Part I Immigration Theory and Evidence The economic theory of immigration seeks to explain why people leave one country and go and live and work in another country. Also, the economic theory of immigration seeks to highlight the economic consequences that immigration has on the welfare of others 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 varied and broad. Furthermore, 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 introductory chapter that precedes this first main 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 textbooks. In its simplest representation, this model assumes 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. 21
22 I Immigration Theory and Evidence I.1 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 ði:1þ 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 per day, 6 days per week. Today, the 40-h workweek is the norm, except where even shorter workweeks have been mandated. Recently, France legislated a 35-hr workweek. In the simple labor market model, we draw the labor supply curves as perfectly vertical. 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 those that we will reach assuming a perfectly vertical supply of labor curve. Fig. I.1 The labor supply curve
I.1 The Basic Labor Market Model of Immigration 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 and the other factors. 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 model such as in Fig. I.3, which shows the labor markets of two countries. Suppose that the supply and demand curves for labor are different in two countries, say Poland and Germany, and wages are 10 euros per hour in Germany and 10 zloty in Poland. If the exchange rate between euros and Polish zloty is, say, equal to one euro ¼ 5 zloty, we can translate the zloty wage into euros. Or, suppose Poland joins the euro area, and Polish citizens exchange 5 zloty for one euro. Then, in euro terms, wages are five times as high in Germany than they are in Poland, 10.00 as compared to 2.00. The wage difference will tend to cause Polish workers (especially plumbers, apparently) 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, which made wages 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 have expected immigration to continue until the wages become equal in the two countries. Figure I.4, however, depicts the more realistic situation where migration tends to reduce, but not eliminate, the difference in wages between two countries. There are, no doubt, assorted stay and stay away factors, such as language differences, moving costs, and family ties, to prevent perfect wage equalization.
24 I Immigration Theory and Evidence Fig. I.3 The labor markets before immigration Fig. I.4 The labor market after immigration I.2 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 losses, the model 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 as they gain higher wages.
I.2 Who Gains and who Loses with Immigration? 25 Table I.1 Gains and losses from immigration 1. Poland: Owners of other (non labor) 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 (non labor) 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 (1 + 2 + 3): 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 More specifically, after q q 0 workers depart, the supply of labor in Poland falls from S to S 0 and total output falls by the area g þ h. The wages of the workers remaining in Poland rise from two to three euros, and their labor income increases from f to e þ f. The other factors earn only d, which is smaller than their former income by the value of the areas e þ 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 fall in total output, g þ 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 þ F to just F, but other factors enjoy a rise in income from D to D þ E þ 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 þ 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 q 0 ¼ Q 0 Q and the average height of the areas G þ H and g þ 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 where its marginal contribution to the real value of output is low to a country where its marginal contribution to the real value of output is higher. Table I.1 summarizes the distributional results from immigration in Fig. I.4.
26 I Immigration Theory and Evidence I.3 Building on the Basic Labor Market Model According to the simple labor market model developed here, the total income in the source country falls, and total income in the destination country increases. 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 detailed later in the book, evidence suggests that, indeed, immigrants capture the greatest part of the immediate gains from immigration. Other results of the model are 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 effectively confirms what many people in immigrant destination countries suspect, namely 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, there is an international transfer of not only a factor of production, but also a consumer. That implies that expenditures, and thus the demand for labor, also shift from the source to the destination countries when people immigrate. Furthermore, immigrants may introduce economies of scale effects. And, in the long run, there are dynamic growth effects associated with the movement of people because immigrants are also innovators, inventors, and entrepreneurs. These, and many more issues, are dealt with in detail in Chaps. 2 9 of this section on the economic theory of immigration.