the increased in immigration need to keep sector i would be large, leading to a large decrease in wages and a large increase in the non-labor market costs. Further, if firms in sector i are allowed to close, the policymaker could reduce immigration. Wages would drop as the firms in sector i lay off their workers and policymaker could scale back immigration without making these other firms worse off. Therefore, the non-labor market costs are always higher if the policymaker chooses to subsidize sector i with increased immigration. Although the policymaker may be willing to subsidize firms with immigration in the short run, the combination of sector size, price change, and the non-labor market costs of immigration will lead the policymaker, at some point, to realize that it is not in her interest to continue to subsidize the sector i through immigration. Sectors that are small and face a large price decrease with openness will be the first ones allowed to close. Further, the costs of keeping sectors in business are increasing in openness because greater openness pushes prices down even more. As the state becomes more open to trade, more sectors will follow suit, as it becomes increasingly expensive for the policymaker to keep them open. Over the long run, then, as trade becomes more open, more sectors will be allowed to close; the proportion of firms that are more productive and capital/high-skill intensive will increase and immigration policy will become more restrictive. Figure 1 illustrates how immigration 10 To simplify the model I assume that the state is small; therefore, if it stops producing good i world prices will not be affected. 10

Figure 1: Immigration policy in response to trade openness if the policymaker uses immigration to keep firms at home Immigration Policy Closed Open Closed Open Trade Policy policy might change in response to trade policy if the policymaker decided to use immigration to subsidize sectors that were negatively affected by trade. The policymaker could also decrease taxation instead of opening immigration to keep firms in sector i in business. In this case immigration policy would remain the same as it was under autarky but tax revenue would fall. As in the scenario above, if the policymaker allowed these firms to close, she could restrict immigration without affecting other firms. If the sector was large and the price change small, the policymaker could reduce taxes for the firms in sector i and be better off than she would be if she allowed the firm to close. If, on the other hand, the sector was small and/or the price change was large, the policymaker would be better off allowing the firm to close. As long as trade does not open too much, the policymaker can subsidize firms that are hurt by trade with tax breaks and keep immigration at the same level. Because the costs of subsidizing firms is increasing in openness, at a certain point trade will open enough that the policymaker prefers to allow firms to close, rather than to continue to subsidize them, and restrict immigration. As trade openness continues, more firms will be allowed to close; the proportion of firms that are more productive and capital/high-skill intensive will increase and immigration policy will become relatively restricted. Figure 2 illustrates the effect of using tax policy to keep firms at home. Opening trade, therefore, has two main effects which lead to changes in the immigration policy. First, opening trade increases the influence that firms have over policy. Firms that are low-skill intensive are more likely to close their doors because open trade leads the price of their goods to decrease, reducing profits. Because firm exit leads to losses of both jobs and tax revenue, policymakers are more likely to place a greater weight on these firms preferences. In the short run, this could lead to a more open immigration policy or a continuation of the current policy as policymakers use open immigration or tax breaks to keep these vulnerable firms producing. In the long run, these 11

Figure 2: Immigration policy in response to firm mobility/mortality if the policymaker uses tax policy to keep firms at home Immigration Policy Closed Open Closed Open Trade Policy policies are unsustainable, leading to a more restrictive immigration policy. The increased immigration restrictions force low-skill intensive firms to increase their productivity or capital/high-skill intensity of production or close their doors. Either choice will then lead to a second effect, namely a change in the overall distribution of firms in the economy. The firms that continue to produce will be more productive and capital/high-skill labor intensive. These results do not depend on the assumptions of the Ricardo-Viner model; most importantly, they do not depend on comparative advantage and interindustry trade. Instead, the results are similar if I examine the effects of intraindustry trade under the Melitz (2003) model, which is an extension of the Krugman (1980) model. 11 Examining the effects of intraindustry trade is important because a large proportion of trade is intraindustry rather than interindustry. Under this model, countries with similar endowments open trade. However, exporting is not costless; firms face some fixed costs that do not vary with the amount exported. Opening trade leads the most productive firms to export and the least productive firms to close their doors. Due to the costs of exporting, only the most productive firms can afford to export; these firms receive higher returns than they did under autarky. As the highly productive firms export, they increase the amount of labor they need and bid up the real wages, forcing the least productive firms to exit (Melitz 2003, 1716). The policymaker under openness to intraindustry trade faces the same trade-off as she did under interindustry trade: subsidize production of the least productive firms or allow them 11 The Krugman (1980) or Melitz (2003) model without costs to trade can also be thought to model increased immigration under autarky. Increased immigration increases the country size; however increased country size has no effect on firm level outcomes the same number of firms produce the same output and earn the same profits (Melitz 2003, 1706). Under this model, no firm would ever have an incentive to lobby for open immigration and under autarky we would always see closed immigration. Empirically, this is not the case and therefore it is unlikely that this model can explain immigration policy under autarky. 12

to close their doors. 12 If the firm cannot survive with these lower taxes or increased immigration, the firm must either also increase productivity or exit. exits, the policymaker, again, can decrease immigration. under either model. 13 Once the firm increases productivity or Therefore, we obtain the same results Further, under the Melitz model if we relax the assumption of perfect competition, we see that, again, the more productive firms may want to spend political capital to reduce immigration or limit tax incentives. These firms can capture more market share if their less productive competition closes. As such, they may want to hasten the demise of the less productive firms by ensuring that less productive firms are not subsidized with open immigration or tax incentives. I now relax the assumption that trade is exogenous to the policymaker. The policymaker now can affect prices by lowering trade barriers. I assume that trade is opened reciprocally so that exportoriented firms have a reason to push for openness. Under the Ricardo-Viner model, prices on goods that are made intensively with labor will drop and goods made intensively with capital/high-skill labor will increase. The overall effect on consumers depends on their consumption bundle and therefore is unclear. For the purposes of this model, I ignore the consumption effects. Under the Melitz (2003) model, prices stay the same but more productive firms can earn higher returns under trade than under autarky. 14 Additionally, under both models total welfare increases. I assume that, like immigration, trade policy is largely driven by firms in these states as they are capital abundant and therefore capital should be the winner from open trade; the importance of labor can come into the model through the α 1 term. Firms that win from trade openness are likely to pay contributions (increased taxation) for trade openness; while firms that lose from trade openness are likely to pay contributions (increased taxation) for closure. From Grossman and Helpman (1994, 846), each lobby will have to pay according to the political strength of the rival. Therefore, if the export-oriented firms are politically more powerful, the import-competing firms would have to pay more for trade protection than export- 12 To obtain the same results under tax incentives, we must make one more assumption; namely, that the most productive firms do not want to buy more immigration as well. If the more productive firms wanted to buy immigration as well, due to the increase in wages, I would expect that immigration would increase with trade openness. However, more productive firms need labor that can work at a higher level of productivity. Most immigrants are low-skill workers and are unlikely to possess the skills needed to preform at the desired level of productivity; therefore, immigrants could not provide the labor that more highly productive firms need. Highly productive firms, therefore, are indifferent to the choice of immigration policy. 13 These results, however, implicitly assume that production by either the more capital/high-skill intensive firms under the Ricardo-Viner model or the more productive firms under the Melitz (2003) model does not increase so much as to increase the economy-wide demand for low-skill labor. Since the firms expanding under trade in the Ricardo-Viner model are more productive and/or capital/high-skill intensive and in the Melitz (2003) model are more productive, the expanding firms are likely to want much more high-skill labor and only some low-skill labor. The firms that exit the economy, on the other hand, are low-skill labor intensive or less productive. Therefore, when they exit, they release much native labor. It is likely that the released native labor will more than meet the demand for low-skill labor from the capital/high-skill intensive or more productive firms. Empirically, rising wage inequality due to increases in productivity and trade seem to bear this out (see for example Feenstra and Hanson (1996) or Kremer (2006)). Rising wage inequality is occurring precisely because low-skill jobs have not been replaced at a high enough rate to keep low-skill wages at the same level. Therefore, I believe that this assumption is justifiable. 14 Prices stay the same because differentiated goods are traded in this model. In the Ricardo-Viner model, homogeneous goods are traded, leading to a price change. 13

oriented firms would for trade openness. Nonetheless, the import-competing firms have the threat of closing if trade opens. This threat allows them to pay less as wages and tax revenue would decrease if the firms closed. To obtain trade openness, the contributions from export-oriented firms must outweigh the costs of subsidizing the losing firms or allowing them to exit the market. As noted above, the policymaker can make the firms that benefit from trade equally well off if she subsidizes the firms that face increased competitive pressures or allows these firms to exit. In equilibrium, both trade and immigration can be open in the short term, but immigration will close in the long term. This leads to my next hypothesis. Hypothesis 9 Immigration policy may become more open, more restricted, or stay the same at low to moderate levels of trade openness but will become more restrictive at high levels of trade openness. Immigration Policy under Trade and Capital Openness I begin by assuming that capital is opened exogenously as well, which I relax later. If trade and capital are open, some firms that are hurt by trade openness have one more option to lower their costs they can move production overseas where costs are lower. Moving production overseas can occur in two ways: first, the firm could move their factory overseas through foreign direct investment, or second, they could outsource part of their production process the part that is no longer productive to do at home to a firm overseas. Firms cannot move production without capital openness because they are legally unable to move their capital to either move their factory or pay their outsourcer. Firms are unlikely to move production without trade openness because trade protection would apply to the goods produced overseas, making them uncompetitive in the home market. Not all firms will be able to move production; some firms, especially those that exploit natural resources like agricultural or mining firms, simply will find moving their production process prohibitively expensive. To the policymaker, moving production overseas is the same as having the firm go out of business; both the jobs and the tax revenue associated with that firm are lost. 15 For firms that cannot make a profit at home, moving overseas is likely to be a better option than closing. When firms move overseas, rather than close, the owners continue to get their share of the profits into the future rather than simply getting what little capital they can from selling the firm s assets. As trade and capital barriers decrease, moving overseas becomes a better option because the firm s profits from producing overseas increase. Although it is outside the scope of this paper to test, we should expect that trade openness should be accompanied by capital openness as firms that are threatened by trade openness should want the exit option. With the option to move production overseas, the firm will be unwilling to pay as much in taxes for any given immigration policy because they have an attractive exit option. Therefore, the policymaker must increase immigration more or she must cut taxes further to keep the firm at home. Either of these options give the policymaker a 15 I assume that states cannot tax overseas production. This is not always the case, but it is clear that states tax overseas earning at a lower rate, which would reduce their tax revenues. 14

lower utility than the similar option in the case where only trade is open. Moreover, once firms have moved overseas, they may find it in their interest to spend political capital (contributions) to keep immigration restricted at home. If the firms move production to a state that sends many migrants to the firm s home state, closing (opening) immigration will lead to a lower (higher) wage in the state where production is taking place. Firms producing in that state, therefore, have an incentive to keep immigration restricted at home. This means that the policymaker will find that it is better to allow the firm to leave sooner (or allow more firms to leave) than to try to keep them. I expect, therefore, that in the short run immigration cannot open as much as it did under only trade openness and that the short run should last for a shorter period of time as the policymaker chooses to allow firms to move overseas sooner than she would allow them to close. This leads to the final hypothesis. Hypothesis 10 Immigration policy will not open as far, if at all, under trade and capital openness as it did under trade openness alone. Further, immigration policy will be restricted at a lower level of trade openness if capital is open as well than if only trade were opened. Finally, we assume that capital policy is also endogenous. The policymaker now can choose a trade, capital, immigration and tax policy. Firms choose contribution schedules over trade, capital and immigration policy and after the policy bundle is chosen, the firm chooses to produce at home with the same production function, increase productivity/capital/high-skill intensity, produce overseas or close. Closing is the worst option and is only chosen if the firm will make negative profits under the other three options. The policymaker knows that if she opens trade, she will be lobbied to open capital as well. If trade and capital are open, the policymaker is worse off because she receives less compensation for a given immigration policy or must cut taxes of the vulnerable firms more. Therefore, to open trade, she must be compensated by the winners" from open trade more than she was when capital remained closed. Similarly, she must also be compensated by those who want open capital. In equilibrium, therefore, we can have open trade and capital chosen by the policymaker, but this policy bundle will only be achieved if those who want open trade and capital are willing to pay for it. Under this scenario, all of the above observable implications still hold even though trade and capital were chosen endogenously instead of exogenously. I argue that firm preferences over immigration vary along two dimensions: productivity/lowskill labor intensity and their ability to move production locations. Firms that use production technology that is low-skill labor intensive will need more labor than firms that use capital or highskill labor intensive production technologies. Similarly firms, regardless of production technologies, will need less labor if the firm s production process uses labor more productively. We expect, therefore, that low-skill labor intensive and less productive firms will be pro-immigration whereas capital or high-skill labor intensive and more productive firms may prefer to spend their political capital on other issues or, in the case of oligopolistic competition, may prefer spend their political capital on restricting immigration. The second dimension captures the ability of the firm to move 15

production overseas. Firms that can are relatively immobile will be more likely to need labor at home, and therefore support immigration more, than firms that can move production. Once firms move overseas, they will be indifferent to or potentially against immigration at home. Table 1 summarizes these two dimensions. Table 1: Firm preferences for immigration along two dimensions Productivity & Skill/ Capital Intensity Mobility Low High Immobile/ Pro-immigration Indifferent/ Anti-immigration Non-tradable Mobile Indifferent/ Anti-immigration Indifferent/ Anti-immigration Support for immigration is going to be driven in large part, then, by the low productivity and low-skill intensive immobile firms. Under autarky, preferences will collapse to one dimension as trade protection will make overseas production unprofitable and capital controls will limit the legal ability of firms to move. As more firms become more productive or more capital or high-skill intensive, support for immigration should decrease. With trade openness, the size of the low productivity and low-skill intensive immobile firms shrinks, also reducing support for immigration. Low productivity and low-skill intensive firms are the firms that are most likely to face increased competition from overseas. These firms can choose either to become more productive or capital/high-skill intensive or close; if capital is open, the firm can also choose to move overseas if it can. Any of the three choices that the firm makes shrinks the size of the pro-immigration coalition. We expect, that over the long run, policymakers will respond to the decrease in the size of the pro-immigration coalition by closing immigration. Therefore, we expect that there will be a long run negative relationship between trade and immigration, especially when capital is open. In the short run, however, we think that policymakers may respond to firms threats to close or to move overseas by offering them incentives, including increased immigration and tax breaks to stay open. Yet we know that immigration policy, and other incentives like corporate tax breaks, tend to be unpopular with the rest of the constituency. As such, these incentives cannot be maintained forever and immigration will close in response to trade and capital openness. Alternative Explanations for Immigration Policy The extant literature on immigration has focused on two sets of variables to explain immigration policy: societal-based variables and interest-based variables. For societal-based arguments, the key variable is the identity of the state as it relates to immigration. Societies see themselves as either immigrant or non-immigrant states and these identities affect the political discussion around border controls. Interest-based arguments, on the other hand, look at the foundations of an individual s position on immigration, based on the labor market, cultural and fiscal effects of immigrants. 16