Migration: The Controversies and the Evidence

Migration The Controversies and the Evidence This volume takes a critical look at the current divide over immigration policies. It hopes to shed new light on the debate by bringing together papers that investigate the link between trade and factor mobility, particularly labour migration, from theoretical and empirical perspectives. It examines the substitutability between trade and migration, the impact of regional integration on the location of economic activity, the role of public goods provisions, and the political economy of migration. Several papers quantify the link between trade, trade policies, migration and income distribution in sending and receiving nations using econometric methods and general equilibrium simulations. Case studies of past and present migration episodes are also presented: the impact of NAFTA on migratory pressure and wage gaps; the trade–migration links between Eastern and Western Europe; and the historical experience with migration flows in the nineteenth century.    is Research Director at the Centro Studi Luca d’Angliano and Professor of Economics at the Università di Brescia. He is a Research Fellow in the International Trade Programme of CEPR.        is Professor of Economics at the University of Geneva and Professeur Invité at CERDU (Université d’Auvergne). He has worked at the research department of the World Bank (1980–93) and has taught at Georgetown University. He is a Research Fellow in the International Trade Programme of CEPR.    .           is Professor of Economics and Director of the Institute for the Study of Labor (IZA). He is Co-Director of CEPR’s Labour Economics research programme.

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The Centro Studi Luca d’Agliano Luca d’Agliano was born in Turin, Italy, in 1961. After obtaining his Bachelor of Arts degree at Cambridge University he was admitted to St Antony’s College, Oxford University. Under the guidance of Amartya Sen, he studied questions relating to developing countries and welfare economics. He died in a road accident in 1984. The Centro Studi Luca d’Agliano was founded in Turin in 1986 in Luca’s memory. Its main activities, in keeping with an approach similar to his, comprise research in development economics, with particular attention to the conflict between efficiency and equity and the fight against poverty.

Migration The Controversies and the Evidence

Edited by

R I C C ARDO FA INI JA IM E DE M E L O and

K L AU S F. Z IM M E RM ANN

            The Pitt Building, Trumpington Street, Cambridge, United Kingdom     The Edinburgh Building, Cambridge CB2 2RU, UK http://www.cup.cam.ac.uk 40 West 20th Street, New York, NY 10011-4211, USA http://www.cup.org 10 Stamford Road, Oakleigh, Melbourne 3166, Australia © Centre for Economic Policy Research 1999 This book is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published 1999 Printed in the United Kingdom at the University Press, Cambridge Typeset in Monotype Times 10/12 [] A catalogue record for this book is available from the British Library Library of Congress cataloguing in publication data Migration : the controversies and the evidence / edited by Riccardo Faini, Jaime De Melo, and Klaus F. Zimmermann. p. cm. ‘Papers presented at a conference on “Trade and factor mobility”, held in Venice on 24–25 January 1997’–Frwd. Includes index. ISBN 0-521-66233-8 (hc.) 1. Free trade–Econometric models–Congresses. 2. Emigration and immigration–Economic aspects–Econometric models–Congresses. 3. Labor mobility–Econometric models–Congresses. 4. Free trade– Europe–Econometric models–Congresses. 5. Europe–Emigration and immigration–Econometric models–Congresses. 6. Labor mobility– Europe–Econometric models–Congresses. 7. International trade– Econometric models–Congresses. I. Faini, Riccardo. II. De Melo, Jaime. III. Zimmermann, Klaus F. HF1703.T7 1999 382–dc21 98-55715 CIP ISBN 0 521 66233 8 hardback

Contents

page xi xiii xv xvi xvii

List of figures List of tables Foreword Acknowledgements List of conference participants 21

Trade and migration: an introduction Riccardo Faini, Jaime de Melo and Klaus F. Zimmermann 1 Trade and migration: the main trends 2 The controversies 3 Insights from theory 4 Quantifying the link between trade and migration 5 Historical and contemporary evidence 6 Conclusions and policy implications

1 2 5 8 12 15 17

PART ONE: INSIGHTS FROM THEORY 22

23

Trade liberalisation and factor mobility: an overview Anthony J. Venables 1 Introduction 2 Competitive models 3 Increasing returns and cumulative causation 4 Concluding comments Appendix Discussion André Sapir

23 23 25 34 45 45 48

Regional integration, trade and migration: are demand linkages relevant in Europe? Rodney D. Ludema and Ian Wooton 1 Introduction vii

51 51

viii Contents

2 The model 3 Labour supply 4 Equilibrium 5 Economic integration 6 Conclusions Discussion Giorgio Basevi 1 Introduction 2 The first issue: stable and unstable equilibria 3 The second issue: different initial countries’ sizes 4 Duality between trade and factor movements 5 Workers’ preferences dependent on the outcome 24

25

Beyond international factor movements: cultural preferences, endogenous policies and the migration of people: an overview Arye L. Hillman and Avi Weiss 1 Policy asymmetries 2 Cultural preferences and immigration policy 3 Models of the migration of people 4 Endogenous immigration policy 5 Conclusions Discussion Francesco Daveri Trade liberalisation and public-good provision: migrationpromoting or migration-deterring? Konstantine Gatsios, Panos Hatzipanayotou and Michael S. Michael 1 Introduction 2 The model 3 Import restriction and international migration 4 Import restrictions and public-good provision 5 Conclusions Appendix 1 Appendix 2 Discussion Ignazio Musu

53 57 59 62 67 68 68 69 74 74 75 76 77 80 83 85 88 91

94

94 96 99 103 106 107 108 112

PART TWO: QUANTIFYING THE LINKS BETWEEN TRADE AND MIGRATION 26

Trade and migration: a production-theory approach Ulrich Kohli

117

Contents

1 2

Introduction The production-theory approach to modelling the demand for imports and foreign-labour services 3 Comparative statics 4 Empirical implementation 5 Empirical results 6 Total factor productivity 7 Conclusions Discussion Marzio Galeotti 27

28

Migration, dual labour markets and social welfare in a small open economy Tobias Müller 1 Introduction 2 Social welfare effects of migration and protection 3 A model of dual labour markets and discrimination 4 Labour market effects of immigration and protection 5 Immigration, protection and social welfare: a simulation analysis 6 Conclusions Appendix 1 The simulation model 2 Data and calibration Discussion Rudolf Winter-Ebmer Globalisation and migratory pressures from developing countries: a simulation analysis Riccardo Faini, Jean-Marie Grether and Jaime de Melo 1 Introduction 2 A Ricardo–Viner model of migration 3 Decomposing the effects of globalisation on the supply of migrants for two archetype economies 4 Simulation results 5 Sensitivity analysis 6 Conclusions Appendix 1 The simulation model 2 The data Discussion Alessandra Venturini

ix

117 121 124 130 133 140 143 147

151 151 153 155 158 162 174 175 175 176 185

190 190 193 197 202 208 211 212 212 217 221

x

Contents

PART THREE: HISTORICAL AND CONTEMPORARY EVIDENCE 29

10

11

Were trade and factor mobility substitutes in history? William J. Collins, Kevin O’Rourke and Jeffrey G. Williamson 1 Introduction 2 Theory 3 Time series: macro-instability and the long swing, 1870–1940 4 Panel data from history: the Atlantic community, 1870–1940 5 Political-economy connections: tariffs and immigration restrictions 6 History’s bottom line Appendix Discussion Gianni Toniolo Liberalisation and incentives for labour migration: theory with applications to NAFTA James R. Markusen and Steven Zahniser 1 Introduction 2 NAFTA 3 Investment liberalisation and income distribution: I – the Feenstra–Hanson model 4 Investment liberalisation and income distribution: II – the Markusen–Venables model 5 Technology and the maize sector 6 Summary and conclusions Discussion Pasquale M. Sgro East–West trade and migration: the Austro-German case Rudolf Winter-Ebmer and Klaus F. Zimmermann 1 Introduction 2 Trade, migration and the labour market consequences 3 East–West flows of goods and people 4 Effects on the labour markets 5 Conclusions Discussion Marina Schenkel

Index

227 227 228 233 244 248 252 253 260

263 263 266 273 280 284 290 294 296 296 297 304 314 324 327 329

Figures

2.1 2.2

Incentives for factor mobility page 26 Mobility dynamics for the sectorally mobile factor and one specific factor 30 2.3 Parameters of the model 31 2.4 Two sector-specific factors internationally mobile and factor A immobile 32 2.5 Lower price of intermediates 38 2.6 x-sector B-intensive 41 2.7 Steep FPE set 43 2.8 Trade barriers lower 43 3.1 KK, labour demand schedule 56 3.2 MM, distribution of preferences 58 3.3 LL, labour supply schedule 59 3.4 Equilibrium allocations 60 3.5 Changing trade costs 64 3.6 Trade liberalisation and location of industry 65 D3.1 Supply of labour function horizontal 70 D3.2 Supply of labour function positively-sloped 72 6.1 Input quantities 119 6.2 Gross output and aggregate input 120 6.3 Total factor productivity 141 7.1 Impact of immigration on native employment: the ‘melting-pot’ case 159 7.2 Impact of immigration on native employment: the ‘guest-worker’ case 161 7.3 Impact of different immigration levels on native social welfare: the ‘melting-pot’ and ‘guest-worker’ cases 169 7.4 Impact of different tariff levels on social welfare 171 7A.1 Structure of nested production functions in the simulation model 175 xi

xii List of figures

8.1 9.1 9.2 9.3 9.4 10.1 10.2 10.3 10.4 10.5 10.6 10.7 11.1 11.2

Labour-allocation decision Long swings in trade and factor flows: USA, 1872–1913 Long swings in trade and factor flows: USA, 1920–39 Long swings in trade and factor flows: UK, 1870–1913 Long swings in trade and factor flows: UK, 1920–37 Investment liberalisation and wage gaps: the Feenstra– Hanson model Investment liberalisation and wage gaps: the Markusen– Venables model (activity shifts) Investment liberalisation and wage gaps: the Markusen– Venables model (factor-price effects) Competitive model with multiple techniques of agricultural production Competitive model with multiple techniques of agricultural production: trade liberalisation Specific-factors model with an outside opportunity Model with a public intermediate good: public infrastructure Immigration and trade, 1986–96 East–West migration and trade: Germany, 1986–94; Austria, 1990–4

195 235 235 236 236 280 282 283 285 286 288 289 307 308

Tables

1.1 1.2 1.3 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 7.1 7.2 7.3 7.4 7.5 7A.1 7A.2 7A.3 7A.4 8.1 8.2 8.3 8.4

Foreign population, early 1980s and early 1990s page 3 Intercontinental migration, 1871–1913 4 European integration and migration, 1960 and 1970 5 Input data – summary statistics 133 Parameter estimates 134 Allen–Uzawa elasticities of substitution, selected years 135 Hicksian elasticities of complementarity, selected years 135 Price elasticities of input demand (cost-function setting) 136 Price elasticities of input demand (production-function setting) 136 Price and quantity elasticities (GNP-function setting) 137 Price and quantity elasticities (immigration-quotas setting) 138 Price and quantity elasticities (variable-resident-employment setting) 139 Policy experiments and labour market specifications 164 Impact of immigration and protection on native social welfare 166 Impact of immigration and protection on output and the labour market 167 Social welfare effects of immigration: sensitivity analysis 172 Education level of the work force in Switzerland, by nationality 174 Equations of the simulation model 177 Variables of the simulation model 179 Employment, Switzerland, 1985 181 Parameters of the simulation model 182 Structure of production, demand and factor allocation 199 Factor–household mapping 200 Policy experiments 201 Macro results: labour supply and home–foreign-labour allocation 203 xiii

xiv List of tables

8.5 8.6 8.7 8A.1 8A.2 8A.3 8A.4 9.1 9.2 9.3 9.4 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10

Household incomes and labour-allocation decisions Micro results: net price and sectoral output shifts Sensitivity analysis: labour supply and home–foreign-labour allocation Model equations Variables and parameters Output and final demand structure Factor shares in value-added Factor mobility correlates with trade, 1870–1913 and 1919–36 Trade and factor mobility, time-series complements or substitutes? Trade and factor mobility correlations: decade averaged panel data for the Atlantic economy, 1870–1940 The determinants of immigration policy, c.1860–1930 Legal immigration to the USA by persons born in Mexico and deportations of Mexicans, FY 1981–95 Canadian, Mexican and US civilian employment, by economic activity, 1994 Comparison of US and Mexican employment structures, 1988 Canadian, Mexican and US maize production, 1992–6 Population, median age and population growth, NAFTA countries, estimates and projections, 1970–2025 Selected economic statistics for Mexico, 1980–95 Relative wage and wage shares, by Mexican region, 1975–88 Average annual compensation, by sector, 1980–93 Monthly compensation per worker in Mexican manufacturing, 1987–95 Foreign investment in Mexico, 1980–95 Simulation results for the alternative-technologies model Empirical studies on the effects of trade and migration on the labour market in Austria and Germany, 1990–7 Economic development in Central and Eastern Europe, 1991–7 Labour, migration and trade, Austria and Germany, 1986–95 Foreign direct investment, 1989–95 Employment growth, Austria, 1987–94 Native employment growth, Austria, 1987–94 Wage growth, Austria, 1987–94 Employment growth, Germany, 1986–94 Native employment growth, Germany, 1986–94 Wage growth, Germany, 1986–94

205 207 209 214 216 217 218 237 242 247 251 264 267 268 269 271 272 274 275 276 278 287 299 305 309 312 315 316 317 319 320 321

Foreword

Trade and migration have often been considered as substitutes. Economic theory treats international trade as the result of differences in factor endowments. Goods thus embody capital and labour, and trade in goods is thus indirectly trade in factors such as labour. Trade in goods embodying labour is thus a substitute for the movement of labour itself. A similar perspective informs policy discussions concerning migration. Increased trade, by fostering the growth of income and wages in poorer countries, can reduce the incentive for migration from the poorer to the richer countries. The historical evidence seems more mixed, however. The rapid growth of trade which took place the turn of the century, and again in the post-war period, was accompanied by more, not less, migration. In the 1980s and 1990s, on the other hand, trade grew rapidly without any corresponding growth of migration. The CEPR has played an active role in the economic analysis of European migrations, beginning with an exploratory workshop in 1985, organised by Louka Katseli, followed by research networks in the late 1990s, funded by the European Commission’s SPES and HCM Programmes. This volume draws on the work of these networks, and in particular on the papers presented at a conference on ‘Trade and Factor Mobility’, held in Venice on 24–25 January 1997. The conference was organised as part of the Centre’s research programme on ‘European Migration: From Economic Analysis to Policy Response’, led by Klaus F. Zimmermann and supported by the European Commission’s Human Capital and Mobility Programme. The Centro Studi Luca d’Agliano provided generous financial support, as did the the Dipartmento di Scienze Economiche at the Università di Venezia. We are particularly grateful to Riccardo Faini, Jaime de Melo and Klaus F. Zimmermann for their efforts in organising the conference and preparing the papers presented at the conference for publication. Stephen Yeo Chief Executive Officer 7 March 1999 xv

Acknowledgements

The editors and publishers acknowledge with thanks permission from NBER to reproduce Table 10.7, from R.C. Feenstra and G.H. Hanson, ‘Foreign Direct Investment and Relative Wages: Evidence from Mexico’s Maquiladoras’ (1995).

xvi

List of Conference Participants

Giorgio Barba Navaretti, Centro Studi Luca d’Agliano Giorgio Basevi, Università di Bologna Carlo Carraro, Università degli Studi di Venezia and CEPR William Collins, Harvard University Francesco Daveri, Università di Brescia Jaime de Melo, Université de Genève and CEPR Gil Epstein, Bar-Ilan University, Israel Riccardo Faini, Università degli Studi di Brescia and CEPR Marzio Galeotti, Università degli Studi di Bergamo Jean-Marie Grether, Université de Genève Panos Hatzipanayotou, Aristotelian University of Thessaloniki Arye Hillman, Bar-Ilan University, Israel Ulrich Kohli, Université de Genève James Markusen, Universitat Pompeu Fabra and CEPR Ignazio Musu, Università Ca’Foscari di Venezia Simona Orlano, Centro Studi Luca d’Agliano André Sapir, ECARE, Université Libre de Bruxelles and CEPR Marina Schenkel, Università degli Studi di Venezia Pasquale Sgro, Deakin University Gianni Toniolo, II Università di Roma, ‘Tor Vergata’ and CEPR Heinrich Ursprung, Universität Konstanz Anthony Venables, London School of Economics and CEPR Alessandra Venturini, Università degli Studi di Bergamo Jeffrey Williamson, Harvard University Rudolf Winter-Ebmer, University of Linz and CEPR Ian Wooton, University of Glasgow and CEPR Klaus F. Zimmermann, Institute for the Study of Labor (IZA)

xvii

1

Trade and migration: an introduction1 R ICCARDO FAI NI , JAI M E DE M E L O A N D K LAU S F. Z I M M E RMANN

International migration is the absentee in the current wave of globalisation, particularly in Europe. Helped by falling communication and transportation costs and by the reduction in policy barriers to commodity and capital flows, trade flows and foreign direct investment (FDI) have increased in the last 20 years at a faster rate than world production. Migration flows, on the other hand, have shown little change during the same period when one excludes the temporary surge following the collapse of the socialist regimes in Eastern Europe. This contrasts sharply with previous integration episodes: in the nineteenth and early parts of this century, but also in the 1960s, international labour mobility played a central role in fostering economic integration. The changing stance towards migration policies goes a long way in explaining these trends. At the turn of the century, the attitude toward immigration used to be quite liberal. Similarly, in the 1960s governments in receiving countries often took an active role in encouraging migration. Nowadays, the policy imperative has become to limit or even to stop any further immigration. In part, this new attitude reflects the fears that immigration may worsen the domestic income distribution by widening the skilled–unskilled wage gap and aggravate unemployment.2 There is little evidence, however, that these concerns are well founded. Nonetheless, recent popular thinking in receiving countries has it that migration is excessive3 and therefore detrimental to the welfare of natives, and that this somehow provides a reason for highly restrictive policies. Clearly, the negative stance toward immigration reflects more than simple economic concerns. Those opposing immigration fear that it may exacerbate social tensions and blur national identities in host countries as well as aggravate domestic economic problems. Pressures to tighten immigration laws have been quite strong, particularly in Europe. However, immigration policies remain a highly divisive issue in many receiving countries. Attempts to tighten such policies have typically led to bitter conflicts among domestic constituencies. They also 1

2

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irritate relationships with sending countries that rely on emigration to alleviate structural imbalances in their labour markets and earn valuable foreign exchange through workers’ remittances. Finally, and perhaps more crucially, immigration controls have so far proved to be quite ineffective in stemming undesired population inflows. Are there more palatable alternatives for migration policies ? If trying to control the symptoms does not work, treating the problem directly by promoting equitable and sustained growth in origin countries might be more effective. Trade integration seems a particularly commendable strategy to alleviate migration pressure, for at least two reasons. First, trading goods represents a way to exchange the services of the factors embodied in those goods. To the extent that barriers to trade are eliminated and commodity trade increases, the exchange of factor services will also increase and therefore the incentive for factors to move should diminish, in which case, as shown by Mundell (1957), trade in goods and the international mobility of factors are ‘substitutes’. Second, deeper trade integration is often advocated as a means to achieve faster convergence between countries with different income levels. The EU experience, where poorer regions have been rapidly catching up with relatively better-off regions, is often cited as evidence (BenDavid, 1993). US and, to a lesser extent, EU policy-makers seem to be convinced by these arguments and have negotiated integration agreements with their relatively poorer neighbours. Yet, both theoretical and empirical evidence on the effectiveness of trade integration is far from being conclusive. In sum, the debate on immigration is still occupying centre stage, and is the subject of much research. This volume hopes to shed new light on this debate by bringing together studies that investigate the link between trade and factor mobility, particularly labour migration, both from theoretical and empirical points of view. In this Introduction, we highlight the main issues and controversies, describing the new evidence brought by the chapters in the volume. Section 1 gives evidence on the importance of international migration. Section 2 briefly introduces the debate and surrounding controversies indicating in passing the dimensions that go beyond the trade–migration link. The remaining sections introduce the contributions in the volume. Section 3 discusses theoretical contributions on the links between trade and migration, while section 4 indicates attempts to model these links and section 5 discusses the evidence from historical and contemporary episodes. Section 6 draws some conclusions for policy implications. 1

Trade and migration : the main trends

Trade flows have increased at a systematically faster rate than production during most of the post-war era. For example, during the 1980s, world trade

Trade and migration

3

Table 1.1. Foreign population, early 1980s and early 1990s (per cent of total population)

Belgium France Germany Italy UK USA Canada

Early 1980s

Early 1990s

29.0 26.8 27.4 20.7 22.8 26.2 16.1

29.1 26.3 28.5 21.7 23.5 27.9 16.1

Source: SOPEMI (1995).

increased at 4.1 per cent per annum while output grew at 3.1 per cent. This pattern has been even stronger in the 1990s with trade growing at 9.2 per cent in 1994–5 and output at 2.9 per cent. Growth in FDI was even stronger. According to UNCTAD, FDI growth between 1981 and 1993 was almost double that of exports. Multinational corporations now account for twothirds of world trade. This expansion in trade and foreign investment largely reflects an increasingly liberal trade regime brought about by the successful negotiations of the Uruguay Round that achieved significant tariff reductions, particularly in those countries where tariffs were initially high (Finger et al., 1996). More importantly it extended the rules of GATT and of the WTO to hitherto exempted or excluded sectors such as textiles, agriculture and services. Similarly, the policy climate for foreign investment has become steadily more liberal. An UNCTAD survey of some 60 countries shows that out of 212 legislative changes during 1993–4, 209 went in the direction of a more liberal FDI framework (UNCTAD, 1995). International labour flows, however, have not followed suit. Consider table 1.1 that provides data for the 1980s. The share of foreigners in the population barely changed during the decade in most European countries and Canada, though it registered a significant increase in the USA. This is not because the propensity to migrate has declined. Quite the opposite: income and wage differentials between rich and poor countries have, if anything, increased during the period. Moreover, falling communication and transportation costs mean that residents in sending countries are increasingly well informed about economic conditions in receiving countries and can afford more easily than in the past the cost of migrating.

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Riccardo Faini et al.

Table 1.2. Intercontinental migration, 1871–1913 a European emigration (per cent of home-country population)

Austria-Hungary British Isles Germany Ireland Italy Spain

1871–80

1901–10

1913

0.03 0.50 0.15 0.67 0.11 0.36

0.48 0.65 0.05 0.70 1.08 0.57

0.61 1.04 0.04 0.68 1.63 1.05

b Immigration from Europe (per cent of the host country population)

USA Canada Argentina

1871–80

1901–10

1913

0.55 0.55 1.17

1.02 1.68 2.92

1.22 3.84 3.83

Source: Ferenczi and Willcox (1934).

The secular fall in mobility costs highlights the contrast between contemporary migration trends and the events at the turn of the century. We know that both trade and capital flows were instrumental in boosting integration among national economies in the late nineteenth century (Krugman, 1995; Sachs and Warner, 1995). Between 1870 and 1913, export flows increased at an average annual rate of more than 4 per cent, whereas the rate of growth of GDP stood ‘only’ at 2.6 per cent. Unsurprisingly, in 1913 exports accounted for a substantially larger share of GDP than in 1870 (Krugman, 1995). The pattern is not very different from what we observe today. However, the growth in trade was then accompanied by a surge in migration flows. Table 1.2a shows that between 1871 and 1880 and 1901 and 1910 the population share of emigration rose in many sending countries. The increase was particularly pronounced in the ‘new’ emigration countries, such as Italy, where the population share of emigrants soared from 0.1 per cent to 1.6 per cent, and in Spain. The pervasive role of migration is even more apparent if we focus on host countries. Between 1871 and 1880, average annual immigration was equal to 0.5 per cent of the domestic population in both the USA and Canada and to slightly more than 1 per cent in Argentina. 30 years later, these figures had doubled or even trebled. At its peak in 1913, immigration was equal to 3.8 per cent of Argentina’s and Canada’s population, and 1.2 per cent of the USA’s (table 1.2b).

Trade and migration

5

Table 1.3. European integration and migration, 1960 and 1970 a Intra-European trade (per cent of imports originating in EC-6)

Belgium France Germany Italy Netherlands

1960

1970

51 32 31 29 49

59 49 44 41 56

b Foreign workers (per cent of labour force)

Belgium France Germany Italy Netherlands

1960

1970

25 26 22 — 21

27 28 26 — 23

Source: Molle (1990).

We find a similar picture when we focus on the more recent integration episode in Europe during the 1960s, during which the share of intra-EC trade for the EC-6 rose rapidly (table 1.3a). This growth in intra-EC trade was accompanied by rising migration (table 1.3b). Between 1956 and 1973 more than 11 million people migrated internationally, mostly from Southern to Northern Europe. The share of foreign workers in the labour force increased substantially from 2 per cent in 1960 to 6 per cent in 1970 in Germany, from 6 per cent to 8 per cent in France and from 5 per cent to 7 per cent in Belgium. In sum, the contrast between table 1.1 on the one hand, and tables 1.2 and 1.3 on the other is clear: whereas increased trade integration at the turn of the century and in the 1960s was accompanied by increased migration, this was not so during the increased trade integration of the 1980s. 2

The controversies

It is widely recognised that the limited role of international labour mobility largely reflects the policy stance of governments in receiving countries. Left to market forces, thanks to cheaper transportation and improved

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information on living conditions abroad, international migration would have most probably registered a massive increase. As mentioned above, the policy stance toward migration in receiving countries has undergone a radical change beginning in the mid-1970s. Whereas in the 1950s and 1960s, governments in Northern Europe sought to encourage immigration and were actively recruiting workers from Southern Europe and Northern Africa, nowadays in most receiving countries the policy imperative has become to halt any further immigration. Policy choices are, of course, not made in a vacuum. The changing stance of policy-makers in receiving countries largely reflects the attitudes of voters there, in particular the belief that immigration may aggravate unemployment and wage conditions of unskilled workers in Europe and the USA. This is a hotly debated issue in the press on both sides of the Atlantic. However, evidence for the USA (Friedberg and Hunt, 1995) and for Europe (Zimmermann, 1995) concludes that immigration has played virtually no role in explaining the worsening labour market conditions of unskilled workers. Yet, voters appear to be undaunted by this evidence and hold an altogether different opinion on these matters. Other elements need to be brought in to understand voters’ attitudes and policy choices. This contrast between voters’ attitudes and evidence of immigration is all the more pronounced once one recognises that a more complete evaluation of immigration in receiving countries should extend beyond the (short-run) impact on the labour market. In particular, immigration will have long-run effects on the demographic structure, and hence on the social security system in the host country. Under the ‘pay-as-you-go’ social security systems with contributions pegged to wage income prevailing in most receiving countries, immigration may indeed yield a further benefit by slowing population ageing, alleviating the dependency burden and allowing a reduction in social security contributions, with a favourable impact on net wages of natives (see Hillman and Weiss, chapter 4 in this volume). However, demographic projections indicate that immigration needs to increase to unprecedented levels to make a dent in the social security problems of receiving countries (Stalker, 1994). The contrast between the predictions of standard economic theorising and the evidence on the one hand and citizen attitudes on the other is controversial and puzzling. At a theoretical level, utilitarianism cannot justify restrictive immigration quotas. Other elements must be taken into account. An obvious extension to the standard utility-maximisation framework is to recognise that voters’ welfare includes other arguments than income (e.g. social capital or ‘cultural cohesiveness’ provided by a relatively homogeneous population, as recognised by Schiff, 1997, for example). Then immigration in receiving countries can be welfare-reducing owing to the disutility

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from ‘excessive’ immigration, and likewise for sending countries. It is also possible that immigration affects the consumption of public goods. It is conceivable that natives perceive that immigrants have relatively intensive consumption patterns of public goods like education, and lower their quality of life. How to reduce immigration in receiving countries is also controversial. In the post-1974 period, governments tended to rely mostly on border and population controls (Collinson, 1993). Yet, as shown by the sequence of immigration regularisation programmes, invariably implemented together with the promise to apply tight immigration limits, controls on population flows are largely ineffective. Porous borders, the reluctance to impose stifling domestic controls in a democratic society and the pull effect of labour demand from labour-intensive sectors in receiving countries have combined to undermine the effectiveness of direct controls and have resulted in a steady flow of immigration. Alternative indirect approaches to limiting migration have been sought. These have revolved around the alternative ways policies can affect the trade links between sending and receiving countries. One approach has focused on encouraging capital flows and directing aid toward emigration countries (Lucas, 1995, ILO–UNCHR, 1992). However, (private) capital flows towards sending countries cannot be easily influenced by policy. Moreover, there is little evidence that even unrestricted capital mobility may result in falling migration. Lucas’ (1990) computations suggest that substantial wage differentials across countries are compatible with free capital mobility. Similarly, aid flows are probably too small to affect the economies in most emigration countries (Albania may be an exception). Moreover, targeting aid toward sending countries, most of which are in the middle-income range, may conflict with the ultimate motivations of aid policy. Under these circumstances, trade policy may represent a more effective strategy to deal with migratory pressures. It holds some clear advantages. First, and most obviously, trade policy is to a large extent under the control of policy-makers. It is largely recognised that both the USA and the EU have concluded regional integration agreements (RIAs) with their relatively poorer neighbours to stem migratory pressures. The NAFTA treaty in particular was explicitly targeted, at least by Mexican officials, at reducing migratory pressure. In former President Salinas’ words: ‘Mexico wants to export goods, not people.’ Similarly, the EU’s activism in concluding trade agreements both with Northern African and Eastern European countries is typically attributed to the desire of limiting migration. Second, but more controversial, are the effects of trade liberalisation: the increases in efficiency should decrease migratory pressures, both in sending and in receiving countries. In sending countries, higher incomes should lower

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outward migratory pressures, especially if unskilled-labour-intensive industries are the main beneficiaries. In receiving countries, trade liberalisation should reduce the demand for unskilled labour, thereby reducing the demand-pull effect on migrants. The effectiveness of trade liberalisation as a way to alleviate migration pressure is not, however, unquestioned. First, theory does not provide an unambiguous answer on the link between trade and migration. Second, as mentioned earlier, historical evidence seems to suggest that periods of greater trade integration were also characterised by large population flows. From these episodes, however, we cannot infer what would have happened to migration in the absence of the drive toward greater trade integration. In the nineteenth century, in particular, trade and mobility costs fell sharply. Similarly, in the 1960s, governments in host countries were actively promoting both trade and labour immigration. It is not surprising then to find that in both episodes trade and migration flows moved in the same direction and showed a concomitant increase. But this does not mean that trade liberalisation by itself provided a boost to migration. This example illustrates the difficulties of inferring the link between trade and migration from sheer observations of the data. Empirical evidence must be accompanied by theory to help identify the main factors at work in shaping the relationship between trade and factor mobility. 3

Insights from theory

In the Heckscher–Ohlin (HO) model, commodity trade arises because nations have different factor endowments. If factor mobility leads to a reduction in such differences it will undermine the basis for trade. In this setup, therefore, trade and factor movements are substitutes. In the standard model with two factors, two goods and two diversified countries with perfect competition and identical technologies shared by both countries, if labour migrates from the labour-abundant country, the production of the exportable good will fall and the output of the importable sector will increase along traditional Rybczynski lines. On both counts, trade will decline. Similarly, in the labour-scarce country, the migration of labour will boost production of the labour-intensive importable good and lead to a decline in the output of the exportable good, and hence to a reduction in trade. It is therefore clear that trade liberalisation should reduce incentives to migrate. Adding internationally mobile capital need not change the basic predictions of the HO model. Consider indeed a simple set-up with three factors – capital, skilled and unskilled labour. Suppose that capital is fully mobile, but skilled and unskilled labour migrations are restricted. Then, trade liberalisation in skill-abundant countries will reduce the incentive for unskilled-labour

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immigration. Once again, therefore, commodity trade and labour mobility are substitutes. Yet, this HO prediction is not shared by all trade models, even those where trade is based on differences in factor endowments. As the contributions by Venables and by Markusen and Zahniser (chapters 2 and 10 in this volume) show, the link between trade and migration can be complex. Rather than summarising these two contributions, consider the following approaches that yield results opposite to the simple HO model outlined above. (1) Modified HO models – With more than two factors, the impact of trade liberalisation on the incentive for factor mobility is generally ambiguous. Even with two factors, though, trade liberalisation may not lead to a convergence in factor prices, unless we rule out the possibility of factor-intensity reversal. Otherwise, with the countries having opposite factor-intensity ranking of the two goods, convergence in commodity prices brought by trade liberalisation will lead relative factor prices to move in the same direction in both countries. Lower barriers to goods trade could as a result cause factor prices to diverge and would therefore enhance the incentive for factors to move. (2) Ricardian models – Suppose that countries have the same endowment but different technologies. Suppose furthermore that the ‘rich’ country has a more productive technology in the labour-intensive sector. It will then export the labour-intensive good and, in the absence of factor mobility, will enjoy a higher wage. If barriers to factor mobility are eliminated, labour will migrate from the ‘poor’ to the ‘rich’ country. The increase in the labour–capital ratio will, again through standard Rybczynski effects, strengthen the specialisation of the rich country in the labour-intensive sector and lead to more trade, opposite to the HO prediction. (3) Specific-factors models – In this set-up, some factors (say, labour) are fully mobile across sectors, while other factors (say, land or capital) are tied to a given sector. By lowering the price of the importable good, trade liberalisation will depress the demand for labour (i.e. the mobile factor) in the import sector and lower both the nominal wage and the real wage in terms of the exportable good (whose price is unchanged). Real wages will, however, increase if expressed in terms of the importable good. Whether real wages as a whole increase or not will then depend on the weight of importable goods in the consumption basket. The effect of trade liberalisation on the incentive to migrate cannot therefore be determined a priori. (4) Financial-constraint models – Consider a simple case where labour migration entails a monetary cost. With imperfect capital markets,

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some would-be migrants may be financially constrained and therefore unable to migrate to the desired destination. Suppose now that trade liberalisation in the labour-abundant sending country raises the wage there, along traditional HO lines. This will relax the financial constraint on would-be migrants and may, somewhat paradoxically, increase migration (Lopez and Schiff, 1995). In a related paper, Schiff (1997) shows that migration costs are often substantial and may therefore impose a severe constraint on would-be migrants. The strength of this argument is boosted by the observation that, for some (low-)income ranges, migration is an increasing function of the wage in the origin country (Banerjee and Kanbur, 1981; Faini and Venturini, 1993). (5) ‘New’ trade theory – With increasing returns and monopolistic competition, the reduction in trade costs will not generally lead to factor price convergence. Consider, for instance, a standard model in the ‘new’ trade theory with one factor (say, labour), one constant-returns-to-scale sector producing a homogeneous good and one increasing-returns-toscale sector producing a set of differentiated goods. In the pre-trade equilibrium, the wage in each country is pinned down by the assumption of constant returns to scale in the homogeneous good sector. Wages in the two countries are therefore equal. When trade opens, however, it is entirely possible that one country will specialise in the increasing-returns-to-scale sector. Wages may therefore diverge and labour will have an incentive to move. Which type of model is relevant will, of course, depend on the characteristics of the economies that are integrating. For example, based on the contributions in this volume, one could argue that HO-based models might be the most relevant approximation to study the factor-movement incentives of NAFTA, and monopolistic competition models to study regional integration in Europe. It is hard to isolate the driving forces in each model because they are typically drawn along several dimensions. It is the contribution of Venables’ lucid survey in chapter 2 to show how trade liberalisation affects the incentives for factor mobility in a unified framework for all the type of models described above (except Ricardian models and factorendowment models that emphasise financial constraints to migration). Venables’ technique is to consider a two-country world in which countries differ only in their endowments of each of two factors with (exogenous) impediments to factor and goods trade. He then studies how, starting from an initial equilibrium with no incentives for further factor mobility, goods-trade liberalisation affects the incentives for factor mobility. Rather than generating new results, his contribution is to show the rich set of outcomes for substitutability/complementarity relations among

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factors of production in the most widely used trade models: HO, specificfactors and monopolistic competition. A somewhat different, but related, issue is whether trade liberalisation will foster convergence among regions or instead will increase the attractiveness of the relatively rich areas. With positive transport costs and (localised) increasing returns to scale, two opposite forces determine the location of economic activity. First, there is an incentive to concentrate production in only one region to exploit scale economies. However, the concentration of production in one region would push up wages there and would also imply higher transportation costs to meet the demand in the backward region. A reduction in trade costs could make it easier for firms to serve consumers located in the relatively poor region while producing in the rich region. Moreover, this would not be the end of the story, given that the greater attractiveness of the richer region would prompt workers to migrate there. Migration, in turn, will increase the market size of the more prosperous region and induce more firms to move there. This cumulative causation process was analysed by Krugman (1991) and is clearly relevant to assess the relationship between trade liberalisation and migration. The issue of the agglomerative forces of integration is raised by Venables and is also picked up by Ludema and Wooton in chapter 3. They develop a more realistic set-up where potential migrants are only partially mobile (not, as in Krugman, fully mobile) because of natural barriers such as the preference for the home country or differences in language and culture. In this set-up, a reduction in trade costs resulting from integration is less likely to lead to a polarised outcome. Ludema and Wooton show the intriguing possibility that, for sufficiently mobile labour, progressive integration may initially lead to agglomeration, then again to diversification as trade costs are lowered further. This leads them to suggest a sequence of integration policies to avoid temporary dislocations of labour: a restriction on labour movements during the initial phases of trade liberalisation, with barriers to labour mobility removed once free trade in manufactures has been established. If the link between trade and migration can be complex, it still remains that there is a fundamental asymmetry in the policies adopted in receiving countries: liberal policies in trade and capital exports, both of which disadvantage low human-capital residents and strict policies against immigration. This puzzling asymmetry is the point of departure of the political-economy perspective taken by Hillman and Weiss in chapter 4. In this setting, labour is not apersonal and cultural preferences (a public good) matter in policy choices. Can then jurisdictions with voluntariness of locational choice replicate the efficiency of the market in the provision of this public good? Unfortunately not, because typically immigration policies are

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not based on discriminatory pricing and people who are willing to pay to belong to a jurisdiction are excluded. Hillman and Weiss also review political-economy models of immigration policy that seek to explain why inefficient immigration policies are adopted. For example, in a median-voter framework, it can be shown that the median voter could simultaneously choose to ban immigration but that she may at the same time support tacitly selective illegal migration in selected industries because she would benefit from immigrants’ presence. In their words: ‘the “illegality” of illegal immigrants has the effect of transforming immigrants from mobile factors of production who would compete in domestic labour markets with the median voter, to sector-specific factors of production whose presence is beneficial.’ They also show how a public-policy perspective can help explain differences in immigration policies across countries. Trade liberalisation may have other non-conventional effects, once one includes the effects of migration on the allocation of benefits coming from a public good. Gatsios, Hatzipanayotou and Michael in chapter 5 consider a simple trade-theoretic model of a small economy where factor incomes are taxed at a fixed rate and the tax revenue is used to purchase a publicconsumption good. They argue that the fall in trade barriers may influence the provision of public goods through both income and induced migration effects. First, any change in trade policy should affect income, leading therefore to a change in tax revenues and in the provision of public goods. Second, trade policy will also have an impact on factor prices and thereby on migration and aggregate income. Finally, the unit cost of the public good may also be affected, depending on the relative labour intensity of the importable good and on the impact of (relative) prices and labour endowment changes on the cost of producing the public good. There is also a further channel of interest (that the authors, however, do not consider) where migration itself may depend on the availability of public goods. This is clearly an interesting avenue for further research. 4

Quantifying the links between trade and migration

The ambiguities of theoretical predictions highlight the need for both modelling (which models conform to the data and how sensitive model predictions are to model choice or model closure), and for evidence (from current and historical episodes). Such a two-pronged approach is needed because we are far from being able to give direct evidence that the data support one model over another. And even if we were able to choose confidently one model over alternatives, not all relevant models could be tested. Furthermore, one would still be left with the possibility that the evidence is

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circumstantial, and therefore not relevant for other episodes. The contributions in Part Two represent efforts to fit structural models that correspond closely to the theoretical models discussed in Part One whereas the contributions in Part Three rely on historical episodes (the nineteenth century, the recent wave of regional integration agreements – NAFTA and Eastern Europe) and use reduced-form methods that are often distant from the models they purport to represent. The two approaches are clearly complementary4 Kohli in chapter 6 studies the impact of immigration on the receiving country. Rather than relying on a reduced-form approach, Kohli takes the GNP function approach, where the value of national output is maximised for given output prices and factor endowments. His model has four inputs: imports, capital, non-resident labour and resident labour – where resident labour and capital are the two factors with endogenously determined prices. His approach is well rooted in trade theory, since it corresponds to the standard specification of the price-taking economy. Although he does not specify a full general equilibrium model, the supply side is complete, which allows him to specify precisely the sense in which inputs and output are substitutes or complements. And by specifying flexible functional forms, Kohli is able to let the data decide on the nature of the trade–migration link without imposing too much structure on his estimates (beyond the assumption that perfect competition prevails in factor and product markets). Kohli’s estimates are for Switzerland over the period 1950–86, where non-resident labour made up to a quarter of the labour supply. He finds that trade and labour mobility are complements both in the Allen–Uzawa sense (i.e. for given input prices) and in the Hicksian sense (i.e. for given quantities). He estimates that an increase in the supply of non-resident workers depresses only slightly the wages of resident workers (a 1 per cent increase in non-resident workers reduces the wage of resident workers by 0.1 per cent), confirming the findings of small effects of migration on wages estimated in other settings. Chapters 7 and 8 use computable general equilibrium models to simulate respectively the effects of exogenous immigration in receiving countries and the effects of alternative policy packages to stem the supply of migrants in sending countries. Both are calibrated models though they differ in their treatment of the labour market and the household-maximisation decision. Müller in chapter 7 studies the impact of immigration in an efficiencywage model of a dual labour market in which immigrants work only in the secondary sector while natives are employed in both sectors. Hence there is discrimination against immigrants of the type ‘equal pay for equal work, but unequal work’. His estimates are also for Switzerland. Besides proposing a labour market specification applicable in some other European

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countries, Müller’s approach allows him to illustrate the trade-off for natives of an increase in immigration. Whereas in the standard labour market specification, an increase in immigration has a very small impact on the welfare of natives, this is not so with a dual labour market when discrimination confines immigrants to the secondary labour market (this case corresponds to the ‘guest-worker’ system often used in Europe). The reasoning is simple. Initially, primary-sector wages are kept high to induce workers there not to shirk. Indeed, if caught shirking, primary-sector workers are fired and are forced to take employment in the (low-wage) secondary sector. Consider now the impact of immigration. By assumption, immigrants are confined to the secondary sector, leading to a fall of wages there. The decline in secondary-sector wages in turn increases the punishment for shirking in the primary sector. Firms can therefore pay lower wages in the primary sector and employment expands, with a first-order effect on welfare. Müller’s simulations show that, under this dual labour market specification, the welfare benefits for natives of a given immigration is four times larger than in the standard perfectly competitive labour market model. Of course, the improvement in natives’ welfare comes at the cost of increased inequality among natives. He also shows that protection (defined to yield the same pattern of sectoral output levels as under immigration) would be preferred by natives in terms of social welfare (here defined by Atkinson’s social welfare function) to immigration in the absence of labour market segmentation in spite of small efficiency losses. On the other hand, with a dual labour market, protection is detrimental for efficiency as secondary-sector jobs are concentrated in the protected industries. Indeed, protection would raise secondary-sector wages and crowd out primary-sector employment. Müller then explores the degree of inequality-aversion necessary for a welfare-maximising government to choose a no-immigration policy under different closure rules for the labour market. He also examines the fear of ‘over-foreignisation’ coming from the perceived failure of the policy of rotation aiming at promoting return migration. In that case, immigrants become permanent residents and the government cannot be indifferent to their welfare. Then one should no longer discriminate against immigrants (as the Swiss government did in 1970 when it improved the legal status of immigrants), and Müller computes a welfare estimate of the welfare gain of removing the operation of the guest-worker system for the population of immigrants in Switzerland in 1985. Though this was not his focus, his results can help explain the change in attitude towards immigration. Faini, Grether and de Melo in chapter 8 use a standard Ricardo–Viner (RV) model (similar in structure to the model used by Müller except for the labour market specification) to study the migration decision in sending

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countries. In their model, the focus is on household decisions. They assume four household categories, each facing a labour supply and migration decision. (Because of the assumption of household heterogeneity, migration is only partial.) This model is then applied to two archetype economies corresponding to the case of a middle-income and of a low-income economy, respectively. The two archetypes differ because of the different weights of agricultural production, the skill composition of their labour force and their pattern of comparative advantage. The authors confront two strategies aimed at reducing migratory pressure: unilateral trade liberalisation (in the North and the South) versus direct measures (increased transfers to the South or increased migration costs) under different model closures (permanent versus non-permanent migration, presence or absence of financial constraints to migration for certain groups, etc.). In this setting, trade liberalisation is bound to elicit a different migratory response in the two archetype economies and it will be sensitive to model closure. For example, in the middle-income economy, the reduction in import barriers is accompanied by a strong export response and, as a result, leads to an appreciation of the real exchange rate which in turn raises the domestic real wage and lowers the incentive to migrate. Conversely, in the low-income country trade liberalisation elicits a relatively weaker export response and brings therefore a depreciation of the real exchange rate. The incentive for migration increases. Overall, the simulation results suggest that if policy-makers want to alleviate migration pressure they should liberalise trade with middle-income rather than with low-income countries. Interestingly enough, this is exactly what the existing North–South regional integration agreements seem to be doing. 5

Historical and contemporary evidence

If structural econometric estimates and simulation studies provide the needed parameter estimates and a feel for orders of magnitude, they are still conditioned on model choice, and perhaps do not sufficiently confront the data, at least in the eyes of the sceptics. Carefully chosen historical episodes over a long time span and contemporary case studies of clearly defined policy episodes provide a useful complement to the modelling approach. In other words, the contributions in Part Three ‘let the data speak’. Collins, O’ Rourke and Williamson in chapter 9 take a close look at the historical evidence on the link between trade and migration. They argue that the direction of this relationship may well depend on the historical period under analysis. Consider, for instance, the New World situation in the nineteenth century, where an ‘open frontier’ meant that new land could be easily brought under cultivation. In this context, a fall in trade costs will

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increase the demand for the land-intensive goods in the New World and lead to a frontier extension whose exploitation would most probably require more capital. In this set-up, therefore, trade and capital mobility may be complements. As reasonable as this argument sounds, the authors fail to find much empirical support for it: when they regress total trade on the absolute values of capital and migration flows, they find that the former variable has a positive coefficient (which they interpret as denoting complementarity) mainly in the post-frontier period in 1919–36. Overall, the authors find little indication that capital and migration may have acted as substitutes for trade. The authors, however, are careful to point that they ‘are only exploring correlations’. Even a positive association between, say, trade and migration may mean only that both benefited from the fall in transatlantic transportation costs. Markusen and Zahniser in chapter 10 look for reasons why the trade and investment liberalisation under NAFTA might not lead to the convergence in unskilled wages in the two countries that would be predicted by the HO model. Though it is too early to detect the effects of NAFTA, much of the liberalisation that had to be carried out by Mexico had already occurred during the 1984–94 period during which the wage gap between skilled and unskilled increased in all regions, particularly in the North where liberalisation had the largest impact. A widening gap also occurred in manufacturing. Three different types of models (two of which are rooted in familiar factor-proportions theory) consistent with the stylised facts of the technology in manufacturing in the USA and Mexico are found to be consistent with a widening gap following trade and investment liberalisation. In one model, goods are ranked by skill intensity. Investment liberalisation leads to a shift of investment towards Mexico. However, those goods whose production is shifted from the USA to Mexico are the least skill-intensive from the US point of view, but the most skill-intensive from Mexico’s standpoint. The demand for skills therefore increases in both Mexico and the USA. Similar HO reasoning also works towards explaining why the reduction of protection in the production of labour-intensive maize in Mexico (but very capital-intensive in the USA) can lead to a rise in the wage–rental ratio in both countries, because from each country’s point of view the price of the capital-intensive good has risen. It is clear from these two examples that only few modifications would need to be brought to the standard HO model to produce different results. Finally, Winter-Ebmer and Zimmermann in chapter 11 focus on East–West migration and trade. One major concern in some EU countries stems from the potential labour market effects of integration and enlargement to the East. Opening markets will encourage factor flows and trade,

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and hence very probably cause adjustments in wages and employment opportunities. Given the ever-rising unemployment rates, and the relative decline of unskilled wages in Western Europe, the Eastern enlargement is seen as a threat to native labour markets. Because of geography and historical ties, Austria and Germany have already received disproportionally more immigrants and stronger increases of trade flows than other countries. It has to be expected that this trend will continue in any process of economic integration in the East. Hence, the Austro-German situation is an interesting case study. The authors first provide an extensive survey of the previous empirical literature on the labour market in Austria and Germany. This is important, since a large part of the European literature deals with the situation in those two countries. Here the findings at large are that neither immigration nor trade had a relevant harming effect on employment and wages. They then provide new econometric evidence on the issue. Using industry-panel data for both countries, they employ a reduced-form approach to examine the effects of trade and immigration (from the East and elsewhere) on total and native employment, and wages. The Austrian findings suggest that immigration has a negative impact on native employment and wages, and no effect on total employment. Imports affect employment negatively and exports have a positive effect on wages. The German results indicate that immigration and trade is not harming employment and wages. Natives seem to be complements to migrants, at least to those from East Europe. Trade does not affect wages at all, and hardly affects employment. These results are in line with other recent studies for both Austria and Germany. 6

Conclusions and policy implications

Theory tells us that factor movements and commodity trade are jointly determined by technology and tastes, pointing out where to look for the factors that determine the link between trade and factor mobility. We also know that new trade models often predict that trade and migration are complements, and economic-geography models point out that integration may lead to an agglomeration of economic activity. Yet, as Sapir notices in his discussion of Venables’ chapter 2, the applicability of increasing returns models to North–South trade may be limited. This does not imply, however, as shown by Markusen and Zahniser, that we should rely exclusively on standard HO theory. Moreover, financial and institutional constraints may reverse the direction of the trade–migration link. In sum, both the theoretical and empirical contributions in this volume suggest that trade liberalisation will not always alleviate the incentives for factor mobility.

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Overall, the chapters in this volume suggest several observations. First, initial conditions matter. Trade liberalisation of high-income countries with middle-income countries is more likely to foster convergence and discourage migration, though liberalisation in investment flows could alter this outcome. By the same token, integration of goods markets between economies with very different initial conditions could lead to opposite outcomes. This is because the fall in trade costs would lead to more polarisation and more migration, in part because of the relaxation of financial constraints on migration costs. There are therefore good reasons to be relatively optimistic about the migration outlook from Eastern Europe to Western Europe following the Europe Agreements. These are middleincome countries, demographic conditions are stable and, provided that the transition to a market economy is successful, massive migrations should not constitute a significant threat. Second, short-run effects may be important, even when integration is between countries that are not at the extremes, as in the case of Mexico and the USA. For instance, it would appear that NAFTA encouraged migration, at least in agriculture in the short run. Disruption of Mexico’s maize production to the benefit of its counterpart in the USA has put downward pressure on unskilled wages on both sides of the border as this highly protected sector in Mexico is a very labour-intensive activity in Mexico and a very capital-intensive one in the USA. This may be a special case, but it serves to point out that even if technology is available to all off the shelf, the same technologies are not always profitable everywhere at the same time. In the longer run, though, improved conditions in the Mexican economy would still stem migratory pressures. The policy message is therefore clear. Trade liberalisation and migration controls are not alternative policy strategies as suggested by a straightforward application of trade theory. They work with differing effectiveness over different time horizons. Migration controls are likely to be somewhat more effective in the short run and, in any case, remain the main tool to avoid massive, and largely undesired, immigration in receiving countries. But, if their objective is to stem migratory pressures, policy-makers’ reliance on migration controls in the short run should not dispense them from searching for more forward-looking strategies to alleviate migration pressure in the medium run. Despite theoretical ambiguities and policy disputes, the evidence continues to point towards benefits from trade liberalisation. NOTES 1 We thank Jean-Marie Grether and Sanoussi Bilal for comments. Financial support to Jaime de Melo by FNRS no. 12-42011.94, to Riccardo Faini by Consiglio Nazionale delle Ricerche and to Klaus F. Zimmermann by the EU

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HCM Programme through the research network ‘European Migration: From Economic Analysis to Policy Response (no. ERBCHRXCT940515) is gratefully acknowledged. 2 Clearly, there are strong analogies between these concerns about the impact of immigration and the controversy surrounding the effects of globalisation and trade integration on the labour market outcome in OECD countries. 3 A poll conducted on the behalf of the European Commission shows that a significant majority of those interviewed believe that ‘immigrants are too many’. This is particularly true in the largest four European countries, with 54.7 per cent of Frenchmen, 56.7 per cent of Germans, 51.3 per cent of Britons and – somewhat surprisingly, given the very low population share of foreigners – 64 per cent of Italians believing the number of migrants to be excessive. 4 Econometric evidence from reduced-form models produces correlations while simulation results from structural models usually correspond closely to the general equilibrium models of trade theory, but they can capture only the effects incorporated in the model, and when calibrated to real-world data, the fit is only for an arbitrarily chosen base period.

REFERENCES Banerjee, B. and S.M. Kanbur (1981). ‘On the Specification and Estimation of Macro Rural–Urban Migration Functions: With an Application to Indian Data’, Oxford Bulletin of Economics and Statistics, 43, 7–29 Ben-David, D. (1993). ‘Equalizing Exchange: Trade Liberalization and Income Convergence’, Quarterly Journal of Economics, 108, 653–79 Borjas, G. (1995). ‘The Economic Benefits of Immigration’, Journal of Economic Perspectives, 9, 3–22 Collinson, S. (1993). Europe and International Migration (London: Pinter) Faini, R. and A. Venturini (1993). ‘Trade, Aid and Migration: Some Basic Policy Issues’, European Economic Review, 37, 435–42 Ferenczi, I. and W. Willcox (1934). International Migrations (Geneva: United Nations) Finger, M., M. Ingco and U. Reincke (1996). The Uruguay Round. Statistics on Tariff Concessions Given and Received (Washington, DC: World Bank) Friedberg, R. and J. Hunt (1995). ‘The Impact of Immigration on Host Country Wages, Employment and Growth’, Journal of Economic Perspectives, 9, 23–44 ILO–UNCHR (1992). ‘Informal Summary Record: Joint ILO–UNCHR Meeting on International Aid as a Mean to Reduce the Need for Emigration’ (Geneva: ILO) Krugman, P. (1991). Geography and Trade (Cambridge, MA: MIT Press) (1995). ‘Growing World Trade: Causes and Consequences’, Brookings Papers on Economic Activity, 1, 327–62 Lopez, R. and M. Schiff (1995). ‘Migration and Skill Composition of the Labor Force: The Impact of Trade Liberalization in LDCs’, PRWP, 1493 (Washington, DC: World Bank) Lucas, R. E. Jr. (1990). ‘Why Doesn’t Capital Flow from Rich to Poor Countries ?’, American Economic Review Papers and Proceedings, 80, 92–6

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Lucas, R. E. B. (1995). ‘International Trade, Capital Flows and Migration: Economic Policies Toward Countries of Origin as a Means of Stemming Migration’, Boston University, mimeo Molle W. (1990).The Economics of European Integration (Aldershot: Darmouth) Mundell, R. (1957). ‘International Trade and Factor Mobility’, American Economic Review, 47, 321–35 Ruffin, R. (1984). ‘International Factor Movements’, in P. Kenen and R. Jones (eds.), Handbook of International Economics (Amsterdam: North-Holland) Sachs, J. and A. Warner (1995). ‘Economic Reform and the Process of Global Integration’, Brookings Papers on Economic Activity, 1, 1–95 Schiff, M. (1997). ‘Migrations et échanges: Aspects normatifs et positifs’, in J. de Melo and P. Guillaumont (eds.), Commerce Nord–Sud, Migration et Délocalisation (Paris: Economica) Siebert, H. (ed.) (1994). Migration: A Challenge for Europe (Tübingen: Mohr) SOPEMI (1995), Tendances des Migrations Internationales (Paris: OECD) Stalker, P. (1994). The Work of Strangers: A Survey of International Labour Migration (Geneva: International Labour Office) UNCTAD (1995). World Investment Report (Geneva: United Nations) Zimmermann K. (1995). ‘Tackling the European Migration Problem’, Journal of Economic Perspectives, 9, 45–62; reprinted in M. N. Jovanovich (ed.), International Economic Integration. Critical Perspectives of the World Economy (London: Routledge, 1998)

Part One Insights from theory

2

Trade liberalisation and factor mobility: an overview A N THONY J. VE NAB L E S

1

Introduction

A reduction in the cost of one type of international transaction – lower transport costs for goods trade or the liberalisation of a factor flow – generally changes the incentives to make other international transactions. There are many examples of the way in which changing trade barriers may change the incentives for factor mobility, although some of these examples pull in opposite directions. For example, in discussion of EU trade policy towards Eastern Europe it is suggested that making trade in goods easier might reduce the incentives for labour to emigrate (Begg et al., 1992). In the study of migration from Europe to the USA in the late nineteenth century, it is argued that reductions in transport costs for agricultural products increased the incentives for labour migration, both inter-regionally and internationally (Harley, 1978, 1980). In a regional context, it is often suggested that falling transport costs were a trigger for migration to cities, as the costs of feeding the urban population were reduced (Bairoch, 1988). The objective of this chapter is to provide an overview of theory on the relationship between trade liberalisation and factor mobility. What does theory suggest about the way in which reducing the costs of making some transactions changes the incentives to make others? Under what circumstances will goods-trade liberalisation reduce factor flows, and under what circumstances will it increase them? What are the consequences of these factor flows for trade? This chapter addresses these issues in a number of commonly used trade models, each of which illustrates different forces that may be important. We start with perfectly competitive models, in which there are no distortions of any sort. In such models we can be sure that narrowing a goods-price difference between two countries also narrows any difference in the price of the factor used intensively in production of that good.1 But what does it do to differences between the prices of other factors? The answer depends on 23

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the relationship between factors of production in the economies’ technologies, and we illustrate two possibilities. The first is based on the Heckscher–Ohlin (HO) model, in which trade liberalisation does indeed reduce the incentives for mobility of both factors. But moving to the richer set of substitution–complementarity relationships between factors, as occurs in the specific-factors model, we show how trade liberalisation may cause factor mobility, which in turn makes the two economies more dissimilar in their relative endowents, increasing trade flows. We then move on from a perfectly competitive environment to situations with increasing returns to scale, and study two models based on the Helpman–Krugman (1985) model of international monopolistic competition. With increasing returns to scale absolute as well as relative factor endowments become important, and a number of additional forces come into play. First, cost levels in the economy may become a function of country size, and we capture this in a variant of the model in which one of the sectors is used as an input to production. Second, market size becomes an important determinant of the location of production. And, third, the cost of living index also becomes a function of country size. Each of these considerations creates the possibility that factor flows are self-reinforcing, so cumulative causation comes into effect: factor inflows enlarge the economy, increasing the real return to factors and creating further inflows. As we shall see, trade liberalisation in models of this type may create factor mobility, possibly causing agglomeration of activity in one location. In developing these ideas, we provide a generalisation of Krugman’s (1991) ‘core–periphery’ model of economic geography, placing his model in a more standard two-country (or region), two-sector and two-factor trade model. The method of analysis employed in the chapter is as follows. Suppose that economies are identical, except in their shares of the world factor endowment. For a given set of goods trade barriers we map out the factor prices associated with each possible division of the world endowment of factors between the two countries – i.e. we construct a contour map of factor prices over the box diagram representing the division of the world endowment between countries. From this, we can derive factor-price differences between economies. If there are barriers to factor mobility then small factor-price differences will not generate factor flows, but large ones will. We can therefore map out the regions of the endowment box in which there are incentives for movement of different factors, turning the endowment box into a phase diagram. If we start the world economy at an initial long-run equilibrium (that is, given the barriers to goods trade and factor trade, at an endowment point at which the gains from factor movements have been exhausted) and then consider a goods-trade liberalisation, is the

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initial equilibrium allocation of factors between economies still an equilibrium, or are there now incentives for further factor mobility? If so, in what direction, and with what long-run outcome? We answer these questions by seeing how the trade liberalisation alters the phase diagram for factor mobility, and using the diagram to trace the direction of factor movements. It should be emphasised that the models presented in this chapter are not new, and neither are the results. However, the chapter poses a somewhat different question from most of the preceding literature. Existing literature on the relationship between goods and factor trade asks whether the two are substitutes or complements. Probably the best known paper in this literature is Markusen (1983), who assumes that economies have identical endowments but – for a variety of reasons – have different factor prices. Starting from a situation where factor mobility is ruled out, Markusen then investigates the consequences for trade of allowing factor mobility and, like the present chapter, concludes that the HO substitution story is not general. The present chapter continues this line of research, but differs from it in the family of models analysed, in the assumption that economies are identical except for factor endowments and, most importantly, in its emphasis on studying the effects on the long-run equilibrium of changes in the cost of international transactions.

2

Competitive models

2.1

Heckscher–Ohlin model

Our point of departure is the HO model, and Mundell’s (1957) observation that if there is free trade and endowments are in the diversification cone, then there is no incentive for factor mobility. What happens if trade is less than perfectly free and as trade barriers change? We can answer this drawing on analysis undertaken by Norman and Venables (1995). Figure 2.1 illustrates the incentives for factor mobility for different divisions of the world endowment of the two factors between the two economies. The factors are labelled A and B, with prices a1, a2, and b1, b2 in the two countries. (The interpretation of the factors will vary from example to example, so it best not to label them as labour or capital a priori.) The height of the vertical axis is the world endowment of factor A, and the length of the horizontal axis is endowment of B. A point in the box represents a division of the world endowment of the two factors between the two countries (labelled 1 and 2), with country 1’s endowment given by the vector from O1 to the point, and country 2’s endowment measured from O2. At any such point we can compute the equilibrium finding, amongst other things, the equilibrium factor and goods prices.

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Figure 2.1

Incentives for factor mobility

The figure illustrates a situation in which trade in the B-intensive industry (call it the x-sector) has real ad valorem trade costs of T⫺ 1 per unit, while trade in the A-intensive sector (the z-sector) is perfectly free. The prices of x-sector output in each country are denoted p1 and p2, and the output of the z- sector will be used as the numeraire. The curves in the box define regions within which international differences in goods and factor prices lie within pre-set bounds. Consider first the lens-shaped region between the two bold curves labelled T. This is the area in which there is no goods trade – autarky prices differ by less than the trade barrier, i.e. p1/p2 ⬍T⬍p2/p1, so trade is not profitable. Clearly, the region includes the main diagonal (where relative endowments and goods prices are the same in both countries) and extends to regions on either side of the diagonal, where differences in relative endowments are small enough to give differences in goods prices of less than T. In the area outside this lens relative prices are fixed, at p1 ⫽Tp2 in the upper left of the figure where country 1 is importing x, and at p2 ⫽Tp1 in the lower right, where country 2 is importing. What about factor prices? In studying the location decisions of factors we have to distinguish between factor prices in terms of the numeraire and factor prices deflated by cost of living indices in each location. If a factor always consumes in the same place then mobility decisions will be guided by the former, but if consumption occurs in the country of residence, then

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the latter are appropriate. We shall assume throughout this chapter that factors consume in the country of residence, so that to look at mobility decisions it is always appropriate to deflate factor prices by a cost of living index, which we shall denote e(p1), e(p2) in countries 1 and 2, respectively. We shall call these deflated factor prices ‘real factor prices’. Looking now at figure 2.1, the presence of trade costs means that factorprice equalisation (FPE) occurs only on the main diagonal of the box. Above and to the left country 1 is poorly endowed with B relative to A and as we have seen p1 ⬎p2 so a1 ⬍a2 and b1 ⬎b2. In the HO model goods-price differences map into proportionately larger factor-price differences, so inequalities between factor prices in terms of the numeraire also hold between real factor prices. If there is free mobility of factors the story is therefore straightforward. Factor movement takes place until the economy reaches the main diagonal, and mobility of just one of the factors is sufficient to reach this diagonal and achieve FPE. The point on the diagonal to which the system converges depends on the initial endowment and the dynamic specification of factor mobility. Since factor mobility gives the economies identical relative endowments, it substitutes for trade. Assuming perfectly frictionless mobility of factors is of course unrealistic, and is an assumption that sits uncomfortably with our assumed friction in goods trade. What if there are costs associated with the mobility of factors as well as of goods? Let us call the ad valorem costs of moving factors A and B, TA ⫺1 and TB ⫺1, respectively. The lines TA and TB on figure 2.1 give the loci of endowments at which factors are indifferent between migrating and not migrating, and are drawn for a relatively high value of TA and lower value of TB. Thus, the curves TA give the set of factor endowments at which a1/e(p1)⫽TA a2/e(p2) and a2/e(p2)⫽TA a1/e(p1). Between these curves differences in ai are small enough that it is not worthwhile for factor A to move. Above and to the left of the upper TA-curve a1/e(p1) is small enough relative to a2/e(p2) for factor A to move from country 1 to country 2, as illustrated by the vertical arrows on the figure. Similarly, the curves TB are the sets of endowments at which b1/e(p1)⫽ TB b2/e(p2) and b2/e(p2)⫽TB b1/e(p1). Outside these curves differences in bi /e(pi) are large enough for B-mobility to follow the horizontal arrows, and inside the difference is small enough for B not to move. What do we learn from figure 2.1? First, we can use it to investigate what combination of goods and factors is traded at equilibrium. Standard HO theory begs this question by partitioning commodities into goods, usually freely tradable, and factors, usually totally immobile. Here we can see that the answer depends on the relative positions of the T-, TA- and TB-curves. Look only at the upper left part of figure 2.1 (arguments for the lower right part are symmetric) and now suppose that we start out in the far upper left.

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At points above the T-, TA- and TB- curves there is, respectively, trade in goods, factor A and factor B. Factor mobility induces movement down and to the right, but as we cross the TA line so factor A mobility ceases – real ai differences are not large enough for further movements to occur. We now move to the right with factor B coming into country 1. This narrows goods price differences, and as the T-contour is crossed goods trade ceases.2 However, real bi differences are still large enough for factor B to move from country 1 to country 2, and the system will end up at a point on the TBcurve, at which point there is no trade of any sort. Armed with this, how does a trade liberalisation affect factor mobility? A reduction in T has two effects. First, it shifts the T-curves inwards; as expected the no-trade region contracts. Second, if the TA- and TB-curves lie outside the T-curve then they are shifted further out (given the levels of mobility barriers TA and TB). The reason is that goods- and factor-price differences outside the TT lens are reduced, so the areas of endowment space in which there is an incentive for factors to move are reduced. The conclusion is then rather obvious. Trade liberalisation reduces the incentives for factor mobility, and will not create factor mobility where there was none before. For example, if prior to the trade liberalisation the economy was on the TB frontier, then the outwards movement of the frontier pushes the system into the interior of the region where there is no incentive for factor B to move. How does this relate to the examples mentioned in the Introduction? Think of country 1 as Eastern Europe and 2 as the EU, and suppose that the initial endowment is in the lower right corner of the box, where country 1 has much labour (factor B) and little capital (factor A). Eastern Europe (country 1) exports good x, which is the labour (B)-intensive good, but faces trade barriers to these exports. These barriers reduce the price of labour and raise the price of capital in Eastern Europe, creating the directions of factor mobility illustrated – labour (B) outflow and capital (A) inflow. A reduction in the barriers pushes the TA- and TB- loci outwards, reducing the international differentials in factor prices, and possibly being large enough to staunch the flow of emigrants. Can this model illuminate nineteenth-century European–US migrant flows? Suppose that country 1 is now the USA and country 2 Europe. Country 1 has little labour (factor B) and much land (rechristened factor A). This places us in the top left corner of the box with the USA exporting the land-intensive good and receiving an inflow of labour. However, trade liberalisation or falling transport costs reduce the incentive for labour inflow. The reason is that the liberalisation raises land rents and – since land and labour are the only factors used in the two sectors – this reduces US wages.

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The failure of the HO model to capture US–European migration flows in a satisfactory way is of course due to the assumption that the same two factors are used in both sectors. We need to separate out specific factors for agriculture and industry, and it is to this that we now turn. 2.2

Specific factors

In the HO model an increase in an economy’s endowment of one factor cannot reduce the return to the other, but in a model with sector-specific factors this complementarity becomes possible and, as we shall see, it greatly increases the richness of the model.3 We continue to assume that factor A can be used in either sector, but now assume that factor B is used only in the x-sector, and introduce factor C, with price ci, used only in the freely traded z-sector. As is well known, with free trade the FPE set in this model is a two-dimensional sub-space of the three- dimensional factor space. What happens if there is not free trade but, as in sub-section 2.1, x-sector output faces trade costs at rate T ? In the HO model the presence of trade costs reduces the dimensionality of the FPE set from a two-dimensional set to a line, and so in the specificfactors model trade costs reduce the FPE set from a line to a point. To analyse mobility dynamics in the three-dimensional endowment space we proceed in two stages, looking first at the mobility of factors A and C, and then at B and C. 2.2.1 Mobility of the non-sector-specific factor Figure 2.2 gives the mobility dynamics for the sectorally mobile factor (A) and one of the specific factors (C). It has factors A and C on the axes, and is drawn under the assumptions that the two economies are equally well endowed with the other sector-specific factor, B, that half of costs in each sector go to factor A and half to the specific factor, and that consumers’ expenditure is equally divided between the two goods. The bold dashed line is the FPE set with free trade. It has a positive slope less than unity, because increasing country 1’s endowment of the specific factor C must be associated with a less than proportional increase in the non-specific factor, A, if factor intensities in each sector are to be held constant and FPE maintained. Above and below the line factor-price differences and consequent mobility are as suggested by the arrows in the top left and bottom right corners of the box. What differences are made by trade costs on good x? On a vertical line in the middle of the box, where C1 ⫽C2, there is no trade and p1 ⫽p2, while to the left of this country 1’s abundance of B relative to C means that p1 ⬍p2. Trade, if it occurs, takes the form of country 1 exporting x (the B-intensive

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Figure 2.2 Mobility dynamics for the sectorally mobile factor and one specific factor

good) and importing z. The goods-price difference unambiguously reduces the real return to factor B in country 1 relative to country 2, and creates a region in which real returns to both factors A and C are higher in country 1 than in country 2. The edges of this region are the lines aa and cc, giving the sets of endowments at which a1/e(p1)⫽a2/e(p2) and c1/e(p1)⫽ c2/e(p2). While the precise positions of these lines depend on consumption shares, the important (and general) point is that the curves intersect only at the central point of the box, dividing endowment space up into four regions, with real factor-price differences as suggested by the arrows. Figure 2.2 is perhaps easiest to interpret if we think of it in terms of our US–Europe migration example. The two economies have equal endowments of land (factor B), but economy 1 has little labour (factor A) and capital (factor C), so we are in the lower-right-hand area of the box. This economy exports agriculture (x-sector, intensive in factor B) which has high transport costs. We see that such an economy can very well find itself with inflows of both capital (C) and labour (A). Even if the economy starts in a region where it is losing one of the factors (e.g. points d or e), it may, depending on adjustment speeds, move into the region in which it is receiving inflows of both factors.4 These factor movements are trade-reducing as they bring convergence of the countries’ relative endowments.5 What is the effect of trade liberalisation in this setting? The answer to this turns on parameters of the model. Figure 2.3 is constructed with the

Trade liberalisation and factor mobility

Figure 2.3

31

Parameters of the model

x-sector relatively more factor A-intensive than the z-sector, and maps out iso-relative factor-price loci for factor A. The three dashed lines are drawn for the case of free goods trade, and are the loci of endowments which give constant relative real ai in the two economies; the central line is a2/e(p2)⫽ a1/e(p1), the lowest line a1/e(p1)⫽TAa2/e(p2) and the uppermost a2/e(p2)⫽TA a1/e(p1), where TA ⬎1 is the barrier to mobility of factor A. The three solid lines are the analogous curves when there are positive barriers to goods trade. Comparing the dashed lines with the solid, there are two points of difference. First, the dashed lines are further apart than the solid. Exactly as we saw with the HO model, trade liberalisation has the effect of shifting the iso-relative factor-price loci outwards – further away from each other. This is because a variation in endowments has a smaller effect on factor prices, the more open is the economy. But second, and more importantly, trade liberalisation rotates the iso-relative factor-price lines clockwise. The reason is that, at a point near O1 country 1 is exporting x, so trade liberalisation increases p1. This raises a1 and e(p1) so, in general, has an ambiguous effect on the real return, a1/e(p1). However, since figure 2.3 is drawn with the assumption that the x-sector is more factor A-intensive than the zsector, the increase in a1 is relatively large, giving an increase in a1/e(p1). This enlarges the region in which factor A flows into country 1, giving the clockwise rotation indicated.

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Figure 2.4 Two sector-specific factors internationally mobile and factor A immobile

In this case, then, trade liberalisation can promote factor inflow. Ignoring C-mobility and assuming a cost to A-mobility of TA, the point f is an initial long-run equilibrium. Trade liberalisation means that the dashed, not the solid, lines become applicable, so factor A flows into country 1 and the system moves to point g. If we were to also allow capital mobility, then there would be an associated capital inflow, moving the economies towards the centre of the endowment box. The result that liberalisation causes inflow of the sectorally mobile factor depends on trade liberalisation increasing the real return to the factor. This arises if the export sector is the more intensive user of the sectorally mobile factor (as assumed here) or if the factor consumes relatively little of the export good (so that the increase in e(p1) is small). Whether this case captures the issues raised by transport-cost reductions and immigration to the USA is therefore an empirical matter, turning on details of technology and preferences. 2.2.2 Mobility of the specific factors Figure 2.4 maps out the case in which the two sector-specific factors are internationally mobile, and factor A is held immobile. As in figures 2.2 and 2.3, the heavy dashed line is the FPE set with perfectly free trade. The line has a negative slope, indicating complementarity of the two factors. For example, if country 1 were to receive an inflow of factor B then this would reduce b1 and also reduce c1 (because factor A moves between sectors,

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raising the intensity of the specific factor in both sectors). Above and below the line factor-price differences are as suggested by the arrows in the upperright- and lower-left-hand corners of the box. What differences are made by trade costs on good x? First, there is a notrade region which forms a lens-shaped area similar to that in figure 2.1. It is not illustrated on figure 2.4, but the kinks in the cc - and bb -lines occur at the edge of this region. On the main O1O2 diagonal p1 ⫽p2, and above and to the left of this diagonal country 1 is relatively poorly endowed with factor B (used in the x-sector), so if trade occurs country 1 imports x and p1 ⬎p2. Whereas point e had FPE under free trade, the goods-price gap p1 ⬎p2 now means that b1 ⬎b2 and c1 ⬍c2. Point e is therefore below the line along which there is FPE for factor B and above the line with FPE for factor C, and both factor prices are equal only at the central point of the box where the two economies are identical. The lines bb and cc give the real FPE sets for each factor, i.e. they are the sets of endowments at which b1/e(p1)⫽b2/e(p2) and c1/e(p1)⫽ c2/e(p2). Their precise positions depend on parameters but the qualitative configuration of the figure and associated directions of factor mobility are general. We are now in a position to see the effects of trade liberalisation. For simplicity, we look only at cases in which mobility of factors B and C is either impossible or completely free. Suppose first that the system is at point f, and that only factor B is mobile. With the initial goods-trade barriers the economy would move from point f to point g. Trade liberalisation now shifts the bb- and cc-loci inwards, towards their free trade positions (the heavy dashed line), so point g becomes inside the region in which country 1 loses factor B: factor movement occurs in the direction of the arrow to some point such as h. The interpretation of this movement is straightforward. At point g country 1 is importing x-sector goods, but the presence of transport costs creates protection for country 1 x-industry. Trade liberalisation reduces this protection, so reduces the real return to the x-sectorspecific factor (B), causing its outflow. There are several noteworthy points about the move from g to h. First, the movement makes the relative factor endowments of the economies more different. At point g country 1 has relatively much C, half of world A and approximately half of world B, but the factor mobility created by trade liberalisation moves it to a point with relatively little B. And, second, the volume of trade increases along the path from g to h. Of course, the trade liberalisation alone increases trade, but there is an additional effect coming from outflow of the factor used in the import-competing sector. What we see in this case is trade liberalisation creating factor movements which make the economies more different in relative factor endowments and which increase trade flows. A similar analysis holds if we assume that only C is mobile, and B is fixed

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at some level. For example, if the initial long-run equilibrium is at point i on figure 2.4, the trade liberalisation creates the downward movement along the dashed arrow to j. At i country 1 is relatively well endowed with B, so exports x-sector output. Trade costs act to protect country 2’s x-sector and reduce country 1’s exports. Reducing this protection causes country 1’s x-sector to expand, drawing factor A into this sector, which in turn reduces the country 1 price of factor C. There is therefore factor C outflow from 1, making the countries’ factor endowments more different and increasing trade volumes. To what real-world situations might this analysis be applicable? Suppose that the initial equilibrium is at point i where country 2 is a developed country (endowed with much skilled labour (C) and little unskilled labour (B)) and country 1 is a developing country which is exporting the unskilledlabour- intensive product, x. The developed country (country 2) now cuts its barriers to imports of x-sector products. As a consequence the developing country (country 1) reallocates its sectorally mobile factor to export production of x-sector output, thus reducing the real wage of skilled labour in the z-sector, and creating a ‘brain drain’ – the movement from i to j. Summarising results from the two competitive models – HO and specificfactors – we see quite a complex set of possible responses. Although the HO model predicts that trade liberalisation reduces the incentives for factor mobility, this need not hold once we allow for the richer set of interactions between factors given in the specific-factors model. Trade liberalisation can cause inflow of the inter-sectorally-mobile factor (if the liberalising sector is a relatively intensive user of the factor) and can cause factor flows that make economies more different (as it may reduce the return to an economy’s scarce, and import-competing, factor). Empirical work is needed to apply these models to particular circumstances. 3

Increasing returns and cumulative causation

A recurrent question in the study of factor mobility is whether mobility tends to reinforce the advantages of existing concentrations of economic activity, or lead to a spatial smoothing out of activity. For example, in the EU, does factor mobility tend to draw factors of production out of peripheral regions and into the centre, or does it lead to convergence of regions? Do reductions in the costs of goods trade between countries or regions tend to reinforce centripetal or centrifugal factor flows? So far, we have worked with models that cannot begin to address these questions, because of the assumption of non-increasing returns to scale in all activities. To address them, we must add some element of increasing returns to scale to the theory, and this is what we now do. Our tools for this

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will be the much-used Dixit–Stiglitz (1977) model of monopolistic competition, and its multi-country extensions (Helpman and Krugman, 1985). We know from Krugman (1991) that this model can support destabilising migration, and we seek in the remaining sections of the chapter to analyse this within the framework we have developed. This will involve some generalisations of Krugman’s model, and we shall show how factor-supply and market-access considerations interact to determine the incentives for factor mobility. 3.1

An increasing-returns model

In this section of the chapter we develop in full a model with trade, factor mobility, and increasing returns to scale. The model has the factor market structure of the HO model of sub-section 2.1, but superimposes monopolistic competition on the x-sector. As in sub-section 2.1 the factors are Ai and Bi with prices ai and bi in countries i⫽1, 2. The z-sector is perfectly competitive, is relatively A- intensive and produces output that is freely traded. The x-sector has trade frictions and is now also assumed to be imperfectly competitive, with Dixit–Stiglitz product differentiation. Using this approach, consumers have a constant elasticity of substitution sub-utility function defined over x-industry-differentiated products. This sub-utility function is given in the appendix (p. 45), but it is more economical to work with the dual to the utility function, and so write the subexpenditure function (or price index) for x-sector products in each country, qi, as ⑀ ⫹n (Tp )1⫺⑀]1/(1⫺⑀), ⑀ ⬎1, i,j⫽1,2, i⬆j, qi ⫽[ni p1⫺ i j j

(1)

⑀ is the elasticity of substitution between varieties, T is the ad valorem trade cost, and ni and pi are, respectively, the number of varieties of x-sector goods produced in country i, and their price. Given expenditure on x-sector products in aggregate in each country, Ei, the demand for the output of a single country i firm in its home and export market are, from the demand system implied by the price index (2.1) xii ⫽pi⫺⑀qi⑀⫺1Ei, xij ⫽pi⫺⑀T1⫺⑀q⑀j ⫺1Ej.

(2)

Each firm sets price at a fixed mark-up over marginal cost, the size of which is given by the elasticity of substitution between varieties, so pi(1⫺1/⑀)⫽g(ai,bi)

(3)

where g(ai, bi) is x-sector unit cost in country i. At a zero profit equilibrium each firm’s total sales, xii ⫹xij, must reach a level determined by the size of the fixed costs. We can choose units such that this level equals unity, so

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xii ⫹xij ⫽pi⫺⑀q⑀i ⫺1Ei ⫹pi⫺⑀T1⫺⑀q⑀j ⫺1Ej ⫽1.

(4)

(The choice of units involves setting each firm’s fixed input requirement F equal to 1/(⑀ ⫺1).) This equation holds provided ni ⬎0; if an economy has no x-sector production then the total sales of a potential entrant must be less than or equal to unity. Assuming n1, n2 ⬎0 it is possible to use (2.1) and (2.4) to obtain an explicit expression for the number of firms operating in each country and this takes the form ni pi ⫽

EjT1⫺ ⑀ Ei ⫺ i,j ⫽1,2, i ⬆j. ⑀ 1⫺ ⑀ 1 ⫺ (pj /pi) T (pj /pi)⑀ ⫺ T 1⫺ ⑀

(5)

Turning to the z-sector, we assume that this sector uses the two primary factors as input, and may also use x-sector products as intermediate goods. These enter x-sector production through a cost function which we assume takes the same form as the consumer’s expenditure function (2.1), so that the country i price index for intermediate goods is qi.6 The z-sector unit cost function is then h(ai, bi, qi). We take z as the numeraire good, so z-sector activity satisfies h(ai, bi, qi)ⱕ1, zi ⬎0, complementary slack, i ⫽1,2.

(6)

Characterisation of equilibrium can be completed as follows. Expenditure on x-sector output, Ei, comes from two sources, final and intermediate demand. Country i income is aiAi ⫹biBi of which proportion ␮ is spent on the x-sector. The input of intermediates per unit output of z is given by the partial derivative hq(ai, bi, qi), so adding consumption and intermediate demands, Ei is Ei ⫽ ␮[aiAi ⫹biBi)⫹qihq(ai,bi,qi)zi.

(7)

Turning to factor markets, equality of supply and demand for factors A and B takes the form Ai ⫽zi ha(ai,bi,qi)⫹ni[xii ⫹xij ⫹F]ga(ai,bi)

(8)

Bi ⫽zi hb(ai,bi,qi)⫹ni[xii ⫹xij ⫹F]gb(ai,bi)

(9)

where the two terms on the right-hand side are factor demand from the zand x- sectors, respectively. We are now in a position to pose the question: given endowments and trade barriers, what are factor prices, and what are the incentives for factor mobility? There are three new forces at work, and they mean that absolute as well as relative, endowments are now important in determining factor prices. The first is that production costs may now on depend on absolute, as well as relative endowments. This arises because a large economy will, other

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things being equal, produce more x-sector products and this reduces its price index, qi. If the x-sector products are used as intermediates, then this is a cost reduction for z-sector firms which, in equilibrium, will be translated into a higher price for one or both of the factors of production. The second force is that the combination of intra-industry trade, increasing returns to scale and trade barriers, implies that firms tend to locate in the market with larger expenditure on x-sector products. This means that the large economy will tend to have disproportionately more x-sector production, raising demand for factors of production, and again tending to give higher factor prices in the large economy. This can be seen by inspection of (5). Set T⬎1 and suppose for simplicity that p1 ⫽p2. Production in the two economies is the same if E1 ⫽E2, but increasing E1 causes disproportionately larger increases in n1. Notice also that this effect becomes more powerful as T is reduced. The third force is a cost of living effect. As we have already noted, the larger economy will tend to have a lower price index for differentiated products, and hence a lower cost of living index. Given factor prices in terms of the numeraire, this effect will increase real factor returns in the larger economy. To analyse the implications of these forces for factor prices and factor mobility we separate them out, first looking at a model in which just the cost effect is operating, and then moving to a model where both the expenditure effect and the cost of living effect are important. 3.2

Country size and costs

Suppose first that x-sector production is used only as an intermediate good, so ␮, the share of consumption expenditure going to the x-sector, is zero.7 What, then, does the FPE set look like, and what are the incentives for factor mobility outside this set? It is easy to see that we have both a1 ⫽a2 and b1 ⫽b2 only if the two economies have identical endowments. It results from the following chain of reasoning. If factor prices are equalised, then so too are x-sector prices (from (3)) and the price indices (from (6)). This means that the numbers of firms in the two economies are equal (from (1), provided T⬎1) in which case so are levels of x-sector expenditure and z-sector production (from (5) and (7)). This implies the same factor demand in the two countries, so that countries must have identical endowments. Notice that this argument hinges on trade barriers. If T⫽1 then increasing returns are entirely global, not national, so the FPE set is a two- dimensional sub-set of endowment space, as in HO and Helpman and Krugman (1985). What happens if we give country 1 more of both factors, holding the A/B

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Anthony J. Venables

Figure 2.5

Lower price of intermediates

endowment ratios in the two countries equal? Supposing that techniques of production are unchanged this raises z1 and n1 equiproportionately (from factor market clearing, (8) and (9)). But as this happens so q1 falls, from the price index, and this generates a cost saving on country 1 z-sector production. This lower price of intermediates is captured by factors of production, so raising one or both of the factor prices in the larger economy. The picture is given in figure 2.5. Axes are as before, and the solid lines aa and bb are the loci of endowments at which factor prices are equalised.8 These divide endowment space into four regions, with directions of factor mobility as illustrated. The first thing to note about figure 2.5 is that the point where the economies is identical has FPE but, if both factors are mobile, is unstable. Unsurprisingly, having built increasing returns into the production sector of the economy, there are gains from cumulatively moving factors into the larger economy, and long-run equilibrium involves complete agglomeration of activity in one economy. The more interesting case is when only one of the factors is mobile. The immobile factor prevents complete agglomeration from occurring, and gives a long-run equilibrium in the interior of the box, lying on either curve aa or bb. Second, how do the loci depend on the size of the barriers to trade in the x-sector? Whereas the solid lines in figure 2.5 are drawn for T⫽1.5, the dashed lines are for T⫽1.1, and we see that the regions in which both factors move from one economy to the other are increased by trade liberalisation.

Trade liberalisation and factor mobility

39

Suppose that only one of the factors – say, factor B – is mobile. Then the point labelled e is an initial long-run equilibrium. Trade liberalisation now creates the incentive for movement along the dashed arrow, horizontally to point f, this making the two economies more different in size. The reason is that the need to locate near final consumers is reduced, enabling the benefits of agglomeration to be more fully realised, so the larger economy becomes a more attractive location for the increasing-returns industry. This raises bi in the large economy relative to the small, giving the movement indicated. The effect of liberalisation is then to create factor mobility, and this makes the economies less similar. It also increases the volume of trade – the two economies are more dissimilar in both relative and absolute endowments. A note of caution needs to be sounded about these results. The analysis is based on perfect factor mobility – what if there are frictions TA and TB in factor movements? We could add a1 ⫽TA a2, a2 ⫽TA a1 and b1 ⫽TB b2 and b2 ⫽TB b1 loci to the figure, and they would take the form of bands around the a1 ⫽a2 and b1 ⫽b2 lines that we have illustrated. The effects of the trade liberalisation is both to move the centres of the bands, as illustrated in figure 2.5, and also to widen the bands, because lower goods trade barriers make the returns to scale less national in scope. This reduces the likelihood that trade liberalisation will cause the factor mobility we saw in figure 2.5. For example, following trade liberalisation factor- price differences at point e might be insufficient to cause factor movement – e might lie in the band between b1 ⫽TB b2 and b2 ⫽TB b1 for the new goods-trade barriers. The message from this section is then that if country size feeds into lower costs via increasing returns of some sort, then factor mobility can be destabilising, and lead to agglomeration of activity in one economy. However, full agglomeration occurs only with perfect mobility of both factors. If a single factor is mobile then there are interior equilibria, such as point e of figure 2.5, but trade liberalisation might cause the smaller economy to become still smaller (the move from e to f ). Frictions in factor mobility reduce the likelihood of this occurring. 3.3

Country size, expenditure and the core–periphery model

We now turn to the market size and cost of living effects of factor mobility in an increasing-returns model. We do this by switching off the intermediate goods linkage – so hq ⫽0 from now on – and instead having x-sector output go to final consumption, so ␮ ⬎0. If there are no transport costs then this is exactly the textbook Helpman–Krugman model, in which standard HO properties hold for net trade and for factor prices. However, as we shall see, the story changes radically when we put some trade frictions in the picture.

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Anthony J. Venables

Our first task is to characterise the FPE set. To do this, it is important to note that the location of the x-industry is determined by two different sets of forces – product market demand, as given in (5), and factor supply, as given by (8) and (9). If trade costs were zero, then (5) would cease to hold (it is undefined when T ⫽1). Intuitively, free trade relaxes the product market conditions as supply has to equal demand only at the world level, not country by country. In this case the FPE set is the full diversification set, as in HO and in Helpman–Krugman. But if T⬎ 1 then both the product and the factor market conditions have to hold, and this requirement reduces the dimension of the FPE set. To find the FPE set we look first at the product market conditions. If factor prices, and hence also goods prices, are equal in the two countries, then (5), giving the value of production in each country, become n1p¯ ⫽

E1 ⫺ T 1⫺ ⑀E2 E2 ⫺ T 1⫺ ⑀E1 , n p ¯ ⫽ 2 1 ⫺ T 1⫺ ⑀ 1 ⫺ T 1⫺ ⑀

(10)

where a bar over a variable denotes FPE. The equations say that location of the industry depends on the location of x-sector expenditures, Ei, and on transport costs. If there are positive transport costs, (1 ⬎T 1⫺⑀), then production will be skewed towards the location with the larger expenditure, and this effect is more powerful the smaller is T (and closer is 1⫺ T 1⫺⑀ to zero), since production is less anchored by the need to supply local consumers. Expenditure, Ei, depends on factor endowments – we have, from (7) E ⫽ ␮(a¯ A ⫹b¯ B ). i

i

i

i

i

Using this in (10) gives x-sector output in each country as a linear function of factor endowments. Equation (10) captures the effect of product market access on industrial location. We also have the usual factor market considerations. Assuming that both the z- and x-sectors are operating in both countries and denoting technical coefficients at FPE factor prices by g¯a, etc. we can use factor market-clearing conditions (8) and (9), together with zero profits (implying xii ⫹xij ⫹F⫽p¯ /g¯), to derive, h¯ B ⫺h¯ A h¯ B ⫺h¯ A n1p¯ ⫽ ¯a 1 b ¯ 1 g¯, n2 p¯ ⫽ ¯a 2 b ¯ 2 g¯. (11) h g¯ ⫺g¯ h h g¯ ⫺g¯ h

冢

a b

a b

冣

冢

a b

a b

冣

These say that the value of x-sector output in each country is (given FPE technical coefficients) a linear function of factor endowments. Equations (10) and (11) give the product and factor market determinants of x-sector production. Requiring them both to be satisfied restricts endowments, and this restriction defines the FPE set. Eliminating n1 (or n2 – the two pairs of equations are not independent) from these equations, noting

Trade liberalisation and factor mobility

Figure 2.6

41

x-sector B-intensive

that both expressions are linear in Ai and Bi and using world endowments A⫽A1 ⫹A2 and B⫽B1 ⫹B2 we can characterise the FPE set as a linear relationship between A1 and B1. The FPE set is no longer the full diversification set of standard HO or Helpman–Krugman analysis, but instead a one-dimensional sub-space of this set. The expression for the FPE set is straightforward, and we need note only that it includes the point at which the two economies are identical, is linear, and has gradient dA1 h¯ag¯(1 ⫺ T 1⫺ ⑀) ⫺ ␮b¯⌬(1 ⫹ T 1⫺ ⑀) ⫽ ⫽ dB h¯ g¯(1 ⫺ T 1⫺⑀) ⫺ ␮a¯⌬(1 ⫹ T 1⫺⑀) 1

b

h¯ag¯(1 ⫺ ␮) ⫹ g¯ah¯␮ ⫺ T 1⫺ ⑀(h¯ag¯ ⫹ ␮b¯⌬) h¯ g¯(1 ⫺ ␮) ⫹ g¯ h¯␮ ⫺ T 1⫺ ⑀(h¯ g¯ ⫹ ␮a¯⌬) b

b

(12)

b

where ⌬ is the determinant of the matrix of technical coefficients ⌬⬅h¯ g¯ ⫺g¯ h¯ ⬎0, a b

a b

positive since the x-sector is B-intensive. (The two different forms given for the gradient are useful in different contexts, and can be derived from each other using homogeneity of the cost functions.) This is illustrated in figure 2.6, in which the FPE set constructed above is

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the line segment de, and the continuation of this set into regions in which one country is specialised is given by the segments, O1d and eO2.9 The FPE set goes through the mid-point of the endowment box and has gradient (given by (12)) less than the O1O2 diagonal. The intuition for this can be seen by considering a point below the O1O2 diagonal. At such a point country 1 is relatively well endowed with B, and hence has relatively much x-sector production. If there are transport costs, this is consistent with FPE only if country 1 has relatively high demand for x-products – i.e. the point is closer to O2 than to O1. de must therefore cut the O1O2 diagonal from above, as illustrated. On either side of the FPE set, nominal factor prices are as illustrated on figure 2.6. Above the FPE set country 1 is relatively well endowed with A, so we have a1 ⬍a2, b1 ⬎b2, and p1 ⬎p2. It is important to note for our purposes that the slope of the FPE set depends on trade costs. Increasing T, we see that as T→⬁ so de goes to the O1O2 diagonal of the box, because under autarky there is FPE only if the endowment ratios of the two economies are equal. (This can be seen by letting T in the second part of (12) which then gives the ratio of world demand for A to world demand for B). Reducing T reduces the gradient of de, rotating the FPE set clockwise around the central point, and at some value of T the FPE set is horizontal (see the first part of (12)). At still lower values of T the FPE set has negative gradient, and as we go to free trade (T →1) the gradient tends to the ratio of factor prices, b/a, so FPE occurs only if the economies have the same incomes and expenditures. The reason is that at low T the tendency for industry to be drawn into the economy with the larger market becomes stronger (as noted in our discussion of (10)), so FPE is possible only if the two markets are of very similar size. In other words the expenditure effect becomes crucial in determining the form of the FPE frontier. To look at the incentives for factor mobility we need to take the further step of deflating factor prices by the cost of living index. Consumers benefit from the full range of products supplied, so the argument in the cost of living index is the price index, qi, which as we have already seen, is decreasing with country size. The implications of this are illustrated in figures 2.7 and 2.8. Figure 2.7 is drawn for a relatively high value of T, and hence relatively steep FPE set – the dashed line O1deO2 . Above this line country 1 is poorly endowed with B relative to A, so b1 ⬎b2 and a1 ⬍a2, and conversely below the line. Adjusting for differences in price indices, qi, the lines aa and bb plot the sets of endowments on which a1/e(q1)⫽a2/e(q2)andb1/e(q1)⫽b2/e(q2). The intuition behind the positions of these lines can be seen by considering point f. At f factor prices are equalised in terms of the numeraire, but economy 1 has more x-sector production than economy 2 (it has a larger market and

Trade liberalisation and factor mobility

Figure 2.7

Steep FPE set

Figure 2.8

Trade barriers lower

43

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Anthony J. Venables

a more B-abundant endowment). It consequently has q1 ⬍q2, so country 1 has a higher real return to both factors. This means that f must lie below the iso-real-a line, and above the iso-real-b line. Given these real factor-price differences, the directions of factor mobility are illustrated by the arrows on the figure. Qualitatively the picture is similar to figure 2.5 (p. 38). If there is free mobility of both factors the equilibrium at C is unstable, but mobility of a single factor gives interior longrun equilibria. Figure 2.8 gives the case when trade barriers are lower. All the lines in the figure have been rotated clockwise around the central point, as we saw in our earlier discussion of the gradient of the FPE set. The importance of this is that it brings a qualitative change in the stability of the system with respect to factor B movements, as the segment DE of the bb line now has negative gradient. This segment is therefore unstable with respect to factorB movements, so B- movements alone will have the effect of making the economies less similar, and causing agglomeration of x-sector production in one or other of the economies – i.e. movement to the edge of the diversification set, along O1D or EO2. To see this result most starkly, suppose that A is immobile, and the world endowment is equally divided between economies. B is mobile, so given high enough goods-trade barriers there is a stable equilibrium at C, with two economies identical, as illustrated in figure 2.7. Trade liberalisation now has the effect of destabilising this equilibrium as it rotates the FPE set around point C to a position such as that illustrated in figure 2.8. There are three equilibria in the model. C remains an equilibrium although it is now unstable, and points horizontally across on O1D or EO2 are stable equilibria. Nothing in the model predicts which of the two stable equilibria is likely to be reached. If this result seems familiar, it is of course, because it is no more than a generalisation of the ‘core–periphery’ model of Krugman (1991). We have placed his analysis in a 2⫻2 technology more in line with standard trade theory, and the generalisation of his result is that a ‘core–periphery’ structure will emerge as a consequence of trade liberalisation if the factor used intensively in the increasing returns sector is internationally mobile. Pulling together results from the models with imperfect competition and increasing returns to scale gives the following conclusions. If both factors are mobile then the models predict complete concentration of economic activity in one location. This is unsurprising – the models are constructed with increasing returns and, if both factors are mobile, with no anchor to hold any activity in a declining country. The more interesting cases are those in which one factor is mobile, and the other immobile. In the intermediate-goods model of sub-section 3.2 we see that trade liberalisation will

Trade liberalisation and factor mobility

45

accentuate differences between the economies, as it raises the returns to agglomeration of industry. The ‘core–periphery’ model of section 3.3 gives a similar result, although in more dramatic form. In earlier cases trade liberalisation affects factor mobility in a continuous way, but in this case we see the possibility of discontinuous change. As trade barriers fall below a critical point so they destabilise the symmetric equilibrium, causing a ‘core–periphery’ structure to emerge. 4

Concluding comments

The very simplest models of international trade offer the comforting result that trade liberalisation brings about a convergence of real incomes that reduces migration pressure. We have seen in this chapter that there are many more forces at work, both in perfectly and imperfectly competitive environments, creating the possibility that trade liberalisation may promote factor mobility, rather than substitute for it. Of course, we know that it is always easy to add distortions of one sort or another to a model to overturn results and establish perverse cases. This chapter has tried to strike a balance between moving beyond simple HO theory, yet not falling into the trap of adding arbitrarily many distortions of various sorts. It has done so by staying within the confines of what are probably the three most widely used models of international trade – HO, specific-factors and Helpman–Krugman – except for the addition of some costs to trade. Even within these confines a very rich set of outcomes is possible. Trade liberalisation can promote migration into a labour-scarce economy (as with our US economy example) or skilled labour outflow (the ‘brain-drain’ case). Adding imperfect competition and increasing returns to scale, trade liberalisation can destabilise a symmetric equilibrium, and cause a core–periphery structure to emerge. It is rather unsatisfactory to conclude with the message that different models produce different outcomes. However, it would indeed be surprising if a single theory were appropriate to study trade and migration in such widely different contexts as migration between countries of the EU or states of the USA, and between countries with widely different factor endowments, economic structures and per capita income levels. The challenge for research is now to identify circumstances where each model is appropriate.

APPENDIX Figures in the chapter are generated by numerical simulation using the following functions:

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Consumer preferences are Cobb–Douglas with shares 1⁄2, 1⁄2 except in section 3.1 where ␮ ⫽0. (i)

In the HO model cost functions take the form, 2/3 2/3 1/3 g⫽a1/3 i b i , h⫽a i b i

for the x- and z-sectors, respectively. (ii) In the specific-factors model cost functions take the form 1/2 1/2 1/2 g⫽a1/2 i b i , h⫽a i ci .

(iii) In the increasing-returns model the sub-utility function dual to the price index is Ui ⫽[nix(ii⑀⫺1)/⑀ ⫹njx(ji⑀⫺1)/⑀]⑀/(⑀⫺1). In construction of figures, ⑀ ⫽5. Cost functions in section 3.2 take the form 2/3 1/2 1/2 g⫽a1/3 i bi , h⫽a i qi ,

and in section 3.3 take the form 2/3 2/3 1/3 g⫽a1/3 i b i , h⫽a i b i .

NOTES This research is supported by by the UK ESRC-funded Centre for Economic Performance at the London School of Economics and by the British Taiwan Cultural Institute. Thanks to participants in the Venice conference and to K. Harley, K. Middelfart-Knarvik, D. Puga and A. Sapir for helpful comments. 1 Dixit and Norman (1980) resolve the difficulty of defining relative factor intensity in multi-factor models precisely by defining it in terms of the effects of goods prices on factor prices. 2 Or to be precise, x-trade ceases. If factors consume in the country of residence this implies that all trade ceases, but if factors were to repatriate income then ztrade would be required to balance international payments. 3 See also Neary (1995) for analysis of factor mobility in the specific-factors model. 4 Although the cc-curve is constructed with returns in the host country equalised, the picture is qualitatively similar if capital moves in response to nominal returns. 5 As country 1’s endowments of A and C expand so does its production of manufactures (z-sector), so if intra-industry trade is superimposed on the model total trade volumes might increase even though inter-industry trade volumes decline. 6 In the applications of the model developed below we shall look only at cases in which x-sector output is used either as a consumer good or as an intermediate, so this assumption is not restrictive.

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7 See Venables (1996) for analysis of a variant of this model, and Faini (1984) and Markusen (1989) for studies of the role of non-traded inputs and producer services in determining trade and growth. In this model there may be multiple equilibria even with immobile factors. We rule this out by setting T sufficiently high to ensure uniqueness. 8 Since the numeraire is the only consumption good (␮ ⫽0) we do not need to distinguish according to where the consumption of mobile factors takes place. 9 Expressions (10) and (11) were derived under the assumption that both sectors are active in both countries. REFERENCES Bairoch, P. (1988). Cities and Economic Development: From the Dawn of History to the Present (Chicago: Chicago University Press) Begg, D. et al. (1992). Is Bigger Better? The Economics of EC Enlargement (London: CEPR) Dixit, A.K. and V.D. Norman (1980). The Theory of International Trade (Cambridge: Cambridge University Press) Dixit, A.K. and J.E. Stiglitz (1977). ‘Monopolistic Competition and Optimum Product Diversity’, American Economic Review, 67, 297–308 Ethier, W.J. (1982). ‘Decreasing Costs in International Trade and Frank Graham’s Argument for Protection’, Econometrica, 50, 1243–68 Faini, R. (1984). ‘Increasing Returns, Non-traded Inputs and Regional Development’, Economic Journal, 94, 308–23 Harley, K. (1978). ‘Western Settlement and the Price of Wheat, 1872–1913’, Journal of Economic History, 38, 865–78 (1980). ‘Transportation, The World Wheat Trade and the Kuznets Cycle’, Explorations in Economic History, 17, 218–50 Helpman, E. and P. Krugman (1985). Market Structure and Foreign Trade (Cambridge, MA: MIT Press) Krugman, P.(1980). ‘Scale Economies, Product Differentiation and the Pattern of Trade’, American Economic Review, 70, 950–9 (1991). ‘Increasing Returns and Economic Geography’, Journal of Political Economy, 99, 483–99 Markusen, J.R. (1983) ‘Factor Movements and Commodity Trade as Complements’, Journal of International Economics, 13, 341–56 (1988). ‘Production, Trade and Migration with Differentiated Skilled Workers’, Canadian Journal of Economics, 21, 492–506 (1989). ‘Trade in Producer Services and in Other Specialized Intermediate Inputs’, American Economic Review, 74, 85–95 Markusen, J.R. and J. Melvin (1981). ‘Trade, Factor Prices and the Gains from Trade with Increasing Returns to Scale’, Canadian Journal of Economics, 14, 450–69 Markusen, J.R. and A.J. Venables (1996). ‘The Theory of Endowment, Intra-industry and Multinational trade’, CEPR, Discussion Paper, 1341 Mundell, R.A. (1957). ‘International Trade and Factor Mobility’, American Economic Review, 47, 321–35

48

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Neary, J.P. (1995). ‘Factor Mobility and International Trade’, Canadian Journal of Economics, special issue, 28, S4–S23 Norman, V.D. and A.J. Venables (1995). ‘International Trade, Factor Mobility and Trade Costs’, Economic Journal, 105, 1488–1505 Sapir, A. (1983). ‘Foreign Competition, Immigration and Structural Adjustment’, Journal of International Economics, 13, 381–94 Venables, A.J. (1996). ‘Equilibrium Locations of Vertically Linked Industries’, International Economic Review, 37, 341–59

Discussion A N DRE SAPIR Ever since Mundell’s (1957) path-breaking contribution, economists are accustomed to thinking that trade liberalisation reduces the incentive for factor mobility. The notion that trade and factor flows are substitutes has widely percolated outside the economics profession. For instance, politicians in the European Union (EU) and in the United States (USA) have embraced regional trade liberalisation largely on the assumption that increased trade would reduce the incentive for immigration of labour from their poorer regional partners. Mundell’s intuitive result rests crucially on two neo-classical assumptions. First, trade conforms to the Heckscher–Ohlin (HO) model, which implies, inter alia, that trade liberalisation tends to equalise factor rewards across countries. Second, international factor mobility is solely a function of differences in international factor prices. Therefore, provided that it achieves full factor-price equalisation, free trade completely eliminates the incentive for factor mobility. Over the past 15 years, a number of contributions have investigated the impact of alternative trade models on the relationship between trade liberalisation and factor mobility. Chapter 2 by Tony Venables, who is himself one of the contributors in this field, provides a splendid overview of this recent literature. The chapter considers two alternatives to the HO workhorse: the Ricardo–Viner (RV) specific-factors model, and the Helpman–Krugman (HK) imperfect-competition model. Using a unified approach encompassing all three models, Venables shows that the Mundellian result does not necessarily carry through to the other two models.

48

Discussion by André Sapir

Neary, J.P. (1995). ‘Factor Mobility and International Trade’, Canadian Journal of Economics, special issue, 28, S4–S23 Norman, V.D. and A.J. Venables (1995). ‘International Trade, Factor Mobility and Trade Costs’, Economic Journal, 105, 1488–1505 Sapir, A. (1983). ‘Foreign Competition, Immigration and Structural Adjustment’, Journal of International Economics, 13, 381–94 Venables, A.J. (1996). ‘Equilibrium Locations of Vertically Linked Industries’, International Economic Review, 37, 341–59

Discussion A N DRE SAPIR Ever since Mundell’s (1957) path-breaking contribution, economists are accustomed to thinking that trade liberalisation reduces the incentive for factor mobility. The notion that trade and factor flows are substitutes has widely percolated outside the economics profession. For instance, politicians in the European Union (EU) and in the United States (USA) have embraced regional trade liberalisation largely on the assumption that increased trade would reduce the incentive for immigration of labour from their poorer regional partners. Mundell’s intuitive result rests crucially on two neo-classical assumptions. First, trade conforms to the Heckscher–Ohlin (HO) model, which implies, inter alia, that trade liberalisation tends to equalise factor rewards across countries. Second, international factor mobility is solely a function of differences in international factor prices. Therefore, provided that it achieves full factor-price equalisation, free trade completely eliminates the incentive for factor mobility. Over the past 15 years, a number of contributions have investigated the impact of alternative trade models on the relationship between trade liberalisation and factor mobility. Chapter 2 by Tony Venables, who is himself one of the contributors in this field, provides a splendid overview of this recent literature. The chapter considers two alternatives to the HO workhorse: the Ricardo–Viner (RV) specific-factors model, and the Helpman–Krugman (HK) imperfect-competition model. Using a unified approach encompassing all three models, Venables shows that the Mundellian result does not necessarily carry through to the other two models.

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While I have nothing to add to the finding that, in theory, there is a ‘possibility that trade liberalisation may promote factor mobility, rather than substitute for it’ (p. 45), I would like to dispute the conclusion of the chapter. There, Tony states that, since ‘different models produce different outcomes . . ., [t]he challenge for research is now to identify circumstances where each model is appropriate’ (p. 45). My feeling is that in the cases listed above, namely regional trade liberalisation between the EU and Eastern Europe or the Mediterranean countries, or between the USA and Mexico, we already know fairly well which model is most appropriate. Because each of these regional trade schemes involves countries with significantly different factor endowments, I feel confident that the HO model is more appropriate than any of the other two models considered in the chapter. Does this mean that I conclude that EU and US politicians are necessarily well founded in accepting that trade and factor flows are substitutes? The answer is ‘yes’, but with an important proviso. The literature reviewed by Tony Venables takes for granted the assumption that factor mobility is purely a response to international factor-price differences. Clearly, this is a major weakness which needs to be addressed by the literature. We know that foreign direct investment (FDI) responds to many other economic forces besides international profit differences. In particular, FDI often occurs between countries with similar factor rewards. Equally, international labour migration is affected by other factors besides international wage differentials. In particular, I find it sensible to assume that migration depends not only on wage differentials, but also on the income level in the sending (i.e. low-income) country. Hence, the relationship between trade liberalisation and migration could be quite complex. One possible such relationship might be as follows. Below a certain lower-income threshold in the sending country, trade liberalisation and migration might be complements since the former tends to foster income, thereby allowing potential migrants to meet the cost of moving abroad. Above this lower-income threshold, trade liberalisation and migration are substitutes, at least until an upper-income threshold. Trade liberalisation and migration are likely to foster income in the sending country. Once a certain upper threshold is reached, migration is likely to slow down or perhaps stop completely, even though the absolute income difference with richer countries might remain substantial. This is due to the fact that individuals are likely to prefer living in their own rather than in a foreign country. Therefore, trade liberalisation and migration might be neither substitutes nor complements above this upper-income threshold. Assuming that migration indeed responds not only to wage differentials but also to wage levels, the important proviso in assessing the relationship between regional trade liberalisation and migration therefore relates to the

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income thresholds discussed above. In particular, the practical issue is whether wage (or income) levels in Eastern Europe, the Mediterranean countries or Mexico are above the lower, but below the upper, income threshold. My guess is that the answer is clearly ‘yes’ for Eastern Europe and Mexico, but only marginally so for the Mediterranean countries. The implication is that the hunch of EU and US politicians is probably correct: regional trade liberalisation is likely to reduce migration flows towards the nations they govern. REFERENCES Mundell, R. (1957). ‘International Trade and Factor Mobility’, American Economic Review, 47, 321–35

3

Regional integration, trade and migration: are demand linkages relevant in Europe? RO D NE Y D. L UDE M A AND IA N WO O T O N

1

Introduction

In this chapter we examine the consequences of increased economic integration between nations within a region. We assume that the countries already have made significant strides towards a common market by lowering trade costs and impediments to factor mobility. However, some barriers remain, and we shall consider economic integration as a combination of dropping barriers to factor mobility and reducing transport costs.1 We are interested in determining the circumstances under which economic integration will lead to agglomeration of economic activity, whereby one part of the region will accumulate virtually all of the manufacturing activity, while the remainder will become largely de-industrialised. This clearly is an important issue for a regional grouping such as the EU, particularly given its recent efforts to deepen the level of integration between member states. We adopt Krugman’s general equilibrium, economic-geography model (1991a) to characterise what we refer to as the ‘labour-demand’ side of the model.2 This produces the agglomerative forces that can lead to a core–periphery pattern through backward and forward ‘demand linkages’. The backward linkage captures the notion that manufacturing production will tend to concentrate where there is a large market, but that the market will be large where manufacturing production is concentrated (because this is where the manufacturing workers live and consume). This is reinforced by the forward linkage in which, other things being equal, the cost of living will be lower in the country with the larger manufacturing sector, because consumers in that location can rely less on imports (which are subject to transport costs). Both of these linkages will tend to draw manufacturing workers into the core, leaving the remainder of the region a rural hinterland. In addition to the barriers to trade in manufactures, we allow for the imperfect mobility of manufacturing labour, which results in an upwardsloping international labour-supply schedule. Thus workers are assumed to 51

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Rodney D. Ludema and Ian Wooton

have preferences for living in a particular country and, in order to induce them to migrate, a relatively higher real wage will have to be offered in the other country. We believe this to be a useful innovation for economic-geography models applied to regions in which language and cultural barriers are significant, despite the lack of formal, legal impediments to mobility. The benefits of introducing imperfect labour mobility into this framework are more than merely adding realism. First, it substantially expands the possible outcomes arising from economic integration. Depending on the relative importance of agglomerative forces and labour mobility, integration may have no impact on the location of manufacturing activity or it may drive it to complete agglomeration, as in Krugman (1991a). An intermediate and more interesting possibility is that integration, in the form of the progressive reduction of trade barriers, may be accompanied by a three-stage pattern of industrial production: international diversification, followed by the agglomeration of activity into a core–periphery pattern, followed by the re-industrialisation of the periphery. Second, introducing imperfect labour mobility allows us to examine the effects of a dual approach to integration, that of reducing trade barriers and reducing barriers to mobility. We show that it may be possible to eliminate temporary agglomeration, and its concomitant disruptions, by appropriately sequencing the two forms of integration. Krugman (1991a) originally set out the demand-linkages model, in part, to explain the core-periphery patterns of North America and Europe.3 However, Krugman (1991b) cites data suggesting that Europe’s core–periphery pattern is more of an income than an employment pattern. That is, as compared to the USA, Europe exhibits more pronounced differences in per capita income across its constituent states, but less pronounced differences in the concentration of manufacturing labour. Krugman’s conclusion is that the demand linkages model does not explain this. This is echoed by Venables (1994), who writes, ‘migration in Europe is perhaps insufficiently responsive to economic factors for [the demand linkage] mechanism to be of much relevance to European integration’.4 A second point mentioned in Krugman (1991b), as well as in Krugman and Venables (1995), is that there are signs of a gradual re-industrialisation of the periphery, in North America, Europe and East Asia. Krugman and Venables (1995) use an alternative model, in which labour is internationally immobile (but intersectorally mobile), to generate a three-stage pattern similar to the one described above. They contrast this alternative model to the demand-linkage model (p.860) as follows: Simple geography models like Krugman (1991a) respond in a monotone way to declining transport costs: when these costs fall below a critical level, industry concentrates in one region. Here, because labor is immobile (and

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53

thus wage differentials between regions emerge), continuing reductions in transport costs eventually lead to a reindustrialization of the low-wage region. We believe this is not just an artifact of the model: it represents a real distinction between interregional and international economics because labor is in fact much less mobile between than within nations.

All of this appears to cast doubt on the demand-linkage model, particularly in its application to Europe. However, it is our view that the results of the demand-linkage model that appear at odds with the facts are essentially artefacts of the assumption of perfect labour mobility. With the assumption of imperfect labour mobility (not complete immobility), we show that the experience of Europe is completely consistent with the demand-linkage model. It is entirely possible for a region like the USA, because of its greater labour mobility (flatter labour-supply schedule), to exhibit more pronounced differences in employment and less pronounced differences in per capita income than Europe. It is also entirely possible to generate a threestage integration pattern. The layout of the chapter is as follows. In section 2 we give the details of the structure of Krugman’s model, which provides the labour-demand schedule. We follow this, in section 3, by an examination of the influence of locational preference on labour supply. The resulting equilibria are discussed in section 4, while section 5 consists of some comparative statics exercises of more liberal trade and factor mobility. Section 6 draws some conclusions. 2

The model

We model labour demand using Krugman’s (1991a) model of economic geography. This has two sectors: agriculture and manufacturing. Agriculture produces a homogeneous good according to constant returns to scale with farm labourers as the sole, sector-specific factor. A unit of the agricultural product requires the input of one labourer. The agricultural workers are internationally immobile. In contrast, the manufacturing industry produces differentiated products with increasing-returns-to-scale technology. It employs internationally mobile labour. Each variety of the manufactured good is produced with increasing returns, these scale economies leading to the concentration of production of each variety in a single plant. The homogeneous agricultural commodity can be traded costlessly, while trade in the differentiated good involves iceberg-type trade costs. As a result, there may be a tendency for plants to locate in the country in which demand for the variety is greater, so as to minimise these trade costs. Thus the nominal wage may be higher in the larger country. In addition, the cost

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Rodney D. Ludema and Ian Wooton

of living differs internationally as imported varieties attract trade costs. Workers may therefore have an incentive to move to the industrialised ‘core’ where the real wage is higher than in the agricultural ‘periphery’, and this concentration of workers increases the size of the market in the core and reinforces the decisions of firms to locate there. All individuals share the same Cobb–Douglas utility function: ␮ C1⫺␮, U⫽CM A

(1)

where CA is consumption of the agricultural good and CM is consumption of the aggregate manufactured good. Therefore agents will always spend the proportion ␮ on manufactures. The manufactures aggregate is defined by: N

CM ⫽

␴ ␴⫺1 (␴ ⫺ 1) ␴ ,

冤兺c 冥 i

(2)

i⫽1

where N is the (large) number of potential products and ␴ ⬎1 is the elasticity of substitution among the varieties. There are two countries in the economic region and two sector-specific factors of production in each country. Agricultural workers are internationally immobile, the supply in each country being (1⫺ ␮)/2. Manufacturing workers may move between countries. Let L1 and L2 be the numbers of workers in country 1 and country 2, respectively, where: L1 ⫹L2 ⫽ ␮.

(3)

Production of a representative variety of the manufactured good produced in country i involves a fixed cost and a constant marginal cost: LMi ⫽a⫹bxi.

(4)

where xi is output of that variety and LMi is the labour used in its production. Agricultural output is freely traded and hence agricultural workers’ earnings are the same in both countries and will be our numeraire. For manufactures, a proportion t⬍1 that is shipped from one country arrives in the other. There is a large number of manufacturing firms, each producing a single product and facing an elasticity of demand equal to ␴. Profit-maximising behaviour will lead firms to price their variety at a mark-up over marginal costs: ␴ pi ⫽ bwi, (5) ␴⫺1

冢

冣

where wi is the wage rate of workers in country i. Relative prices must then be: p1 w 1 ⫽ . p2 w2

(6)

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Free entry implies zero profits, hence: (pi ⫺bwi)xi ⫽awi, (7) which implies: a(a ⫺ 1) x1 ⫽x2 ⫽ . (8) b The numbers of varieties of the manufactured good produced in country i is ni. Combining (4) and (8) yields: n1 L1 ⫽ . (9) n2 L2 The quantities of each variety consumed will depend on their prices. Prices of imports must take into account the transport cost. Hence, for country 1, ⫺␴

冢 冣 冢 冣

c11 p1t ⫽ c12 p2

⫽

w1 t w2

⫺␴

.

(10)

where cij is the quantity consumed in country i of a variety manufactured in country j. The share of the manufacturing labour force in country 1 is denoted f ⬅ L1/␮. Define z11 to be the ratio of country 1’s expenditure on local products to its expenditure on varieties imported from country 2, while z12 is the ratio of country 2’s expenditure on manufactured imports to its expenditure on local goods. Therefore: 1⫺ ␴

z11 ⫽

冢 冣

z12 ⫽

冢 冣

w1 t w2 w1 w2 t

1⫺ ␴

f ; 1⫺f f . 1⫺f

(11)

The total income of workers equals the total spending on the products that they produce. If Yi is the national income of region i (including agricultural income), then the nominal wages of an individual worker in each region are: w1 ⫽ w2 ⫽ where:

1 f

冤冢1 ⫹ z 冣Y ⫹ 冢1 ⫹ z 冣Y 冥;

1 1⫺f

z11

z12

1

2

11

12

冤冢1 ⫹ z 冣Y ⫹ 冢1 ⫹ z 冣Y 冥 1

1

1

11

Y1 ⫽

1⫺␮ ⫹w1 f␮ 2

Y2 ⫽

1⫺␮ ⫹w2(1⫺f)␮. 2

2

(12)

12

(13)

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Rodney D. Ludema and Ian Wooton

Figure 3.1

KK, labour demand schedule

For a given allocation of manufacturing labour f, (11)–(13) are a system that determines nominal wages, incomes and spending patterns. Because of transport costs, the prices of manufactures differ in the two countries and therefore the cost of living will be a determinant of a worker’s decision as to location. The price indices of manufactured goods are: P1 ⫽

冤

1⫺ ␴

冤冢 冣

w P2 ⫽ f 1 t

w2 t

1

1⫺ ␴ 1 ⫺ ␴

冢 冣 冥

␴ ⫹(1⫺f) fw1⫺ 1

冥

␴ ⫹(1⫺f)w1⫺ 2

;

1 1⫺␴

.

(14)

Real wages of workers in each country are:

␻1 ⫽w1P1⫺␮; ␻2 ⫽w2P1⫺␮.

(15)

Figure 3.1 illustrates the labour-demand schedule KK, plotting f, the proportion of the (manufacturing) labour force in country 1, against ␻ ⫽ ␻1/␻2, the real wage in country 1 relative to that in country 2. Using an elasticity of substitution between manufactures (␴ ⫽4, as in Krugman, 1991a), the figure shows dramatic differences in the schedules for different trade costs. With high trade costs, the forces of agglomeration are low – when there are consumers in both locations, firms will produce in both countries. This is drawn as KK(t⫽0.5). As trade costs fall, the stronger the agglomerative forces become, as illustrated by KK(t⫽0.6) and KK(t ⫽0.75).

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It is worth noting that having even more liberal trade makes the KK curve flatter. Indeed, as t approaches one, the KK curve approaches horizontal. That the slope of the KK curve rises and then falls as the transport cost is reduced is largely irrelevant in the presence of perfect labour mobility (that is, as in Krugman, 1991a), but it turns out to be very important in the presence of imperfect labour mobility, as we shall see in section 5. 3

Labour supply

Mobile workers are assumed to have different preferences over the location in which they would rather live and work. Because of these, the relative wage that will have to be offered to induce each worker to migrate will depend on the strength of her locational preference. We shall show that this can have a significant effect in mitigating the forces of industrial agglomeration that arise in the presence of increasing-returns-to-scale technology. An industrial worker will make her decision as to where to live and work based on a comparison of real wages, in the light of her strength of preferences for living in each country. Why a worker prefers one country or the other is not explicitly modelled, merely being represented as a discount rate that would have to be applied to the relative real wage in order to induce the worker to move. However, real-world experience certainly provides a great deal of casual evidence of non-pecuniary benefits that individuals enjoy from living in one country or the other.5 These preferences will be represented by a density function and we shall examine how changes in the distribution may alter the structure of industrial production within the region.6 Let (␥i be worker i’s discounting of the real wage offered in country 1, while (1 ⫺ ␥i) is her discounting of the real wage in country 2.7 Worker i will be indifferent between the two locations when the discounted real wages are equalised, that is:

␥i␻1 ⫽(1 ⫺ ␥i)␻2.

(16)

We assume that workers’ preferences are distributed across the interval [0, 1] and we will investigate the consequences of different distributions of national sentiment. Let the (␥i be distributed according to a truncated normal distribution:8 g(␥i;s)⫽

␾(␥i;s)

冦⌽(1;s) ⫺ ⌽(0;s), 0,

0⬍␥i⬍1; elsewhere.

(17)

␾(␥i;s) represents the cumulative normal distribution with mean of 0.5 and standard deviation s ⬎0. ␾(␥i;s) is the probability density function of the same distribution. By adopting this distribution, we are assuming that

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Figure 3.2

MM, distribution of preferences

preferences are symmetric about the mean of 0.5 – that is, indifference between the two locations. The greater is s, the stronger the location preferences of some of the workers. Figure 3.2 illustrates the distribution of workers for various values of s. When s⫽ 0.05, the values of g are spread fairly widely from below 0.4 to above 0.6. A worker at one or other of these values would require a 50 per cent premium to induce her to move from her preferred location. This distribution of preferences is drawn as MM(s⫽ 0.05). Reducing the standard deviation concentrates preferences much more tightly around the mean, requiring smaller migration premia. As an example we have drawn MM(s ⫽0.005). Were s⫽0, workers would have identical preferences and be indifferent between the two countries. Thus MM(s⫽0) is a spike at the mean of 0.5. Let the marginal worker have preference weight ␥¯ i ⫽ ␥, such that a worker whose ␥i ⬎ ␥¯ will choose to live and work in country 1. Then f, the proportion of manufacturing workers in country 1, will be determined by: f⫽1⫺G(␥¯;s),

(18)

where G is the cumulative distribution function, the integral of (17). Define ␪ ⬅(1⫺ ␥¯)/␥¯. This defines the marginal worker and hence, from (16), ␻ ⫽ ␪. Thus we can calculate the labour-supply schedule, showing the relative supply of workers to country 1 given the relative real wage and the degree of disparity in preferences over location. Figure 3.3 plots various laboursupply schedules. LL(s⫽0.05) shows a steep, relatively inelastic schedule,

Are demand linkages relevant in Europe?

Figure 3.3

59

LL, labour supply schedule

corresponding to a fairly broad distribution of tastes. LL(s⫽0.005) plots a more elastic labour-supply curve where workers need less to induce them to migrate. LL(s ⫽0) is a perfectly elastic supply schedule corresponding to a worker being indifferent between locations, which is the case implicitly assumed by Krugman (1991a). 4

Equilibrium

We have now established a labour-demand schedule, showing the proportion of the manufacturing labour force that will be employed in country 1 as a function of the relative real wage offered by that country, given the level of international transport costs. We have also found the labour-supply schedule, showing the willingness of workers to take employment in country 1 as a function of the real wage and for particular distributions of preferences over locations in the two-country region. Our next task is to determine the equilibrium employment pattern, resulting from these preferences and transport costs. An equilibrium arises either at a point of intersection between the demand and supply schedules (an interior solution) or at either end-point, where all of the manufacturing labour is employed in a single country (a corner solution). Not all equilibria are stable solutions: a stable interior equilibrium requires that the labour demand schedule (KK) have a slope less than that of the labour supply schedule (LL) at the point of intersection. A stable corner solution occurs when the LL schedule lies above the

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(a)

(b)

Figure 3.4

Equilibrium allocations

KK schedule at f⫽0 or when the LL schedule lies below the KK schedule at f⫽1 (all manufacturing workers employed in country 2 or country 1, respectively). If labour is in perfectly elastic supply, as in Krugman (1991a), the labour-supply schedule LL(s ⫽ 0), illustrated in figure 3.4a, is flat at relative wage ␻ ⫽ 1. Three possible configurations of equilibria are possible, depending crucially on the level of the trade costs. The forces of

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agglomeration are weak when transport costs are high. Thus, when trade costs are high as in KK(t ⫽ 0.5), the labour demand curve is downwardsloping, crossing LL(s ⫽ 0) from above at the single equilibrium of diversified production, f ⫽ 1⁄2. As trade costs are reduced the labour-demand schedule changes slope as the forces of agglomeration become stronger. At some intermediate levels of trade costs, such as KK(t ⫽ 0.6), the labourdemand schedule cuts ␻ ⫽ 1 at three points, yielding five equilibria. The interior equilibrium of diversified production (f ⫽ 1⁄2) remains stable and, in addition, the two corner equilibria (corresponding to complete agglomeration in one or other of the countries) are stable, while the other two equilibria are unstable. If transport costs are reduced sufficiently, the labour-demand curve becomes everywhere upward-sloping, as with KK(t ⫽ 0.75), and diversification becomes unstable and only agglomerated equilibria are stable. Now consider the implications of labour being in less-than-perfectlyelastic supply – that is, when the labour-supply schedule slopes upwards. One thing is immediately clear: when the labour-demand schedule is downward-sloping, as is the case for KK(t⫽0.5) in figure 3.4a, a diversified equilibrium will continue to be the only possibility, irrespective of the degree of international labour mobility. However, an inelastic labour supply will mitigate agglomerative forces and diversification may remain a stable equilibrium even when demand linkages are relatively strong. Thus in figure 3.4a, the curve LL(s⫽0.05) is steeper than KK(t⫽0.75) and consequently manufacturing will be spread across the region, despite the agglomerative forces. Agglomeration of manufacturing activity is not an equilibrium in the case of LL(s⫽0.05), as this corresponds to a distribution of workers’ preferences over locations such that substantial premia would have to be paid to induce many workers to migrate. What would be the result were workers, on the whole, less concerned with location? With LL(s⫽0.005) workers are closely concentrated around the mean (indifference) and the tails of the distribution are virtually empty. Yet even this degree of locational preference may be sufficient to offset the forces of industrial agglomeration and result in diversification across the region. In figure 3.4b, the labour demand schedule KK(t ⫽0.63) is positively-sloped which, if labour were freely mobile, would result in an agglomerated equilibrium. But even with a distribution close to indifference the equilibrium can be diversified production. However, agglomerative forces may dominate, resulting in agglomeration outcomes becoming stable equilibria in addition to or in place of the diversified equilibrium. Thus KK(t⫽0.65) intersects LL(s⫽0.005) five times: a stable, diversified equilibrium bounded by two unstable equilibria which are themselves flanked by stable, agglomerated equilibria. But there may

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now be some workers for whom the economic inducements will never be sufficient for migration. Consequently, the agglomeration is not complete and a small share of the manufacturing labour force remains in the periphery. This is also the case for outcomes where only the agglomerated equilibria are stable, as when the labour-demand schedule KK(t⫽0.67) intersects LL(s⫽0.005). This situation is interesting, both in being consistent with casual empiricism (no country is left entirely without a manufacturing sector) and in providing a genuine role for government policy to encourage industrial location (beyond the ‘bang-bang’ nature of policies when agglomeration is complete and migration incentives lead to a total move of all manufacturing from one country to the other).9 How consistent is our model with reality? Let us compare some stylised facts for the USA and the EU. The American economy can be characterised as a fully integrated market, with few or no barriers to inter-state factor movements and low internal-trade costs. Consequently, it will have an upward-sloping (but not very steep) labour-demand curve and a virtually flat labour-supply schedule. The resulting equilibrium yields a highly agglomerated economy, with a relatively low income differential. In Europe, trade barriers are low, but higher than those in the USA, while impediments to factor movements are also greater (for both administrative and cultural reasons). Agglomeration forces may still be strong (KK upward-sloping), but both the labour-demand and labour-supply curves will be steeper than those of their American counterparts. Manufacturing will have a partially agglomerated equilibrium fairly close to diversification and there will be a higher wage differential than that in the USA. Thus the experience of Europe relative to the USA is quite consistent with the demand-linkage model. We have shown that is possible to construct cases where the equilibrium is diversification or partial agglomeration depending on the strength of the agglomerative forces on the labour-demand side and the immobility or unwillingness of labour to move on the supply side. What we now want to show is that, even when labour is initially relatively immobile (as, say, in Europe), the demand linkages that generate agglomerative forces will be important in determining the response of the region to market integration. 5

Economic integration

We model economic integration in two ways: the lowering of trade barriers and an increase in the willingness of labour to migrate. Trade is liberalised as t is increased, free trade being attained when it reaches unity. Improved labour migration will be reflected in weaker locational preferences of all

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63

workers (that is, reductions in s), such that a lower premium is necessary to induce each worker to move to the other country. While liberalisation of trade and factor movements will lead to more efficient production of manufactures within the region, it may have serious distributional consequences. Specifically, whenever agglomeration occurs, those factors left in the periphery will suffer lower real incomes as fewer manufactures are locally produced, resulting in a higher cost of living. The local governments will then have an incentive to try to ensure that the core develops in their country, an issue examined in another paper (Ludema and Wooton, 1998). 5.1

Trade liberalisation

With freely internationally mobile labour, trade liberalisation will eventually reach the point at which agglomerative forces are sufficiently strong that the region will jump from having industry dispersed between the countries to a core–periphery pattern of production. Once this jump has occurred, the pattern will be maintained for any further trade liberalisation. This will not, in general, be the outcome of trade liberalisation when labour is less freely mobile between the countries in the region. Instead, two possibilities arise. First, lowering trade costs will affect the allocation of labour between countries, leading to agglomeration only in situations in which the slope of the labour-demand schedule is positive (so that the forces of agglomeration are strong) and steeper than the labour-supply schedule. Therefore, if the labour-supply line remains steeper than the labour-demand schedule at any level of trade costs, 0ⱕtⱕ1, then agglomeration will never occur, despite the trade liberalisation. Thus, unless the region has sufficiently mobile workers, agglomerative forces can be held at bay and the region will always have widely dispersed industry. This situation seems to be what Venables (1994) has in mind when he suggests that European migration is ‘perhaps insufficiently responsive to economic factors’ for agglomerative forces ‘to be of much relevance to European integration’. The second, and more intriguing, possibility arises when labour is more freely (but not completely) mobile. This is illustrated in figure 3.5 in which LL(s⫽0.005) represents a fairly elastic labour supply and the KK schedules show labour demand under increasingly liberal trade (from fairly high trade barriers with KK(t⫽0.6) to free trade for KK(t⫽1)). In these circumstances demand linkages can certainly have a role to play. The initial stages of trade liberalisation will shift the labour-demand schedule from a negatively-sloped function (at the diversified equilibrium of f⫽ 1⁄2) to one that is positively-sloped. As the slope increases, there may be a range of trade costs for which the labour-demand curve becomes steeper than the

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Figure 3.5

Changing trade costs

labour-supply curve at f⫽ 1⁄2. Consequently, manufacturing will gradually move to a partially agglomerated equilibrium with all but the least mobile workers from one country having moved into the industrial core. However, this agglomeration will be only a temporary phenomenon as trade liberalisation proceeds. If trade costs continue to fall, the labourdemand schedule gets flatter again, as trade liberalisation weakens the agglomerative forces. (At free trade, labour demand is perfectly elastic because, even with demand linkages, there are no benefits to agglomeration if goods can be costlessly moved around the region.) Therefore workers will begin to desert the core and return to their preferred locations. Eventually, trade liberalisation will have progressed sufficiently for the region to return to a stable, diversified equilibrium. Thus weak locational preferences (less-than-perfectly mobile labour) may result in three phases of trade liberalisation. It may initially drive production from diversification into partial agglomeration and then back into diversification, as the curves cross then re-cross. These effects are qualitatively different from those derived under the assumption of freely mobile labour, both in the temporary nature of the agglomerated equilibrium and the fact that the degree of industrial concentration (when agglomeration occurs) varies with the transport cost. We sketch out the shift from diversification to agglomeration (and back again) as trade is liberalised in figure 3.6. Trade liberalisation is indicated by declining (1 ⫺t). Stable equilibria are drawn as solid lines, while the dotted lines indicate unstable equilibria. Were labour freely mobile, we

Are demand linkages relevant in Europe?

Figure 3.6

65

Trade liberalisation and location of industry

would see the now familiar ‘pitchfork’ diagram where trade liberalisation initially adds stable agglomerated equilibria to the initial unique equilibrium of diversified production.10 Further reduction in trade barriers changes the slope of the KK curve and only the diversified equilibria remain stable until all trade impediments are eliminated. Instead of this, we find that the agglomerated equilibria do not involve such an extreme concentration of manufacturing. As trade liberalisation progresses, initially the agglomerative forces increase and the equilibria shift further apart. Eventually though, as was pointed out above, continued demolition of trade barriers lessens the incentive for agglomeration. Consequently, the agglomeration will become less pronounced, ultimately disappearing as the region returns to diversified production. Thus, in place of the pitchfork we have a shape somewhat more reminiscent of a spearhead. 5.2

Increased labour mobility

If economic integration can also take the form of reduced barriers to labour migration (say, in the form of improvements in foreign-language instruction), then the labour-supply schedule will rotate, becoming flatter. When agglomerative forces are weak (the labour-demand schedule being negatively- sloped) increased labour mobility, for any given level of trade costs, will have no effect and diversification remains the sole equilibrium. For stronger demand linkages, the labour-demand schedules will be upward-sloping. If initially the labour supply is relatively inelastic, increased labour mobility may cause the equilibrium allocation to change from diversification to increasing agglomeration as the slope of the labour-supply

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schedule falls. Thus improving labour mobility will enable agglomerative forces to have an increasing effect. 5.3

Comprehensive regional integration

We now consider moves towards establishing a common market in the region with free trade and unrestricted international labour movements. Trade liberalisation is clearly a worthwhile objective in this setting. Indeed, we have shown that completely free trade in goods eliminates the need of movements of factors of production and, consequently, this may be the only policy that the governments of the region need pursue. Though labour mobility would not be necessary to achieve economic efficiency, it may be desirable in meeting the social or political aspirations of the region. The results of sub-sections 5.1 and 5.2 indicate that the timing of the two elements of regional integration – trade liberalisation and increased labour mobility – may be crucial in avoiding temporary dislocations in production and local employment. If labour is initially relatively immobile, trade liberalisation will take place without inducing any international migration. Once a (fairly) liberal trade regime is established, a diversified equilibrium will arise. In that situation factor movements could be allowed, or even encouraged, though no net international movements will be necessary to maintain the diversified equilibrium. If, however, trade liberalisation takes place in the presence of reasonably footloose labour, it might lead to swings towards agglomeration and then back to diversification, with the associated emigrations and return migrations of manufacturing workers. These temporary dislocations in the labour market could cause a great deal of undesirable social upheaval throughout the region. These problems might be avoided by sequencing the integration policies. Specifically, a restriction on international movements of labour while the trade barriers are being dismantled would suppress the labour migrations that would be induced by the agglomerative forces. These forces decline as trade barriers fall. Hence, once free trade in manufactures has been established, barriers to factor mobility could be reduced. This policy prescription is already foowed by the EU in agreements with new members. The EU and acceding countries initially eliminate their bilateral tariffs, while restrictions on factor mobility are maintained for several years before being lowered. This ensures that industrial structures can adjust without inducing problems of large, temporary international labour migrations. In particular, it ensures that the acceding country has a better chance of retaining its manufacturing sector and does not experience deindustrialisation through its union with a larger economic entity.

Are demand linkages relevant in Europe?

6

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Conclusions

This chapter uses elements of the new economic geography to examine regional integration. A common market is attained by the elimination of both barriers to trade in goods and impediments to factor mobility. While a lot of attention has been given to the effects of trade liberalisation in models of economic geography, our explicit consideration of issues of factor mobility is both novel and yields outcomes that differ significantly from those where a single regional market for homogenous labour is assumed. If workers differ in their willingness to move between regions, the equilibrium regional distribution of industry may be affected. First, the reluctance of some workers to move may constrain the forces of industrial agglomeration, leading to countries retaining shares of industrial production which would have been drawn into a core area of the region if labour were more freely mobile. Second, even when agglomeration occurs, it will not be complete, as some workers will remain unwilling to migrate in equilibrium. Trade liberalisation will induce a smoother transition in regional manufacturing activity than occurs with freely mobile labour. However, as a diversified industrial structure will be the equilibrium for both high trade costs and low trade costs, it may be advisable to restrict labour movements until the trade liberalisation phase is complete.11 We conclude that economic-geography models are indeed relevant to common markets, such as Europe. When demand linkages are sufficient to generate strong agglomerative forces, the national governments will have to take some care in choosing both the depth of integration and the timing of its achievement. NOTES Paper presented at the Venice conference (24–25 January 1997). We wish to thank Giorgio Basevi, Julia Darby, Riccardo Faini and Jim Malley for their help, comments, and suggestions. 11 Thus the single-market initiative of the EU sought to advance the ‘four freedoms’, two of which were free trade in goods and free mobility of labour. 12 Krugman considers regions within a country. However, given our interest in the EU, we re-label the model to have international migration between countries that are part of a common factor market. 13 Europe’s hub is ‘somewhere in or near Belgium’ (Krugman, 1991a, 484). 14 If agglomerative forces are strongest at the level of particular industries, and not manufacturing as a whole, Krugman and Venables (1995) suggest that the economic geography of Europe will be affected, despite a relatively low degree of international labour mobility.

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15 Indeed, a small differential in real wage rates between Glasgow and Washington, DC would not be sufficient to induce either author to change location. 16 This approach to modelling labour supply is similar to that of Faini (1996). 17 For analytical convenience we have assumed 0 ⱕ␥i ⱕ 1. The level of ␥i is not important, the relevant number is the ratio ␥i /(1⫺ ␥i), which can take any nonnegative value. 18 We adopt a normal distribution for convenience, and are grateful to Giorgio Basevi for encouraging us to use the normal. We wish to have a distribution of tastes such that some workers are more willing to migrate than others and that allows us to make parametric changes to the degree of labour mobility. 19 We investigate the roles of national governments in influencing location elsewhere (Ludema and Wooton, 1998). 10 See, for example, Puga (1996). 11 Indeed, countries acceding to membership of the EU typically lower trade barriers before intra-regional factor mobility is permitted. REFERENCES Faini, R.(1996). ‘Increasing Returns, Migrations and Convergence’, Journal of Development Economics, 49, 121–36 Krugman, P. (1991a). ‘Increasing Returns and Economic Geography’, Journal of Political Economy, 99, 483–99 (1991b).Geography and Trade (Cambridge, MA: MIT Press) Krugman, P. and A. J. Venables (1995). ‘Globalization and the Inequality of Nations’, Quarterly Journal of Economics, 110, 857–80 Ludema, R. D. and I. Wooton (1998). ‘Economic Geography and the Fiscal Effects of Regional Integration’, CEPR, Discussion Paper, 1822 Puga, D. (1996). ‘The Rise and Fall of Regional Inequalities’, CEPR, Discussion Paper, 314 Venables, A. J. (1994). ‘Economic Integration and Industrial Agglomeration’, Economic and Social Review, 26, 1–17

Discussion G IO RGI O BASE V I 1

Introduction

In their chapter 3, Ludema and Wooton (hereafter, LW) integrate Krugman’s (1991) model by considering an imperfectly elastic supply of labour with respect to international differences in real wages. Thus, they get

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15 Indeed, a small differential in real wage rates between Glasgow and Washington, DC would not be sufficient to induce either author to change location. 16 This approach to modelling labour supply is similar to that of Faini (1996). 17 For analytical convenience we have assumed 0 ⱕ␥i ⱕ 1. The level of ␥i is not important, the relevant number is the ratio ␥i /(1⫺ ␥i), which can take any nonnegative value. 18 We adopt a normal distribution for convenience, and are grateful to Giorgio Basevi for encouraging us to use the normal. We wish to have a distribution of tastes such that some workers are more willing to migrate than others and that allows us to make parametric changes to the degree of labour mobility. 19 We investigate the roles of national governments in influencing location elsewhere (Ludema and Wooton, 1998). 10 See, for example, Puga (1996). 11 Indeed, countries acceding to membership of the EU typically lower trade barriers before intra-regional factor mobility is permitted. REFERENCES Faini, R.(1996). ‘Increasing Returns, Migrations and Convergence’, Journal of Development Economics, 49, 121–36 Krugman, P. (1991a). ‘Increasing Returns and Economic Geography’, Journal of Political Economy, 99, 483–99 (1991b).Geography and Trade (Cambridge, MA: MIT Press) Krugman, P. and A. J. Venables (1995). ‘Globalization and the Inequality of Nations’, Quarterly Journal of Economics, 110, 857–80 Ludema, R. D. and I. Wooton (1998). ‘Economic Geography and the Fiscal Effects of Regional Integration’, CEPR, Discussion Paper, 1822 Puga, D. (1996). ‘The Rise and Fall of Regional Inequalities’, CEPR, Discussion Paper, 314 Venables, A. J. (1994). ‘Economic Integration and Industrial Agglomeration’, Economic and Social Review, 26, 1–17

Discussion G IO RGI O BASE V I 1

Introduction

In their chapter 3, Ludema and Wooton (hereafter, LW) integrate Krugman’s (1991) model by considering an imperfectly elastic supply of labour with respect to international differences in real wages. Thus, they get

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a larger set of possible outcomes, some of which throw useful insights on the question of the preferred sequence between liberalisation of trade in goods, or of labour movements, as the process of international economic integration proceeds. I shall concentrate my comments on two main issues, and briefly mention a few other points. 2

The first issue: stable and unstable equilibria

The number of possible outcomes identified by LW is incomplete. In order to see it, notice that the demand for labour in Krugman’s model, and the supply of labour in LW’s model, are both non- linear in the (f, ␻) space; while their analytical expression is not easily derived, numerical simulations suggest that they may present at least one point of inflection. Moreover, the demand function is not monotonic in ␶. It is negatively-sloped for high transport costs (i.e. for a low value of ␶), it gets positively-sloped as transport costs are reduced (i.e. for a high value of ␶), but it flattens as they tend to zero (i.e. as t tends to unity). As for the supply function, it is positivelysloped but, in LW’s example, it gets flatter as labour becomes internationally more mobile (i.e. as ␣ ⫽ ␤ tend to infinity). Consider first the case analysed by Krugman (i.e. when the supply of labour function is horizontal – when ␣ ⫽ ␤ tend to infinity in LW’s model). We have three possible sub-cases: (1a) The demand for labour function is negatively-sloped (high transport costs, or a low value of ␶). In this case (figure D3.1a) there are three equilibria, but the two corner ones are unstable, while the unique interior equilibrium is stable. The two countries get the same (half) share of manufactures. (1b) The demand for labour function is positively-sloped (low transport costs, or a high value of ␶). Also in this case (figure D3.1b) there are three equilibria, but the two corner ones are now stable, while the unique interior equilibrium is unstable. One or the other country gets all of the manufacturing sector. (1c) The slope of the demand for labour function alternates in sign (intermediate transport costs, or an intermediate value of ␶). In this case (figure D3.1c) there are five equilibria, the two corner ones are stable, like the middle one, while the two intermediate ones are unstable. Thus there are two possibilities: complete agglomeration of industry in one or the other country, or the two countries get half of the industrial sector each. Consider now the case analysed by LW – i.e. when the supply of labour function is positively-sloped (when 0ⱕ ␣ ⫽ ␤ ⱕ⫹⬁). We have four possible subcases:

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(a)

(b)

(c)

Figure D3.1

Supply of labour function horizontal

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(2a) The demand for labour function is negatively-sloped (high transport costs, or a low value of ␶). In this case (figure D3.2a) there are three equilibria, but the two corner ones are unstable, while the unique interior equilibrium is stable. The two countries get the same (half) share of manufactures. Thus the implications of this case are the same as those of case (1a). (2b) The demand for labour function is positively-sloped, it cuts the supply of labour function only once, and with a larger slope in the neighbourhood of the crossing point. In this case (figure D3.2b) there are three equilibria, the two corner ones are stable, while the unique interior equilibrium is unstable. One or the other country gets all of the manufacturing sector. Thus the implications of this case are the same as those of case (1b). (2c) The demand for labour function is positively-sloped, it cuts the supply of labour function only once, and with a smaller slope in the neighbourhood of the crossing point. In this case (figure D3.2c) there are three equilibria, the two corner ones are unstable, while the unique interior equilibrium is stable. The two countries get the same (half) share of manufactures. Thus the implications of this case are the same as those of cases (1a) and (2a). (2d) The demand for labour function is positively-sloped, it cuts the supply of labour function three times, with a smaller slope in the neighbourhood of the first crossing point, with a larger slope in the neighbourhood of the second crossing point, and again with a smaller slope in the neighbourhood of the third crossing point. In this case (figure D3.2d) there are five equilibria, the two corner ones are unstable, like the middle one, while the two intermediate ones are stable. Thus there are two alternative solutions, both with incomplete agglomeration of industry in one or the other country. This is the case emphasised by LW. (2e) The demand for labour function is positively-sloped, it cuts the supply of labour function three times, with a larger slope in the neighbourhood of the first crossing point, with a smaller slope in the neighbourhood of the second crossing point, and again with a larger slope in the neighbourhood of the third crossing point. In this case (figure D3.2e) there are five equilibria, the two corner ones are stable, like the middle one, while the two intermediate ones are unstable. In this case there are two possibilities: complete agglomeration of industry in one or the other country, or the two countries get half of the industrial sector each. This is the same result as in case (1c). It follows from this last case, which LW have not considered, that their conclusions (‘if workers have some, limited location preferences, . ..

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(a)

(b)

(c)

Figure D3.2

Supply of labour function positively-sloped

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(d)

(e)

Figure D3.2

(cont.)

complete agglomeration is not an equilibrium outcome, while an equal allocation of workers ... is an unstable equilibrium’), and (‘If workers differ in their willingness to move between regions, ... even when agglomeration occurs, it will not be complete’), are not correct generally. Moreover, their result is based on the particular inflection of the supply of labour function, which initially is concave downward and then turns concave upward. This, however, depends on the assumption that ␣⫽ ␤ in the frequency distribution of workers’ preferences. With ␣ large enough relative to ␤, it is possible to get the opposite sequence of concavity, as in case (2e) represented above in figure D3.2e. In fact it would have been natural, it seems to me,

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that, having selected a ␤-distribution, which allows us to control for both the concentration of workers around the mode and the skewness of their distribution, LW should not have abandoned this second possibility by imposing ␣⫽ ␤: if so, they might as well have used a simpler symmetrical distribution, like the normal one. 3

The second issue: different initial countries’ sizes

The above analysis implies that in cases (1c) and (2e) an important element is the initial difference in the relative size of a country’s industrial sector. If the countries that decide to integrate are close in their initial shares of the industrial sector, then they will convergence to the even solution, each of them getting half of the sector. On the other hand, if the countries have widely different initial shares of the industrial sector, then equilibrium will move to the complete agglomeration solution. This suggests that, in choosing the countries to integrate, it is important to consider how wide apart they are in their relative economic structure. This is a conclusion reminiscent of a similar one, obtained with a growth model by Dallas and De Vries (1995).1 Consideration of the relative size of the industrial sectors in the countries that decide to integrate their economies also provides additional suggestions about the sequence of liberalisation of trade and of labour mobility, on which LW concentrate most of their conclusions. In fact, since we have seen that cases (1c) and (2e) may induce a country to lose all of its industrial sector if it has a relatively small share of it to start with, it follows that countries that plan to integrate with others endowed with a relatively larger share of the industrial sector should avoid falling in the traps of these two cases. As figures D3.1c and D3.2e indicate, this can be obtained by rotating counterclockwise the supply of labour (or clockwise the demand for labour), so as to eliminate the crossing points with unstable equilibria. This can indeed be done by increasing the obstacles to labour mobility when liberalising trade in goods. 4

Duality between trade and factor movements

The preceding section followed the suggestions of LW’s chapter by considering as most appropriate the sequence of liberalising trade first, and then allowing also international labour movement. As pointed out by LW, this is indeed the approach taken in the EU. However, other areas of integration have experimented a different sequence. Consider NAFTA, but also the EU vis-à-vis its Eastern and Southern neighbours, where liberalisation of trade has followed the (possibly illegal) mobility of labour, and in fact it has been implemented in order to avoid or limit migration.

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This leads me to consider that the neatness of the Heckscher– Ohlin–Samuelson (HOS) framework, where mobility of products and of factors are dual to each other, is lost in the geo-economic model à la Krugman. It would be interesting to explore under what conditions such a duality could be recovered, without losing the richer characterisation of the geo-economic structure that Krugman’s models allow. 5

Workers’ preferences dependent on the outcome

In the model used by LW to characterise labour preferences about location, these are predetermined and do not change with the result. It might be interesting to consider an alternative model, where preferences about location are partly exogenous and partly dependent on the results of the more or less diffused density of the industrial population in the two countries; this, however, would require making the model explicitly dynamic.2 NOTES 1 Their model was also used by Basevi (1991) to analyse the prospects of German re-unification. 2 Attempts along these lines are those by Bertola (1993) and Faini (1995).

REFERENCES Basevi, G. (1991). ‘Eastern Europe, Germany and the EC: A Framework for Analysing their Economic Integration’, in W. Heisenberg (ed.), German Unification in European Perspective (London: CEPS, Brassey’s) Bertola, G. (1993). ‘Models of Economic Integration and Localized Growth’, in F. Torres and F. Giavazzi, Adjustment and Growth in the European Monetary Union (Cambridge: Cambridge University Press) Faini, R. (1996). ‘Increasing Returns, Migrations and Convergence’, Journal of Development Economics, 49, 121–36 Dallas, H. and C.G. De Vries (1995). ‘Piecemeal versus Precipitous Factor Market Integration’, International Economic Review, 36, 569–82 Krugman, P. (1991). ‘Increasing Returns and Economic Geography’, Journal of Political Economy, 99, 483–99

4

Beyond international factor movements: cultural preferences, endogenous policies and the migration of people: an overview A RY E L . HIL L MAN AND AV I W E IS S

While international migration can be studied as a case of international factor mobility in response to factor-reward differences, we can also proceed beyond theories which view immigration in terms of international factor movements. (1) Rather than considering migration only in terms of location responses of apersonal factors of production, we might wish to consider the greater complexities that are introduced by recognition of the personal relationships and characteristics of people. (2) We might wish to consider whether and how national and cultural preferences influence immigration policies. (3) We might wish to view countries’ immigration policies as endogenously determined by the self-interest of pre-existing residents. Such directions of investigation suggest that the economic considerations that are stressed by the theory of international factor movements only partially explain the propensity of national states to control and restrict immigration. For immigration policies are also seen as reflecting cultural preferences and affinities, and perhaps likes and dislikes that are contained in the collective memories of different peoples. Although these latter considerations add relevant dimensionalities to the study of international migration, incentives derived from comparative incomes retain a primary role in providing a market foundation for international migration. In section 1 we provide a brief overview of international migration, as presented by the theory of international trade and factor mobility (for more comprehensive accounts than we present here, see Wong, 1995, and chapter 2 in this volume), but we observe how differences in policies adopted by countries toward trade and immigration are inconsistent with policy symmetries implied by the theory. To investigate the possible source of the policy asymmetry, in section 2 we place cultural preferences inside a Tiebout locational-choice model as a means of describing collective 76

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attributes of culturally homogeneous populations. We observe, however, the explanatory limitations of the Tiebout model that are due to inconsistencies between the locational analogue of voluntary market choice and exclusion from jurisdictions effected by restrictive immigration policies. In section 3 we review approaches to international migration which go beyond the theory of international factor movements by endowing people with personal locational preferences and attributes and by acknowledging that people may have families. Section 4 reviews models where the migration policies chosen by countries are endogenous – that is, policies are explained by economic and political self-interest and the institutional mechanisms of collective choice. Section 5 draws conclusions. While this chapter complements the picture of international migration as described in the traditional models of international factor movements, the complete range of complementary issues is broad, and their investigation at the time of writing remains incomplete and awaits further research into how preferences based on cultural affinity affect economic behaviour and the endogeneity of economic policies. 1

Policy asymmetries

In the classic models of international trade, factors of production are internationally immobile. This is indeed the means of defining the country. A ‘country’ is a collection of factors of production located in the same national jurisdiction. Free trade in goods among such collections of factors of production is efficient (absent various second-best arguments that are due to assumptions of market imperfections) and, likewise, market incentives lead factors of production to move internationally to maximise income. Depending on the assumptions regarding technology, international trade in goods and international movements of factors of production may be substitutes or complements (that is, trade in goods may enhance or diminish the incentives for factors of production to move internationally). The efficiency of free trade has not pre-empted protectionist policies, instituted ostensibly and primarily for income-distribution reasons (see Hillman, 1989). The barriers against free movement in goods have historically been less intense than the restrictions countries have imposed on the free international movement of labour, and policies with regard to the international movement of real capital have in general also been more liberal than labour immigration policies (see Schultze, 1998). The standard international-economics models do not address these asymmetries in policy. Let us adopt a Heckscher–Ohlin (HO) view of the world, where international movements of goods and factors of production are substitutes. We can rephrase the above observations as follows: countries have been more open

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to indirect inflow of factor services embodied in goods and to direct capital flows than to direct inflows of labour. In HO and in the other international-economics models, factors of production are apersonal entities. Indeed, in principle in HO it matters not for the basic results whether goods move or factors move – and if factors move internationally, it does not matter which factor moves; the results are the same (see Mundell, 1957). The Rybczynski theorem tells us that residents of a country diversified in production should not care at all about international movements of labour or capital, since international-factor movements do not affect their real incomes (changes occur only in domestic production patterns and the content of international trade). The factorprice equalisation (FPE) theorem tells us that it is a matter of indifference for relative incomes of factor owners in production-diversified countries whether goods or factors move internationally. Depending on the specification of the model, more complex and varied outcomes are also possible. Davies and Wooton (1992) distinguish between the incomes of pre-existing residents and immigrants in a model with two traded goods and three factors of production, and formulate a taxonomy which includes results which deviate from the usual presumptions about the income-distribution consequences of immigration of skilled and unskilled labour. The relation between immigration and domestic income distribution is tied to a debate regarding the extent to which the widening disparity between incomes of skilled and unskilled workers in the USA, and the unemployment of unskilled workers in the EU, is due to international trade, or to technology which has advantaged skilled and disadvantaged unskilled workers (see the overviews by Richardson, 1995; Wood, 1995; Slaughter and Swagel, 1997). The evidence reveals the presence of both effects. To the extent that the predictions of the international FPE theorem have been realised, we are confronted with the question: why have the income disparities been permitted to develop via trade, when policies have nonetheless restricted the direct immigration of foreign unskilled labour which would have had the same adverse consequences for unskilled labour in the developed countries? That is, if policies reflect voters’ preferences, then the policies which have prevented direct entry of foreign labour via immigration would be expected to have been complemented by policies which pre-empt the FPE theorem – and (since relative product prices have changed either because of liberal trade policies or changes in world prices) also pre-empt the income-distribution consequences of the Stolper–Samuelson theorem. We have here used the framework of the HO model as if the income-distribution consequences of that economic model alone mattered for policy. The HO model comes naturally to mind as a framework to consider the interface between trade and immigration policies, because of the natural

Cultural preferences, endogenous policies and the migration of people 79

intuition that is offered for the relation between product-embodied and direct international-factor movements, and because the skilled–unskilled income differentials appear to be a reflection of the type of long-run changes that are described by that model. One might, however, wonder also if any policy-maker or voter has ever believed or acted upon the prediction of the Rybczynski theorem (if he or she knew it). With some few exceptions (NAFTA in the USA, for example), policy questions have been formulated in terms of economic interests as identified in the shorter-run specificfactors model of international trade. Factor owners with industry associations have identifiable self-interested trade policy positions, but domestically intersectorally mobile factors of production do not – and domestically intersectorally mobile factors of production do not confront the indifference to labour immigration of the Rybczynski theorem but are rather exposed to real income declines by the immigration of competing foreign labour. It seems reasonable that voters find appealing the idea, presented by the long-run HO model, that the indirect entry (via embodiment in imports) of foreign low-cost labour into a country disadvantages domestic labour. At the same time, voters can also be expected to find appealing the idea, put forward in the short-run specific-factors model, that the direct entry of immigrants competing with domestic labour is also disadvantageous. If there is a presumption one way or the other in the short-run specific-factors model, it is that mobile labour benefits from free trade (see Ruffin and Jones, 1977). Yet domestic mobile labour (which is of course mobile in both the short and the long run) ostensibly bases its trade-policy position on the factor-content propositions of the long-run HO model, and its position on immigration policy on the short-run specific-factors model. Whether or not voters are aware that their policy positions derive from two different economic models cannot be expected to affect self-interested voting behaviour. In practice, the distinction between labour and capital owners is not as stark as presented in the traditional basic models. In modern market economies, the Marxist demarcation has not been realised, and workers are also capital owners to different degrees (see Mayer, 1984 on how both the HO and specific-factors models can incorporate diverse factor sources of peoples’ incomes). We can suppose that the distribution of ownership of productive wealth leaves the median voter not particularly well endowed with capital, but the policy success of the median voter has been more in keeping out or restricting access of foreign labour seeking to immigrate than in keeping out the same foreign labour via international trade. We thus have a fundamental policy asymmetry. The policies adopted in the developed world have allowed for liberal trade in goods and also liberal real-capital exports which disadvantage low human-capital residents. The

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same order of liberalism has, however, not been observed in policies toward labour immigration. Differences can be noted in the presumed basic rights. Liberal trade policies reflect the right to transact in markets without prejudice due to the jurisdictional location of the buyers and sellers. Liberal policies with regard to international investment reflect property rights to capital and the right of the owner to choose how and where his or her capital can most profitably be placed. The same liberalism with regard to international migration would presume the right of an individual to choose freely where he or she wishes to live and work without regard for the placement of national boundaries. 2

Cultural preferences and immigration policy

The policy asymmetry that is reflected in the restrictions on the immigration of labour implies that we cannot view factors of production as interchangeable if we wish to explain policy decisions. Labour is of course distinct from goods and capital, in that the latter are inanimate whereas labour consists of people. People have cultures and cultural preferences, and these cultural preferences can in turn affect population and immigration policies. Besides determining immigration policies, own-culture preferences can also lead a local population to implement policies of expulsion. We need only consider the history of the many expulsions of the Jews from different domains of Christian Europe, and in more contemporary times the expressions of anti-immigrant sentiment in election results in France and Austria and the behaviour of fringe groups in Germany and in Denmark. What, then, are we to make of cultural preferences – if we do not wish to ignore the influence of these preferences on immigration policies? An approach that an economist can offer to introduce cultural preferences is a Tiebout-type locational model (see Hillman, 1994). Charles Tiebout (1956) proposed that locational choice among competing jurisdictions offers a solution to the preference-revelation problem for public goods. Jurisdictions are able to exclude outsiders from consumption of the goods that are collectively provided to residents. Exclusion permits a price for access to be charged, so that the different offerings provided by jurisdictions have the character of a market where consumers confront price offers for different quantities and types of collective goods. Under the assumptions set out by Tiebout, locational choice becomes a perfect substitute for a competitive market in collective goods, and the Pareto-efficiency of the market for public goods is restored. Applying the Tiebout model in the context of migration policies, we perceive jurisdictions with cultural preferences and other

Cultural preferences, endogenous policies and the migration of people 81

manifestations of attributes of people. People who wish to live with certain types of other people congregate together in the same jurisdiction. The cultural preferences can be expressed in a federal system. For example, in the USA the Amish people choose to pursue their own values and live within their own culture within their closed communities, but under the jurisdiction of the state of Pennsylvania and the US federal government. A liberal view upholds the basic right of such congregations of people to adopt a policy of cultural homogeneity, even if there are differences from mainstream values and culture – subject to evident qualifications regarding humaneness and external effects. These qualifications are satisfied for the Amish. The qualifications are not satisfied, for example, if a community of people has a culture where there is predatory behaviour towards neighbours and neighbouring communities and peoples. Cultural preferences can also be expressed at the national level. The Amish do not use immigration policy to restrict entry into their culturally homogeneous communities, since they have no jurisdiction over immigration policy. Such preferences were, however, expressed in the immigration policies of the American states before federation, and have been expressed in the immigration policies of the USA: the Lady of the Statue of Liberty did not welcome all peoples equally. Nor did the other New World countries that sought immigrants practise culturally free policies. A Tiebout model encompasses in principle preferences for collective features of life expressed in cultural preferences. Are there, however, limits to Tiebout when culture is a locationally provided public good? That is, how far can we take Tiebout as a justification for culturally- and nationallybased restrictive immigration policies? We will refrain from taking the simple position that nationalism and cultural identity are necessarily a source of evil. Great evils have been committed because of nationalism and culture of some peoples – but other cultures have brought humane values to the world. Our question here in attempting to reformulate Tiebout is not whether countries should be influenced in their immigration policies by desires for cultural preservation and national identity – but given that countries do base immigration policies on cultural preferences, can the Tiebout model assure the locational analogue to an efficient market? The source of potential compromise of efficiency in a Tiebout world is the need for competition among locations and voluntariness of locational choice. The locational analogue to a competitive non-spatial market supposes voluntary decisions by consumers, who choose the price and quality–quantity offer of a jurisdiction in the same manner as a consumer responds to a market price in making a consumption decision. It is important that the locational decision be voluntary in the manner of the market decision. It is also important that there be no exclusion of people who are

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willing to pay for admission to a jurisdiction – that is, the locational market should clear, so that in equilibrium no one is excluded from where they wish to be. If personal cultural likes and dislikes are embedded in individual preferences, some people may not wish to be with people who wish to be with them, and vice versa. This is not an asymmetry that could be present in the standard rendition of the Tiebout locational model, where all that matters for inclusion in a jurisdiction is willingness to pay, and not the identity of the prospective entrant. Some people may thus find themselves involuntarily excluded from a jurisdiction. Tiebout would assume that there exists a perfect substitute to the jurisdiction which excludes them, and that this perfect substitute will accept them; or that the excluded people themselves have the means and opportunity to create their jurisdiction – that is, competitive replication assures that there is no exclusion. Where competitive replication is not possible, the problem of exclusion, or of facilitating discriminatory admission, remains. Discriminatory pricing for excluded potential entrants resolves the problem of discriminatory admission (see Hillman and Swan, 1983): efficiency is maintained by permitting admission by those people willing to pay a price which at least compensates those previously present for their entry. If institutions to facilitate discriminatory pricing are not present, people who wish to pay the higher price without which they cannot have access to the jurisdiction cannot enter (or cannot avoid being expelled), and the equilibrium is inefficient. Discrimination has been facilitated in some countries on the basis of wealth. Australia and Canada, for example, have permitted immigration contingent on ownership of sufficient capital. This is, however, a rationing mechanism, and not a discriminatory pricing mechanism since the capital is not transferred in payment (although the future returns may be taxed). To find an example par excellence of a discriminatory pricing mechanism, we can again turn to the history of the Jews. Jews could immigrate to Christian jurisdictions (although in general not be citizens and not own land and often live only in designated areas), by being permitted to pay a special tax to compensate for their presence. Under Islam, as well, Jews paid a special tax. The mechanisms were discriminatory but efficient; the Jews could live their distinct communal and private lives within their culture and values by paying the price which allowed their entry. Profound inefficiencies arose when a discriminatory pricing mechanism was not permitted to function. The market failure was immense when supreme-value ideologies denied the possibility of a market solution (see Bernholz, 1991): the alternatives to discriminatory locational pricing have been expulsion and murder. A final aspect of Tiebout that we wish to consider concerns property rights and theft in the context of migration. If people have different wealth,

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then location is not based solely on preferences, and poorer people may find themselves in jurisdictions where they do not wish to be. They then may seek to exit, even if in so doing they break the law of the country of entry by being illegal immigrants. In non-spatial markets high-income populations similarly fare better than the poor. We can compare the act of theft in a non-locational market with illegal immigration to a locational jurisdiction where the immigrant ‘has no right to be’. If basic rights are indeed the same, illegal immigrants would then have the same moral deficiencies as thieves. There is no commandment which declares, ‘you shall not immigrate illegally into a country’, whereas there is a commandment that one should not steal. The question here is whether failure to contribute to a public good from which one benefits is theft. Laws which deny the children of illegal immigrants access to state-funded education have this connotation. 3

Models of the migration of people

We have thus far put forward a perspective on international migration with foundations in the international-economics literature. This literature is apersonal, until we introduce people’s preferences for cultural and national homogeneity and consider the possibilities in terms of Tiebout jurisdictions. An alternative perspective on international migration is provided by a point of departure from labour economics. In this literature, immigrants are not so much factors of production as people with personal attributes and their own locational preferences. The push–pull distinction (see Zimmermann, 1994), for example, distinguishes between people ‘pushed’ out of their countries as a result of adverse domestic conditions, and people ‘pulled’ into richer countries by the attraction of higher wages. In either case, relative evaluations of circumstances influence the migration decision, and the international factor market income differences are present that underlie equilibrating international-factor movements. The push–pull dichotomy proposes, however, that we ask people why they left their homeland. If the answer is, ‘I left because of poverty and insecurity at home’, this is push; if the answer is, ‘I left because of the better opportunities abroad’, this is pull. Under the conditions of push, people would not emigrate if only conditions were better at home, since higher incomes available abroad might not compensate for their own-cultural preference. Under conditions of pull, economic comparisons matter more. The push–pull framework is personal rather than apersonal, in asking why people are led to make international migration decisions – in contrast to asking why international factor movements take place. The restrictions that countries place on international immigration also become more personalised. A Tiebout re-characterisation of the models of

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international economics sits uncomfortably with the models themselves, since we move from apersonal factors of production to consider the possibility that people have likes and dislikes in social interaction and that cultural preferences matter. In a push–pull dichotomy, we are confronted at the onset with questions regarding who is pulled and who tends to be pushed. Whereas departure due to pull is voluntary, departure due to push may not be. Push–pull is therefore less politically correct in not avoiding or downplaying contentious issues. Political correctness is indeed difficult when we consider the role of personal and cultural attributes of people in influencing migration policies and we investigate whether xenophobia or prejudice may be part of the explanation for immigration restrictions – or part of the reason for expulsion from a jurisdiction (enforcement and expulsion or deportation are of course also economic decision variables, see Ethier, 1986; Bond and Chen, 1987). Restrictive immigration laws are enforced upon people rather than factors of production, and it is people who are apprehended and deported. One may therefore wish to personalise immigrants, and also introduce asymmetric information about their attributes (see, for example, Schmidt et al., 1994; Haque and Kim, 1995; Stark, 1995b). The ‘brain-drain’ models have described how differentiated populations in poorer countries are subject to different emigration incentives (see, for example, Bhagwati, 1976; Kim, 1976; Kwok and Leland, 1982), either by criteria set by the receiving country’s government or by emigrants’ own self-selection (see Borjas, 1987). Stark (1995b) has further proposed that immigrant remittances to those remaining at home should be seen as a selection device to keep potential low-skilled migrants from emigrating in a process of ‘strategic selfselection’. In the presence of asymmetric information about workers’ skills, it may be better for all workers from the emigrating country if low-skilled workers do not migrate. That is, because of asymmetric information by employers regarding immigrants’ skills, emigration by the low-skilled would decrease the earnings ability of the high-skilled. If the loss to the high-skilled workers is sufficiently great, they may benefit by compensating the low-skilled workers for the damage they sustain by not migrating, thus making all better off. We can note that this requires substantial internalisation by those who have emigrated (for an empirical evaluation, see Docquier and Rapoport, 1997). Further models by Stark (1984, 1991, 1995a) develop other personal aspects of migrants’ decision-making. Stark perceives people as having preferences biased in favour of remaining in their known home environment rather than leaving for the foreign unknown, and immigration as occurring on the basis of relative rather than absolute deprivation (see also Stark and Taylor, 1991). That is, emigration takes place when people feel

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sufficiently relatively deprived by reference to standards in their own countries, and return emigration is predicted to take place once people have accumulated sufficient wealth for them no longer to feel deprivation relative to their peer groups in their home neighbourhoods. Return emigration occurs, even in the face of reduced real income, and such reverse ‘international factor movement’ is contrary to the direction of movement predicted by factor-reward differences. Stark also uses the conception of ‘family’ to investigate migrant behaviour (see, for example, Stark, 1991). The notion of ‘family’ is another avenue to explain remittances and return migration, and also dispersed relocation to spread family risk and the role of networks in determining geographic clustering of immigrants. The immigrants, whether legal or illegal, who have children (with them) require access to education, and they also benefit from other social services. In the USA there has been a debate against this background whether immigration to the USA is fiscally beneficial – that is, whether taxes paid by immigrants meet the cost of education and social welfare expenses. Huddle (1993) estimates that immigrants impose an annual cost of $40 billion, while Passel and Clark (1994) estimate a net contribution of $27 billion. Borjas (1994) estimates a $16 billion loss. At the same time, given demographic trends, immigrants may in the longer term rescue the US social security system by providing a working population to sustain the oldage consumption of the population which has chosen low rates of reproduction. 4

Endogenous immigration policy

Endogenous-policy models seek to explain the choice of observed policies. Enhanced efficiency is one reason for choice of a policy. Efficiency would imply the choice of free trade and, complementing the free movement of goods and services, free international movement of capital and labour as these factors seek their highest return. Yet, as we have observed, countries invariably use their sovereignty to restrict immigration – which has led us to preferences for cultural and national homogeneity, and to domestic income-distribution effects of migration. A political-economy model explicitly encompasses how collective decision-making institutions and optimising policy-makers respond to the different sources of interest of gainers and losers from policies and can explain why efficient policies are not adopted. A public-choice model, in particular, encompasses awareness of the possible imperfections of policy outcomes of representative democracy that arise as the consequence of the interaction between self-interested political agents who determine policy, and coalitions of likewise self-interested economic agents who favour policies that may not be in the interest

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of society at large. Such a model thus recognises that political agents may be receptive to rent-seeking, so introducing an additional potential source of social cost. Direct-democracy models of endogenous policy, on the other hand, exclude political agents from policy discretion; the median voter determines the chosen policy, but there is no basis for presumption that the median voter’s preferred policy is also the socially optimal one. Endogenous-policy models do not, however, seek to recommend policies to policy-makers. As Foreman-Peck (1992) succinctly states in reviewing nineteenth- and early twentieth- century international immigration movements, the issues are simply who gains and loses from migration, and who is in a position to influence policy. We proceed here to briefly review endogenouspolicy models of international immigration. These models, again, transcend the economic analysis of international factor movements – to ask why departures from efficient policies might be observed. Thus, Benhabib (1996) considers a resident population which views immigration policy as an instrument of income-maximisation, and derives the median voter’s preferred policy for capital and skill requirements of eligible immigrants, given the wealth holdings of a country’s population. There is of course no reason to suppose that the immigration policy which is in the self-interest of the median voter is welfare-maximising for the country at large. However, under direct democracy the preferences of the median voter nonetheless determine the policy equilibrium in the manner described by Benhabib. The median voter also determines the equilibrium policy under representative democracy if the issue of migration is dominant in the choice among whom to support among representatives offering themselves for election. Mazza and van Winden (1996) model an institutional framework which more directly reflects representative democracy, by specifying policy as the outcome of political influence exercised by the groups affected by immigration of labour. The weights which determine the ability of a group to transform size into political influence are endogenous and changed by the presence of increased numbers of immigrants. Immigrants thereby affect endogenous domestic income distribution and, by the effects on political influence, can thereby over-compensate resident workers for the decline in wages due to the presence of competing immigrant labour. Mazza and van Winden also investigate policy coordination among different jurisdictions. In Hillman and Weiss (1995), we observe that, despite immigration restrictions, illegal immigrants are nonetheless openly present in many countries, and that the openly visible illegal immigrants also tend to be concentrated in selective industries. The median voter is a worker who would compete directly with immigrants, and who would suffer a real-income decline from their presence. Hence the equilibrium policy is that immigration is illegal.

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This does not, however, mean that immigration is not permitted. Legal immigration is not allowed; the median voter can, however, benefit from illegal immigration. The illegality permits selective enforcement of restrictive immigration laws, which confines illegal immigrants to employment in sectors where the median voter benefits from the immigrants’ presence. In particular, the median voter is happy to have illegal immigrants who are selectively confined to non-traded goods sectors. The ‘illegality’ of illegal immigration has the effect of transforming immigrants from mobile factors of production who would compete in domestic labour markets with the median voter, to sector-specific factors of production whose presence is beneficial. Hence, while legal immigration is not allowed, illegal immigration is nonetheless an equilibrium endogenous policy. A complementary perspective looks at the countries of emigration. Epstein et al. (1998) describe a country where spatial proximity of a member of the population or family to a ‘king’ determines how well the individual or family fares from the king’s largesse in making gifts and placing the burden of taxation. The population differs in productive and rent-seeking abilities – that is, people have different personal comparative advantages in production and in non-productive rent-seeking. The members of the population allocate their resources between production and rent-seeking. The institutions which determine influence or proximity to the king establish whether more or fewer productive residents are located closer to the king. The outcome of who is at the ‘end of the line’ of privilege then determines whether the best rent-seekers or the most productive segments of the king’s population have an incentive to emigrate. Emigration unravels the king’s population, as people are pushed abroad because of their inferior positioning in the domain of privilege. However, in the absence of the redistribution determined by proximity to the king, no one has an incentive leave the country. All who leave are pushed. Jahn and Straubhaar (1997) implicitly address the question of the nature of the preferences that underlie restrictive immigration laws. They point out that immigration is illegal only because a law states it to be so. A wide spectrum of immigration laws can in principle be legislated. Beyond the question of why people immigrate illegally, there is the more fundamental question why the population of a country through its collective decisionmaking mechanisms has decided that entry into the country of foreigners is illegal. Differences in immigration policies are studied by Buckley (1996), who compares the policies of the USA and Canada, two New World recipient countries. Canada has been more successful at attracting, on average, ‘higher-quality’ immigrants than the USA, as reflected in higher educational attainment, better language skills and more managerial and professional

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skills. This is attributed by Buckley to the different criteria used to establish eligibility for immigration. The USA emphasises family reunification, whereas Canada specifies individual characteristics in a points system. Buckley’s endogenous-policy basis for the differences has three elements. In the USA, (1) employers and immigrants tend to form interest groups with political influence, (2) politicians have a greater interest in furthering their natural constituencies, which include immigrants and (3) immigration policy as legislated and enforced by the federal government can conflict with the policies sought by individual states, so the policies which might be desired at a lower level of the federal structure are not feasible.1 Some countries have guest-worker programmes. Such programmes are also open to interpretation as reflecting preferences for national cultural homogeneity. The immigrants are designated as ‘temporary visitors’, and it is made clear by the conditions of their entry that they are expected in due course to depart rather than join the permanent resident population. The transience is consistent with the use of guest-workers as a policy response to sectoral ‘labour shortages’. Yet the policy of rotation also seeks to ensure that guest-workers continue to perceive themselves as transient, and in particular do not bring their families with them. Often guests do not wish to go home; policy responses to ensure that the guests leave include contingent deferred payments (Simon, 1989), and placement of the obligation of ensuring departure on the employer who has been specifically granted the permit to import the intended transient worker. Bonded employers of guest-workers have limited means to ensure return emigration. Rather than leave the country, the guest-worker can simply leave the legal employer for the illegal market. Despite the policy intentions of guest-worker programmes, such programmes are well known to be porous and to be the point of entry for illegal immigration (see Epstein et al., 1999). Such attempts at cultural homogeneity by a policy of a revolving door have in general not been successful. 5

Conclusions

This chapter has presented an overview of international migration of labour which broadens the scope of questions and permissible answers beyond the framework of market-determined responses to international differences and factor rewards and the characteristics of technologies. We should not be understood as suggesting diminished importance for the general equilibrium framework of the models of international economics. On the contrary, no sound study of international immigration can be undertaken without an understanding of the resource-allocation and income-distribution consequences of international-factor movements as

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displayed in these models. We have, however, shown that, notwithstanding their fundamental analytical virtues, these basic models are limited in the scope of appreciation of the complexities that underlie peoples’ international migration decisions, and the policy decisions of others to attempt to thwart or regulate these decisions. Some aspects of behaviour are not exemplary, in particular in chosen policies that reflect personal likes and dislikes of the population. However non-explanatory, these dimensions of behaviour nonetheless are explanatory variables for migration-related phenomena beyond market responses to factor-reward differentials. NOTE 1 Another reason is illegal immigration. The USA receives illegal immigrants from Mexico and Cuba, often with little human capital. Canada does not share a border with these countries. REFERENCES Benhabib, J. (1996). ‘On the Political Economy of Immigration’, European Economic Review, 40, 1737–43 Bernholz, P. (1991). ‘The Constitution of Totalitarianism’, Journal of Institutional and Theoretical Economics, 147, 424–40 Bhagwati, J.N. (1976). ‘The Brain Drain’, International Social Science Journal, 28, 691–729 Bond, E.W. and T.J. Chen (1987) ‘The Welfare Effects of Illegal Immigration’, Journal of International Economics, 23, 315–28 Borjas, G.J. (1987). ‘Self Selection and the Earnings of Immigrants’, American Economic Journal, 77, 531–53 (1994). ‘The Economics of Immigration’, Journal of Economic Literature, 32, 1667–1717 Buckley, F.H. (1996). ‘The Political Economy of Immigration Policies’, International Review of Law and Economics, 16, 81–99 Card, D. (1990). ‘The Impact of the Mariel Boatlift on the Miami Labour Market’, Industrial and Labour Relations Review, 43, 245–57 Davies, J.B. and I. Wooton (1992). ‘Income Inequality and International Migration’, Economic Journal, 102, 789–802 Docquier, F. and H. Rapoport (1997). ‘Are Migrant Minorities Strategically Self–Selected?’ SUITE Working Paper, 97/2 Epstein, G., A.L. Hillman and H. Ursprung (1998). ‘The King Never Emigrates’, Review of Development Economics, 3(2) Epstein, G., A.L. Hillman and A. Weiss (1999). ‘Creating Illegal Immigrants’, Journal of Population Economics, 12, 3–21 Ethier, W.J. (1986). ‘Illegal Immigration: The Host-Country Problem’, American Economic Review, 76, 56–71

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Foreman–Peck, J. (1992). ‘A Political Economy Model of International Migration, 1815–1914’, The Manchester School, 60, 359–76 Haque, N.U. and S.J. Kim (1995). ‘Human Capital Flight: Impact of Migration on Income and Growth’, International Monetary Fund Staff Papers, 42, 577–607 Hillman, A.L. (1989). The Political Economy of Protection (Chur: Harwood Academic Publishers) (1994). ‘The Political Economy of Migration Policy’, in H. Siebert, (ed.), Migration: A Challenge for Europe (Tübingen: J.C.B. Mohr, Paul Siebeck) (1997). ‘The Social Consequences of Trade and Technology: Marginalization and Policy Response in the Developed World’, Research Paper, World Trade Organisation Hillman, A.L. and P.L. Swan (1983). ‘Participation Rules for Pareto-Optimal Clubs’, Journal of Public Economics, 20, 55–76 Hillman, A.L. and A. Weiss (1995). ‘A Theory of Permissible Illegal Immigration’, paper presented at CEPR Workshop on ‘Illegal Immigration’, Thessaloniki Huddle, D. (1993). ‘The Costs of Immigration’, Rice University, manuscript Jahn, A. and T. Straubhaar (1997). ‘On the Political Economy of Immigration Control’, paper presented at CEPR Workshop on ‘Illegal Immigration’, Athens Kim, K.H. (1976). ‘The Economics of the Brain Drain: Pros, Cons and Remedies’, Journal of Economic Development, 1, 55–80 Kwok, V. and H. Leland (1982). ‘An Economic Model of the Brain Drain’, The American Economic Review, 72, 91–100 Mayer, W. (1984). ‘Endogenous Tariff Formation’, American Economic Review, 74, 970–85 Mazza, I. and F. van Winden (1996). ‘A Political Economic Analysis of Labour Migration and Income Redistribution’, Public Choice, 88, 333–63 Mundell, R.A. (1957). ‘International Trade and Factor Mobility’, American Economic Review, 47, 85–95 Passel, J.S. and R.L. Clark (1994). ‘How Much Do Immigrants Really Cost? A Reappraisal of Huddle’s “The Cost of Immigrants”’ (Washington, DC: Urban Institute) Richardson, J. D. (1995). ‘Income Inequality and Trade: How to Think, What to Conclude’, Journal of Economic Perspectives, 9, 33–56 Ruffin, R. and R. Jones (1977). ‘Protection and Real Wages: The Neo–Classical Ambiguity’, Journal of Economic Theory, 44, 337–48 Schmidt, C.M., A. Stilz and K.F. Zimmermann (1994). ‘Mass Migration, Unions, and Government Intervention, Journal of Public Economics, 55, 185–201 Schultze, G. (1998). The Political Economy of Capital Controls (Cambridge: Cambridge University Press) Simon, J.L. (1989). The Economic Consequences of Immigration (Oxford: Basil Blackwell) Slaughter, M.L. and P. Swagel (1997). ‘The Effect of Globalization on Wages in the Advanced Countries’, Staff Studies for World Economic Outlook (Washington, DC: International Monetary Fund)

Cultural preferences, endogenous policies and the migration of people 91 Stark, O. (1984). ‘Rural to Urban Migration in LDCs: A Relative Deprivation Approach’, Economic Development and Cultural Change, 32, 475–86 (1991). The Migration of Labour (Oxford: Basil Blackwell) (1995a). Altruism and Beyond: An Economic Analysis of Transfers and Exchanges Within Families and Groups (Cambridge: Cambridge University Press) (1995b). ‘Return and Dynamics: The Path of Labour Migration when Workers Differ in their Skills and Information is Asymmetric’, Scandinavian Journal of Economics, 97, 55–71 Stark, O. and J.E. Taylor (1991). ‘Migration Incentives, Migration Types: The Role of Relative Deprivation’, Economic Journal, 101, 1163–78 Taylor, J.E. (1992). ‘Earnings and Mobility of Legal and Illegal Immigrant Workers in Agriculture’, American Journal of Agricultural Economics, 74, 889–96 Tiebout, C. (1956). ‘A Pure Theory of Local Expenditures’, Journal of Political Economy, 64, 416–24 Venables, A.J. (1998). ‘Trade Liberalisation and Factor Mobility: An Overview’, chapter 2 in this volume Wood, A. (1995). ‘How Trade Hurts Unskilled Workers’, Journal of Economic Perspectives, 9, 57–80 Wong, K. (1995). International Trade in Goods and Factor Mobility (Cambridge, MA: MIT Press) Zimmermann, K. F. (1994). ‘European Migration: Push and Pull’, Proceedings volume of the World Bank Annual Conference on Development Economics, 1994, Supplement to The World Bank Economic Review and The World Bank Research Observer, 313–42; reprinted in International Regional Science Review, 19 (1996), 95–128

Discussion FR A N CE SC O DAVE RI Hillman and Weiss in chapter 4 effectively survey a large number of ideas embodied in the recent migration literature. Their survey succeeds in providing both ‘the big picture’ and vivid examples of these ideas, and it is therefore a useful and enjoyable read. The survey can be broadly split into three parts, each discussing a separate question. The first part – inclusive of sections 1 and 2 – is about the causes of asymmetries in trade and migration policies. It is argued that cultural differences play a major role in determining such policy asymmetries.

Cultural preferences, endogenous policies and the migration of people 91 Stark, O. (1984). ‘Rural to Urban Migration in LDCs: A Relative Deprivation Approach’, Economic Development and Cultural Change, 32, 475–86 (1991). The Migration of Labour (Oxford: Basil Blackwell) (1995a). Altruism and Beyond: An Economic Analysis of Transfers and Exchanges Within Families and Groups (Cambridge: Cambridge University Press) (1995b). ‘Return and Dynamics: The Path of Labour Migration when Workers Differ in their Skills and Information is Asymmetric’, Scandinavian Journal of Economics, 97, 55–71 Stark, O. and J.E. Taylor (1991). ‘Migration Incentives, Migration Types: The Role of Relative Deprivation’, Economic Journal, 101, 1163–78 Taylor, J.E. (1992). ‘Earnings and Mobility of Legal and Illegal Immigrant Workers in Agriculture’, American Journal of Agricultural Economics, 74, 889–96 Tiebout, C. (1956). ‘A Pure Theory of Local Expenditures’, Journal of Political Economy, 64, 416–24 Venables, A.J. (1998). ‘Trade Liberalisation and Factor Mobility: An Overview’, chapter 2 in this volume Wood, A. (1995). ‘How Trade Hurts Unskilled Workers’, Journal of Economic Perspectives, 9, 57–80 Wong, K. (1995). International Trade in Goods and Factor Mobility (Cambridge, MA: MIT Press) Zimmermann, K. F. (1994). ‘European Migration: Push and Pull’, Proceedings volume of the World Bank Annual Conference on Development Economics, 1994, Supplement to The World Bank Economic Review and The World Bank Research Observer, 313–42; reprinted in International Regional Science Review, 19 (1996), 95–128

Discussion FR A N CE SC O DAVE RI Hillman and Weiss in chapter 4 effectively survey a large number of ideas embodied in the recent migration literature. Their survey succeeds in providing both ‘the big picture’ and vivid examples of these ideas, and it is therefore a useful and enjoyable read. The survey can be broadly split into three parts, each discussing a separate question. The first part – inclusive of sections 1 and 2 – is about the causes of asymmetries in trade and migration policies. It is argued that cultural differences play a major role in determining such policy asymmetries.

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The second part (section 3) draws on theories of migration where cultural factors play a role, unlike the standard theory based on wage differentials. The third part of the survey (section 4) concerns the endogenous determination of immigration policies as a response to cultural heterogeneity. The survey as a whole revolves around the idea that cultural heterogeneity is an important determinant of the policy attitudes of governments. This is the main point I wish to take up in my discussion. While I agree that taking heterogeneity seriously is important, I am not entirely convinced that cultural differences across communities can go a long way in explaining migration policies. Why should cultural heterogeneity matter for migration policies? The authors’ starting point is that factor movements are not interchangeable. Capital inflows, as well as the imports of goods, do not usually imply the mixing up of people, unlike migration. Then, if natives dislike having too much variety of people around, liberalising labour flows is not the same as liberalising flows of capital or goods. Hillman and Weiss report clear examples of how Jews painfully suffered the consequences of what can be termed the ‘adverse cultural preferences’ of other people. Yet understanding the observed asymmetry in trade and migration policies in industrial countries does not require an appeal to culture. One can easily accept that factors are not the same. One can also accept that asymmetries in policies towards migration and trade have to do with some specificity of labour compared to capital (or goods). But factors of production are not the same for a number of reasons other than heterogeneity of preferences. First of all, even non-racist voters dislike seeing the access to a congestible public good being diluted by the arrival of new entrants, not contributing to the fiscal pool as much as they gain from it. When repatriating Albanians, Italians are not driven by resurrected Fascist sentiments. Instead, this occurs under the perception (or the fear) that unrestricted flows of immigrants will congest the access to locally provided public goods, such as low-cost housing and other social services, such as health care and primary education. Second, even when not congesting local public goods, immigration may be harmful when illegal (i.e. when immigrants are constrained to look for jobs in non-traded sectors). If immigrants become street-vendors, they are often perceived as competitors by small retailers, who also face severe competition from large-scale retailers and malls. Moreover, illegal immigrants tend to get involved in outright illegal activities as well, since this is a cheap, though risky, way of earning money. The operations of criminal organisations (which levy implicit taxes on legal activities) often receive a good kick by the inflow of illegal immigrants.

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Third, if immigrants are granted the same rights as the other citizens in a given community, political-economy reasons suggest that migration still differs from capital inflows. All of these reasons have nothing to do with heterogeneity of preferences. First of all, Bhagwati and Rodriguez (1975), showed that the inflow of labour from abroad, unlike the inflow of capital, implies a reformulation of the social-welfare function of a given community. The welfare effects of migration were shown to be crucially dependent on the treatment of TLB (those left behind). In addition to that, suppose that voters have the same preferences but different endowments of labour and capital. In this case, if immigrants are endowed with less capital than natives, the median voter theorem predicts that their arrival makes redistribution more likely. None of these sketched rationales has anything to do with cultural preferences. At the same time, in the absence of empirical work, I do not know how to rule out these explanations as opposed to the rationale favoured by Hillman and Weiss. This just tells us that, in principle, many reasons may underlie the variety of trade and migration policies in place in industrial countries. Further progress towards appropriately endogenising migration and trade policies would thus entail the specification of empirically meaningful ways of testing competing theories. In any case, had cultural differences something to say on migration policies, this ought to be in a cross-section of localities, rather than over time. Culture changes slowly compared to policies. In chapter 4, Hillman and Weiss quote the electoral success of chauvinist groups in Germany, Austria and France as examples of ‘cultural’ distaste for foreigners. However, it is not clear that the fortunes of Lepenists and the like are long-run in nature. If anything, as of today (December 1997), the electoral success of chauvinist movements in Europe seems waning already, while it was rampant only few months ago. I simply do not see how such short-run policy swings can be related to, presumably long-lasting, cultural preferences. To sum up, taking heterogeneity of preferences seriously and understanding their influence on the process of policy-making is an ambitious and challenging task. A fruitful parallel route to take is then to formulate locally verifiable predictions, over and above general propositions, which are sometimes harder to test. R E F E RE N CE Bhagwati. J. and C. Rodriguez (1975). ‘Welfare-theoretical Analyses of the Brain Drain’, Journal of Development Economics, 2, 196–221

5

Trade liberalisation and public-good provision: migration-promoting or migration-deterring? KO NSTANT INE GAT SI OS, PANOS HATZIPANAYO TOU AND MICHAE L S. M ICHAE L

1

Introduction

Since its establishment in 1947, several rounds of GATT negotiations have promoted the liberalisation of international trade in commodities. Meanwhile, numerous preferential trading agreements (APEC, CARICOM, NAFTA) have deepened regional economic integration among countries willing to go further. Recognising the importance of barriers in services trade, including labour services, as costly as commodity trade barriers, the Uruguay Round (1994) extended the principles of goods trade liberalisation to service markets, through the General Agreement on Trade in Services (GATS). Moreover, in its constitution, the EU recognises the free mobility of labour as one of the ‘four–pillar freedoms’ that make the European common market ‘an area without internal frontiers in which the free movement of goods, persons, services and capital are ensured’ (EEC Treaty, art. 48 (2)). Standard international trade theory has prescribed free trade as the regime that maximises the economic welfare of countries without market power, as well as global economic welfare. On the other hand, numerous studies have examined the relationship between free commodity trade and free international movements of factors of production. Within the traditional Heckscher–Ohlin (HO) framework, it has been long established that under free trade and factor–price equalisation (FPE), commodity trade and factor movements are perfect substitutes in a weak and strong version of a quantitative and price-equalisation sense (see Mundel, 1957; Wong, 1995).1 If under free trade factor prices do not equalise, however, then free trade in goods and factors are substitutes in the weak price-equalisation sense and in the weak and strong quantitative sense.2 The formal treatment of international trade and international migration in the literature has followed two basic approaches. First, that of the ‘brain drain’ associating 94

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international migration with movements of human capital (Hamada and Bhagwati, 1976). Second, that of including international labour mobility into the standard two-good, two-factor model of international trade (see Dixit and Norman, 1980; Brecher and Bhagwati, 1981).3 Despite the obvious advantages of free trade for most countries, and for the world as a whole, tariffs, import quotas and voluntary export restraints (VERs), among other restrictive trade measures, have been used to protect domestic markets. Within the neo-classical trade context when factor prices equalise under free trade, such restrictive trade practices are required to induce international factor (capital, labour) movements.4 On the other hand, without FPE in free trade, trade restrictions are not required to induce international-factor movements. Thus, according to standard trade theory, liberalisation of commodity trade, by and large, generates a tendency for FPE across countries that is expected to dampen internationalfactor (e.g. labour) movements. Recent trends in the world economy, however, depict a broader liberalisation of commodity trade and increased flows of international migration that do not comply fully with the traditional theoretical prediction. But throughout the history of world migration, international labour movements occurred not only because of wage differentials favouring the host countries. One prominent factor inducing world-wide labour mobility is the level (and variety) of public goods immigrants can consume in the host versus the source countries. The literature on international migration has examined the impact of international labour movements on the system of transfer payments and public-good provision in labour-exporting or labour-importing countries.5 How does migration affect a source or host country’s government tax revenue and ability to provide public goods and services to its population? How extensive is the use of public goods and services by an average immigrant family in a host country, and what is their contribution (through income taxes or other transfer payments) to their production cost? Does the pattern of public goods consumed by immigrants differ from that of natives in host countries, due to, for example, ethnic, age or household characteristics?6 Such issues constitute the core on policy debates regarding the fiscal repercussions of international migration. To the best of our knowledge, the issue of the ‘public-finance’ aspects of international migration has not been adequately tackled within the literature of international and development economics. The present chapter, using a general equilibrium trade model, reverses the angle of analysis developed by the literature of fiscal repercussions of international migration. Within a trade-theoretic context of a labourexporting or a labour-importing country, we examine how trade liberalisation affects domestic public-good provision, and the flows of international

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migration. To this end, it is assumed that the labour-exporting or labourimporting country is small in world commodity and factor (i.e. labour) markets, unable to affect through its actions the world prices of goods and the world rate of return to labour. Under competitive conditions, the country produces two private traded – one exportable and one importable – goods, and a public-consumption good. Imports are subject to a tariff, or a quota or a VER constraint. Revenue from trade restrictions is lump-sum distributed to domestic residents under a tariff or an import-quota regime, and to foreign residents (exporters or governments) under a VER regime. The government finances the provision of the public good through income taxation and provides it to domestic residents free of charge. It is further assumed that migration is temporary in the sense that income earned by immigrant workers in the host (labour-importing) country are remitted to the source (labour-exporting) one.7 Moreover, labour mobility between the labour-exporting or labour-importing country and the rest of the world continues until the domestic and world net rate of return to the factor are equated. Within this framework, the chapter derives conditions under which trade liberalisation, through lower import restrictions reduce both the provision of public good and domestic employment by causing emigration. Three basic relationships emerge as the fundamental determinants of our results. First, the relationship (i.e. complementarity–substitutability) between the importable and public-consumption goods in production, second, the impact of trade liberalisation on government net income tax revenue and, third, the impact of international migration on the unit cost of public-good production. 2

The model

Consider a small open economy with identical consumers producing two private traded goods – one exportable and one importable – and one publicconsumption good. Many primary factors (m), which are either intersectorally mobile or sector-specific, are used in the production of all three goods. Domestic factor endowments, i.e. v, are fixed, i.e. dv ⫽0, but the country’s supply of one factor, labour, is variable due to international migration. The domestic labour supply (L) is given by L ⫽ L ⫹L*, where L is the fixed endowment of labour, and L* (⬎0) denotes the number of immigrant workers for a labour-importing (host) country, and L* (⬍0) denotes the number of emigrant workers for a labour-exporting (source) country. We assume full employment so that dL ⫽dL*. Let w and ␳ (⬎ 0) denote, respectively, the domestic rate of return to labour and the income tax rate and let w* be the world net rate of return to labour. No taxes or subsidies are levied on the exportable good, which is assumed

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to be the numeraire whose price is normalised to one. The domestic and world relative price of the importable good is, respectively, p and p*. The difference between the two prices, denoted by t (⫽p⫺p*), may be due to a tariff, an import quota or a VER. Since the country is assumed small in all world markets, changing the import restrictions or the income tax rate ␳ does not affect the world prices of goods and the world rates of return to factors. Technologies in the production of private and public goods are homogeneous of degree one and strictly concave in the primary factors. The private sector produces the two traded goods and is assumed to behave competitively. The public sector is assumed to minimise the production cost of the public-consumption good. Let R(p, g, L) be the maximum value of the private gross domestic product (GDP) given the relative price of the importable, p, the supply of public-consumption good g, and the domestic supply of labour L. The fixed endowments of the non-traded factors are omitted from the GDP function since they do not affect the analysis. The partial derivative of the GDP function with respect to p (i.e. Rp ⫽⭸R/⭸p) is the country’s supply function of the importable, and with respect to L (i.e. RL ⫽⭸R/⭸L) gives the marginal revenue product of labour. Henceforth, all subscripts denote partial derivatives. The R(p, g, L) function is assumed to be strictly concave in L, concave in g (i.e. Rgg is non-positive), and to have, among others, the following properties (see Abe, 1995): Rg ⫽⫺Cg, and Rgg ⫽⫺Cgg,

(1)

where Cg(␻) is the unit cost of the public good, assumed to be homogeneous of degree one and concave in ␻ (i.e. Cùù␻ ⫽0), and ␻ is the vector of factor prices. The property Rg ⫽⫺Cg means that the unit increase in the public-good production causes a reduction in the value of private goods produced equal to its unit cost. In equilibrium, the domestic rate of return to labour equals the factor’s marginal revenue product in the alternative domestic uses. That is, w⫽ RL(p, g, L). Labour mobility between the labour-importing or labourexporting country and the rest of the world continues until the domestic net rate of return to the factor equals the world net rate of return. That is: (1 ⫺ ␳) w⫽(1⫺ ␳) RL(p, g, L)⫽w*.

(2)

The function E(p, g, u) represents the minimum expenditure required to achieve utility level u, at prices p, and at the level of the public-consumption good g. An increase in the consumption of the public good reduces the private expenditure required to achieve a given level of utility u. In the public-economics literature, ⫺Eg ⬎0 is called ‘the consumer marginal willingness to pay for the public good’ (see King, 1986).

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It is assumed that the government finances the production of the publicconsumption good through income taxes, and that it provides it to households free of charge. The government budget constraint requires that income tax revenue from the production of private- and public-consumption goods equal the cost of the public-good. That is, B⫽ ␳ [R(p, g, L)⫹gCg (␻)]⫺gC g (␻)⫽0,

(3)

where B is the government net tax revenue.8 Differentiating (3), recalling that L* is positive for a labour-importing country and negative for a labourexporting one, and that dL⫽dL*, after rearranging terms we obtain: dB⫽[␳Rp ⫹(1⫺ ␳)gRgp]dp⫹[Rg ⫹(1⫺ ␳)gRgg]dg⫹ [␳RL ⫹(1⫺ ␳)gRgL]dL⫽0.

(4)

Observing (4) we note that changes in the domestic relative price of the importable good, in the level of public-good provision and in the domestic labour supply, all affect net government revenue through both a direct effect and an indirect effect attributed to the induced changes in the unit cost of the public good. Using the properties of the GDP function, (4) indicates that, other things being equal, an increase in the provision of the public good reduces government net tax revenue – i.e. whether (⭸B/⭸g)⫽[Rg ⫹(1⫺ ␳)gRgg] ⬍0. Other things being equal, whether a decrease in the domestic relative price of the importable good reduces or raises government net tax revenue – i.e. (⭸B/⭸p)⫽[␳Rp ⫹(1⫺ ␳)gRgp] is positive or negative – in part depends on whether Rgp (⫽Rpg) is positive or negative. We say that Rgp is positive when the importable and public-consumption goods are complements in production, and negative when they are substitutes.9 In the case of complementarity between the two goods in production, (⭸B/⭸p) is positive, while in the case of substitutability (⭸B/⭸p) may be positive or negative. Hereafter, we call (⭸B/⭸p) the induced price effect of freer trade on government net income tax revenue. Finally, recalling that Rg ⫽⫺Cg, gRgL is positive when changes in a country’s domestic employment and payments to factors employed in the production of the public good are inversely related, and negative when they are positively related.10 Thus, when gRgL is positive, international migration increases government net tax revenue for a labour-importing country, and reduces it for a labour-exporting one – i.e. (⭸B/⭸L)⫽[␳RL ⫹(1⫺ ␳)gRgL]⬎0. When gRgL is negative, international migration has an ambiguous impact on government net tax revenue, regardless of whether the country is a labourimporting or a labour-exporting one. We call (⭸B/⭸L) the wage-migration effect of freer trade on government net income tax revenue. We define the country’s trade-expenditure function, which equals the excess of domestic expenditure over the country’s GDP, as Z(p, g, u, L)⫽ E(p, g, u)-R(p, g, L). The properties of the trade-expenditure function follow those of the expenditure and GDP functions. For example, the

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Z-function is strictly concave in p (i.e. Zpp ⬍0). Its derivative with respect to p (i.e. Zp) gives the country’s import-demand function, i.e. Zp(p, g, L, u) ⫽ Ep(p, g, u)–Rp(p, g, L). To indicate that imports under a quota or a VER regime are quantity-constrained we have: Zp(p, g, L, u)⫽Ep(p, g, u)⫺Rp(p, g, L)⫽ Zp.

(5)

We assume temporary migration (i.e. guest-workers), where immigrant welfare is considered part of the source-country’s welfare. In the case of a labour-importing country, the budget constraint requires that private expenditure must equal net income from the production of private traded and public goods, minus immigrant remittances, plus any revenue accruing to domestic residents from the prevailing trade restrictions. Correspondingly, for a labour-exporting country emigrant remittances are added to its total income earnings. It is assumed that tariff revenue is lumpsum distributed to domestic households, that quota rents accrue to domestic residents (home government or importers), and that VER rents accrue to foreigners (foreign government or exporters). Then, the income-expenditure identity for a labour-importing or labour-exporting country’s is given by: E(p, g, u)⫽(1⫺ ␳) [R(p, g, L)⫺g Rg(p, g, L)]⫺ w*L* ⫹(1⫺ ␣)t Zp(p, g, L, u),

(6)

where ␣, the fraction of revenue from trade restrictions accruing to foreigners, equals zero in the case of a tariff or an import quota, and one in the case of a VER. Lastly, w*L* is positive for a labour-importing country and negative for a labour-exporting one. Under a tariff regime, (2), (3) and (6) can be solved for the three endogenous variables u, g and L as a function of the policy instruments t and ␳. Under an import quota or a VER regime, (2), (3), (5) and (6) can be solved for the four endogenous variables u, g, p and L as a function of the policy instrument Z and ␳. Appendix 1 (p. 107) provides some details of the comparative statics analysis. In the remainder of the chapter we examine the effects of relaxing the import restrictions (a decrease in the tariff rate, or an increase in the level of imports under a quota or a VER regime) on the level of domestic employment, and on the level of public-good provision.11 To acquire a better understanding of the economic intuition of our results, we use the specific-factors model as a special case. 3

Import restriction and international migration

An issue extensively examined in the international trade literature is whether goods trade and international-factor movements are substitutes or complements. In the neo-classical framework with free trade and FPE, the

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two are substitutes in a strong and weak version of a quantitative or priceequalisation sense (see Mundel, 1957). In such a case, trade impediments (e.g. a tariff), which discourage goods trade, are required to encourage factor movements. The latter continue, in response to factor-price differentials, until goods trade disappears. If, under free trade, factor prices do not equalise, goods trade and international-factor movements are substitutes in the weak price-equalisation sense, and in the strong and weak quantitative sense. In this case, no trade impediments are required to induce international-factor movements. In this section we examine, in the presence of public-good provision, the effects of freer trade, due to lower import restrictions, on labour supply in a labour-exporting or a labour-importing country. Using (A1) and (A2) of appendix 1, and recalling that ␣ ⫽0 under an import tariff or a quota and that ␣ ⫽1 under a VER, the effects of lowering the import restrictions (i.e. dt⬍0, or d Zp⬎0) on the country’s employment are given by: (dL/dt)⫽{⫺RLp ⫹RLg ␦⫺1 [␳Rp ⫹(1⫺ ␳)gRgp]} ␦ ␥t

(7)

(dL/d Zp)i ⫽{⫺RLp ⫹RLg ␦⫺1 [␳Rp ⫹(1⫺ ␳)gRgp]} ␦ ␥i,

(8)

where i⫽ q (quota), v (VER), ␥t ⫽(1⫺ ␳)(1⫺tZpu)⌬⫺1 t ⬎0, ␥q ⫽(1 ⫺ ␳)(1 ⫺ ⫺1 tZpu)⌬⫺1 q ⬍and ␥v ⫽(1⫺ ␳)⌬v ⬍0. Furthermore, recall from the discussion of (4) that [␳Rp ⫹(1⫺ ␳)gRgp]⫽(⭸B/⭸p), and ⭸⫽(⭸B/⭸g) ⫽[Rg ⫹(1 ⫺ ␳)gRgg] ⬍0. Equations (7) and (8) differ by the respective term ␥j, j ⫽ t, q, v. The common bracketed term in the two equations indicates that lowering the tariff rate (i.e. dt ⬍ 0) or increasing the volume of imports (i.e. d Zp ⬎ 0) under quantitative import constraints affects domestic employment through direct (i.e. ⫺ RLp ␦␥j), and indirect (i.e. RLg (⭸B/⭸p)␥j) changes in the marginal revenue product of labour. The former represent the traditional impact of altered import restrictions in the presence of international migration. The latter, specific to the present context, is due to the induced price effect on government net income tax revenue and level of public-good provision. In examining these two effects on domestic employment we have: Lemma 1: Assume that the importable good is labour-intensive (i.e. RLp ⬎ 0). Then, a decrease in its domestic relative price, due to lower import restrictions, entails a direct negative impact on the level of domestic employment. The opposite result obtains when RLp ⬍0. Lemma 1 is a well known conclusion in the international trade literature. Under the condition stated in this lemma freer trade, through lower import constraints, entails a direct positive impact on the number of emigrants

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from a labour-exporting country and a direct negative impact on the number of immigrants into a labour-importing country. Lemma 2: Sufficient conditions for lower import restrictions to induce a negative impact on either country’s domestic employment, through the induced price effect, are either (1) RLg ⬎0 and (⭸B/⭸p)⬎0, or (2) RLg ⬍0 and (⭸B/⭸p) ⬍0. Discussion: Consider, for example, the case where RLg ⬎0 and (⭸B/⭸p)⬎0. Then, a decrease in the domestic relative price of the importable, due to lower import restrictions, reduces government net tax revenue, and thus the public-good provision. Since also RLg ⬎0, the induced decrease in publicgood provision entails a negative impact on the country’s marginal revenue product of labour, and its levels of employment. That is, the induced price effect on government net income tax revenue entails a positive impact on emigration from a labour-exporting country, but a negative impact on immigration into a labour-importing country. An analogous reasoning emerges when RLg ⬍0 and (⭸B/⭸p)⬍0. Lemmas 1 and 2 suggest that in the present context of public-good provision, the overall effect of freer trade, due to lower import restrictions, on domestic employment in a labour-exporting or in a labour-importing country depends on (1) the factor intensity of the importable good, (2) the impact of lower import restrictions on government net tax revenue, which in part depends on the complementarity or substitutability in production between the importable and public-consumption goods and (3) the relationship between the level of public-good provision and the marginal revenue product of labour. Sufficient conditions for lower import restrictions to overall reduce domestic employment in a labour-exporting or in a labour-importing country are (1) that the importable good is labour-intensive, (2) that the importable and public goods are complements in production and (3) that public-good provision positively affects the marginal revenue product of labour. If one of these conditions does not hold, then lower import restrictions may raise employment in a labour-exporting or a labour-importing country. To acquire a better understanding of these results, we apply the specificfactors trade model as a special case.12 3.1

A specific-factors model

Consider a small open labour-exporting or labour-importing country producing two private traded goods – one exportable, the numeraire, and one importable good – and one public-consumption good. Labour is internationally and intersectorally mobile. The same sector-specific capital is used

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in the production of the importable (M), and public-consumption good (g), while another type of capital, or land, is the specific factor in the production of the exportable (A) good. Moreover, drawing on casual empiricism, we would like to think of a labour-exporting country being a developing country where the capital–labour ratio in the production of the importable good is greater than that in the production of the public-consumption good. The opposite could be true for a labour-importing developed country. Appendix 2, in the tradition of sector-specific trade models (see Mayer, 1974), shows that a decreased domestic relative price of the importable good (due to lower import restrictions), reduces the wage rate (i.e. RLp ⬎0), and the rate of return to the sector-specific capital in the production of the importable good (i.e. rp ⬎0). Using these results in the present context of public-good provision, its unit cost of production falls (i.e. C gp ⬎0) with trade liberalisation. As a result, Rgp (⫽⫺C gp ⬍0, implying that the importable and public-consumption goods are substitutes in production. We consider two cases, a case where the public-good is non-capital-intensive (i.e. kg ⬍km) relative to the importable good, and thus RLg is positive, and the case where kg ⬎km, and thus RLg ⬍0. The former case is expected to hold for the developing labour-exporting country, but is less likely for the developed labour-importing country, while the latter case is likely to hold for the labour-importing country (see appendix 2). Lemma 3, using the above specific-factors model, examines, under public-good provision, the overall effect of lower import restrictions on a labour-exporting and a labour-importing country’s employment when kg ⬍ km. Lemma 3: Within this specific-factors model, lower import restrictions reduce employment in a labour-importing or labour-exporting country if (⭸B/⭸p)⬎0 (sufficient but not necessary) and may increase it if (⭸B/⭸p) ⬍0. Discussion: A reduction in the tariff rate or an increase in the level of imports under a quota or a VER regime reduces the domestic relative price of the importable good. Since, within the specific-factors model, RLp ⬎0, the marginal revenue product of labour falls. Thus, through the first right-hand-side term of (7) and (8), i.e. ⫺RLp␦␥t, lower import restrictions exert a direct negative impact on the country’s domestic employment. The second righthand-side term in (7) and (8), i.e. RLg ␦⫺1(⭸B/␦p)␦␥t, is the indirect impact of lower import restrictions on the marginal revenue product of labour, through the induced price effect on government net tax revenue. Assuming that (␦B/␦p)⬎0 means that, other things being equal, lower import restrictions which reduce the domestic relative price of the importable good reduce government net tax revenue, and thus public-good provision.

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When the public good is relatively non-capital-intensive compared to the importable good (i.e. kg ⬍km) – a more likely case in a labour-exporting country – demand for labour falls, thus affecting negatively the marginal revenue product of labour, the domestic wage rate and the country’s domestic employment. In this case, freer trade has an overall negative effect on the country’s domestic employment, by causing emigration If, however (⭸B/⭸p) ⬍0, the consequent increase in public-good provision may increase domestic employment. In the case where the production of the public-good is relatively capitalintensive compared to the imported good (i.e. kg ⬎km) – a more likely case for a developed labour-importing country – then RLg is negative. In this case, through the indirect effect and assuming that (⭸B/⭸p)⬍ 0, implies that, other things being equal, lower import restrictions raise government net tax revenue and public-good provision. Since the production of this good is relatively capital-intensive (i.e. kg ⬎km), demand for labour falls, thus negatively affecting the marginal revenue product of labour, the domestic wage rate and the country’s domestic employment. As a result, freer trade reduces the country’s domestic employment by causing emigration. If, however, (⭸B/⭸p)⬎0, the opposite result may emerge. How do these results differ from those of trade liberalisation on international migration in the context of a standard (i.e. two-good, three-factor, constant-returns-to-scale production technologies identical across countries) specific-factors model? In such a framework, assuming that labour is the only internationally mobile factor (i.e. sector-specific factors are internationally immobile), trade liberalisation tends to reduce international differences in wages and thus dampens its international mobility (see Venables, 1997).13 Here, under public-good provision, aside of the impact of trade liberalisation on international migration through the induced direct changes in the price of labour, two additional determinants must be considered. First, the relative factor intensities between the public and the importable (i.e. protected) goods and, second, the effect of trade liberalisation on government net income tax revenue and the level of public-good provision. 4

Import restrictions and public-good provision

The present context of examining the effects of trade liberalisation raises an interesting side-issue of international migration – that is, the issue of the possible ‘public-finance’ repercussions of international labour movements. In particular, drawing again on casual empiricism, the impact of international migration on government tax revenue and the provision of public goods is a recurring policy issue in labour-exporting and labour-importing countries. In this section we examine how lower import restrictions, in part through

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international migration, affect government net income tax revenue and the provision of public goods in a labour-exporting or a labour-importing country. Using (A1) and (A2) of appendix 1, and recalling that ␣ ⫽0 under an import tariff or quota and that ␣ ⫽1 under a VER, the effect of lowering the import restrictions (i.e. dt⬍0, ordZp ⬎0) on the level of public-good provision is, respectively, given by: (dg/dt)⫽{⫺[␳Rp ⫹(1⫺ ␳)gRgp]⫹[␳RL ⫺1 ⫹(1⫺ ␳)gRgL]RLL RLp}RLL␥t (dg/dZp)i ⫽{⫺[␳Rp ⫹(1⫺ ␳)gRgp] ⫺1 ⫹[␳RL ⫹(1⫺ ␳)gRgL]RLL RLp}RLL␥i,

(9)

(10)

where i ⫽q, v. Also from the discussion of (4), [␳Rp ⫹(1 ⫺ ␳)gRgp]⫽ (⭸B/⭸p), and [␳RL ⫹(1⫺ ␳)gRgL]⫽(⭸B/⭸p). Equations (9) and (10) differ again by their respective ␥j, j⫽ t, q, v, term. The common bracketed term in the two equations indicates that either lowering the tariff rate (i.e. dt⬍0), or increasing the volume of imports (i.e. dZp ⬎0) under quantitative import constraints affects the provision of the public good through the induced price effect (i.e. ⫺ (⭸B/⭸p) RLL␥j), and wage-migration effect (i.e. (⭸B/⭸L)RLL␥j), on the government net income tax revenue. In examining these two effects we have: Lemma 4: If the importable and public-consumption goods are complements in production (i.e. Rgp ⬎0), then lower import restrictions, through the induced price effect, exert a negative impact on public-good provision. This result may not hold if the two goods are substitutes in production (i.e. Rgp ⬍0). Discussion: A reduction in the tariff rate or an increase in the level of imports allowed under a quota or a VER regime entails a decrease in the domestic relative price of the importable good. As a result, its domestic production and government net income tax revenue decrease, negatively affecting the level of public-good provision. This is captured by the righthand-side term – ␳RpRLL␥j in (9) and (10). A further decrease in publicgood provision, captured by the term ⫺(1⫺ ␳)gRgpRLL␥j, is induced if this commodity is a complement to the importable in production (i.e. Rgp ⬎0). If, however, the two goods are substitutes in production (i.e. Rgp ⬍0), then the reduction in import restrictions may positively affect the level of publicgood provision through the induced price effect. Lemma 5: A sufficient condition for lower import restrictions to induce a negative impact on public-good provision through the induced wagemigration effect is that RLp ⬎0 and RLg ⬎0.

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Discussion: A reduction in the tariff rate or an increase in the level of imports allowed under a quota or a VER regime entails a decrease in the domestic relative price of the importable good. If the importable good is labour-intensive (i.e. RLp ⬎ 0) then the induced fall in the domestic relative price of the importable lowers the domestic wage, employment and, thus, net income tax revenue and the provision of the public good. This is captured by the term ␳RLRLp␥j in (7) and (8). A further reduction in income tax revenue and the provision of the public good, captured by the term (1 ⫺ ␳)gRgLRLp␥j, is induced if the reduction in employment increases the unit cost of the public good. In such a case, the reduction in import restrictions negatively affects, through the induced wage-migration effect, the level of public-good provision. If either of the two conditions does not hold, then freer trade, through lower import constraints, may positively affect the public-good provision through the induced wage-migration effect. Lemmas 4 and 5 suggest that sufficient conditions for lower import restrictions to overall reduce public-good provision are (1) the importable and public goods are complements in production, (2) the importable good is labour-intensive and (3) the outflow of labour increases the unit cost of the public good. The above results are further discussed within the context of the specific-factors trade model described in sub-section (3.1) and appendix 2, and by distinguishing between the case where kg ⬍ km and kg ⬎ km. 4.1

The specific-factors model

Within the specific-factors model, it is well known that RLp is positive. Assuming that the same type of sector-specific capital is used in the production of the importable and public-consumption goods, and that kg ⬍km, international emigration raises payments to factors employed in the production of the public good and its unit cost of production (i.e. ⫺gRgL ⫽ (dCg/dL)⬍0). Trade liberalisation reduces the domestic price of the importable, which in turn lowers the marginal revenue product of labour and results in an outflow of labour from the country. The latter, other things being equal, raises the domestic rate of return to labour, and reduces the rate of return to the specific factors (see appendix 2). Since kg ⬍km, the unit cost of the public good increases, and international migration, through the wage-migration effect, reduces net income tax revenue and the provision of the public good. Within the specific-factors model, Rgp is negative (see appendix 2) and thus the reduction in p (1) reduces the unit cost of the public good and (2) reduces the tax revenue. If the total effect is a reduction in net income tax

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revenue, then trade liberalisation reduces the level of public-good provision. If, however, net revenue increases, then trade liberalisation may increase the provision of the public good. When, however kg ⬎km – a likely case for a labour-importing developed country – then trade liberalisation that reduces the domestic price of the importable and the marginal revenue product of labour causes an outflow of labour that raises payments to factors employed in the production of the public good and its unit cost of production (i.e. ⫺gRgL ⫽(dCg/dL)⬎0). In such a case, international emigration, through the wage-migration effect, negatively affects net income tax revenue, and hence the provision of the public good if |(1 ⫺ ␶)gRgl |⬎ ␶RgL. It is thus more likely that trade liberalisation increases the provision of the public good when kg ⬎km. 5

Conclusions

What are the links between international trade and incentives for international migration? In particular, how does trade liberalisation affect factor prices in labour-exporting and labour-importing countries, and thus the incentives for migration? These questions, among other related ones, have preoccupied economists and policy-makers for a long time. In response, the international trade literature has invoked reasons – such as differences in endowments or production technologies among countries, imperfect competition and increasing returns – to establish the link between trade in goods and factors of production. The simplest of these trade models (e.g. HO models), under rather restrictive assumptions, have concluded that the two are perfect substitutes. In this chapter, departing from the standard trade approach, we consider a prominent link between the two to be the level of public-goods provision in labour-exporting and labour-importing countries. In the light of certain fiscal repercussions of international migration, we analyse the effect of trade liberalisation on the provision of public goods and on international labour movements. We build a general equilibrium trade model of a small (in world goods and factor markets) open economy, producing one imported, one exported and one domestic public-consumption good. The country’s imports are restricted either with tariffs or quantitative restrictions (QRs) while it is assumed that there is perfect international labour mobility. The effect of trade liberalisation on domestic employment and thus on emigration and on public-good provision depends on (1) the factor intensity of the importable good, (2) the relationship in production between the importable and the public good and (3) the relationship between the level of the public good and the marginal revenue product of labour. Sufficient

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but not necessary conditions for trade liberalisation to reduce the level of public-good provision and to cause emigration are (1) the importable good is labour-intensive, (2) the importable and the public good are complements in production and (3) an increase in the level of public-good provision to increase the marginal revenue product of labour. We use the specific-factors model, as an example, and we show that under plausible conditions it is very likely that trade liberalisation will cause emigration and reduce the level of public-good provision. The present analysis by no means exhausts the wealth of issues that arise in the context of trade, international migration and the provision of public goods. Further research will be required to answer questions such as: How do changes in the relative provision of public goods in labour-exporting and labour-importing countries affect international migration? What are the factors determining the size of the income tax rate and the desired level of public-good provision? How does international migration respond to changes in the (income) taxes imposed to finance the provision of public goods? What are the effects of international migration on the utility of a representative agent in a labour-exporting or a labour-importing country? Appropriate modifications of the present model can accommodate more efficiently these and related questions.

APPENDIX 1 Under an import tariff, assuming that the labour-importing or labourexporting country is a small open economy in world markets, (2), (3) and (6) constitute a system of three equations in terms of the endogenous variables u, g and L, as a function of the policy instrument t. Totally differentiating the three equations we obtain:

冤

(1⫺tZpu)[Eg ⫹(1⫺ ␳)gRgg ⫹tZpg] [(1⫺ ␳)gRgL ⫹tRpL] 0 [Rg ⫹(1⫺ ␳)gRgg] [rRL ⫹(1⫺ ␳)gRgL] 0 (1 ⫺ ␳)gRLg (1⫺ ␳)gRLL

冤

冥 冤

⫺[␳Rp ⫹(1⫺ ␳)gRgp ⫺tZpp] ⫺[␳Rp ⫹(1⫺ ␳)gRgp] ⫺(1⫺ ␳)RLp]

dt⫹

冥

冥冤 冥

⫺(R ⫺gRg) ⫺(R⫺gRg) d␳, RL

du dg ⫽ dL

(A1)

where ⌬t, the determinant of the left-hand-side coefficients matrix, is positive for stability. Under an import quota or a VER, assuming that the labour-importing or labour-exporting country is a small open economy in world markets, (2),

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(3), (5) and (6) constitute a system of four equations in terms of the endogenous variables u, g, p and L, as a function of the policy instrument Zp. Totally differentiating the four equations we obtain:

冤

1 [Eg ⫹(1⫺ ␳)gRgg] [␳Rp ⫹(1⫺ ␳)gRgp] ⫹ ␣Zp] (1⫺ ␳)RgL 0 [Rg ⫹(1⫺ ␳)gRgg] [␳Rp ⫹ (1⫺ ␳)gRgp] [␳RL ⫹ (1⫺ ␳)gRgL] Zpg Zpp ⫺RpL Zpu 0 (1⫺ ␳)RLg] (1⫺ ␳)RLp] (1 ⫺ ␳)RLL]

冤 冥 冤 (1⫺ ␣)t 0 1 0

dZp ⫹

冥

⫺ (R⫺gRg) ⫺ (R⫺gRg) d␳, 0 RL

冥冤 冥

du dg ⫽ dp dL

(A2)

where ⌬j, i⫽ q,v, the determinant of the left-hand-side coefficients matrix is negative for stability. Note that when a⫽0 we get ⌬q (⬍ 0), and when a⫽1 we get ⌬v (⬍0).

APPENDIX 2 Within the context of the sector-specific model, we examine the effects of international migration and lower trade restrictions (entailing a smaller domestic relative price for the importable good), on the rates of return to factors, and the unit cost of public-good production. Profit-maximisation under perfect competition requires that the return to each factor is equated to its marginal revenue product in the alternative uses (see eq. (2)). That is: w⫽pML(Km, Lm, g) r ⫽pMK(Km, Lm, g) q ⫽AK(Ka, L⫺Lm ⫺Lg, g) pML(Km, Lm, g)⫽AL(Ka, L ⫺Lm ⫺Lg, g),

(B1)

where w, r and q are the rates of return to the intersectorally mobile labour, to capital specific in the production of the importable good, and to capital specific in the production of the (numeraire) exportable good. The relative price of the former is given by p(⫽pM/pA), Mj (⫽⭸M/⭸j), j ⫽Km, Lm and Ai (⫽⭸A⭸i), i ⫽Ka, La are the respective marginal products of factors in the production of the two private-traded goods. We assume that it is the prices of traded goods and factor supplies that determine the factor rewards, which in turn determine the unit cost of the public good (see Komiya, 1967, for a similar analysis in the context of two

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traded and one private non-traded good). Thus, total differentiation of (B1), with respect to p, treating Lg and g as constant, yields: (dw/dp)⫽⍀⫺1pALL ⬎0 (dr/dp)⫽MK ⫺⍀⫺1pMLMKL ⬎0 (dq/dp)⫽⍀⫺1AKLML ⬍0 (dLm/dp)⫽⫺⍀⫺1ML ⬎0.

(B2)

Total differentiation of eq. (B1), under the same assumptions, with respect to L yields: (dw/dL)⫽⍀⫺1pMLLALL ⬍0 (dr/dL)⫽⍀⫺1pMKLALL ⬎0 (dq/dL)⫽⍀⫺1pAKLMLL ⬎0 (dLm/dL)⫽⍀⫺1ALL ⬎0,

(B3)

where ⍀⫽ (pMLL ⫹ALL)⬍0. Under constant returns to scale and the assumption of the sector-specific model, MKL (⫽⫺MLL/km) and AKL (⫽⫺ AKK/ka), km ⫽(Km/Lm) and ka ⫽(Ka/La) are both positive. The unit cost of public-good production is given by Cg ⫽wLg ⫹rKg, where Lg and Kg, respectively, are the amounts of labour and sector-specific capital used in the production of the public good. It is assumed that sectorspecific capital used in the production of the public-consumption and the importable goods is the same. Then, using eq. (B2), it is evident that reducing import restrictions, which entails a reduction in the domestic relative price of the importable good, reduces the unit cost of public-good provision. That is: (dCg/dp)⫽Cpg ⫽Lg (dw/dp)⫹Kg (dr/dp)⬎0.

(B4)

Recalling the properties of the GDP function, we have Rpg ⫽Rgp (⫽⫺ Cpg) ⬍0. That is, within the context of the specific-factors model, the importable and public-consumption goods are substitutes in production. The effect of international migration on the unit cost of public-good production can be written as: (dCg/dL)⫽⫺RgL ⫽(Lg/km) (dw/dL) (km ⫺kg),

(B5)

where kg ⫽(Kg/Lg). Equation (B5) indicates that international migration, which entails a reduction in the source-country’s labour endowment, increases the unit cost of public-good production, i.e. (dCg/dL)⬍0, if km ⬎ kg, if the production of the public good is relatively less capital-intensive than that of the importable good. International emigration decreases the unit cost of public-good production, i.e. (dCg/dL)⬎ 0, if km ⬍kg, if the production of the public good is relatively more capital-intensive than that of the importable good.

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NOTES The authors gratefully acknowledge the constructive comments by R. Faini, I. Musu and participants in the CEPR conference on ‘Trade and Factor Mobility’. We alone are responsible for any remaining shortcomings of the chapter. 21 In the quantitative sense, goods trade and factor movements are substitutes (complements) if an increase in the volume of trade reduces (raises) the level of factor movements, or vice versa. In the price-equalisation sense, goods trade and factor movements are substitutes if free trade in goods implies FPE, or vice versa. The above definitions constitute the weak version of substitutability or complementarity. In the strong version of the two definitions, the term ‘or vice versa’ is replaced by the term ‘and vice versa’ (see Wong, 1995). 22 In 2 ⫻3 neo-classical trade models with endogenous effective supply of the third factor, international trade in goods and factor movements are likely to be complements rather than substitutes (see Findlay, 1995, ch. 5). 23 Ethier (1985) develops an alternative approach, which emphasises the embodiment of key characteristics of international migration (temporary nature, imperfect substitutability and asymmetric variations in employment between migrant and native labour). 24 For tariff- or quota-induced international capital movements, see among others, Brecher and Diaz-Alejandro (1977); Brecher and Findlay (1983); Hatzipanayotou and Michael (1993). 25 For example, Grubel and Scott (1966) argue that an important way through which emigration affects welfare in labour-exporting countries is through any induced changes in the cost of public-goods provision (public education, police protection, judicial services, etc.) to the remaining non-emigrant population. The authors note that governments in these countries may reduce the level of such services by nearly the same proportion by which tax revenue declines due to emigration. Thus, the tax burden on non-emigrants, for providing these public goods, either remains unchanged or increases marginally. For a recent survey on migration issues see Borjas (1994, 1995); Friedberg and Hunt (1995); Zimmermann (1995). 26 Simon (1984) maintains that because early immigrant populations are constituted of more workers and fewer dependants, their contribution to the production cost of public goods and services is relatively high. Moreover, he estimates that in the USA, an average immigrant household whose head entered the country less than 10 years ago consumes 15–48 per cent fewer public services than a native one. Greenwood and McDowell (1986) quote evidence whereby in the USA, regardless of sex and duration of residence, immigrant families use up fewer public services compared to natives. 27 Remittances have been a major source of foreign exchange earnings for a number of traditionally labour-exporting Southern European and Asian countries. For example, during the 1980s, Greece’s average annual foreign exchange earnings from remittances were approximately US$ 835 million, Spain and Pakistan’s US$ 2billion, India’s US$ 2.5 billion and S. Korea’s US$ 1.4 billion (our own calculations, using OECD data). 28 The structure of the present model implies that the government sets the income tax at a rate ␳, which in turn determines the level of income taxes, and level of public-good provision g. Alternatively, it could be assumed that it is the level of g that the government chooses, and in turn adjusts the income tax rate to

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10

11

12

13

111

generate the required income tax revenue for its financing. The process of determining the optimal sizes of ␳ and g is beyond the scope of the present chapter. From the properties of the GDP function Rgp⫽⫺ Cpg. Then, the importable and public-goods are complements in production, if the induced decrease in the domestic relative price of the importable increases the unit cost of public-good provision, and substitutes if it decreases the unit cost. ˜ VL, where R ˜ ⫽R ˜ (pvp(p,g), Using (1) and (2) we obtain gRgL ⫽⫺ gCwg RVL ⫽ ⫺VgR p g g), v and v , respectively, are the vectors of primary factors used in the production of the private traded and the public goods, and vp ⫹vg ⫽v since we are assuming full employment. International migration, which reduces domestic labour supply, reduces (respectively, increases) payments to factors employed in the production of the public-good if VgR˜VL (respectively, ⬍ 0). Note that for the purposes of the analysis it is assumed that the income tax rate is constant (i.e. d␳ ⫽ 0). Thus, changes in the level of the public good are due to the so-called price effect and wage-migration effect of trade liberalisation on tax revenue and the cost of public-good provision. In the specific-factors model, free trade in goods, alone, rarely leads to FPE. But the properties of the model ensure that only one factor (intersectorally mobile or sector-specific) needs to be internationally mobile for prices of all other factors to be equalised in free trade (see Findlay, 1995, ch. 1). If the internationally mobile factor is a sector-specific one (e.g. capital), then trade liberalisation induces international mobility of that factor and enhances trade not only due to the lower trade restrictions, but also due to enlarged differences in relative factor endowments between countries following international factor mobility.

REFERENCES Abe, K. (1995). ‘Tariff Reform in a Small Open Economy with Public-good Production’, International Economic Review, 33, 209–22 Borjas, G. (1994). ‘The Economics of Immigration’, Journal of Economic Literature, 32, 1667–1717 (1995). ‘The Economic Benefits of Immigration’, Journal of Economic Perspectives, 9, 3–22 Brecher, R. and J. Bhagwati (1981). ‘Foreign Ownership and the Theory of Trade and Welfare’, Journal of Political Economy, 89, 497–511 Brecher, R. and C. Diaz-Alejandro (1997). Tariffs, Foreign Capital and Immiserizing Growth’, Journal of International Economics, 7, 317–22 Brecher, R. and R. Findlay (1983). Tariffs, Foreign Capital and National Advantage with Specific Factors’, Journal of International Economics, 14, 277–88 Dixit, A. and V. Norman (1980). TheTheory of International Trade: A Dual General Equilibrium Approach (Cambridge: Cambridge University Press) Ethier, W. (1985). ‘International Trade and Labor Migration’, American Economic Review, 75, 691–707 Findlay, R. (1995). Factor Proportions, Trade, and Growth (Cambridge: MA, MIT Press)

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Friedberg, R. and J. Hunt (1995). ‘The Impact of Immigrants on Host-country Wages, Employment and Growth’, Journal of Economic Perspectives, 9, 23–44 Greenwood, M. and J. McDowell (1986). ‘The Factor Market Consequences of US Immigration’, Journal of Economic Literature, 24, 1738–72 Grubel, H. and A. Scott (1966). ‘The International Flow of Human Capital’, American Economic Review, 56, 268–74 Hamada, K. and J. Bhagwati (1976). ‘Domestic Distortions, Imperfect Information and the Brain Drain’, in J. Bhagwati (ed.), The Brain Drain and Taxation, vol. II: Theory and Empirical Analysis (Amsterdam, North-Holland) Hatzipanayotou, P. and M. Michael (1993). ‘Import Restrictions, Capital Taxes, and Welfare’, Canadian Journal of Economics, 26, 727–38 King, M. (1986). ‘A Pigovian Rule for the Optimal Production of Public Goods’, Journal of Public Economics, 30, 273–91 Komiya, R. (1967). Non-traded Goods and the Pure Theory of International Trade’, International Economic Review, 8, 132–52 Mayer, W. (1974). ‘Short-run and Long-run Equilibrium for a Small Open Economy’, Journal of Political Economy, 82, 955–67 Mundel, R. (1957). International Trade and Factor Mobility’, American Economic Review, 47, 321–35 Simon, J. (1984). ‘Immigrants, Taxes and Welfare in the United States’, Population Development Review, 10, 55–69 Venables, A. (1997). ‘Trade Liberalisation and Factor Mobility: An Overview’, chapter 2 in this volume Wong, K. (1995). International Trade in Goods and Factor Mobility (Cambridge, MA: MIT Press) Zimmermann, K. (1995). ‘Tackling the European Migration Problem’, Journal of Economic Perspectives, 9, 45–62; reprinted in M.N. Jovanovic (ed.), International Economic Integration. Critical Perspectives of the World Economy (London: Routledge, 1998)

Discussion IG N AZ IO MUSU Chapter 5 examines two interesting related issues: the first is the effect of trade liberalisation on international migration; the second is the effect of trade liberalisation on provision of public goods in different countries; the two effects are connected because the original contribution of this chapter

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Friedberg, R. and J. Hunt (1995). ‘The Impact of Immigrants on Host-country Wages, Employment and Growth’, Journal of Economic Perspectives, 9, 23–44 Greenwood, M. and J. McDowell (1986). ‘The Factor Market Consequences of US Immigration’, Journal of Economic Literature, 24, 1738–72 Grubel, H. and A. Scott (1966). ‘The International Flow of Human Capital’, American Economic Review, 56, 268–74 Hamada, K. and J. Bhagwati (1976). ‘Domestic Distortions, Imperfect Information and the Brain Drain’, in J. Bhagwati (ed.), The Brain Drain and Taxation, vol. II: Theory and Empirical Analysis (Amsterdam, North-Holland) Hatzipanayotou, P. and M. Michael (1993). ‘Import Restrictions, Capital Taxes, and Welfare’, Canadian Journal of Economics, 26, 727–38 King, M. (1986). ‘A Pigovian Rule for the Optimal Production of Public Goods’, Journal of Public Economics, 30, 273–91 Komiya, R. (1967). Non-traded Goods and the Pure Theory of International Trade’, International Economic Review, 8, 132–52 Mayer, W. (1974). ‘Short-run and Long-run Equilibrium for a Small Open Economy’, Journal of Political Economy, 82, 955–67 Mundel, R. (1957). International Trade and Factor Mobility’, American Economic Review, 47, 321–35 Simon, J. (1984). ‘Immigrants, Taxes and Welfare in the United States’, Population Development Review, 10, 55–69 Venables, A. (1997). ‘Trade Liberalisation and Factor Mobility: An Overview’, chapter 2 in this volume Wong, K. (1995). International Trade in Goods and Factor Mobility (Cambridge, MA: MIT Press) Zimmermann, K. (1995). ‘Tackling the European Migration Problem’, Journal of Economic Perspectives, 9, 45–62; reprinted in M.N. Jovanovic (ed.), International Economic Integration. Critical Perspectives of the World Economy (London: Routledge, 1998)

Discussion IG N AZ IO MUSU Chapter 5 examines two interesting related issues: the first is the effect of trade liberalisation on international migration; the second is the effect of trade liberalisation on provision of public goods in different countries; the two effects are connected because the original contribution of this chapter

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is to analyse the effects of trade liberalisation on migration through the effects on provision of some public good. The analysis is developed through a series of comparative static exercises with a general equilibrium model focusing on the production side of the economy and using duality theory. Although there are a number of analytical results, depending on assumptions on labour intensity of the importable good and on the degree of substitution between the importable and the public good, a general outcome seems to emerge from the whole analysis: this quite reasonable result being that trade liberalisation is likely to reduce immigration or increase emigration not only directly by reducing the labour marginal revenue, but also indirectly by reducing the tax revenue coming from trade restrictions, and hence by providing fewer funds to finance the provision of a public good which is assumed to have a positive effect on the labour marginal revenue. Hence the causal chain is from trade liberalisation to lower taxes to lower provision of public good to lower demand for labour. A second interesting result more specifically concerns the relation between trade liberalisation and provision of public goods. The effect of a lower provision of public goods from trade liberalisation comes from lower tax revenue; but this is not only the effect of lower trade restrictions, but also of the lower level of domestic employment associated with fewer immigrants and more emigrants. This result seems to me particularly relevant in developed countries, where immigrants may be important precisely because they are a source of government income to provide some goods which may be attributed the feature of public goods, as it could be the case with a payas-you-go social security system in a country with serious demographic problems. This result, however, cannot be fully appraised within the assumptions of the model, because among these assumptions we find that of migration being temporary, which means that income earned by immigrant workers in the host country are remitted back to the source one. It would be worth exploring the effects of relaxing this assumption. On the other hand, it may be admitted that the effect of a lower provision of public goods because of lower immigration can be a source of less concern when the public goods are those specifically required by immigrants (public order, sheltering structures, health services), in which case, however, the feature of public goods is not fully present. To more satisfactorily analyse this kind of problem, it would be worth extending the model introducing public goods in a utility function, and possibly distinguishing between residents and immigrants. Finally, the chapter assumes full employment and hence directly relates the level of domestic employment to the level of migration. Analysing what happens with disequilibrium in the labour market would be interesting,

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because in many countries immigration is a source of concern precisely as a threat to employment of domestic residents. A reading of this chapter confirms the extreme importance of further research on the relation between trade liberalisation and international migration; the issue of public goods plays a crucial role in this relation, and in exploring it the chapter provides a relevant and original contribution.

Part Two Quantifying the links between trade and migration

6

Trade and migration: a productiontheory approach U LR ICH KOHL I

1

Introduction

Do guest-workers threaten the jobs of native workers? Do foreigners, willing to work for low wages, drive down domestic wages? These and similar questions have long preoccupied workers, policy-makers and economists, in Switzerland and elsewhere, and they have become particularly pressing at a time when globalisation is likely to increase exposure of workers from industrialised countries to competition from low-wage nations. One line of research that has proved useful to address this type of question is what has become known as the ‘production-theory’ approach to migration.1 This approach, introduced by Baldwin Grossman (1982), treats foreign labour services as an input to the technology. Moreover, due to differences in characteristics and attributes, foreign labour is treated as being conceptually different from domestic labour. This makes it possible to determine whether immigrants and natives are substitutes or complements in production. One can then also assess the job-displacement and income-redistribution effects of international labour mobility.2 It is quite surprising, however, that none of the studies based on the production-theory framework has modelled international migration within an open-economy setting. That is, no allowance has been made for possible links between international factor movements and foreign trade.3 Many additional questions thus remain unanswered. Does immigration reduce or enhance a country’s foreign trade? Who benefits most from international movements of labour in an open-economy context? How does a change in the terms of trade affect the distribution of income in the presence of international labour mobility? This lack of empirical evidence is all the more surprising since the theoretical trade literature has examined the links between trade and factor movements quite carefully without, however, coming to a firm conclusion. Thus, for some authors, foreign trade can be viewed as a substitute for international factor movements,4 while for others it acts rather as a complement.5 The main objective of this chapter is to 117

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attempt to give an empirical answer to some of these questions, and we shall see that one has to be quite careful in defining in what sense trade and factor movements might be complements or substitutes. In what follows, we will model the production sector of the Swiss economy, taking into account the input of foreign labour together with the input of intermediate products of foreign origin. This chapter can thus be viewed as a contribution towards the integration of the production-theory approach to migration and the production-theory approach to modelling foreign trade.6 The production-theory approach to modelling foreign trade views imports as an input to the technology.7 Imports are used together with primary factor services to produce goods destined for domestic and foreign markets. This approach recognises the fact that most foreign trade is in raw materials and non-finished products, and that even most socalled ‘finished goods’ must still go through a number of domestic channels before meeting up with final demand, so that a significant proportion of the final price tag is accounted for by domestic value-added. An attractive feature of the production-theory approach is that it rests on solid theoretical foundations. Furthermore, it yields a wealth of results about the substitution possibilities allowed for by the technology that cannot be matched by traditional methods which typically rely on single-equation methods. Last but not least, unlike many models of international trade theory, the production-theory approach can easily be implemented empirically since the data it requires are of the type contained in the National Accounts.8 It is a simple matter then to extend the productiontheory approach to import determination to allow for international labour mobility. One unfortunate characteristic of the production-theory approach to immigration is that it has involved a fair degree of confusion. Some of the empirical evidence is in terms of Allen–Uzawa elasticities of substitution, and some of it is in terms of Hicksian elasticities of complementarity. Analysts have often failed to fully appreciate this distinction when comparing results drawn from different studies. Yet comparison of Allen– Uzawa elasticities of substitution and Hicksian elasticities of complementarity is not a simple matter since the passage from one set of elasticities to the other is far from being trivial, and is not always well understood. Two inputs, such as domestic and foreign workers, could be complements in the Hicksian sense and substitutes in the Allen–Uzawa sense. One objective of this study is to clarify this point by reporting both Hicksian elasticities of complementarity and Allen–Uzawa elasticities of substitution between resident and non-resident workers. By presenting our results for these alternative settings, we will be better able to assess the effects of immigration on the income of domestic factors of production, and to

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Figure 6.1

Input quantities

examine the effects of changes in the payments to immigrants on the employment opportunities of resident workers. However, we will argue that other sets of elasticities may be still better suited to analyse the impact of immigration in an open-economy context; this will make it possible to assess the impact of changes in domestic factor endowments and in traded good and service prices on immigration, foreign trade, production and the distribution of income. Immigration has long been an important issue in Switzerland where a large proportion of the resident labour force is of foreign origin, and where non-resident workers have, at times, made up nearly a quarter of the labour force. Non-resident workers either are holders of seasonal or yearly permits, or they live in neighbouring countries and cross the border on a daily basis to work in Switzerland. As shown by figure 6,1, relative inputs have changed substantially over time. The use of resident labour does not exhibit much of a trend throughout the post-war period. Increases in the domestic labour force have been offset to some extent by reductions in the length of the work week. The use of non-resident labour, on the other hand, increased very substantially throughout the 1950s and much of the 1960s, but it fell dramatically in the mid-1970s. The input of capital increased steadily, whereas the use of imports, on average, increased at an even faster

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Figure 6.2

Gross output and aggregate input

pace. The sharp reduction in the number of non-resident workers in the mid-1970s is apparent in figure 6.2, which shows an implicit Tornqvist index of aggregate inputs (dashed line), and it has had a marked effect on the level of gross output (solid line). The difference between the two lines can be interpreted as total factor productivity (TFP), and it has increased throughout much of the period. Concern has been expressed recently that flexible functional forms may not be flexible enough to adequately model technological change and productivity growth, see Diewert and Wales (1992). This may be particularly relevant here, given the shock which apparently – judging from figure 6.2 – affected the Swiss economy in the mid-1970s. As suggested by Diewert and Wales, one way of handling the problem is with the help of spline functions. In this chapter, we will innovate and experiment along an alternative route, by increasing the level of flexibility of the aggregator function with respect to time. The remainder of this chapter is organised as follows. Section 2 briefly reviews alternative descriptions of the aggregate technology. Section 3 discusses the comparative statics of the model, while section 4 examines its empirical implementation. Sections 5 and 6 present our main empirical results, and section 7 draws some conclusions.

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2

The production-theory approach to modelling the demand for imports and foreign-labour services

The production-theory approach to migration treats immigrants as an input to the technology. Similarly, the production-theory approach to foreign trade views imports as intermediate products. We will therefore consider that aggregate output is produced with the use of four inputs: imports (M), non-resident labour (N), resident labour (L) and capital (K). The aggregate technology can be represented by the following production function: y⫽f(x),

(1)

where y is the quantity of gross output, x ⬅[xj] (j僆M, N, L, K) is the vector of input quantities. We assume that f(x) is increasing, quasi-concave, and linearly homogeneous with respect to the components of x. Variable returns to scale have become an important ingredient of many models, in international trade theory as well as in growth theory. However, under variable returns to scale, aggregation over agents in order to get a representation of the country’s technology may become next to impossible, due to departures from perfect competition, and because intermediate goods no longer necessarily net out. We do not believe that variable returns to scale at the plant, firm or industry level can be adequately accounted for by simply relaxing the linear homogeneity assumption at the aggregate level. For the sake of coherence, we therefore prefer to proceed with constant returns to scale as our maintained hypothesis. Our treatment clearly rests on some heroic assumptions about aggregation. For a start, we assume that all outputs can be aggregated into a single composite good, which can be either absorbed at home or exported to the rest of the world.9 Furthermore, considering four inputs only may seem restrictive as well. The reader may feel that it would important to distinguish between skilled and unskilled, resident and non-resident workers, and perhaps that one should disaggregate capital and/or imports. In truth, the theoretical model which we will develop in this section and the next can easily accommodate disaggregation almost ad infinitum. It suffices to interpret y and the xj s as vectors, and to use a transformation function instead of a production function as a starting point. To keep the empirical application manageable, however, one must obviously draw the line somewhere. Degrees of freedom rapidly vanish as the number of inputs and/or outputs increase, and difficulties meeting the required regularity conditions without compromising flexibility rapidly becoming overwhelming. In reference to the literature, our model of the aggregate technology, by considering four inputs, is already more general than most. It would of course also be of interest to disaggregate labour between

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native and foreign-born workers, or between Swiss citizens and foreigners. This does not seem to be possible, however, since the income data are not available. One can argue, however, that the distinction between non-resident and resident workers, which is dictated by data availability, does make sense, since it amounts to distinguishing between recent and temporary immigrants (‘guest-workers’), on the one hand, and non-recent and longterm immigrants on the other, the latter being well integrated and similar to Swiss workers in most respects. The use of non-resident labour services is somewhat concentrated, both in terms of industries and geographically. The number of transborder workers is naturally largest in border areas, particularly so in Geneva, Basle and the Ticino. The ‘frontaliers’ tend to be employed in a large variety of industries, and in a wide range of skills. Holders of seasonal and yearly permits, on the other hand, tend to be more evenly distributed across the country, but they tend to be low-waged and concentrated in particular industries, such as construction or food and lodging services. This might militate in favour of using a two-sector model. However, as argued previously, even though disaggregation of output could easily be handled by the model, it would make the empirical application that much more complex, and it is not clear that if some further disaggregation were indeed contemplated, this would be the most urgent direction in which it should be carried out.10 While international labour mobility is an important issue in the Swiss case, one could argue that capital mobility is even more relevant. No attempt is made here to model international capital movements. There are several reasons for this. Some practical ones first: distinguishing between domestically and foreign owned capital would increase the size of the model, and data on the quantity and the price of both types of capital would be difficult to obtain. In fact, it is likely that as far as production possibilities are concerned, the question of ownership is largely irrelevant. This suggests that the return to both types of capital might be same, in which case aggregation can be justified on Hicksian grounds. There are also some conceptual reasons why the issue of international capital mobility is not tackled here. By focusing on current production decisions exclusively, we do not attempt to model the investment process. In any case, international capital flows typically take the form of movements in equity and financial assets: it is the ownership of the capital stock that is traded, rather than the physical capital stock itself. Modelling international capital flows as exogenous changes in the domestic endowment of capital seems very unsatisfactory. The dismantling of a machine or a factory in order to rebuild it in a different country is the exception, not the rule. Moreover, to the extent that international capital flows can have a direct effect on the domestic endowment of capital, they should first impact on the trade

A production-theory approach 123

account – as part of imports or exports of capital goods – and on gross output – as part of domestic investment or disinvestment. Under cost-minimisation, the country’s technology can also be described by the unit cost function defined as: c(w)⬅min x

冦兺w x : f(x)ⱖ1冧 j j

(2)

j

where w⬅[wj] is the vector of input prices. Under competitive conditions, unit cost is equal to the price of aggregate output (p). By Shephard’s (1953) lemma, the unit-output cost-minimising demand for inputs can be obtained by differentiation of (2):11 xj ⭸c(w), ⫽ j僆{M, N, L, K}. y ⭸wj

(3)

It is noteworthy that the demand for all inputs, including imports and foreign labour services, will generally depend on all four input prices. A change in the price of imports, for instance, is liable to affect the demand for foreign labour services, just as a change in the wage rate of non-resident workers may impact on the demand for imports. To assess these price effects – and, more generally, the substitution possibilities allowed for by the technology – it is useful to compute the Allen–Uzawa elasticities of substitution between input j and input k, ␴jk. It is of course well known that:12

␴jk ⫽

c(w)cjk(w), j, k僆{M, N, L, K}, cj(w)ck(w)

(4)

where cj(w)⬅ ⭸c(w)/⭸wj, and cjk(w)⬅⭸2c(w)/(⭸wj⭸wk); ␴jk is positive if inputs j and k are substitutes in the Allen–Uzawa sense and it is negative if the two inputs are complements. These elasticities are relevant if one wishes to assess the impact of an increase in the price of one input on its quantity demanded, and on the quantities of all other inputs. Thus, if ␴LN is positive, one can assert that a reduction in the wage paid to guest-workers will reduce the demand for native labour services, and could thus lead to increased unemployment among resident workers. The Allen–Uzawa elasticities of substitution given by (4) are defined for given input prices, and they are not to be confused with Hicksian elasticities of complementarity, ␺jk, defined for given input quantities.13 If the production function is known, the elasticities of complementarity can be obtained directly as:

␺jk ⫽

f(x)fjk(x), j, k僆{M, N, L, K}, fj(x)fk(x)

(5)

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where fj(x)⬅⭸f(x)/⭸xj, and fjk(x)⬅⭸2f(x)/(⭸xj⭸xk}); ␺jk is positive if inputs j and k are q-complements in the Hicksian sense, and it is negative if they are q-substitutes. The sign of ␺LN is crucial in determining whether an increase in immigration raises or reduces the return to domestic labour. The Hicksian elasticities of complementarity can also be derived from estimates of the cost function. Let us define ⌺ ⬅ [␴jk] as the Allen–Uzawa substitution matrix and ⌿ ⬅ [␺jk] as the Hicksian q-complementarity matrix. As shown by Kohli (1991), the link between ⌿ and ⌺ is given by: ˜ ⫺1S˜ ⫺1, ˜ ⫽S˜ ⫺1⌺ ⌿

(6)

where: ˜⬅ ⌿

冤冥 冤冥 ⌿ u

(7)

u⬘ 0

˜⬅ ⌺

⌺ u

(8)

u⬘ u

S˜ is a 5 ⫻ 5 diagonal matrix with the four cost shares and a one as elements, and u is a four-dimensional unit vector. Thus, the passage from one set of elasticities to the other is not trivial, and it involves the inversion of a bordered matrix. Note that as soon as the number of inputs exceeds two, one cannot infer anything about the sign of ␴jk from the sign of ␺jk alone.14 Thus, two inputs could be Hicksian q-complements, and yet they could equally well be Allen–Uzawa substitutes or complements. 3

Comparative statics

3.1

The cost-function setting

While both the Allen–Uzawa substitution matrix ⌺ and the Hicksian qcomplementarity matrix ⌿ are informative as to the relationships between the various inputs, their elements – particularly their size – are somewhat difficult to interpret. It is often more convenient to resort to ordinary price and quantity elasticities. Consider demand system (3). The comparative statics of that system can be captured by a matrix of price elasticities of demand E⬅[␧jk] defined as follows:

A production-theory approach 125

␧jk ⬅

⭸ln xj(w,y) . ⭸lnwk

(9)

It is well known that the elements of E can be obtained directly from the Allen–Uzawa elasticities of substitution:15 ␧jk ⫽ ␴jksk,

(10)

where sk is the cost share of the kth input, sk ⬅wkxk/(⌺wjxj). Moreover, it follows directly from (2) and (3) that ⭸ln xj (w,y)/⭸ln y⫽1, that ⭸ln c(w)/⭸ln y⫽0, and that ⭸ln c(w)/⭸ln wj ⫽sj. The full comparative statics of the model can therefore be summarised by the following system:

冤冥 冤 xˆM xˆN

xˆL ⫽

xˆK … pˆ

␧MM ␧MN

␧ML

␧MK

⯗

1

␧NM

␧NN

␧NL

␧NK

⯗

1

␧LM

␧LN

␧LL

␧LK

⯗

1

␧KM

␧KN

␧KL

␧KK

…

…

…

…

sM

sN

sL

sK

where the hats (^) denote relative changes. 3.2

⯗

冥冤 冥 w ˆM w ˆN

,

(11)

w ˆL

1

w ˆK … … yˆ ⯗ 0

The production-function setting

Alternatively, if one departs from the Hicksian elasticities of complementarity, one would naturally be led to the matrix of quantity elasticities of inverse demand, H⬅[␩ jk], to describe the comparative statics of the model. These elasticities are defined as:

␩ jk ⬅

⭸ ln wj(x,p) . ⭸ ln xk

(12)

The elements of H can be obtained directly from the Hicksian elasticities of complementarity as follows:

␩ jk⫽ ␺jksk,

(13)

where sk is again the cost share of the kth input. The full comparative statics of the model can now be summarised in the following way:

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冤冥 冤 w ˆM w ˆN

w ˆL ⫽ w ˆK … yˆ

␩MM ␩MN

␩ML

␩MK

⯗

1

␩NM ␩NN

␩NL

␩NK

⯗

1

␩LM ␩LN

␩LL

␩LK

⯗

1

␩KM ␩KN

␩KL

␩KK

…

…

…

…

sM

sN

sL

sK

⯗

冥 冥冤

xˆM xˆN ,

(14)

xˆL

1

xˆK … … pˆ ⯗ 0

where we have taken account of the first-order conditions for profit-maximisation which imply that ⭸ln f(x)/⭸ln xj ⫽sj. Moreover, ⭸ln wj(x,p)/⭸ln p⫽1, and ln f(x)/⭸ln p⫽0. It is immediately visible that the square matrix in (14) is simply the inverse of the square matrix in (11); this illustrates our earlier result (6). 3.3

The GNP-function setting

While both the price elasticities of demand (matrix E) and the quantity elasticities of inverse demand (matrix H) are relevant in some circumstances, one can argue that in an open-economy context, yet another set of elasticities is necessary. Indeed, it is reasonable to assume that the endowments of domestic factors (capital and resident labour) are given. At the same time, considering Switzerland as a small open economy, we can view the prices of output, imports and non-resident labour services as pre-determined as well.16 In such a setting, which is known as the GNP-function framework,17 the substitution possibilities allowed for by the technology can be described by the following matrix of price and quantity elasticities, ␧⬅[⑀jk]:

冤冥 冤

⑀YY ⑀YM ⑀YN ⯗ ⑀YL ⑀YK

yˆ

xˆM

⑀MY ⑀MM ⑀MN ⯗ ⑀ML ⑀MK ⑀NY ⑀NM

xˆN ⫽ … … … w ˆL ⑀LY ⑀LM w ˆK ⑀KY ⑀KM

⑀NN ⯗ ⑀NL ⑀NK …

…

⑀LN

⯗

…

⑀LL ⑀LK

⑀KN ⯗ ⑀KL ⑀KK

冥冤 冥 pˆ

w ˆM

w ˆN . … xˆK xˆK

(15)

A production-theory approach 127

These elasticities are defined for given prices of gross output, imports and foreign labour services, and for given domestic factor endowments. The elasticities in the northwest corner of (15) are the price elasticities of output supply and variable input demand. The elasticities in the southwest corner indicate the impact of changes in the prices of output and variable inputs on domestic factor rental prices (the Stolper–Samuelson (SS) effects). The elasticities in the northeast corner of (15) capture the effect of changes in domestic factor endowments on the supply of output and on the demand for variable inputs (the Rybczynski effects). In the southeast corner, finally, we find the quantity elasticities of the inverse demand for the domestic factors. It is noteworthy that the homogeneity properties of the GNP function that is dual to f(x) imply the following restrictions: ⌺⑀ih ⫽ 0, i, h僆{Y,M,N} h

⌺⑀jk ⫽ 0, j, k僆{L,K} k

⌺⑀ij ⫽ 1, i僆{Y,M,N}, j僆{L,K} j

⌺⑀ji ⫽ 1, j僆{L,K}, i 僆{Y,M,N}. i

The signs of ⑀LN and ⑀KN are particularly important in determining the impact of increased immigration on domestic factor payments; thus, if ⑀LN ⬎0 a reduction in wN, which leads to an increase in the demand for guest-workers, will tend to reduce the rental price of resident labour. The sign of ⑀MN, on the other hand, will indicate the impact of changes in the wage rate paid to non-resident workers on the demand for imports. If ⑀MN ⬎0, immigration will tend to act as a substitute for foreign trade in the sense that an increase in the cost of non-resident labour would tend to favour imports. The elasticities contained in (15) can easily be calculated from the estimates of the price elasticities of input demands contained in (11). That is, it is a simple matter to solve the system of (11) for yˆ , x ˆ M, xˆN, w ˆ L and w ˆK, as functions of pˆ , w ˆ M, w ˆ N, xˆL and xˆK.18 Of course, the GNP-function elasticities could be obtained directly if one chose to use the GNP-function to describe the aggregate technology, just as the elasticities in (14) could be obtained directly from the production function, without having to rely on (6). In order to best illustrate the difference between the various sets of elasticities, however, we want to derive them all from the same set of econometric parameter estimates. That is, we do not want to change the econometric specification as we move from one set of elasticities to the next.

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Ulrich Kohli

Immigration quotas

One might argue that the GNP-function setting is inappropriate in that it treats foreign labour services as a variable input, whereas, in practice, working permits are not issued freely. This militates in favour of treating xN as a fixed, rather than as a variable, input. Thus, compared to (15) there would now be three – rather than just two – fixed inputs. The comparative statics of the model could then be summarised by the following matrix of price and quantity elasticities, ⌽⬅[␾jk]:

冤冥 冤

冥冤 冥

␾YY ␾YM ⯗ ␾YN ␾YL ␾YK

yˆ

␾MY ␾MM ⯗ ␾MN ␾ML ␾MK

xˆM … … w ˆN ⫽ ␾NY w ˆL ␾LY w ˆK ␾KY

…

…

…

…

␾NM ⯗ ␾NN ␾NL ␾NK ␾LM ⯗ ␾LN ␾LL ␾LK

␾KM ⯗ ␾KN ␾KL ␾KK

pˆ

w ˆM … xˆN .

(16)

xˆL

xˆK

Matrix ⌽ can easily be computed from estimates of E. The elements of ⌽ will indicate the impact of higher immigration on domestic factor rental prices, as well as on imports and gross output. At the same time, they will yield information about the impact of a change in the terms of trade on domestic as well as foreign factor rental prices. A negative value of ␾MN would suggest that immigration and trade are substitutes in the sense that a larger contingent of non-resident workers tends to reduce the demand for imports. 3.5

Domestic workers’ displacement effects

One of our original questions was: does immigration tend to reduce employment opportunities for native workers? None of the settings examined so far makes it possible to directly answer this question. Indeed, to address the domestic employment issue, one should treat the input of resident workers as variable. This would be legitimate in the short run in the presence of domestic wage rigidities, for instance. Thus, it would be of interest to examine the effect of higher immigration when resident labour, together with imports and gross output, are treated as variable. The comparative statics of the model could then be described by the following matrix ⌰⬅[␪]:

A production-theory approach 129

冤冥 冤

冥冤 冥

␪YY ␪YM ␪YL ⯗ ␪YN ␪YK

yˆ

xˆM

␪MY ␪MM ␪ML ⯗ ␪MN ␪MK ␪LY ␪LM

␪LL

⯗

␪LN ␪LK

xˆL ⫽ … … … … … … … w ˆN ␪NY ␪NM ␪NL ⯗ ␪NN ␪NK w ˆK ␪KY ␪KM ␪KL ⯗ ␪KN ␪KK

pˆ

w ˆM

w ˆL . … xˆN

(17)

xˆK

The price and quantity elasticities are defined for given output, import, and resident labour prices, and for given quantities of non-resident labour and capital. A negative value of ␾MN would indicate that immigration and trade are substitutes, in the sense that access to a larger pool of non-resident workers would tend to reduce the demand for imports, given variable domestic employment. At this stage, the reader might wonder which one of the five settings reviewed here best describes reality, and which one is the most useful.19 In fact, all five settings describe the same technology, and thus are equally ‘correct’ or ‘incorrect’. Yet, some settings may be more relevant than others, depending on the circumstances and on the problem which one wants to analyse. The cost-function setting is probably the one that is best known, and it is useful in the short run, when input prices may be sticky and the level of output pre-determined. In the long run, on the other hand, the production function and the GNP-function settings may be more useful. If immigration quotas are the issue, then clearly the elasticities contained in (16) and (17) are more relevant. Thus, there does not exist a set of elasticities that is to be favoured over all other ones. Our point here was rather to show that a custom-built set of elasticities that best suits the problem at hand can easily be obtained. Furthermore, great care should be taken when comparing elasticities drawn from different sources, since elasticities typically only show partial – or ceteris paribus – effects, and it is essential to always keep in mind what the other things being held constant actually are. The obvious implication of this is that empirical estimates of a particular effect – the impact of an increase in the number of guest-workers on the earnings of resident workers – might differ greatly depending on which other variables are allowed to adjust, and which ones are held constant. Finally, one should be aware of the fact that our approach, by focusing on production decisions exclusively,

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merely offers a partial equilibrium treatment. Imaginative use of this technique makes it possible to deal with a large variety of circumstances, and to answer many questions, but there is no doubt that this approach has its limits, and that ultimately only a general equilibrium approach, endogenising the prices as well as the quantities of all inputs and outputs, can give complete answers. This is particularly true in the immigration debate since, for instance, the supply of migrants should probably be explained as well. Similarly, one could argue that the supply of foreign goods, the work–leisure decision of domestic workers, the level of capacity utilisation, domestic investment decisions, and intertemporal consumption behaviour should be modelled too. 4

Empirical implementation

4.1

Functional form

Upon specification of a functional form, cost function (2) can be estimated. However, it is statistically more efficient to estimate instead the system of derived demand functions (3). The estimates can then be used to recover (2), and to calculate estimates of (4), (6), (10), (13) and (15)–(17). In what follows, we will use the Translog functional form (Christensen et al., 1973). It can be written as: ln c(w,t) ⫽ ␣0 ⫹

兺␣ ln w ⫹ 2 兺兺␥ 1

j

j

jk

j

␣Tt⫹

j

兺␦ T ln w t⫹ 2 ␦ 1

j

j

ln wj ln wk ⫹

k

2 TT t ,

j, k 僆{M, N, L, K},

(18)

j

where t is a time trend intended to capture the effects of technological change. Symmetry implies ␥jk ⫽ ␥kj. Linear homogeneity requires ⌺j␣j ⫽1, ⌺␥jk ⫽0, and ⌺j␦j T⫽0. As indicated by (3), the input demand functions can be obtained by differentiation of (18). In share form: sj ⫽ ␣j ⫹

兺␥

jk

ln wk ⫹ ␦jTt,

(19)

k

where sj is once again the cost share of the jth input. 4.2

Smoothing

Some concern has been expressed that flexible functional forms may not be flexible enough to pick up the ups and downs of technological change and

A production-theory approach 131

productivity growth (see Diewert and Wales (1992), for instance). The Translog cost function (18) provides a second-order approximation to an arbitrary cost function, with respect to prices as well as with respect to time. This means that TFP is modelled as a quadratic function of time, or that the rate of technological change, which can be obtained by differentiating (18) with respect to t, is a linear function of time. That is, except for the influence of changing relative prices, the rate of technological change is either monotonically increasing or decreasing throughout the entire estimation period. This may be too restrictive an assumption, and some additional flexibility may be needed. One way of handling this problem is with the help of spline functions, see Diewert and Wales (1992); Fox (1994). An alternative may be focusing on TFP and applying a number of filters, see Fox (1994); Fox and Kohli (1998). In this chapter, we will experiment along an alternative route, by increasing the level of flexibility of the aggregator function with respect to time. That is, while we continue to assume that the cost function provides a second-order approximation with respect to prices, we increase the degree of the approximation with respect to time to a degree ␶ ⬎2. In what follows, we consider values for ␶ equal to 3 and 4. In the ␶ ⫽4 case, the Translog cost function becomes as follows:

兺␣ ln w ⫹ 2 兺兺␥ 1

ln c(w,t)⫽ ␣0 ⫹

j

j

j

jk

j

兺␦

␣Tt⫹

jT lnwj t⫹

j

ln wj ln wk ⫹

k

兺␦

2 jTT lnwj t ⫹

j

兺␦

3 jTTT ln wj t ⫹

j

1 1 1 ␦ t2 ⫹ ␦TTTt3 ⫹ ␦TTTTt4, j, k ⑀ {M,N,L.K}, 2 TT 6 24

(20)

where ⌺j ␦jTT ⫽0 and ⌺j ␦jTTT ⫽0. The case ␶ ⫽3 requires ␦jTTT ⫽ ␦TTTT ⫽0, ᭙j僆M,N, L,K. If, moreover, one imposes ␦jTT ⫽ ␦TTT ⫽0, ᭙j僆M,N, L, K, one is back to the ␶ ⫽2 standard flexible specification (18). In the general case, the input demand-share equations become: sj ⫽ ␣j ⫹

兺␥

jk

ln wk ⫹ ␦jTt⫹ ␦jTTt2 ⫹ ␦jTTTt3.

(21)

k

One could obviously keep increasing the flexibility with respect to time almost ad infinitum, or at least until all degrees of freedom are exhausted. However, there seems to be little point in doing so. For one thing, while one wishes to make the model sufficiently flexible with respect to time, one also wishes to keep it as parsimonious as possible. The ␶ ⫽4 version of the model allows for two inflection points in the path of TFP, as opposed to none with the standard specification. This should be enough to pick up the major

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trends in factor-productivity developments over a 30- or 40-year period, and it is precisely the number advocated by Diewert and Wales (1992) in their study. Another reason why one may not want to increase the value of ␶ beyond reason is that, while it will tend to increase the goodness of fit, it will gradually squeeze out any role for economic variables such as relative prices. One knows, indeed, that any economic time series can be exactly explained by a polynomial of time of sufficiently high degree. 4.3

Data

The cost function is estimated for Switzerland with annual data covering the period 1950–86. We require price and quantity series for all four inputs and for gross output. Gross output and import figures are derived from the National Income and Product Accounts, together with the income shares of labour and capital. The price of imports is inflated by import duties, whereas the price of gross output is net of indirect taxes, but includes subsidies. The quantity of labour is obtained by multiplying employment figures by the average length of the work week. The quantity of capital is calculated as a Tornqvist quantity index of structures and equipment. Both stocks are obtained by cumulating the corresponding real investment series, subject to exogenous rates of depreciation; this was accomplished over an extended period of time (starting in 1914) so that by the beginning of the sample period the figures are essentially independent of initial values. The price of labour and capital services were obtained by deflation. The disaggregation of employment between resident and non-resident labour is based on Favarger (1992). The resident-worker category comprises natives as well as foreign workers who are residents of Switzerland. Non-resident workers are holders of seasonal permits, annual permits or transborder permits. Data on the number of non-resident workers are readily available, whereas their income can be derived from the Swiss balance of payments which records payments to non-resident workers. All prices are normalised to unity for 1980. Quantities are expressed in million 1980 Swiss francs; t is defined as a time trend with unit annual increments and normalised to zero for 1980. Summary statistics of the input data are shown in table 6.1; additional details, and the series themselves, are available upon request. 4.4

Stochastic specification and estimation techniques

We assume that demand functions (21) are exact, except for errors in optimisation. We specify a vector of additive disturbances which we assume to be

A production-theory approach 133

Table 6.1. Input data – summary statistics Mean (1)

1980 value (2)

Stand. dev. (3)

Min (4)

Max (5)

wM wN wL wK

0.77652 0.59952 0.60442 0.80162

1.00000 1.00000 1.00000 1.00000

0.17273 0.40951 0.40484 0.18901

0.56926 0.11137 0.13611 0.58467

1.12891 1.42308 1.46850 1.25165

xM xN xL xK

40214.2 12520.9 80794.0 30126.0

71760.7 28963.9 91691.4 43794.3

23703.0 25075.9 28017.2 13832.5

29707.8 24500.2 67127.4 28918.7

86606.9 20925.9 91691.4 50798.1

sM sN sL sK

0.27931 0.06451 0.42359 0.23259

0.33190 0.04146 0.42408 0.20255

0.02498 0.02651 0.03667 0.01688

0.22901 0.02523 0.36734 0.20114

0.33190 0.11093 0.50230 0.25374

identically distributed, serially independent, normal random vectors with mean vector zero. The model is estimated by using the algorithm of Berndt et al. (1974); this is essentially an iterative version of Zellner’s (1962) method for seemingly unrelated regressor equations, and it is numerically equivalent to maximum likelihood. 5

Empirical results

Estimates of (19) are reported in table 6.2, column (1). We verified that the estimated cost function satisfies all required regularity conditions (monotonicity and concavity) for all observations.20 Asymptotic t-values are shown in parentheses. We next re-estimated the ␶ ⫽3 and ␶ ⫽4 versions of the cost function – see (20) above. The corresponding parameter estimates are shown in columns (2) and(3) of table 6.2; again, we verified that all regularity conditions are met for all observations. It is apparent that the additional flexibility with respect to time leads to a significant improvement in the goodness of fit: conducting a likelihood-ratio test for the hypothesis ␶ ⫽2, conditional on the alternative hypothesis ␶ ⫽3, produces a test statistic of 61.96 for a ␹2 critical value of 9.21, at the 99 per cent confidence level with two degrees of freedom. The test for ␶ ⫽3, conditional on ␶ ⫽4, yields a test-statistic of 30.64 for the same ␹2 critical value. The lower levels of flexibility with respect to time are therefore decisively rejected, and we proceed with the ␶ ⫽4 estimates shown in table 6.2, column (3), as our preferred set of estimates.21

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Table 6.2. Parameter estimates (asymptotic t-values in parentheses) ␶⫽2 (1) ␣M

␶ ⫽3 (2)

␦MTT

0.30889 (71.22) 0.04511 (11.01) 0.43342 (54.45) ⫺ 0.08138 (2.82) ⫺ 0.10102 (⫺ 4.67) 0.07754 (2.42) ⫺ 0.10114 (⫺ 3.50) 0.25804 (6.72) ⫺ 0.42431 (⫺ 6.52) 0.00345 (3.78) ⫺ 0.00793 (⫺ 9.14) 0.00732 (4.31) .—

␦NTT

.—

␦LTT

.—

␦MTTT

.—

␦NTTTT

.—

.—

␦LTTT

.—

.—

351.01

381.99

␣N ␣L ␥⌴M ␥MN ␥ML ␥NN ␥NL ␥LL ␦MT ␦NT ␦LT

LL

0.30778 (67.28) 0.05015 (14.27) 0.42502 (72.68) 0.07127 (1.86) ⫺ 0.05914 (⫺ 2.41) 0.03797 (0.98) ⫺ 0.04785 (⫺ 1.68) 0.12210 (3.17) ⫺ 0.11577 (⫺ 1.86) 0.00292 (3.48) ⫺ 0.00724 (⫺ 11.09) 0.00586 (5.37) ⫺ 0.00001 (⫺ 0.39) ⫺ 0.00014 (⫺ 5.48) 0.00029 (6.67) .—

␶ ⫽4 (3) 0.30748 (62.49) 0.04089 (15.42) 0.43595 (77.65) 0.07439 (2.03) ⫺ 0.07482 (⫺ 4.08) 0.04292 (1.17) ⫺ 0.05360 (⫺ 3.10) 0.16097 (6.45) ⫺ 0.18427 (⫺ 3.78) 0.00355 (3.68) ⫺ 0.00604 (⫺ 11.44) 0.00379 (3.42) ⫺ 0.00003 (⫺ 0.30) 0.00022 (4.09) ⫺ 0.00018 (⫺ 1.61) 0.00000 (0.63) 0.0001 (6.92) ⫺ 0.00001 (⫺ 4.49) 397.31

A production-theory approach 135

Table 6.3. Allen–Uzawa elasticities of substitution, selected years

␴MM ␴MN ␴ML ␴MK ␴NN ␴NL ␴NK ␴LL ␴LK ␴KK

1950

1960

1970

1980

1986

⫺ 1.906 ⫺ 13.810 1.353 0.202 ⫺ 161.943 15.506 ⫺ 5.709 ⫺ 1.623 0.832 ⫺ 1.571

⫺ 1.721 ⫺ 2.734 1.401 0.368 ⫺ 21.471 6.232 ⫺ 0.683 ⫺ 2.589 0.810 ⫺ 1.466

⫺ 1.613 ⫺ 2.100 1.390 0.377 ⫺ 17.976 5.813 ⫺ 0.569 ⫺ 2.770 0.793 ⫺ 1.515

⫺ 1.465 ⫺ 4.951 1.320 0.359 ⫺ 55.513 10.030 ⫺ 2.692 ⫺ 2.263 0.791 ⫺ 1.601

⫺ 1.432 ⫺ 4.078 1.316 0.344 ⫺ 44.574 8.914 ⫺ 2.358 ⫺ 2.293 0.780 ⫺ 1.623

Note: These estimates are based on the parameter values shown in table 6.1, column (3).

Table 6.4. Hicksian elasticities of complementarity, selected years

␺MM ␺MN ␺ML ␺MK ␺NN ␺NL ␺NK ␺LL ␺LK ␺KK

1950

1960

1970

1980

1986

⫺ 21.928 44.668 9.752 ⫺ 3.712 ⫺ 118.381 ⫺ 24.268 20.226 ⫺ 5.815 5.447 ⫺ 10.510

⫺ 6.243 5.982 1.806 1.809 ⫺ 15.491 ⫺ 3.225 3.547 ⫺ 1.824 1.991 ⫺ 6.095

⫺ 5.266 4.821 1.572 1.885 ⫺ 13.190 ⫺ 2.776 3.533 ⫺ 1.790 2.039 ⫺ 6.728

⫺ 5.529 8.970 2.620 0.885 ⫺ 33.162 ⫺ 7.561 8.782 ⫺ 2.796 3.350 ⫺ 9.698

⫺ 4.984 7.368 2.238 1.203 ⫺ 27.604 ⫺ 6.245 8.188 ⫺ 2.495 3.255 ⫺ 10.519

Note: These estimates are based on the parameter values shown in table 6.1, column (3).

The parameter estimates in table 6.2 can be used to calculate Allen–Uzawa elasticities of substitution (␴jk) and Hicksian elasticities of complementarity (␺jk); these are reported for selected years in tables 6.2 and 6.3, respectively. It is apparent from table 6.3 that non-resident workers are Allen–Uzawa complements for imports as well as for capital.22 All other pairs of inputs are Allen–Uzawa substitutes for each other. Judging from table 6.4, non-resident workers and resident workers are Hicksian q-substitutes for each other,23 whereas all other pairs of inputs are Hicksian q-complements for each other,

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Table 6.5. Price elasticities of input demand (cost-function setting, matrix E, 1986 estimates) ␧mn ⬅ ⭸ lnhm(y, wM, wN,wL, wK)/ ⭸lnzn hm ⑀ {xM, xN, xL, xK}, zn ⑀ {wM, wN, wL, wK}

␧Mn ␧Nn ␧Ln ␧Kn

zn ⫽ wM

zn ⫽ wN

zn ⫽ wL

zn ⫽ wK

⫺ 0.449 ⫺ 1.279 0.413 0.108

⫺ 0.192 ⫺ 2.094 0.419 ⫺ 0.111

0.570 3.860 ⫺ 0.993 0.338

0.071 ⫺ 0.487 0.161 ⫺ 0.335

Note: These estimates are defined for a given quantity of output and given input prices. They are based on the parameter values shown in table 6.1, column (3).

Table 6.6. Price elasticities of input demand (productionfunction setting, matrix H, 1986 estimates) ␩mn ⬅⭸ lnhm(p, xM, xN, xL, xK)/ ⭸lnzn hm ⑀ {wM, wN, wL, wK}, zn ⑀ {xM, xN, xL, xK}

␩Mn ␩Nn ␩Ln ␩Kn

zn ⫽ xM

zn ⫽ xN

zn ⫽ xL

zn ⫽ xK

⫺ 1.563 2.311 0.702 0.377

0.346 ⫺ 1.297 ⫺ 0.293 0.385

0.969 ⫺ 2.704 ⫺ 1.080 1.409

0.248 1.690 0.672 ⫺ 2.171

Note: These estimates are defined for a given price of output and given input quantities. They are based on the parameter values shown in table 6.1, column (3).

except early on in the sample when one finds some evidence of q-substitutability between imports and capital.24 Thus, trade and labour mobility are complements in the Swiss case, both in the Allen–Uzawa sense and in the Hicksian sense. Non-resident and resident workers, on the other hand, are substitutes in both settings. Imports and capital, as well as resident workers and capital, are substitutes in the Allen–Uzawa sense, but complements in the Hicksian sense for most of the sample period. To get a better feeling of the magnitudes involved, we move to tables 6.5 and 6.6, which report 1986 estimates of matrices E and H. Consider the

A production-theory approach 137

Table 6.7. Price and quantity elasticities (GNP-function setting, matrix ␧, 1986 estimates) ⑀mn ⬅⭸ lnhm(p,wM, wN, xL, xK) / ⭸ lnzn hm ⑀ {y, xM, xN, wL, xK}, zn ⑀ {p, wM, wN, xL, xK}

⑀Yn ⑀Mn ⑀Nn ⑀Ln ⑀Kn

zn ⫽p

zn ⫽ wM

zn ⫽wN

zn ⫽ xL

zn ⫽xK

0.568 1.338 3.157 1.014 2.719

⫺0.420 ⫺1.056 ⫺1.883 ⫺0.189 ⫺1.123

⫺0.148 ⫺0.282 ⫺1.274 0.176 ⫺0.596

0.439 0.261 ⫺ 1.620 ⫺ 0.422 0.885

0.561 0.739 2.620 0.422 ⫺ 0.885

Note: These estimates are defined for a given output, import and nonresident labour service prices, and for given domestic-factor endowments. They are based on the parameter values shown in table 6.1, column (3).

price elasticities of input demands shown in table 6.5 to begin with. The own-price elasticity of the demand for imports is estimated to be ⫺0.449 – which may seem quite low – while the own-price elasticity of the demand for non-resident labour is found to be rather large in absolute value, at ⫺ 2.094. Remember though that these price elasticities are defined for given input prices and a given level of gross output. The estimate of ␧MN shows that a 1 per cent increase in the cost of non-resident labour services would reduce the demand for imports by about 0.2 per cent, but increase the demand for resident labour by about 0.4 per cent. A 1 per cent increase in the price of imports, on the other hand, would reduce the demand for foreign labour services by about 1.3 per cent. Looking at the estimates of the ␩jks shown in table 6.6, one sees that a 1per cent increase in the number of non-resident workers would increase the marginal product of imports by about 0.3 per cent, the marginal product of capital by about 0.4 per cent, but reduce the marginal product of resident workers by about 0.3 per cent. An increase in the endowment of capital, on the other hand, would enhance the marginal product of all three other inputs, not least non-resident workers. As argued earlier, it might be more appropriate to consider the prices of goods and of non-resident labour services as pre-determined, together with the endowments of domestic factors. This brings us to the GNP-function setting, and to the corresponding elasticity estimates (matrix ␧) shown in table 6.7. The own-price elasticity of the demand for imports is now found

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Table 6.8. Price and quantity elasticities (immigration-quotas setting, matrix ⌽, 1986 estimates) ␾mn ⬅ ⭸ lnhm(p, wM, xN, xL, xK)/ ⭸lnzn hm ⑀ {y, xM, wN, wL, wK}, zn ⑀ {p, wM, xN, xL, xK}

␾Yn ␾Mn ␾Nn ␾Ln ␾Kn

zn ⫽p

zn ⫽ wM

zn ⫽xN

zn ⫽ xL

zn ⫽ xK

0.201 0.640 2.478 1.449 1.241

⫺ 0.201 ⫺ 0.640 ⫺ 1.478 ⫺ 0.449 ⫺ 0.241

0.116 0.221 ⫺ 0.785 ⫺ 0.138 0.468

0.627 0.620 ⫺ 1.272 ⫺ 0.645 1.643

0.256 0.159 2.057 0.783 ⫺ 2.111

Note: These estimates are defined for a given output and import prices, and for given quantities of labour (non-resident and resident) and capital. They are based on the parameter values shown in table 6.1, column (3).

to be ⫺1.056, while the own-price elasticity of the demand for foreign labour services is ⫺1.274. These elasticities cannot be compared directly to the ones reported in table 6.5, since ⑀MM and ⑀NN – contrary to ␧MM and ␧NN – are defined for variable gross output and fixed endowments of capital and domestic labour. Of considerable interest are the so-called Stolper–Samuuelson elasticities (⑀ij, i僆{Y,M,N}, j 僆{L,K}) and Rybczynski elasticities (⑀ji, j僆{L,K}, i僆{Y,M,N}). These show, for instance, that an increase in the price of imports hurts capital relatively much more than labour, whereas an increase in the price of non-resident labour actually favours resident labour. An increase in the endowment of capital will tend to heavily increase the demand for non-resident labour services. Looking at the negative signs of the cross-price elasticities ⑀MN and ⑀NM, one can conclude that trade and labour mobility are complements in the sense that, for given domestic factor endowments, an increase in the price of either foreign input will tend to reduce the demand for both. We next turn to the question of the effects of exogenous changes in the number of non-resident workers. The relevant elasticities (matrix ⌽, 1986 figures) are shown in table 6.8. If the number of non-resident workers is held constant, the own-price elasticity of imports is now found to be quite a bit closer to zero than otherwise (compare the estimate of ␾MM with that of ⑀MM shown in table 6.7), which is an illustration of the Le Châtelier principle. Of special interest is the estimate of ␾LN which shows that, as one might have expected it, an increase in the number of non-resident workers

A production-theory approach 139

Table 6.9. Price and quantity elasticities (variable-residentemployment setting, matrix ⌰, 1986 estimates) ␪mn ⬅ ⭸ lnhm(p, wM, wN,yN,xK) /⭸lnzn hm ⑀ {y, xM, xL, wN, wK}, zn ⑀ {p, wM,wL, xN, xK}

␪Yn ␪Mn ␪Ln ␪Nn ␪Kn

zn ⫽ p

zn ⫽ wM

zn ⫽wL

zn ⫽xN

zn ⫽xK

1.610 2.032 2.246 ⫺ 0.378 4.931

⫺0.637 ⫺1.071 ⫺0.696 ⫺0.593 ⫺1.385

⫺ 0.972 ⫺ 0.961 ⫺ 1.550 1.971 ⫺ 2.547

⫺ 0.018 0.089 ⫺ 0.214 ⫺ 0.513 0.117

1.018 0.911 1.214 0.513 ⫺ 0.117

Note: These estimates are defined for a given output, import and resident labour service prices, and for given quantities of nonresident labour and capital. They are based on the parameter values shown in table 6.1, column (3).

depresses the wages of resident workers, but the impact is very small.25 Looking at the Stolper–Samuelson effects, it is interesting to note that nonresident workers are relatively more hurt than the domestic factors of production by a worsening in the terms of trade. Once again, we find that imports and foreign labour services seem to work hand in hand. We now turn to the estimates of matrix ⌰ shown in table 6.9. Remember that these price and quantity elasticities are valid for given prices of output, imports and resident labour services, and given quantities of non-resident labour and domestic capital. They are thus relevant in the short run, if domestic wages are sticky. With resident labour services variable, the demand for imports is found to be quite price-elastic.26 The demand for resident labour is found to be quite price-elastic as well. The estimate of ␪LN indicates the effect of an increase in the number of non-resident workers on the demand for resident workers. Its negative value shows that, as expected, foreign workers displace native workers. The effect is not as small as it seems since the number of resident workers is about five times larger than the number of non-resident workers. An elasticity of ⫺0.214 thus indicates that the replacement effect is almost one for one. However, what is crucial here is the assumption of a fixed domestic wage rate. The relatively large price elasticity of the demand for resident labour reveals that not much of a reduction in domestic wages would be needed to restore full employment. Indeed, this is confirmed by the very low estimate of ␾LN shown in table 6.8. Thus, if immigration causes unemployment, then the prime culprit will be

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domestic wage rigidity. One again, we find that trade and labour mobility are complements, in the sense this time that an increase in the number of non-resident workers will tend to increase the demand for imports. Comparing our results with those reported in Kohli (1993), we find some interesting similarities, in spite of the differences in specification, functional form and modelling of technological change. Thus, both studies found that non-resident workers are substitutes for resident workers, and complements for capital in the Allen–Uzawa sense. Both studies also found that imports are Hicksian complements for capital and both types of labour, and that non-resident workers are Hicksian substitutes for resident workers. There are some differences, however. Thus, the earlier study suggested that imports might be Allen–Uzawa substitutes for foreign labour, and that non-resident labour might be a Hicksian substitute for capital. However, it is rather remarkable that in spite of these differences all ⑀jk elasticities – i.e. those consistent with the GNP-function setting – have the same signs. In particular, both studies concur that imports and non-resident labour services are complements in the sense that an increase in one input will reduce the demand for the other, and that an increase in the cost of non-resident labour services will favour resident workers, but penalise capital owners. 6

Total factor productivity

Our econometric results can also be used to model TFP. A state-of-the art measure of the change in TFP is given by the following index.27 Rt,t⫺1 ⬅

冑

c(wt⫺1,t ⫺ 1) c(wt ,t ⫺ 1) , c(wt⫺1,t) c(wt ,t)

(22)

where the subscripts indicate the time period. This index shows the cost reduction that results from the passage of time, using either period-t or period-t-1 input prices as weights. It can be shown that if the cost function is Translog, then Rt,t⫺1 can be calculated from knowledge of the data alone, as follows: Rt,t⫺1 ⫽

Wt,t⫺1, Pt,t⫺1

(23)

where Wt,t⫺1 is a Tornqvist input price index:28 Wt,t⫺1 ⫽exp

冤兺2 (s ⫹s 1

jt

jt⫺1)

冥

(ln wjt – ln wjt⫺1) ,

j

(24)

and Pt,t⫺1 is the output price-change factor: Pt,t⫺1 ⫽

pt . pt⫺1

(25)

A production-theory approach 141

Figure 6.3

Total factor productivity

Since the construction of the data ensures that the value of gross output equals the total cost of inputs: ptyt ⫽

兺w x , jt jt

(26)

j

it follows immediately that Rt,t⫺1 can also be calculated as: Yt,t⫺1 Rt,t⫺1 ⫽ X * , t ,t⫺1

(27)

where Yt,t⫺1 is the output-change factor: Yt,t⫺1 ⫽

yt , yt⫺1

(28)

and X*t,t⫺1 is an implicit Tornqvist index of input quantities: X*t,t⫺1 ⬅

Pt,t⫺1Yt,t⫺1 . Wt,t⫺1

(29)

Thus, as suggested in the Introduction, TFP growth can be deduced from figure 6.2 by looking at the difference between the two lines. The cumulated index of TFP is also shown in figure 6.3. One sees that TFP has increased

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Ulrich Kohli

substantially during the post-war period, although the index fell very dramatically in the mid-1970s. An entire decade had elapsed before it fully recovered. We can also follow an econometric approach to measuring TFP growth. That is, we can obtain Rt,t⫺1 from the estimates of the structural parameters of the cost function. We begin by introducing (20) into the logarithmic version of (22). This yields: ln Rt,t⫺1 ⫽ ␣T ⫹

1 2

兺␦

jT

兺␦ 1 ␦ 2兺 1 2

jTT(ln

(ln wjt ⫺ln wjt⫺1)⫹

wjt ⫺ln wjt⫺1)(2t⫺1)⫹

jTTT(ln

wjt ⫺ln wjt⫺1)(3t2 ⫺3t ⫹1)⫹

1 1 ␦ (2t⫺1)⫹ ␦yTTT(3t2 ⫺3⫹1)⫹ 2 jTT 6 1 ␦ (4t3 ⫺6t2 ⫹4t⫺1). 24 jTTTT

(30)

Computation of (30) requires estimates of ␣T, ␦T, and – in the higherorder flexibility cases – ␦TTT and ␦TTTT. These estimates can be obtained by regressing the so-far unexplained portion of the price of output on t, t2, t3 and t4. For this purpose, we have estimated the following equation: 1 1 1 ln ut ⫽ ␣0 ⫹ ␣Tt⫹ ␦TTt2 ⫹ ␦TTTt3 ⫹ ␦TTTTt4, 2 6 24

(31)

where

兺 ␣ lnw ⫺ 2 兺 兺 ␥ ln w ln w 兺 ␦ ln w t ⫺ 兺 ␦ ln w t ⫺ 兺 ␦ 1

ln ut ⬅ln pt ⫺

j

jt

j

jT

j

jk

j

jt

jTT

j

jt

kt ⫺

k

jt

2

jTTT

ln wjtt3.

(32)

j

Our results are summarised in figure 6.3, which shows the econometric estimate of the index, based on (30), using the second-order, third-order and fourth-order approximations, respectively. One sees that the second- and the third-order approximations do a rather poor job at tracking the TFP index. Both curves are concave, and they indicate a severe slowdown in the rate of technological progress. The second-order approximation actually suggests technological regress towards the end of the sample period. The fourth-order approximation, on the other hand, performs much better, and

A production-theory approach 143

it indicates a resurgence of technological progress towards the end of the sample period, after the downturn of the mid-1970s. The two-stage approach which we have followed here to estimate the rate of technological progress is somewhat similar to the one used by Fox and Kohli (1998). There is one major difference, however. Thus, in the present treatment, the first stage already takes account of the type of smoothing which will be applied in the second stage. That is, if a fourth-order approximation is selected, this impacts on the estimation of the input-share equations since, as shown by (21), these will then be functions of t, as well as of t2 and t3. 7

Conclusions

The main purpose of this chapter was to combine the production-theory approach to modelling immigration with the production-theory approach to modelling foreign trade. Indeed, it is rather odd that until now international labour mobility and international trade were essentially modelled separately in empirical work. Yet immigration is clearly an international phenomenon; the production-theory approach to immigration must thus be compatible with the production sector of an open economy. An attempt was made here to increase the flexibility of flexible functional forms with respect to time. A second-order approximation with respect to time does not allow for any inflection points in the path of TFP. Given the ease with which our approach can be implemented, it may be viewed as an attractive alternative to the spline method proposed by Diewert and Wales (1992). Among our main empirical results, we have found that the displacement effects of immigration into Switzerland could be very severe in case of downward wage rigidity. If wages are flexible, increased immigration will lower the income of domestic workers, but only weakly so. Capital owners are the beneficiaries of immigration; it is therefore not surprising that the call for increased access to foreign labour markets generally emanates from business leaders. Imports and non-resident labour are found to be complements for each other, in many different meanings of the word. They are Allen–Uzawa complements, and they also are Hicksian q-complements. Furthermore, they are also complements in the sense that more non-resident workers tend to lead to more imports; this is true whether or not resident labour services are held constant. Moreover, in the GNP-function setting, a reduction in the price of non-resident labour services, which tends to favour the demand for such services, also pulls along the demand for imports.

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NOTES Originally presented at the Venice conference (January 25–27 1997). I wish to thank Marzio Galeotti, Klaus F. Zimmermann and an anonymous referee for many useful comments and suggestions. Financial assistance from the Swiss National Science Foundation under grant no. 12-45777.95 is gratefully acknowledged. 11 See Greenwood and McDowell (1986) for a survey of the economic effects of immigration. 12 The production-theory approach has been applied to Swiss data by Butare and Favarger (1992); see Bürgenmeier et al. (1992) for a condensed version in English. 13 Wong (1988) does discuss the impact of international labour mobility on the volume of trade. However, he treats foreign labour as a perfect substitute for domestic labour. Hence, there is no difference in his model between migration and a change in the domestic endowment of labour. 14 See Mundell (1957), for instance. 15 See Markusen (1983) among others. 16 This chapter differs from our earlier work (Kohli, 1993) in several important respects, particularly the choice of specification and functional form, the derivation of the comparative statics of the model and the modelling of technological change. 17 See Burgess (1974a, 1974b); Woodland (1982); Kohli (1991). 18 See Kohli (1982, 1992) for estimates for Switzerland. 19 For an alternative treatment, albeit without international labour mobility, see Kohli (1991), for instance. 10 The question would then arise as to whether the two (or more) outputs are produced jointly or not; see Kohli (1991) for estimates of labour- demand functions under both assumptions. It is also noteworthy that there seems to be very little discussion of multiple-output models in the labour-demand literature; for instance, this topic is not even raised in Hamermesh’s (1993) otherwise very detailed book. 11 See Diewert (1974). 12 Uzawa (1961). 13 See Hicks (1970). We use the terminology of Sato and Koizumi (1973) and Syrquin and Hollender (1982). 14 This point is also made by Hamermesh (1993). 15 See Kohli (1991), for instance. 16 This differential treatment of resident and non-resident labour is made possible by our assumption that the two types of workers have different attributes, and hence are separate inputs. 17 See Kohli (1978, 1991), Woodland (1982); the GNP-function label comes from the fact that this setting corresponds to the description of the technology by a variable-profit function which is the solution of maximising GNP, for given factor endowments and given prices of traded goods and services. In truth, because net labour payments abroad are taken into account, but net capital payments are not, the function is a hybrid of GNP and GDP. 18 See Kohli (1991) for additional details. 19 The list is not exhaustive: there are many more combinations of endogenous versus exogenous treatments which we could have considered. 20 Monotonicty and concavity are an integral part of our theoretical framework, and they must be satisfied for the econometric estimates to be economically meaningful. Regularity-condition failures have plagued previous work in the immigration literature; thus, a little known fact about Baldwin Grossman’s

A production-theory approach 145

21 22 23 24

25 26 27 28

(1982) widely cited study is that her estimates fail to satisfy concavity. In the Translog case, curvature conditions can be imposed locally if needed. However, there is no guarantee that this will be sufficient for the conditions to be met for all observations. Moreover, imposition of curvature conditions often leads to a reduction in the rank of the Hessian matrix. It is therefore fortunate that these conditions were met here at the outset, since a rank reduction would rule out some of the manipulations described in section 3. One can see that the estimates of some of the ␥jr s change substantially as ␶ is allowed to increase; this is not surprising since our test results indicate that restricting the value of ␶ does violence to the data. Butare and Favarger (1992), on the basis of a three-input Translog production function that excludes imports and for which ␶ ⫽ 2, also find that non-resident workers are Allen–Uzawa complements for capital. This is in contrast with the findings of Butare and Favarger (1992). The finding that the Hicksian elasticity of complementarity between imports and capital changes sign, even though the Allen–Uzawa elasticity of substitution does not, once again underscores the fact that the passage from one set of elasticities to the other is not trivial. This result confirms the findings obtained for other countries; see Greenwood et al. (1996, 1997) for recent findings for the USA. The comparison of ␪MM with ␾MM provides another illustration of the Le Châtelier principle. See Caves et al. (1982); Diewert and Morrison (1986), for instance. Given that the cost function is Translog, Wt,t⫺1 can also be interpreted as the geometric mean of two indexes, both measuring the cost implications of changes in input prices, but one doing it with reference to time-t-1’s technology, and the other one refering to time-t’s technology: Wt,t⫺1 ⬅

冑

c(wt,t ⫺ 1) c(wt,t) . c(wt⫺1,t ⫺ 1) c(wt⫺1,t)

REFERENCES Baldwin Grossman, J. (1982). ‘The Substitutability of Natives and Immigrants in Production’, Review of Economics and Statistics, 64, 596–603 Berndt, E. R., B. H. Hall, R. E. Hall and J. A. Hausman (1974). ‘Estimation and Inferences in Nonlinear Structural Models’, Annals of Economic and Social Measurement, 3/4, 653–65 Bürgenmeier, B., T. Butare and P. Favarger (1992). ‘Effects of Foreign Labour on the Production Pattern: The Swiss Case’, Swiss Journal of Economics and Statistics, 128, 103–24 Burgess, D. F. (1974a). ‘A Cost Minimisation Approach to Import Demand Equations’, Review of Economics and Statistics, 56, 225–34 (1974b). ‘Production Theory and the Derived Demand for Imports’, Journal of International Economics, 4, 103–17 Butare, T. and P. Favarger (1992). ‘Analyse empirique du cas de la Suisse’, in B. Bürgenmeier (ed.), Main d’oeuvre étrangère: Une analyse de l’économie suisse (Paris: Economica)

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Caves, D. W., L. R. Christensen and W. E. Diewert (1982). ‘The Economic Theory of Index Numbers and the Measurement of Input, Output, and Productivity’, Econometrica, 50, 1393–1414 Christensen, L. R., D.W. Jorgenson, and L. J. Lau (1973). ‘Transcendental Logarithmic Production Frontiers’, Review of Economics and Statistics, 55, 28–45 Diewert, W. E. (1974). ‘Applications of Duality Theory’, in M. D. Intriligator and D. A. Kendrick (eds.), Frontiers of Quantitative Economics, vol. 2 (Amsterdam: North-Holland) Diewert, W. E. and C. J. Morrison (1986). ‘Adjusting Output and Productivity Indexes for Changes in the Terms of Trade’, Economic Journal, 96, 659–79 Diewert, W. E. and T. J. Wales (1992). ‘Quadratic Spline Models for Producer’s Supply and Demand Functions’, International Economic Review, 33, 705–22 Favarger, P. (1992). ‘Evolution de l’économie suisse depuis 1948’, in B. Bürgenmeier (ed.), Main d’oeuvre étrangère: Une analyse de l’économie suisse (Paris: Economica) Fox, K. J. (1994). ‘Model Selection Criteria and the Non-Parametric Estimation of Technical Progress’, School of Economics Discussion Paper, 94/17, The University of New South Wales Fox, K. J. and U. Kohli (1998). ‘GDP Growth, Terms-of-trade Effects, and TFP’, Journal of International Trade and Economic Development, 7, 87–110 Greenwood, M. J. and J. M. McDowell (1986). ‘The Factor Market Consequences of US Immigration’, Journal of Economic Literature, 24, 1738–72 Greenwood, M. J., G. L. Hunt and U. Kohli (1996). ‘The Short-run and Long-run Factor-market Consequences of Recent Immigration to the United States’, Journal of Regional Science, 36, 43–66 (1997). ‘The Factor-market Consequences of Unskilled Immigration to the United States’, Labour Economics, 4, 1–28 Hamermesh, D. S. (1993). Labor Demand (Princeton: Princeton University Press) Hicks, J. R. (1970). ‘Elasticity of Substitution Again: Substitutes and Complements’, Oxford Economic Papers, 22, 289–96 Kohli, U. (1978). ‘A Gross National Product Function and the Derived Demand for Imports and Supply of Exports’, Canadian Journal of Economics, 11, 167–82 (1982). ‘Production Theory, Technological Change, and the Demand for Imports: Switzerland, 1948–1976’, European Economic Review, 18, 369–86 (1991). Technology, Duality, and Foreign Trade: The GNP Function Approach to Modeling Imports and Exports (Ann Arbor: University of Michigan Press) (1992) ‘Production, Foreign trade, and Global Curvature Conditions: Switzerland, 1948–1988’, Swiss Journal of Economics and Statistics, 128, 3–20 (1993). ‘International Labor Mobility and the Demand for Imports’, Swiss Journal of Economics and Statistics, 129, 547–61 Markusen, J. (1983). ‘Factor Movements and Commodity Trade as Complements’, Journal of International Economics, 13, 341–56 Mundell, R. (1957). ‘International Trade and Factor Mobility’, American Economic Review, 47, 321–35

A production-theory approach 147 Sato, R. and T. Koizumi (1973). ‘On the Elasticities of Substitution and Complementarity’, Oxford Economic Papers, 25, 44–56 Shephard, R. W. (1953). Cost and Production Functions (Princeton: Princeton University Press) Syrquin, M. and G. Hollender (1982). ‘Elasticities of Substitution and Complementarity: The General Case’, Oxford Economic Papers, 34, 515–19 Uzawa, H. (1961). ‘On a Two-sector Model of Economic Growth’, Review of Economic Studies, 29, 40–7 Wong, K. (1988). ‘International Factor Mobility and the Volume of Trade: An Empirical Study’, in R. C. Feenstra (ed.), Empirical Methods for International Trade (Cambridge, MA: MIT Press) Woodland, A. D. (1982). International Trade and Resource Allocation (Amsterdam: North-Holland) Zellner, A. (1962). ‘An Efficient Method of Estimating Seemingly Unrelated Regressions and Tests for Aggregation Bias’, Journal of the American Statistical Association, 57, 348–68

Discussion MA R Z IO GAL E OT T I Labour, whatever its geographical origin or its other characteristics, is an input to the production process. Therefore, the issue of the impact of migration upon the utilisation of native workers and/or the rate of return of their services has to be studied within a production-theoretic approach. Ulrich Kohli has done this using more disaggregated data then those used in this chapter (Greenwood et al., 1996). In chapter 6, however, the author starts from the observation that several researchers have indeed studied the migration issue using a production-theoretic approach, but they have surprisingly not taken into account the fact that, rather than ‘importing’ workers, the domestic economy can import the goods that those workers contribute to produce in the home country. This remark brings up the issue of trade as a possible alternative (or actually as a complementary activity) to labourfactor mobility. Hence the interest in characterising the substitution possibilities in production between ‘imported’ labour and imported goods. Two brief remarks come to mind at this point. First, the productionbased analysis of migration invariably holds the number of hours worked

A production-theory approach 147 Sato, R. and T. Koizumi (1973). ‘On the Elasticities of Substitution and Complementarity’, Oxford Economic Papers, 25, 44–56 Shephard, R. W. (1953). Cost and Production Functions (Princeton: Princeton University Press) Syrquin, M. and G. Hollender (1982). ‘Elasticities of Substitution and Complementarity: The General Case’, Oxford Economic Papers, 34, 515–19 Uzawa, H. (1961). ‘On a Two-sector Model of Economic Growth’, Review of Economic Studies, 29, 40–7 Wong, K. (1988). ‘International Factor Mobility and the Volume of Trade: An Empirical Study’, in R. C. Feenstra (ed.), Empirical Methods for International Trade (Cambridge, MA: MIT Press) Woodland, A. D. (1982). International Trade and Resource Allocation (Amsterdam: North-Holland) Zellner, A. (1962). ‘An Efficient Method of Estimating Seemingly Unrelated Regressions and Tests for Aggregation Bias’, Journal of the American Statistical Association, 57, 348–68

Discussion MA R Z IO GAL E OT T I Labour, whatever its geographical origin or its other characteristics, is an input to the production process. Therefore, the issue of the impact of migration upon the utilisation of native workers and/or the rate of return of their services has to be studied within a production-theoretic approach. Ulrich Kohli has done this using more disaggregated data then those used in this chapter (Greenwood et al., 1996). In chapter 6, however, the author starts from the observation that several researchers have indeed studied the migration issue using a production-theoretic approach, but they have surprisingly not taken into account the fact that, rather than ‘importing’ workers, the domestic economy can import the goods that those workers contribute to produce in the home country. This remark brings up the issue of trade as a possible alternative (or actually as a complementary activity) to labourfactor mobility. Hence the interest in characterising the substitution possibilities in production between ‘imported’ labour and imported goods. Two brief remarks come to mind at this point. First, the productionbased analysis of migration invariably holds the number of hours worked

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per worker constant and concentrates on changes along the ‘extensive margin’ of labour. It is important to bear in mind that possibilities of substitution of hours with workers are ruled out in this case, and this restrictive assumption certainly affects the results concerning the substitution patterns of native workers, immigrant workers, imported goods and other inputs. Secondly, another interesting issue would be the extension of the analysis of labour mobility vis-à-vis trade flows to also account for the international mobility of capital in the form of technology transfers, via imports of capital goods and foreign direct investment (FDI). Chapter 9 by Collins et al. in this volume tackles this issue from a historical perspective (Collins et al., 1998). Ulrich Kohli is one of the first authors to have pioneered the application of modern microeconomic theory of production and of the duality between production, cost and profit functions to international trade. He has done so in several papers, and the present chapter is a nice example of the flexibility of this analytical tool for both theoretical and empirical purposes. Experience suggests that some people, faced with these applications for the first time, remain somewhat perplexed considering the aggregation assumptions on which they are built: a story developed with the individual decision-maker in mind is applied to data covering the whole economy. As a matter of fact, one should not be surprised: in the traditional approach to international trade analysis, in the study of labour demand and in many other instances such aggregation assumptions are often implicitly made. The present approach makes it clear what are the benefits against the costs of the aggregation assumption: the ability to generate a wealth of empirical results that only enough structure imposed on the data can yield. Ulrich Kohli in this chapter shows how the many relevant issues and questions which are at the heart of the migration debate can be empirically addressed and answered within a production-theoretic framework by appropriately treating the various inputs to the production process and the corresponding prices. The basis for the several empirical exercises that are carried out is the estimation of (the input share equations associated with) a cost function treating all inputs as variable. On this basis the author is able to characterise p-substitution (Allen–Uzawa elasticities of substitution) as well as, through appropriate manipulations, q-substitution (Hicks’ elasticities of complementarity). With further manipulations, he then proceeds to compute similar elasticities by assuming that: (1) domestic labour and capital are fixed inputs (in the short run), and (2) foreign labour is also fixed. Now, this information could have been obtained more directly by estimating the GNP function or variable profit function. In fact Lau (1976) shows that the (normalised) restricted profit function is the most general (dual) representation of the firm’s technology that ecompasses unrestricted

A production-theory approach 149

profit, revenue, restricted and unrestricted cost functions. Perhaps it was more natural to base the estimation on this more general representation and on that basis to infer elasticities for specific cases, instead of following a ‘specific- to-general’ procedure as done by Kohli. Obviously also in this more general case one would have used the same set of parameter estimates to compute all the elasticities of interest. As a matter of fact, working with a GNP function grants an extra degree of freedom, in that it allows derivation and estimation of supply equations for domestic output and exports, along with input demand equations. This would bring increased efficiency of the estimates and dispense with the assumption made in the chapter of perfect substitutability between domestic and exported outputs. The chapter uses a flexible functional form for the cost function – the Translog – which successfully goes through the difficult passage of satisfying unconditionally the curvature conditions required for a well behaved cost function. Those who are familiar with applied production analysis making use of flexible functional forms will find this fact quite remarkable. One aspect, however, with respect to which the chapter is somewhat deficient is the description of the data. While it is true that, as the author himself notes, one of the advantages of the production-theoretic approach to trade is that it uses easily available data from the National Income and Product Accounts (this is not entirely true since data for the user cost of capital and its stock need to be constructed), no distinction is made among employment by country of residency. I would have liked to know how the price of the two types of labour was computed and where the necessary data came from. I have always believed that the main difficulty here was to obtain separate labour cost data for resident and non-resident workers. The data available for investigating the trade-/factor-mobility issue are clearly a major constraint to the depth with which the problem can be studied. In fact, not only must one clearly define which notion of elasticity of substitution/complementarity is used, but must also be careful in defining the criterion used to distinguish various types of labour inputs. And here the data available can play an important role. Ethnicity is the criterion adopted in Kohli’s chapter. Of course, if the data permitted other potentially more relevant criteria could be used, chiefly education and skill/experience. Riccardo Faini has brought to my attention, for instance, a paper by Gang and Rivera-Batiz (1994) which studies the q-complementarity issue (only) by concentrating on those two attributes of the labour input. In general, all these procedures amount to hedonic adjustments to measured inputs and outputs and one can in principle operate as many adjustments as the data permit. Incidentally, let me note that ethnicity (perhaps correlated with distance) may have independent explanatory power as an attribute, besides that

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of skill and education, so that ideally one would like to take into account all these three dimension in the analysis. A further remark is that the production approach to trade typically assumes that the supply of inputs is perfectly elastic, so that the ‘whole economy’ takes input prices as given. It is, however, difficult to accept this assumption for factors such as labour, even if it may be reasonable for imports in a small open-economy context. Actually, my non-expert impression is that supply considerations play an important role in many instances of the migration debate. I am thinking of Italy, where certain low-skilled job opportunities are not picked up by native workers even in the presence of high unemployment rates. Finally, from an econometric standpoint I am always a bit surprised by the fact that applied production studies generally do not worry about the endogeneity of the right-hand-side variables of the estimated equations. Taken literally, this fact implies that estimated elasticities are not reliable. In summary, the reason I was asked to comment on this chapter is because I have some background in applied production analysis. I therefore cannot but appreciate it because Kohli has once again shown how production theory is a tool of analysis that lends itself to interesting extensions and applications and that can be taken to relate to very relevant policy issues such as the trade/migration debate. REFERENCES Collins, W.J., K.H. O’Rourke and J.G. Williamson (1998). ‘Were Trade and Factor Mobility Substitutes in History?’, chapter 9 in this volume Gang, I.N. and F.L. Rivera-Batiz (1994). ‘Labour Market Effects of Immigration in the United States and Europe’, Journal of Population Economics, 7 Greenwood, M.J., G. Hunt and U. Kohli (1996). ‘The Short-run and Long-run Factor-market Consequences of Recent Immigration to the United States’, Journal of Regional Sciences, 36, 43–66 Lau, L.J. (1976). ‘A Characterization of the Normalized Restricted Profit Function’, Journal of Economic Theory, 12

7

Migration, dual labour markets and social welfare in a small open economy TO BIAS M ÜL L E R

1

Introduction

In most European countries, liberal immigration policies came to a halt in the 1970s. More recently, hostility towards immigrants seems to be growing again and immigration is increasingly seen as having negative consequences for the host country, especially if immigrants are unskilled. This attitude is in contrast to the ‘guest-worker’ policy of the 1950s and 1960s when large numbers of unskilled workers migrated to North European countries. At that time, their arrival was seen as largely beneficial for the host countries. Entrepreneurs in labour-intensive industries saw immigration as an alternative to protection, in the context of increasing import competition from developing economies (Bhagwati, 1982). The shift towards more restrictive immigration policies in the 1970s was accompanied by a resurgence of protection. The steady reduction in tariff protection since 1947 was offset in the 1970s and 1980s by the growth of non-tariff barriers (Bhagwati, 1988). How can these changes in migration and trade policies be explained? They are often imputed to macroeconomic difficulties and to rising unemployment in Europe. However, there is no obvious relation between protection and unemployment and most empirical analyses fail to find a link between immigration and unemployment. In this chapter, I explore an alternative explanation of these developments. Starting from Bhagwati’s (1982) discussion of the choice between protection and immigration policy, I extend his analysis by focusing on a more complete representation of the ‘guest-worker’ system,1 and by taking income distribution explicitly into account. Indeed, the standard welfare analysis of migration fails to explain the observed attitudes towards immigration. According to the utilitarian welfare criterion, immigration yields a surplus to the host country. Thus, utilitarianism cannot justify restrictive immigration quotas. From a different perspective, it is often acknowledged that unskilled immigration 151

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increases income inequality among natives. According to this argument, the guest-worker policy, favouring the immigration of unskilled workers, would be rejected. As a description of the guest-worker system, the standard analysis is deficient in two respects. First, it neglects the existence of discrimination against immigrants, which is common especially in countries favouring temporary immigration. Second, the impact of immigration on income distribution is generally analysed separately from efficiency considerations (see also chapter 6 in this volume). Therefore, the question whether the aggregate gain from unskilled immigration prevails over its unfavourable influence on income distribution cannot be answered. In this chapter, these two issues are addressed. Efficiency and distributional aspects are considered in an integrated framework by using Atkinson’s (1970) social welfare function. Discrimination is modelled in the framework of a segmented labour market, and the legal restrictions faced by immigrants in the labour market are taken explicitly into account. In most European countries, discrimination against immigrants manifests itself as ‘equal pay for equal work, but unequal work’ (Hammar, 1985). Trade unions usually demand that all workers, regardless of nationality, be offered the same wage. However, in countries having implemented a guest-worker system, immigrants are directed towards certain occupations, characterised by low wages and bad work conditions. The immigrants’ access to stable jobs with good work conditions is often limited by legal discrimination, since some countries restrict work permits to certain occupations or sectors, or allow firms to hire immigrants only if no native worker can be found. The behaviour of employers often also appears to be discriminatory against immigrants, who usually have less country-specific human capital and higher expected quit rates than natives. In quantitative studies, however, the evidence on discrimination against immigrants is not as clear-cut. Dustmann (1993) reports for Germany that earnings of foreign workers are not only initially lower (by 13–19 per cent) than those of natives; he does not find any convergence over time towards the natives’ earnings level. However, not all studies on German data confirm these results (see Zimmermann, 1993, for a survey). For Switzerland, preliminary results by de Coulon and Flückiger (1995) indicate that immigrants with the same characteristics than natives receive 10 per cent lower wages. In the model presented below, I assume that discrimination against immigrants takes place in a dual labour market (Piore, 1979). Wages in the primary sector are determined by efficiency-wage considerations. Therefore, primary-sector jobs are rationed and immigrants have only limited access to them. However, immigrants can always find a job in the secondary sector where the wage rate is set at the market-clearing level.

Migration, dual labour markets and social welfare 153

Discrimination implies that immigrants receive the same wage as natives for a given job, but they have a smaller probability of finding a job in the primary sector. In this case, immigration increases the natives’ chances of finding a primary-sector job. From the viewpoint of social welfare, however, this gain is tempered with an increase in income inequality, since immigration tends to reduce the wage rate relative to the return to capital. On the other hand, protection of sectors that are intensive in unskilled labour expands the output of the secondary sector and therefore diminishes the natives’ chances of finding a primary-sector job. This model is closely related to those developed by Ethier (1985), Schmidt et al. (1994) and Winter-Ebmer and Zweimüller (1996), who take into account the specific position of immigrants in the labour market. Their approaches are complementary to the efficiency-wage model used here. Ethier (1985) shows how the hiring of immigrants can insulate native workers from employment fluctuations. There is discrimination against immigrants in the sense that only natives have long-term, implicit labour contracts, whereas immigrants are hired freely at the current wage rate. Schmidt et al. (1994) analyse the impact of immigration in the presence of trade unions. There is discrimination against immigrants in the sense that immigrant welfare is not given the same weight in the union’s objective function as native welfare. In this model, immigration might lead to higher unskilled employment if skilled and unskilled labour are q-complements. Winter-Ebmer and Zweimüller (1996) use an insider–outsider model of wage bargaining. They assume the existence of a two-tier wage system, where immigrants (outsiders) receive lower wages than native workers (insiders). Because of discrimination, immigration has an ambiguous effect on native wages. The remainder of the chapter is organised as follows. In section 2, the impact of immigration and protection on social welfare is discussed, assuming that there is no discrimination against immigrants. An openeconomy efficiency-wage model of a dual labour market is presented in section 3 and the impact of immigration and protection analysed from a theoretical standpoint in section 4. Finally, in section 5, the dual labour market model is integrated into a simulation model for Switzerland and the impact of immigration and protection on social welfare is simulated for different labour market closures. The evolution of Swiss immigration policy is interpreted in that context. Section 6 draws some conclusions. 2

Social welfare effects of migration and protection

Standard welfare analysis shows that natives, as a group, gain from immigration (Berry and Soligo, 1969). The gain is higher, the more the

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immigrants’ relative factor endowment differs from the natives’. However, by contrast with the debate on trade liberalisation, nobody seriously proposes to allow free international migration. One of the main reasons for this attitude is that immigration, especially unskilled immigration, tends to increase income inequality, since it reduces the wage rate and raises the return to capital. The widespread intuition assuming that the redistributive impact of unskilled immigration is stronger than the efficiency gain is confirmed by the following result (Müller, 1998a): if (physical or human) capital is unequally distributed among natives, and if immigrants hold less capital than natives, infinitesimal immigration decreases social welfare.2 This implies that the generalised Lorenz curve representing the income distribution before immigration dominates the generalised Lorenz curve after immigration. At first sight, this result seems to contradict the standard analysis showing the welfare gains from immigration. In fact, the standard analysis implicitly uses a particular form of the social welfare function, often called the ‘utilitarian’ or ‘Benthamite’ social welfare function, which takes only mean income into account. It is the only form of the social welfare function for which infinitesimal immigration has no impact on social welfare. This is due to the fact that the efficiency gain, which is only of second order, disappears when immigration is infinitesimal. In order to avoid confusion, I will hereafter denote the utilitarian welfare criterion by ‘U-welfare’, whereas the term ‘social welfare’ will refer to the more general social welfare function of the Atkinson (1970) type. The social welfare functions underlying the result quoted above are often criticised because of the assumption that utility is cardinal and that interpersonal comparisons of utility levels are possible. These restrictive assumptions are, however, necessary if one wants to be able to rank situations for which the criterion of Pareto-optimality is not conclusive. On the other hand, it is important to stress that the utilitarian social welfare criterion, which is routinely used in most discussions of welfare effects, is even more restrictive than the class of social welfare functions defined above. The utilitarian criterion would be pertinent only if any change in immigration policy were accompanied by non-distortionary redistribution measures which would compensate the losers. This is not a very realistic assumption. In view of these considerations, what kind of immigration policies would governments be expected to establish? If the objective of the government were to maximise social welfare, it would not allow any unskilled immigrants to enter the country, but might welcome skilled immigrants, for two reasons. First, unskilled immigration tends to increase income inequality, whereas the impact of skilled immigration on inequality is ambiguous.

Migration, dual labour markets and social welfare 155

Second, the efficiency gain is probably greater in the case of skilled immigration, because of the complementarity between capital and skilled workers (Borjas, 1995). In short, the guest-worker system of immigration does not look at all attractive from the perspective of social welfare. Of course, the view that governments act according to a social welfare criterion is simplistic. Nevertheless, a social welfare function is a convenient and rigorous way of considering efficiency and equality aspects in a common framework. Moreover, more elaborate theories of political economy seem to lead to similar conclusions. For example, Benhabib’s (1992) direct-democracy model of immigration policy shows that unskilled immigration would be accepted in a national referendum only if the median capital–labour ratio is greater than the capital–labour ratio of the person who is indifferent to immigration. If immigration is infinitesimal, the latter is equal to the average capital–labour ratio. Therefore, if the distribution of capital is asymmetric and skewed to the right (a plausible assumption), unskilled immigration would be rejected in a referendum. Now turn to the social welfare impact of protection. On the one hand, if importables are labour-intensive, a tariff will in general increase the wage rate relative to the return to capital, and therefore reduce income inequality. On the other hand, the efficiency loss induced by a tariff is small for low tariff levels, since a tariff has no first-order effect on U-welfare if the initial situation is free trade (Neary, 1988). Consequently, in terms of social welfare the efficiency loss of protection tends to be outweighed by reduced inequality if the initial tariff level is not too high. To sum up, a government acting according to the social welfare criterion would hardly implement a policy of free trade combined with large-scale immigration of unskilled workers. Then why did some European countries allow immigration in the form of the guest-worker system? As many observers have suggested, this question cannot be answered without taking into account the fact that there is discrimination against immigrants in the dual labour markets of the host countries. This issue is taken up below. 3

A model of dual labour markets and discrimination

This section describes the model of a dual labour market which is used below to reconsider the impact of immigration and of trade policy on the welfare of natives. In this analysis, the role of discrimination against immigrants is highlighted. The dual labour market is modelled in a standard efficiency-wage framework.3 Work conditions in the primary and the secondary sectors are not identical. The primary sector offers jobs with good working conditions,

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stable employment relationships and good chances for internal promotion. By assumption, workers in this sector cannot be perfectly monitored. Thus, firms in the primary sector prefer to pay wages above market-clearing levels in order to induce workers to supply effort. As a consequence, jobs are rationed in the primary sector and workers are queueing up for them. However, they can always find jobs in the secondary sector. These jobs are much less attractive and consist in repetitive tasks that can be monitored without cost. In this sector, the wage rate is set competitively. Thus, there is no unemployment.4 For the sake of simplicity, the instantaneous utility function of a representative worker is assumed to have the following separable structure: u(c1,c2,e)⫽ ␮(c1,c2) ⫺ e,

(1)

where c1 and c2 are the consumption levels of the two traded goods, ␮ is a homothetic quasi-concave function, and e denotes effort. The variable e can take only two values: 0 if the worker does not make an effort (i.e. if she ‘shirks’), and e ⬎0 if she does not shirk. A worker’s indirect utility function, derived from (1), is given by: v(p1,p2,w,yo,e)⫽

w ⫹ yo ⫺ e, ␲(p1,p2)

(2)

where ␲ is a price-index dual to ␮, p1 and p2 are goods prices, w is the wage rate and yo is income from other sources (capital income, transfers). Natives are assumed to maximise expected utility over their infinite life horizon:

冢冕 v(p ,p ,w,y ,e)exp(⫺rt)dt冣, ⬁

U ⫽E

1

2

o

(3)

0

where r is the natives’ discount rate. A worker who shirks faces a probability d of being discovered and fired. Moreover, an exogenous proportion q of workers quit primary jobs in each period. All native workers in the secondary sector have the same probability of finding a primary-sector job. This is not necessarily the case for immigrants: different cases will be examined below. The problem of a native worker in the primary sector, who has to decide whether to shirk or not, can be analysed by relating the utility levels that she can attain in the two cases. Let V1n denote the expected present value of utility of a non-shirking native worker holding a primary-sector job. If she shirks, the expected present value of utility is V1s. Let V2 denote the present value of utility of a secondary-sector job. To relate these three situations, I follow the asset-equation approach introduced by Shapiro and Stiglitz (1984). If a worker has a job in the primary sector, she will receive wage w1. She has an exogenous

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probability q of quitting that job. In that case, she will lose, in terms of utility, the difference between V1n and V2. If a worker does not shirk, the return to a primary-sector job is therefore equal to: rV1n ⫽

w1 ⫹ yo ⫺ e ⫺q(V1n ⫺V2). ␲(p1,p2)

(4)

If the worker decides to shirk, her instantaneous utility is greater because she does not supply any effort. However, she faces a higher probability of losing her job in the primary sector since she might be detected as a shirker and fired. For a shirking worker, the return to a primary sector job is therefore given by: rV1s ⫽

w1 ⫹ y o ⫺ (q⫹d) (V1s ⫺ V2). ␲(p1,p2)

(5)

A worker in the primary sector does not shirk if V1n ⱖV1s. Using (4) and (5), this condition can be rewritten as follows: d (V1n ⫺V2)ⱖe.

(6)

The term on the left represents the cost of shirking, equal to the expected utility loss of a shirker whose probability of being detected and fired is equal to d. A worker does not shirk if this cost is greater than the immediate benefit of shirking, which consists in avoiding any effort. In the steady state, if a worker decides not to shirk, she will never shirk in a primary-sector job. For such a worker, the return to a job in the secondary sector is equal to: rV2 ⫽

w2 ⫹ y o ⫺ e ⫹a (V1n ⫺ V2), ␲(p1,p2)

(7)

where a is the probability of moving from a secondary-sector to a primarysector job. (Conversely, for a worker who always shirks, V1n must be replaced by V1s in eq. (7). Using (4) and (7), the no-shirking condition (6) can also be expressed as: w1⫺w2 e ⱖ (r⫹a ⫹q). ␲(p1,p2) d

(8)

At equilibrium, there is no shirking and (8) holds with equality, since there is no reason for a primary-sector firm to pay a higher wage. To derive an expression for the probability of moving from a secondarysector to a primary-sector job, a, assume first that no immigrants are present in the country. The flow out of the primary sector is qL1, where L1 is native employment in the primary sector. The flow into the primary sector is a (L⫺L1), where L is total native employment. At equilibrium,

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these two must be equal. Thus, if all native workers have the same probability of finding a primary-sector job, a is given by: a⫽q L1/(L⫺L1).

(9)

When immigrants arrive in a dual labour market, the economic outcome depends on social and institutional arrangements. In order to highlight these differences, I will discuss two extreme cases. First, I assume that the law does not allow employers to recruit immigrants if suitable native candidates can be found. Consequently, all immigrants are forced to accept jobs in the secondary sector. This can be seen as a simplified view of a guest-worker system. In this case, all primary-sector jobs are held by natives. Therefore, the natives’ probability of finding a primary-sector job (a) depends only on native employment and is given by eq. (9). Alternatively, I assume that immigrants are identical to natives in all respects. In that case, immigrants cannot be distinguished from natives and there is no discrimination against them. In a certain sense, this represents the ideal case of a ‘melting pot’, where immigrants are expected to stay in the host country and where they have the same rights as natives. Thus, immigrants have the same probability as natives of finding a job in the primary sector, i.e. L1/L⫽L*/L*, where L* is total employment of immigrants and 1 L*1 is primary-sector employment of immigrants. Therefore a is given by: a⫽

q(L1 ⫹ L*) qL1 1 ⫽ . L ⫹ L* ⫺ L1 ⫺ L*1 L ⫺ L1

Obviously, this expression is identical to the guest-worker case. However, the structure of employment is different in the two cases. Indeed, in the melting-pot case, L*⫽L* (L1/L) is immigrant employment in the primary 1 sector, whereas no immigrants are employed in the primary-sector in the guest-worker system. Secondary employment of immigrants is L*⫽L* (1 2 ⫺L1/L) in the melting-pot case, and L*⫽L* in the guest-worker system. 2 In order to compare the effects of immigration and protection in a small open economy, the relation between the dual labour market and goods trade must be specified. I will procede in two steps. First, I discuss the effects of immigration and protection on U-welfare from a theoretical viewpoint, using a simple two-sector model. However, in the choice between tariffs and immigration, there remains a trade-off between efficiency and equity. This issue is taken up in section 5, with the help of a multi-sector, three-factor simulation model. 4

Labour market effects of immigration and protection

In a standard small-country model, immigration yields a U-welfare gain, whereas protection induces a loss. Does the segmentation of the labour

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Figure 7.1

Impact of immigration on native employment: the ‘melting-pot’ case

market change this result? In this section, I discuss this question by considering small (infinitesimal) immigration flows or tariff changes and by using the utilitarian welfare criterion. Distributional issues and social welfare considerations are postponed until section 5. I assume that capital is specific to the primary and the secondary sectors.4 Both sectors exhibit constant returns to scale and produce traded goods. The country is a price-taker on goods markets. The primary sector offers only ‘good’ jobs, paying efficiency wages w1, whereas the secondary sector offers only ‘bad’ jobs, paying the competitive wage w2. Firms are assumed to maximise profits, so that wage rates are equal to the marginal product of labour in each sector. The relation between wage rates in the two sectors is given by eq. (8), holding with equality, and (9). Assuming to begin with that immigrant employment is exogenous, equilibrium in the dual labour market can thus be described by the two following equations, which are represented diagrammatically in figure 7.1: w1 ⫽ ␲(p1,p2)

冢

冣

qL e r⫹ ⫹p2 f L2 (K2,L⫹L*⫺L1 ⫺L*) 1 d L ⫺ L1

w1 ⫽p1 f L1 (K1,L1 ⫹L*), 1

(10) (11)

where f i is the production function of sector i and f Li denotes the partial derivative of f i with respect to L. Equation (10) reflects both the no-shirking constraint and the marginal product of labour in the secondary sector. Since the derivative of the right-hand side with respect to L1 is positive, this equation is represented by the upward-sloping curve, labelled NSC⫹ MPL2, in figure 7.1. The marginal product of labour in the primary sector is depicted by the downward-sloping curve, labelled MPL1. In order to simplify the welfare analysis, I assume that the capital stocks

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of both sectors are entirely owned by natives and that the new immigrants do not bring any capital with them. I assume furthermore that there are initially no tariffs and no immigrants present in the host country. It is well known since Grubel and Scott (1966) that infinitesimal immigration has no impact on the natives’ U-welfare in a model without distortions. This would also be true in the present model if the proportion of natives working in the primary sector remained constant after the arrival of immigrants.6 Consequently, the equivalent variation of native U-welfare caused by immigration is equal to: EV⫽

w1dL1 ⫹ w2dL2 w1 ⫺ w2 ⫽ dL . ␲(p1,p2) ␲(p1,p2) 1

Native U-welfare improves if the probability for natives of finding a primary-sector job increases as a consequence of immigration. Thus the qualitative U-welfare consequences of infinitesimal immigration can be analysed simply by determining the sign of the change in native primarysector employment. The case of tariffs is similar. As mentioned above, a tariff has no first-order effect on U-welfare if the initial situation is free trade. Therefore, the U-welfare effect of a small tariff on imports depends crucially on the variation of native employment in the primary sector. Now turn to the impact of immigration on U-welfare of natives. Assume first that immigrants cannot be distinguished from natives, so that they are not discriminated against in the host country (the melting-pot case). Figure 7.1 illustrates the ambiguous impact of immigration on native employment in the primary sector. Immigration shifts the MPL1-curve to the left and the NSC⫹ MPL2-curve to the right. The primary-sector wage unambiguously falls, but the impact of immigration on native employment in the primary sector, and thus on native U-welfare, is ambiguous. It can be shown that the natives’ probability of finding a primary-sector job rises only if the elasticity of labour demand is (much) greater in absolute value in the primary sector than in the secondary sector (see Müller, 1998b). This uncertain outcome of immigration would obviously be changed if immigrants could be prevented from penetrating the primary sector. In countries that have implemented the guest-worker system, there is occupational segregation because immigrants do not have the same chances as natives of finding a primary-sector job. Discrimination might be explicit, as in legal dispositions limiting the rights of immigrants, or it might be due to the fact that employers perceive immigrants as a distinct group with characteristics that differ from the natives’ (e.g. different quit rates). The latter case will be discussed below in section 5. Here I simply assume that the host country does not grant the same rights to immigrants as to natives. In Switzerland, for example, employers who want to obtain a work permit

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Figure 7.2

Impact of immigration on native employment: the ‘guest-worker’ case

for an immigrant must prove that they are unable to recruit a native worker (or a foreigner with a permanent residence permit). In the present model of a dual labour market, the consequence of such a regulation is that immigrants are not able to obtain primary-sector jobs, since natives always prefer those to secondary-sector jobs. The U-welfare impact of guest-worker immigration can be seen in figure 7.2. Since immigrants are confined to the secondary sector, immigration does not affect the MPL1-schedule, but shifts the NSC⫹MPL2-curve to the right. Therefore, native employment in the primary sector rises unambiguously and primary-sector wages decline. As in a standard specific-factors model, returns to capital rise in both sectors and the two wage rates fall. However, the wage differential increases. Indeed, since the probability of being hired in the primary sector has risen for natives, the wage differential must be higher in order to prevent them from shirking. Interestingly, it is possible in this model that immigration increases the natives’ expected labour income even if both wage rates fall (see Müller, 1997b). However, natives who work in the secondary sector and who do not receive any capital income are necessarily worse off ex post. Therefore, ex post there is necessarily a conflict between the aggregate gain from immigration and a more unequal income distribution. What is the welfare impact of a tariff if the labour market is segmented? The implementation of a tariff increases output in the secondary sector and moves labour from the primary to the secondary sector. Indeed, the NSC⫹ MPL2-schedule shifts to the left; the MPL1-curve is not affected by the tariff. Obviously, the tariff has the opposite effect of guest-worker immigration. In particular, primary-sector employment diminishes and the tariff induces a Uwelfare loss for natives. The impact of a tariff on income distribution is

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ambiguous in this model. Protection increases the return to capital in the protected sector and lowers it in the other sector. The primary-sector wage rises, but proportionally less than the price of the importable good. 5

Immigration, protection and social welfare: a simulation analysis

From the discussion in the preceding sections it follows that in the case of protection and immigration, the government faces a trade-off between efficiency and equality. On the one hand, guest-worker immigration entails a first-order efficiency gain, since it increases the proportion of natives holding primary-sector jobs, but it also leads to a more unequal income distribution. On the other hand, protection produces a first-order efficiency loss, but might well reduce income inequality. Under what conditions does the efficiency gain of immigration outweigh its adverse distributional impact? When is the efficiency loss due to protection compensated by its favourable impact on income distribution? Which option would be preferred by a decision-maker motivated by social welfare? In this section, I consider these questions from an empirical perspective with the help of a simulation model which is calibrated on Swiss data. Of course, the answers to the questions above depend strongly on value judgements, in particular on the degree of ‘inequality-aversion’ of decision-makers. 5.1

The simulation model

In the simulation model, capital is sector-specific7 and there are two skill categories of labour, mobile between sectors. Since the simulations focus on the immigration of unskilled workers, I assume, for simplicity, that the skilled labour market is competitive (for a similar hypothesis in a model with trade unions for unskilled workers, see Schmidt et al., 1994). By contrast, the unskilled labour market is segmented and there are good and bad jobs, as described above in section 3. Markets for goods are assumed to be competitive and the firms’ production functions are nested CES functions. Because of the small-country assumption, the domestic prices of traded goods are fixed. Some sectors, however, produce non-traded goods. Since their prices are endogenous, the demand side matters in the simulation model (the equations of the model are given in the appendix, p. 175). Obviously, the simulation model differs only very little from the theoretical model used in section 4. The main differences are the presence of two labour categories and of non-traded goods. Furthermore, in the simulation model all industries offer good and bad jobs; however, the proportion of good jobs varies from one industry to the other. Preferences of all households are described by Cobb–Douglas utility

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functions. Moreover, I assume that all households have identical utility functions. Since the conditions of exact linear aggregation are satisfied in this case, domestic demand depends only on aggregate income and is not affected by a change in the distribution of income. As a consequence, income distribution issues can be considered independently from the determination of equilibrium. In order to model immigration as well as income distribution among natives, three types of households are distinguished in the model: (1) immigrant households, who do not own any capital; (2) native households endowed with unskilled labour; (3) native households endowed with skilled labour. All native households receive some income from capital. For simplicity, I assume that the share of capital income received by a native household is equal to its share of native labour income. Tariff revenues are redistributed to all households (including immigrants) according to their share in total income. Thus, a change in tariffs does not affect income inequality. These assumptions imply that native income inequality depends only on relative income from skilled and unskilled labour. In particular, a rise in the return to capital does not increase income inequality. This is, of course, a conservative assumption since it tends to under-state the rise in income inequality due to guest-worker immigration. However, this treatment of income distribution captures the main source of income inequality, as the following result in Flückiger and Silber (1995) shows. Decomposing the overall Gini index by income source, these authors conclude that the contribution of labour income to an overall Gini index of 0.40 is estimated to be equal to 0.24. The main indicator used to evaluate the impact of immigration and tariff policies is the social welfare of natives. I assume thereby that the government does not redistribute income in order to compensate native households for any losses due to those policies. Social welfare depends on the individual utility levels of natives. Because of the Cobb–Douglas specification, indirect utility is equal, by appropriate normalisation, to real income – i.e. nominal income deflated by a geometric price index. The measure of social welfare used in the simulations is Atkinson’s (1970) equally-distributed equivalent income, ye. It defines the level of per capita real income which if equally distributed would provide the same level of social welfare as the actual distribution. The degree of inequality-aversion is captured by a parameter, ␧, which allows us to cover a large range of value judgements. If ␧⫽0, the decision-maker is completely insensitive to distribution issues, since in this case ye is equal to average income (the utilitarian case). With increasing ␧, the decision-maker attaches more and more weight to lower incomes.

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Table 7.1. Policy experiments and labour market specifications Policy experiment M P-1 P-2

Immigration of unskilled workers (quota of 200,000 immigrants) Protection (10 per cent tariff on Textiles and Clothing) Protection (tariffs on all low-skill traded goods) Labour market specification

STD M-P G-W S-D

5.2

Integrated labour market, no efficiency wages, no discrimination Dual labour market, no discrimination against immigrants Dual labour market, legal discrimination against immigrants Dual labour market, immgrants and natives have different quit rates

Policy experiments and labour market specifications

To analyse the effects of immigration and protection on social welfare in Switzerland, three main policy experiments are carried out using four different specifications of the labour market (see table 7.1). In a first set of simulations, immigration quotas and tariff rates are fixed. Then, the consequences of varying immigration and protection levels and of different skill levels of immigrants are analysed. In the first set of simulations, the impact of migration policy is simulated by assuming that 200,000 unskilled immigrants arrive to Switzerland (M). This can be interpreted as an estimation of the number of ‘guest-workers’ in Switzerland since it is approximately the number of low-skill foreigners who had temporary working permits in 1985, the base year of the model (foreigners holding a permit of residence are treated as natives). The effects of protection are captured through two policy experiments. First, I consider the effects of sector-specific protection by simulating a tariff on imports of Textile and Clothing (P ⫺1). The ad valorem equivalent of tariff barriers in these sectors is not far from 10 per cent in Switzerland. It is, however, difficult to compare simulations M and P⫺1 because of their different sectoral impact. In the two-sector framework of Bhagwati (1982), immigration and protection can be considered as being equivalent in the sense that a same output level of the importable good can be achieved by both policy instruments. Simulations P⫺1 and M are not equivalent according to that definition since the former increases the output level of the two protected sectors in very large proportions, whereas the latter increases moderately the output of all low-skill sectors. In experiment P ⫺2, the tariff structure is designed in such a way that the output levels of all low-skill traded goods are equal to their output levels in

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experiment M. Thus, comparability between immigration and protection in the sense of Bhagwati (1982) is ensured (however, firms in skill-intensive sectors prefer option M to P-2, since their production rises in the first case and falls in the second). The tariff rates in experiment P-2 range from 1.0 per cent (Beverages) to 2.6 per cent (Agriculture). In order to highlight the role of a segmented labour market and of discrimination against immigrants, the experiments are carried out using four alternative labour market specifications. The first case represents the standard specific-factors model (STD) where the labour market is integrated and wages are set competitively. There is no discrimination against immigrants. This specification is useful as a benchmark for the other simulations. In the second case, the labour market is assumed to be segmented, with efficiency wages in the primary sector, but discrimination does not take place because immigrants and natives are indistinguishable. In particular, their quit rates are perceived to be identical by employers. This is the melting-pot (M–P) specification discussed above. In the third case, I assume that immigrants face legal discrimination, preventing them from entering the primary sector. Since employers must prove that they cannot find a native worker to fill a job vacancy and since primary jobs are preferred to secondary jobs, immigrants are stuck in the secondary sector. This is the guest-worker (G–W) specification. In the fourth case, discrimination originates in the fact that immigrants are perceived as having, on average, higher quit rates than natives. Empirically, this assumption can be justified by the observation that many immigrants intend to return to their home country in the near future. This is true even for immigrants who arrived in the host country a long time ago. For Germany, Dustmann (1993) reports that 55 per cent of all immigrants intend to return to their country of origin within the next 10 years. Among them, 85 per cent have been living in Germany for more than 10 years. If quit rates are different, discrimination occurs even if immigrants have the same legal rights as natives in the labour market. It is a form of statistical discrimination (S–D) because the membership in a group (natives, immigrants) determines an individual’s probability of finding a primary-sector job. This can be seen from the no-shirking conditions for natives and immigrants (see (40) and (41) in appendix table 7A.1). Because of competition between firms, natives and immigrants are paid the same wage in the primary sector. Since immigrants expect to stay a shorter time in primary-sector jobs than natives, primarysector employers will hire proportionately fewer immigrants in order to induce them not to shirk. Note that this treatment of discrimination follows very closely Bulow and Summers (1986), who apply it to the case of discrimination against women. In the simulations, I assume that the immigrants’ quit rates are three times higher than the natives’.

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Table 7.2. Impact of immigration and protection on native social welfare (percentage changes in equally distributed equivalent income, ye ) Inequality-aversion parameter (␧) Policy Labour market experiment specification

0

0.2 0.05 0.04 0.23 0.11

M

STD M-P G-W S-D

P-1

STD, M-P, G-W, S-D ⫺ 0.05

P-2 P-2

STD M-P,G-W, S-D

⫺ 0.02 ⫺ 0.03

0.5

1.0

2.0

⫺0.03 ⫺0.15 ⫺0.35 ⫺ 0.72 ⫺0.04 ⫺0.17 ⫺0.37 ⫺ 0.75 0.16 0.07 ⫺0.10 ⫺ 0.42 0.03 ⫺0.08 ⫺0.27 ⫺ 0.63

3.0 ⫺ 1.03 ⫺ 1.07 ⫺ 0.70 ⫺ 0.94

⫺0.04 ⫺0.04 ⫺0.02

0.01

0.04

⫺0.01 ⫺0.02

0.14 0.13

0.21 0.19

0.02 0.01

0.06 0.05

The simulation model is calibrated on Swiss data for the year 1985 (see the appendix), taking into account the presence of immigrants and the fact that the Textile and Clothing sectors are protected. Then a hypothetical free trade, no-immigration situation is simulated; this is the starting point for all policy experiments. 5.3

Simulation results

The policy experiments described above shed new light on Bhagwati’s (1982) discussion of tariff and immigration policies in the context of increased import competition. First, I follow his analysis by assuming that the two policy options have the same objective: to achieve a given output level in low-skill sectors. Second, the consequences of different protection and immigration levels are discussed. Finally, an informal sensitivity analysis of the model is carried out. 5.3.1 The choice between protection and immigration The results of the policy experiments described above suggest that, from the perspective of native social welfare, immigration might be preferred to protection only if there is discrimination against immigrants or if the government is completely insensitive to the distribution of income among natives (see table 7.2). Consider first the case of an integrated, competitive labour market (STD). In this context, unskilled immigration (M) is not an attractive policy option from the viewpoint of social welfare. As expected from the

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Table 7.3. Impact of immigration and protection on output and the labour market (percentage changes from the base values) Unskilled immigration Experiment Labour market specification

STD

M-P

M G-W

Output: aggregate and selected low-skill sectors Aggregate output 2.0 1.9 Food 7.0 7.0 Textile 3.9 3.9 Clothing 3.7 3.7 Construction 5.7 5.7 Hotels, restaurants 2.9 3.0

1.9 5.7 3.9 5.5 9.1 6.5

S-D

Protection P-1 P-2 STD G-W G-W

1.9 0.1 0.1 0.1 6.5 ⫺1.4 ⫺ 1.4 5.7 3.9 79.1 78.9 3.9 4.4 30.1 29.7 5.5 7.0 ⫺1.0 ⫺ 1.1 9.1 4.3 ⫺1.4 ⫺ 1.4 ⫺3.2

Employment, wages and capital income Total unskilled employment 6.0 6.0 6.0 6.0 0 0 0 Native unskilled employment 0 0 0 0 0 0 0 – Primary sector — ⫺ 0.5 4.1 1.5 — ⫺ 0.1 ⫺0.3 – Secondary sector — 2.0 ⫺17.7 ⫺6.5 — 0.5 1.2 Unskilled wage ratea ⫺2.4 ⫺ 2.4 ⫺1.6 ⫺2.1 0.1 0.0 0.2 – Primary sector — ⫺ 2.3 ⫺1.6 ⫺2.0 — 0.0 0.2 – Secondary rate — ⫺ 2.4 ⫺4.7 ⫺3.3 — 0.1 0.4 Skilled wage rate 1.0 1.0 1.0 1.0 ⫺0.2 ⫺ 0.2 ⫺0.5 Capital income 1.1 1.1 1.0 1.1 ⫺0.2 ⫺ 0.2 ⫺0.0 Note: In the case of dual labour markets, average unskilled wage rate for natives.

a

discussion in section 2, the U-welfare gain from immigration is very small and the adverse impact on income distribution prevails even for low levels of inequality-aversion. On the other hand, protection of low-skill sectors increases the unskilled wage relative to the skilled wage (see table 7.3) and thus has a favourable impact on income distribution. The efficiency loss from protection is relatively small, especially in the broad-based approach with moderate tariffs applying to many goods (P–2). Consequently, protection is preferred to immigration unless the degree of inequality-aversion is very small. What if the labour market is segmented? If there is no discrimination against immigrants (M–P), both immigration and protection induce a shift of native unskilled employment from the primary to the secondary sector. However, this effect is so small that it hardly influences the social welfare outcome.

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If there is discrimination against immigrants, natives will find unskilled immigration more profitable. In the guest-worker system (G–W), secondary-sector employment of natives declines by more than a sixth as a consequence of immigration. By contrast, the impact of immigration on average native income is surprisingly small (it rises by only 0.2 per cent). This is due to the fact that only a small share (9 per cent) of native workers hold secondary-sector jobs. Moreover, the sign of the social welfare effect depends on the inequality-aversion parameter. Therefore, if the government is insensitive to distribution issues, it would favour guest-worker immigration. On the other hand, if the government is characterised by an inequality-aversion parameter greater than 0.7, it would be hostile to unskilled immigration and prefer protection. If discrimination has its source in different quit rates (S–D), the outcome lies in between the M–P and the G–W cases. Indeed, the U-welfare gain for natives is smaller than in the guest-worker case since only 7 per cent of native workers in the secondary sector succeed in moving to the primary sector. 5.3.2 The welfare impact of different immigration or protection levels In the simulations above, it is assumed that the government considers only two policy options with pre-determined levels of immigration or protection. Obviously, these levels might also be chosen by the government. In particular, to counter the continued pressure of import competition from developing countries, the government might envisage large-scale immigration or high tariff rates. The impact of varying immigration levels on the social welfare of natives is depicted in figure 7.3. As expected from the simulations above, large-scale immigration is beneficial for natives only if the degree of inequality-aversion is low. But figure 7.3 reveals two more striking features. First, successive immigration waves become increasingly beneficial, or less unfavourable, for natives (the curves are concave). Second, the difference between the G–W and the M–P cases increases with rising immigration levels. An intuitive understanding of the first observation can be obtained by considering the impact of immigration when some immigrants are already living in the host country. Each new arrival of unskilled immigrants prompts, over and above the second-order U-welfare gain, a redistribution of income from earlier unskilled immigrants towards natives, because of the fall of unskilled wages relative to skilled wages and to the return to capital. Thus, the more unskilled immigrants reside in the country the more beneficial a new arrival of unskilled immigrants is for natives. Obviously, the increasing gain for natives is obtained at the expense of immigrants. However, in a M–P system, this redistribution effect is quite small. In

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Figure 7.3 Impact of different immigration levels on native social welfare: the ‘melting-pot’ 兹莥(M–P) and ‘guest-worker’ 兹莥(G –W) cases

terms of native social welfare, it outweighs the increase in income inequality among natives only if the degree of inequality-aversion is small. If ␧⫽ 1~or~2, the social welfare effect remains negative even for high levels of unskilled immigration. Compared to the M–P case, immigration is doubly beneficial for natives in a G–W system. On the one hand, immigration enables more natives to find a job in the primary sector and, on the other, it increases the wage gap between the primary and the secondary sectors. The influence of the first effect gradually diminishes with rising immigration levels, since there are fewer and fewer natives in the secondary sector who could gain from shifting to the primary sector.8 The second effect, however, becomes increasingly favourable to natives, because it reinforces the redistribution effect mentioned above. Indeed, the drastic fall in secondary-sector wages hurts especially immigrants, whereas primary-sector wages, which most natives receive, fall less than in the M-P case. In other words, the segregation of the work force is reinforced with rising immigration: almost all natives have a primary-sector job, whereas all immigrants have secondary-sector jobs. Assuming that the government aims at maximising social welfare,9 what are the implications of these observations for migration policy? If no other policy instruments are available, the government would choose either free immigration or no immigration, depending in particular on the degree of inequality-aversion. Furthermore, if the government pursues only the interests of natives, it would opt for a guest-worker system, which is more advantageous than the melting-pot system in two respects. First, its impact on social welfare is more favourable for natives for a given level of immigration, as shown above. Second, the immigration pressure is likely to be

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smaller than in the melting-pot case, since the immigrants’ wages decrease more rapidly with rising immigration levels, the immigrants being confined to a small labour market segment. Moreover, the bad working conditions in the secondary sector discourage many potential immigrants. It might seem unrealistic that the model contains no mechanism which would limit the usefulness of increasing immigration levels for natives. However, if a low degree of inequality-aversion is assumed, the guestworker specification of the model reflects Swiss immigration policy quite well until the first half of the 1960s (Hoffmann-Nowotny, 1985): this policy was liberal towards the exterior and restrictive towards the interior. Borders were open to migrants, but migrants met hard restrictions once inside the country. As a result of that policy, the number of foreigners in Switzerland increased from 285,000 in 1950 to 810,000 in 1965. Swiss immigration policy underwent an important turnaround in 1970 when restrictive immigration quotas were introduced. According to Hoffmann-Nowotny (1985), this change in policy was ‘not dictated by economic interests at all, it was instead the result of grassroots pressure based mainly on the issue of “over-foreignization”’. The fear of ‘over-foreignization’ (Überfremdung – an unpalatable German word which evokes the Swiss’ fear of losing their cultural identity because of the presence of foreigners) can be linked to the failure of the policy of ‘rotation’. Instead of returning to their home country, as had been expected, many immigrants decided to stay on in Switzerland. This observation suggests an alternative interpretation, which does not refer to the concept of cultural identity, of the shift towards a restrictive immigration policy. As discussed above, the G–W system was advantageous for natives because of the legal discrimination against immigrants. By contrast, there is no legal discrimination against foreigners holding a permit of residence, since they have the same rights in the labour market as natives. Thus, when it became clear that many immigrants would in fact become permanent residents, unskilled immigration appeared much less attractive from the perspective of native social welfare (see the M–P specification in figure 7.3). It is therefore likely that further immigration would be halted in these conditions. Moreover, if immigrants are expected to become permanent residents, it is difficult for the government to argue that it is completely indifferent to their welfare. Yet, if immigrants are included in the government’s social welfare objective, the social welfare implications of immigration are very different from that outlined above. On the one hand, the arrival of unskilled immigrants is likely to decrease social welfare because it diminishes average income (of natives and immigrants) and increases income inequality. Thus, further unskilled immigration will be stopped a fortiori. On the other, from the perspective of social welfare it is not advisable to discriminate against

Migration, dual labour markets and social welfare 171

Figure 7.4

Impact of different tariff levels on social welfare (the G –W case)

immigrants who are expected to become permanent residents (interestingly, since 1970 the Swiss government has improved the legal position of immigrants and lifted some of the discriminatory restrictions). Indeed, the M–P policy performs better than the G-W system with respect to the social welfare of natives and immigrants, for any degree of inequality-aversion. If 1 million immigrants are present in Switzerland (the actual number of foreigners in 1985), social welfare is 0.5 per cent higher if ␧⫽0 (2.4 per cent if ␧⫽1) in the M–P system. This is hardly surprising. Since in the G–W case immigrants are confined to the secondary sector, total secondary-sector employment expands more, relative to primary-sector employment, than in the M–P case. Moreover, overall income inequality is greater in the G–W system because immigrants receive lower wages. Now turn to the consequences of rising tariff levels. It is well known that the efficiency cost of protection increases with initial tariff levels (Neary, 1988). In terms of social welfare, the improvement in income distribution induced by protection is therefore less likely to compensate for the deadweight loss when tariff rates reach high levels. This can be seen in figure 7.4, which depicts the social welfare effects of a uniform proportional increase in tariffs on low-skill goods (the tariff structure is the same as in experiment P–2). Optimal tariff rates are quite low for moderate levels of inequalityaversion. Would protection of low-skill sectors have been an alternative to large-scale immigration in Switzerland? The arrival of almost 1 million immigrants in the 1950s and 1960s had an important impact on the output levels of low-skill sectors. If the government had tried to achieve a similar

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Table 7.4. Social welfare effects of immigration: sensitivity analysis (percentage changes in equally distributed equivalent income, ye ) Inequality-aversion parameter (␧) Sensitivity analysis

Labour market

0

0.2

0.5

1.0

2.0

3.0

I-D LMS-1 LMS-2 LMS-3 S-25 S-25 and I-D S-50 S-50 and I-D

G-W G-W G-W G-W G-W G-W G-W G-W

0.23 0.23 0.30 0.26 0.16 0.16 0.12 0.12

0.09 0.18 0.24 0.20 0.17 0.09 0.20 0.11

⫺0.15 0.09 0.15 0.10 0.19 ⫺0.04 0.33 0.08

⫺ 0.57 ⫺ 0.05 ⫺ 0.02 ⫺ 0.05 0.22 ⫺ 0.27 0.53 0.04

⫺1.25 ⫺0.32 ⫺0.36 ⫺0.35 0.26 ⫺0.66 0.91 ⫺0.04

⫺1.58 ⫺0.57 ⫺0.73 ⫺0.61 0.28 ⫺0.85 1.23 ⫺0.09

impact by tariff policy, the required tariff rates would have exceeded 10 per cent on average. Figure 7.4 shows that, for moderate levels of ␧, such a policy would have been less beneficial than guest-worker immigration for the social welfare of natives. Discrimination hardly affects the impact of protection on social welfare (see table 7.2). Even if immigrants are included in the social welfare function, the impact of protection is not altered significantly, since all unskilled workers, natives and immigrants, gain from the redistribution of income resulting from a rise in tariffs. Thus, if the failure of the policy of rotation is acknowledged, protection appears more advantageous than immigration. 5.3.3 Sensitivity analysis Since the model has been calibrated using many simplifying assumptions, it is useful to test the sensitivity of the results to some of them. For comparability, all simulations are carried out using the G–W specification (see table 7.4). Of course, this is no full-fledged sensitivity analysis since every change in parameters or in model structure is simulated separately. Overall, the qualitative welfare results of the model are quite robust and all model variants give similar estimates of the variation of average native income (U-welfare). By contrast, results differ significantly as to the impact of immigration on native income inequality. 5.3.4 Income distribution (I-D) The assumption that capital income is distributed to natives in proportion to their labour income tends to underestimate the impact of immigration on income inequality. In order to test the sensitivity of results to this assumption, I re-calculated the social

Migration, dual labour markets and social welfare 173

welfare measure using the extreme alternative assumption that all income from capital is paid to native skilled households. In this case, which certainly over-estimates the impact of immigration on inequality, the level of inequality-aversion at which a decision-maker would be indifferent to G–W immigration is around 0.3, down from 0.7 in the original simulation. 5.3.5 Labour market segmentation (LMS) In the treatment of the primary and secondary sectors, several crucial assumptions rely on very little information. I will test the sensitivity of results to four of them. First, some authors interpret the dual labour market hypothesis as implying that ‘good’ and ‘bad’ jobs are located in different firms. To test this assumption, I recalibrate the model assuming that three industries (i.e. Construction, Arrangement and Hotels and restaurants) offer only ‘bad’ jobs for unskilled workers, whereas the others offer only ‘good’ jobs. The results are surprisingly similar to the original version of the model (LMS–1). Second, the wage differential between jobs in the primary and secondary sectors is not estimated directly. In the model it is calibrated using the average wage differential between unskilled natives and immigrants (15 per cent). Doubling this latter number increases the U-welfare gain from immigration by only a third (LMS–2). Third, there is no reliable information on the share of unskilled natives working in the secondary sector. Assuming that this share is only half as large as in the original model (where it is 16 per cent) yields results that differ very little from the original model (LMS–3). This is due to the fact that the wage differential between unskilled natives and immigrants is given (see above). 5.3.6 Skill-mix of immigrants (S) In the simulations above, all immigrants were assumed to be unskilled. Yet, in recent years, the Swiss government has tried to facilitate the immigration of highly skilled workers. Such a policy has many advantages. Skilled immigrants pay higher taxes and are less likely to be unemployed than unskilled migrants. Moreover, their human capital may have external effects in production. Here I focus on another issue: their impact on income distribution and social welfare. I simulate this immigration policy by assuming that either 25 per cent (S–25) or 50 per cent (S–50) of immigrants are skilled. Since skilled labour and capital are complements in production, the immigration of skilled workers increases the return to capital even more than the arrival of unskilled workers. Hence, the assumption on the distribution of capital income among natives becomes a more sensitive issue. Thus, I report also the social welfare effect under the alternative hypothesis that all capital income is paid to skilled workers (I–D). The results show that the presence

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Table 7.5. Education level of the work force in Switzerland, by nationality (percentage of the work force of each category) Foreigners Education level

Swiss

Permanent residents

Others

Elementary education, compulsory school Apprenticeship, professional or high school University

14.8 74.5 10.1

40.7 50.7 27.6

29.0 36.1 26.0

Other training, no answer

20.6

21.0

28.9

Source: Swiss Labour Force Survey (1991).

of skilled immigrants attenuates the adverse impact of immigration on income inequality. On the other hand, the U-welfare gain from immigration is reduced because there is no discrimination against skilled workers. Therefore, a government entirely insensitive to income distribution would admit only unskilled ‘guest-workers’. By contrast, a government concerned with income inequality would rather try to attract skilled immigrants. Nevertheless, it would not abolish legal discrimination against the unskilled immigrants if it expects them to return to their country of origin. Recent Swiss immigration policy bears a strong resemblance to the latter option. Indeed, an important share of recently arrived immigrants are highly skilled (see table 7.5). However, the proportion of immigrants with elementary education remains high and intermediate education levels are under-represented. This suggests that recent policy is a typical Swiss compromise: part of the immigration quota is allocated to highly skilled workers, while the remainder is used to pursue the traditional guest-worker policy. 6

Conclusions

From the results above, it appears that immigration of unskilled workers seems advantageous to natives only if immigrants ultimately return to their home country. If, however, immigrants acquire the status of permanent residents and thereby the same rights as natives in the labour market, unskilled immigration is likely to meet with much more resistance. In that case, natives might find protection the better response to increased import competition, from the perspective of social welfare. In this view, the failure of the rotation system might be one of the causes of the switch to restrictive

Migration, dual labour markets and social welfare 175

Figure 7A.1

Structure of nested production functions in the simulation model

immigration policies in the 1970s. In turn, this change in immigration policy may have contributed to the resurgence of protectionism in Europe. Swiss immigration policy today seems to waver between a narrow view of national interest, which favours a guest-worker system, and a broader view of social welfare, focusing on the economic and social integration of immigrants. The fact that an increasing share of foreigners hold permanent residence permits shows that the guest-worker system has not worked as expected. Nevertheless, many discriminatory aspects of this system have been maintained. As a consequence, further immigration of unskilled workers is still perceived as being advantageous for natives, at least in the short run. This would probably change if the government put more emphasis on the better integration of foreigners. However, it is clear that if the economic consequences of immigration shape the natives’ attitudes towards immigrants, the choice between a discriminatory guest-worker system and a policy oriented towards the integration of immigrants is largely determined by ethical values.

APPENDIX A.1

The simulation model

The model is disaggregated into 28 production sectors, indexed over i or j. Some of the goods and services that are produced are not traded internationally (see table 7A.3). The production functions are nested CES functions. Their structure is depicted in figure 7A.1. Skilled labour and capital, which is specific to each sector, are assumed to be separable from other inputs since empirical evidence seems to indicate that these factors are p-complementary

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(see Hamermesh, 1993). Unfortunately, such evidence is completely lacking for the relation between (unskilled) primary and secondary jobs, which I assume to be separable from other production factors. Firms minimise costs subject to the production function. The derived demand equations resulting from this problem are equations (12)–(16). Equation (17) is marginal cost, table 7A.1 contains all equations of the model and table 7A.2 lists the variables of the model. Equations (18)–(27) define the distribution of income to households. Subscripts s and u designate skilled and unskilled labour, superscripts (or subscripts) n and f designate native and foreign (immigrant) households or labour supply. Subscripts 1 and 2 refer to primary and secondary-sector jobs. Native households own all domestic capital and also receive some capital income from abroad (18). The variable ␾s determines the share of capital income distributed to skilled households, which is equal to their share in native labour income. The variable ␺n determines the share of net tariff income distributed to (skilled and unskilled) native households. It is equal to the natives’ share in capital and labour income. The variable s1 designates the share of (native) unskilled labour income that (native) primarysector workers receive. Equation (28) is Atkinson’s (1970) measure of equally distributed equivalent income. The domestic final demand equation (29) is derived from a Cobb–Douglas utility function. Because of the assumption of identical preferences, domestic demand depends only on aggregate income. Equation (31) is the small-country assumption. The current account balance (B) is exogenous and the real exchange rate adjusts to ensure external equilibrium. Labour supply by immigrants is proportional to the number of immigrants who live in the host country ((25) and (30)). The equilibrium condition (39) for secondary-sector jobs includes also exogenous labour supply by ‘border workers’ – i.e. commuters who work in Switzerland but are not allowed to live there. Equations (40) and (41) are the efficiency-wage equations determining the relation between the wage gap and employment in the primary and secondary sectors. They are derived from (8) and (9) in the text. Equation (42) defines the geometric consumer price index, which is dual to the Cobb–Douglas utility function, as the numeraire. Thus, all income variables can be interpreted in real terms. A.2

Data and calibration

The simulation model is calibrated on a social accounting matrix for Switzerland in 1985 (see Antille et al., 1991). The breakdown of wage income by skills is taken from Gaillard et al. (1991). In 1985, the foreign

Migration, dual labour markets and social welfare 177

Table 7A.1. Equations of the simulation model Production Kj.⫽Kj(rj,ws, w1, w2, P1, … PM, Qj)

(12)

LSj.⫽LSj(rj, ws, w1, w2, P1, … PM,Qj)

(13)

LU 1j .⫽LU 1j (rj, ws, w1, w2, P1, … PM, Qj)

(14)

LU 2.j ⫽LU 2j (rj, ws, w1, w2,P1,

(15)

… PM,Qj)

Iij.⫽Iij(rj, ws, w1, w2, P1, … PM, Qj)

(16)

Pj.⫽MCj(rj,ws, w1, w2, P1, … PM)

(17)

Income YK.⫽ ⌺iriKi ⫹YKF E

(18)

YL.⫽ ws(Lns ⫹ L sf ) ⫹w1(Ln1 ⫹L f1)⫹ w2(Ln2 ⫹ L f2)

(19)

YT.⫽ ⌺itiMNiPWiE

(20)

␺

(21)

n n n n.⫽ (wsLs ⫹ w1L1 ⫹ w2L2 ⫹ YK)/(YL ⫹ YK)

␾ s

n n n n s.⫽ wsLs /(wsLs ⫹ w1L1 ⫹ w2L2)

(22)

n n n 1.⫽ w1L1/(w1L1 ⫹ w2L2)

(23)

Ns ys.⫽ ␾s␺n(YL ⫹ YK ⫹ YT ⫺ B) .⫽ wsLns ⫹ ␾sYK ⫹ ␾s␺n(YT ⫺B)

(24)

(Ln1/Lnu)Nu y1.⫽ s1(1⫺ ␾s)␺n(YL ⫹ YK ⫹ YT ⫺ B) .⫽ w1Ln1 ⫹ s1(1⫺ ␾s)YK ⫹ s1(1⫺ ␾s)␺n(YT ⫺B)

(25)

(Ln2/Lnu)Nu y2.⫽ (1⫺s1)(1⫺ ␾s)␺n(YL ⫹YK ⫹YT ⫺B) .⫽ w2Ln2 ⫹ (1⫺s1)(1⫺ ␾s)YK ⫹ (1⫺s1)(1⫺ ␾s)␺n(YT ⫺ B)

(26)

Nfyf.⫽ (1⫺ ␺n)(YL ⫹YK ⫹YT ⫺B) .⫽ wsL sf ⫹w1L f1 ⫹w2L f2 ⫹ (1⫺ ␺n)(YT ⫺B)

(27)

Natives’ social welfare (equally distributed equivalent income) ye ⫽ ye.⫽

兵

1

n n 1⫺␧ n n 1⫺␧ bi [ fs y1⫺␧ s ⫹ (L1 /Lu)fu y1 ⫹(L2 /Lu)fu y2 ] 1 ⫺ ␧ /⌸iP i

y sfsy1

(Ln1/Lnu)fu

(Ln /Ln)f y2 2 u u /⌸iPbi i

if ␧⬆ 1 if ␧⫽1

(28)

where fs ⫽Ns /(Ns ⫹ Nu) and fu ⫽ Nu /(Ns ⫹ Nu)

Domestic final demand PiCi.⫽ bi(YLn ⫹YK ⫹YT ⫺B)

(29)

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Table 7A.1. (cont.) Net imports and equilibrium on goods markets MNi.⫽Ci ⫹⌺j Iij ⫺Qi Pi.⫽ (1⫹ ti)PWiE if i is a traded good MNi.⫽0 if i is a non-traded good Unskilled employment and immigrant labour supply Lnu..⫽ Ln1 ⫹Ln2 L uf .⫽ L f1 ⫹ L f2 L uf .⫽a uf Nf L sf .⫽a sfNf Equilibrium on labour markets Lsn.⫹.L sf .⫽ ⌺j LSj Ln1.⫹ L f1 ⫽⌺j LU1j Ln2.⫹ L f2 ⫹ L2b ⫽ ⌺j LU2j

(30) (31) (32)

(33) (34) (35) (36)

(37) (38) (39)

Efficiency wages w 1 ⫺ w2 e qnLnu ⫽ r ⫹ ⌸iPibi d Ln2

.

冢

冣

w 1 ⫺ w2 e qf L f ⫽ r⫹ fu bi ⌸iPi d L2

.

冢

冣

(40)

(41)

Numeraire ⌸iP bi i.⫽1

Alternative labour market specifications • • • •

Standard (STD): e/d⫽0 Melting-pot (M-P): qn ⫽qf Guest-worker system (G-W): replace (41) by L f1 ⫽0 Statistical discrimination (S-D): qf ⬎qn

(42)

Migration, dual labour markets and social welfare 179

Table 7A.2. Variables of the simulation model Endogenous variables Pj rj ws w1 w2 Qj LSj LU 1j LU 2j Iij Ln1 L2n L sf L uf L 1f L 2f YK YL YT ␺n ␾s s1 ys y1 y2 yf ye Ci MNi E

domestic price of good j return to capital in industry j skilled wage rate unskilled wage rate (primary-sector jobs) unskilled wage rate (secondary-sector jobs) gross output of industry j skilled labour used in production of industry j primary-sector employment (of unskilled workers) in industry j secondary-sector employment (of unskilled workers) in industry j intermediate good i used in production of industry j primary-sector employment of unskilled natives secondary-sector employment of unskilled natives skilled labour supply, by immigrants unskilled labour supply, by immigrants primary-sector employment of unskilled immigrants secondary-sector employment of unskilled immigrants total income from capital total labour income accruing to residents (natives and immigrants) tariff income natives’ share in total capital and labour income skilled natives’ share in native labour income share of primary-sector income in native unskilled labour income per capita income of skilled natives per capita income of unskilled natives working in the primary-sector per capita income of unskilled natives working in the secondary-sector per capita income of immigrants equally-distributed equivalent income of natives total domestic final demand net imports of good i real exchange rate

Exogenous variables Kj Nf Ns Nu Lns Lun L2b YKF B ti PWi qn qf

capital stock in industry j number of immigrants number of skilled natives number of unskilled natives skilled labour supply, by natives unskilled labour supply, by natives unskilled labour supply, by border workers income from capital abroad, held by natives current account balance tariff rate on good i world price of good i quit rate of natives quit rate of immigrants

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population in Switzerland was 1.02 million or 15.6 per cent of total population. However, the majority of foreigners were in the possession of a permit of residence, giving them the same rights on the labour market as Swiss citizens. (In the administrative jargon, Swiss citizens and foreigners with residence permits are called the ‘indigenous work force’.) However, foreigners without a residence permit face various restrictions. Therefore, it seems reasonable to define as ‘guest-workers’ all unskilled foreigners who do not hold a permit of residence. In 1985, the number of foreigners without a permit of residence was 283,000, or 4.3 per cent of total population (border workers are not included in this number). Of these, 200,000 are estimated to have low skills. It is difficult to find an operational definition of the secondary sector in the literature on dual labour markets. Trying to quantify the number and the sectoral distribution of secondary-sector jobs is even more hazardous. In their test of the dual labour market hypothesis for the US, Dickens and Lang (1985) conclude that 12 per cent of working male heads of households are employed in the secondary sector. They also note that this proportion is likely to be higher for women. Unfortunately, no such estimates exist for Switzerland. So I assume that 12 per cent of the total population (including foreigners) hold a secondary-sector job in the initial equilibrium. As to the sectoral distribution of these jobs, there is no quantitative evidence to my knowledge. I assume that the number of secondary jobs in each industry is proportional to the number of foreign workers without a permit of residence (see table 7A.3). This assumption ensures that there is no sectoral bias in the distribution of foreigners holding secondary-sector jobs. In order to calibrate the no-shirking conditions, one needs to know the wage differential between the primary and secondary sectors. The latter can be calculated from the wage differential between indigenous workers and ‘guest-workers’, using the shares of natives and immigrants working in the secondary sector (since the proportion of immigrants holding a secondarysector job is higher than the proportion of natives, a positive wage differential between the primary and the secondary sectors is reflected in lower average wages for immigrants). De Coulon and Flückiger (1995) estimate the wage differential between Swiss and foreign workers to equal approximately 10 per cent. This number probably under-estimates the wage differential of the present model for two reasons. First, recently arrived immigrants are under-represented in their database (the Swiss labour force survey). Second, all foreigners are lumped together in their estimation, in contrast with my definition of immigrants. Foreigners holding a residence permit (and having arrived a long time ago) can be expected to receive higher wages than more recent immigrants. Therefore, I chose to fix the wage differential between indigenous workers and recent immigrants at a

Migration, dual labour markets and social welfare 181

Table 7A.3. Employment, Switzerland, 1985, by sector and by nationality of workers Share of foreign workers

Foreigners without permit of residencea

222 224 260 228 224 232 237 268 217 263 211 270 220 222 232 299 157 257 210 139 494 214 137 265 109 251 322 495

27.9 24.6 27.1 16.9 32.5 39.7 46.7 20.8 32.7 16.7 43.0 31.9 31.9 36.1 37.3 34.3 26.7 26.2 51.0 23.9 14.8 40.1 13.0 24.2 11.6 27.6 17.1 13.2

26.2 21.0 10.6 25.3 28.7 13.0 21.3 28.1 29.0 23.3 11.2 15.6 15.6 15.0 17.2 11.9 26.3 29.1 32.7 15.3 24.9 27.9 24.6 21.5 23.2 21.6 26.4 24.6

3418

21.8

10.1

Employment (000) Percentage of employment) Agriculture, forestry Electricity, gas, water Food Beverage Tobacco Textiles Apparel Lumber, furniture Paper Printing, Graphic arts Leather, Shoes Chemical industry Oil refineries Plastics Non-ferrous minerals Metal Machinery Electrical machinery, watches, jewelry Construction Arrangement, installationb Wholesale and retail trade Hotels, restaurants Transport Communication Banking Insurances Other servicesb Government, social securityb Total

Notes: a Foreigners holding seasonal permits, permits of abode and border workers. b Sectors producing non-traded goods or services.

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Table 7A.4. Parameters of the simulation model Parameter Elasticity of substitution: primary jobs – secondary jobs

␴Uj

2.00

Elasticity of substitution: skilled labour – capital

␴KS j

0.50

Elasticity of substitution: unskilled labour – capital/skill aggregate

␴VjA ␴ Zj

1.50

Discount rate (efficiency wages)

r

0.05

Native quit rate

qn

0.10

Elasticity of substitution: value added – intermediate inputs

0.10

slightly higher level, more consistent with the empirical results by Dustmann (1993) for Germany (15 per cent). The quit rate and the discount rate of natives were quantified as indicated in table 7A.4. In fact, only their ratio matters, since e/d is calibrated from base year data by using (40). The substitution elasticities in production (see table 7A.4) were chosen on the basis of the survey by Hamermesh (1993). The calibration of all other parameters is standard.

NOTES I would like to thank Marc Bacchetta, Bernard Decaluwé, Jaime de Melo and Rudolf Winter-Ebmer for very helpful suggestions and comments. This work was supported by the Swiss National Fund for Scientific Research (Grant no. 12-42011.94). The methodological aspects were developed under the auspices of the Programme d’analyses et de recherches économiques appliquées au développement international (PARADI), which is funded by the Canadian International Development Agency. 1 Unfortunately, the euphemistic term ‘guest-worker’ has been used too often to be ignored. Would you ask your guests to clean your bathroom? 2 The social welfare function is assumed to be of the Atkinson (1970) type: it is individualistic, symmetric, additively separable and inequality-averse. It can be represented as W ⫽ 兰u(y) f(y)dy, where y is income, f is the frequency density function of income and u is an increasing, strictly concave function. 3 The basic structure of this model follows Shapiro and Stiglitz (1984). Bulow and Summers (1986) and Jones (1987) adapted it to a dual labour market. More recently, efficiency wages have been integrated into international trade models. Copeland (1989) analyses trade policy issues using a Ricardian trade model with a dual labour market and efficiency wages. Brecher (1992) develops an efficiencywage model with unemployment and a non-traded good. 4 Unemployment can be added to this model by assuming that primary-sector firms hire only unemployed workers. In that case, some workers prefer to remain unemployed and to wait for a job in the primary sector, rather than work in the secondary sector. See Bulow and Summers (1986).

Migration, dual labour markets and social welfare 183 5 The Heckscher–Ohlin (HO) case with intersectoral capital mobility is analysed in Müller (1997b). 6 To see this, differentiate total income of natives, Yn, holding L1 constant. Then, because of constant returns to scale: dYn ⫽L1dw1 ⫹ K1dr1 ⫹ (L⫺L1)dw2 ⫹ K2dr2 1 1 2 2 ⫽p1(L1 f LL ⫹K1 f KL )dL*1 ⫹p2 [(L⫺ L1) f LL ⫹K2 f KL ](dL* ⫺dL*) 1 ⫽0, where ri is the return to capital in sector i. Note that this property does not hold if immigrants are present at the initial equilibrium (L*⬎ 0) or if some capital is owned by non-residents. 7 This choice is motivated by empirical evidence. Indeed, Kohli (1993) shows that the specific-factors model performs substantially better than the HOS production structure in explaining the US experience. 8 However, some natives always remain in the secondary sector, which is expanding with immigration; otherwise natives working in the primary sector would lose the incentive not to shirk. 9 This is obviously a naive view of policy-making. Social welfare considerations do not constitute a theory of political economy. However, since income distribution issues are prominent in the immigration debate, the concept of social welfare is certainly a better description of a government’s objective than the traditional criterion of U-welfare.

REFERENCES Antille,G., M. Bacchetta, F. Carlevaro, C. Maranon, T. Müller and N. Schmitt (1991).Effets d’équilibre général de l’intégration de la Suisse à l’Europe (Coire: Editions Rüegger) Atkinson, A. B. (1970). ‘On the Measurement of Inequality’, Journal of Economic Theory, 2, 244–63 Benhabib, J. (1992). ‘A Note On the Political Economy of Immigration’, New York University, mimeo Berry, R. A. and R. Soligo (1969). ‘Some Welfare Aspects of International Migration’, Journal of Political Economy, 77, 778–94 Bhagwati, J. N. (1982). ‘Shifting Comparative Advantage, Protectionist Demands, and Policy Response’, in J. N. Bhagwati (ed.), Import Competition and Response (Chicago: University of Chicago Press) (1988). Protectionism (Cambridge, MA: MIT Press) Borjas, G. J. (1995). ‘The Economic Benefits from Immigration’, Journal of Economic Perspectives, 9, 3–22 Brecher, R. A. (1992). ‘An Efficiency-wage Model with Explicit Monitoring’, Journal of International Economics, 32, 179–91 Bulow, J. I. and L. H. Summers (1986). ‘A Theory of Dual Labor Markets with Application to Industrial Policy, Discrimination, and Keynesian Unemployment’, Journal of Labor Economics, 4, 376–414 Copeland, B. R. (1989). ‘Efficiency Wages in a Ricardian Model of International Trade’, Journal of International Economics, 27, 221–44

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De Coulon, A. and Y. Flückiger (1995). ‘Différences de salaire entre Suisses et étrangers’, Université de Genève De New, J. P. and K. F. Zimmermann (1994). ‘Native Wage Impacts of Foreign Labor: A Random Effects Panel Analysis’, Journal of Population Economics, 7, 177–92 Dickens, W. T. and K. Lang (1985). ‘A Test of Dual Labor Market Theory’, American Economic Review, 75, 792–805 Dustmann, C. (1993). ‘Earnings Adjustments of Temporary Migrants’, Journal of Population Economics, 6, 153–68 Ethier, W. J. (1985). ‘International Trade and Labor Migration’, American Economic Review, 75, 691–707 Flückiger, Y. and J. Silber (1995). ‘Income Inequality Decomposition by Income Sources and the Breakdown of Inequality Differences Between Two Population Subgroups’, Swiss Journal of Economics and Statistics, 131, 599–615 Gaillard, S., R. Salzgeber and J. Schütz (1991). Europäische Integration: Arbeitsmarktliberalisierung und Strukturwandel in der Schweiz (Chur: Verlag Rüegger) Grubel, H. B. and A. D. Scott (1966). ‘The International Flow of Human Capital’, American Economic Review, 56, 268–74 Hamermesh, D. S. (1993). Labor Demand (Princeton: Princeton University Press) Hammar, T. (1985). European Immigration Policy: A Comparative Study (Cambridge: Cambridge University Press) Hoffmann-Nowotny, H.-J. (1985). ‘Switzerland’, in T. Hammar (ed.), European Immigration Policy: A Comparative Study (Cambridge: Cambridge University Press) Jones, S. R. G. (1987). ‘Minimum Wage Legislation in Dual Labor Market’, European Economic Review, 31, 1229–46 Kee, P. (1995). ‘Native-immigrant Wage Differentials in the Netherlands: Discrimination?’, Oxford Economic Papers, 47, 302–17 Kohli, U. (1993). ‘US Technology and the Specific-factors Model’, Journal of International Economics, 34, 115–36. Müller, T. (1998a). ‘Immigration, Protection, and Social Welfare’, ⬍at proof⬎ (1998b). ‘Dual Labor Markets and Discrimination against Immigrants’, Working Paper, Department of Economics, University of Geneva Neary, J. P. (1988). ‘Tariffs, Quotas, and VERs with and without Internationally Mobile Capital’, Canadian Journal of Economics, 21, 714–35 Piore, M. J. (1979). Birds of Passage: Migrant Labor and Industrial Societies (Cambridge: Cambridge University Press) Schmidt C. M., A. Stilz and K. F. Zimmermann (1994). ‘Mass Migration, Unions, and Government Intervention’, Journal of Public Economics, 55, 185–201 Shapiro, C. and J. E. Stiglitz (1984). ‘Equilibrium Unemployment as a Worker-discipline Device’, American Economic Review, 74, 433–44 Winter-Ebmer, R. and J. Zweimüller (1996). ‘Immigration and the Earnings of Young Native Workers’, Oxford Economic Papers, 48, 473–91 Zimmermann, K. F. (1993). ‘Ökonomische Konsequenzen der Migration für den heimischen Arbeitsmarkt’, Schweiz. Zeitschrift für Volkswirtschaft und Statistik, 129, 283–301

Migration, dual labour markets and social welfare 185

Discussion RU D OL F WI NT E R-E B ME R Chapter 7 is very interesting, and a contribution I certainly enjoyed reading. Looking at the topic, I even wondered why nobody else had tackled this problem earlier. Tobias Müller starts from the observation that the assimilation process of immigrants is different in, say, the USA from Western Europe. The famous Chiswick (1978) study suggests that foreignborn workers catch up in earnings with natives in 13 years. In the typical ‘guest-worker’ country, Germany, this does not seem to be the case at all: foreigners start at lower levels and have lower rewards to job experience than Germans (Licht and Steiner, 1994). This differential treatment of immigrants gives rise to the suspicion of segmented labour markets for natives and foreigners. Therefore, the question arises: if natives can discriminate against foreigners, does this change the welfare assessment of immigration? One way towards this end is to look at migration policies having the potential of a Pareto-improvement – provided some sort of redistributive scheme is applied. Chapter 7 uses a different framework: welfare of natives is expressed by an explicit social welfare function of the Atkinson type, so that inequality-aversion of the social planner can be explicitly considered. The profitability of a specific migration scenario can thus be judged with respect to the inequality-aversion of the society. It turns out that for low levels of inequality-aversion immigration is beneficial for the host country, even more so if the immigrants have no access to the primary sector of the economy. The more important inequality concerns get, the less favourable immigration will be. This contrasts with the impact of protectionist measures: here we have an efficiency loss, but this loss will be over-compensated for by the (welfareenhancing) impact of less inequality. Furthermore, the more inequalityaverse the society is, the more favourable the protection scenario gets. The choice of the best policy could be resolved if we knew the inequality-aversion of the society, measured by Atkinson’s ␧. But we don’t. One indication could be the interpretation of ␧: a value of ␧⫽0 (0.2, 1, 2) would mean that redistributing one dollar to the poor would be considered as socially worthwhile, (even) if the rich would have to pay one dollar (1.14, 2, 4 dollars) in taxes. This could also be interpreted in terms of the bureaucratic losses the policy-maker is willing to incur in order to redistribute. If law-makers had a social welfare function in mind with ␧⫽0.2, they should be prepared to accept bureaucratic losses of up to 14 per cent of transfers given. Such a low

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value of ␧ would certainly speak more in favour of immigration as compared to protectionist measures. Bhagwati (1982) discusses two recipes to counter a shift in comparative advantage in the production of a labourintensive good, say, footwear: protection of these industries from import competition or an increase in immigration quotas. In fact, for Bhagwati immigration and protection can be considered as being equivalent in the sense that they allow the same level of the import-competing good. In chapter 7, Müller tries to understand why different policy options have been used in the 1960s and in the 1980s: a guest-worker system with discrimination proved profitable in the 1960s because it increased welfare of natives (and the welfare of the immigrants was not included in the social welfare function anyway). As the temporary immigrants became more and more permanent, discriminating against them became less of an option: therefore, large-scale immigration became less favourable from the income distribution point of view, as compared to protection. However, other interpretations are possible. The 1960s were a period of labour shortage, whereas the 1980s were characterised by chronic unemployment in Western Europe. This example illustrates nicely the tension between long-run equilibrium trade theory and short-run labour market concerns. The current political discussion sets very different alternatives: trade restrictions or immigration restrictions. This reflects the overwhelming importance of short- or medium-term unemployment problems in the realm of sticky wage adjustments and high unemployment persistence. The dual labour market economy here is modelled as an efficiency-wage framework of the shirking type. Workers in the primary sector work hard, because they do not want to fall back to low (market-clearing) wages of the secondary sector. It would be interesting to see if a different modelling of the efficiency wage mechanism changed matters greatly. Suppose, for example, that there is unemployment which acts as the threat mechanism in the non-shirking condition. More immigration would prima facie increase unemployment and reduce the necessary efficiency-wage premium, leading to falling wages in the primary sector, which might possibly decrease or increase inequality, depending on the share of skilled versus primary-sector unskilled workers in the work force. In the specific-factors model used here, capital is sector-specific and the main gain from immigration (apart from higher returns to capital) is the possibility for natives to rise into the primary sector. In the case of non-discrimination, this advancement is highly improbable, because it would require the labour elasticity in the primary sector to be much higher than in the secondary sector. Moreover, as stressed by Müller in a previous version of his study, if capital were mobile between sectors in a Heckscher–Ohlin (HO) world, a similar result would restrain welfare gains

Migration, dual labour markets and social welfare 187

from immigration: immigration would increase native employment only in the primary sector, if the secondary sector is relatively capital-intensive. Considering these cases, the present one seems restrictive. The calculation of U-welfare for natives assumes that capital income is distributed to native households in proportion to their wage incomes. In this framework inequality considerations are confined exclusively to within-workers’ redistribution, distribution issues between capital owners and employees are therefore neglected. The sensitivity check on p.000 shows that competing assumptions, like all capital income to the skilled, reduce the admissible ␧-values for welfare-improving migration considerably. I suppose that this would even be more the case if all capital income were to go to a separate capitalist class. Finally, it might be interesting to compare the results of this chapter with the literature on Pareto-gains from trade liberalisation. Whereas generally in models with no distortions Pareto-gains from trade can be achieved via lump-sum transfers, Brecher and Choudri (1994) extend the analysis to allow unemployment in the form of an efficiency-wage mechanism. Individual workers losing jobs would require some sort of compensation to maintain their pre-liberalisation welfare levels. This compensation would weaken the incentive to work hard unless it were countered by rising efficiency wages. As Brecher and Choudri show, rising wages may lead via rising prices to the infallibility of Pareto-gains from trade liberalisation using any transfer system. The question of compensation for losers is not addressed in Müller’s chapter, but it is certainly important for political economy aspects of migration legislation. Coming to the empirical implementation, I am a little bit worried by the nested CES specification. Basically, the set-up restricts the substitution possibilities – there is no room for complementarity relations because two factors each form a composite factor with separability assumptions. Above all, the separability between skilled and unskilled workers seems questionable. In fact, it is assumed that secondary, primary and skilled workers interact in the production process (in a representative firm). This runs somewhat counter to my intuition of segmentation, which goes primarily across firms, possibly along firm size categories – e.g. good jobs in big firms with internal labour markets, etc. Interestingly, the author gets very similar results if he reserves the good jobs to three sectors only. The categories natives and immigrants – excluding those with a permanent residence – seem not particularly evident to me, unless there is evidence of differential assimilation processes of the two immigrant groups (of course, the final question concerns the inclusion in the social welfare function, as is mentioned at the end of the chapter!). Similarly, the introduction of primary and secondary labour markets for unskilled workers only is somewhat

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peculiar, whereas no efficiency-wage structure is assumed for the skilled labour market. Notwithstanding these critical observations, the empirical results are sensible and very interesting. The mechanism of the upgrading of native workers’ jobs caused by increasing immigration is an idea which is often heard from practitioners of the labour market. In an empirical study for Austria, we found related evidence: native workers employed in firms without foreigners had flatter earnings–experience profiles than those being employed in firms with a considerable presence of immigrants (WinterEbmer and Zweimüller, 1995). This suggests that in the presence of immigrants native workers profit more from internal labour markets. The implementation of higher quit rates for immigrants is a good extension, which comes from the discrimination literature, where job segregation and differential job promotion is explained efficiently by differentials in expected quit rates. Again, these simulation patterns confirm econometric results of statistical discrimination in job advancement (Winter-Ebmer and Zweimüller, 1997) owing to expected quit rates. I have some problems with the variation in the number of migrants. The general result is that immigration is welfare-enhancing as long as inequality-aversion is not too great. Moreover, immigration gets even more favourable the higher the stock of immigrants is already. Immigration in the guest-worker system is doubly beneficial for natives: (1) it enables more natives to find a job in the primary sector and (2) it increases the wage gap between the primary and the secondary sector. Of course the first effect vanishes as more immigrants arrive, but the second remains. This positive welfare effect of redistribution is caused by the specific situation chosen: wages for skilled labour and returns to capital rise, but wages in the secondary sector fall drastically (where no natives work in the end). To conclude, I consider the inclusion of a dual labour market together with more explicit treatment of inequality-aversion a major topic in the assessment of the consequences of immigration policies. Müller has gone a considerable way down this road. I would guess – given the great many extensions which suggest themselves – that others will in due course follow. REFERENCES Bhagwati, J.N. (1982). ‘Shifting Comparative Advantage, Protectionist Demands, and Policy Response’, in J.N. Bhagwati (ed.), Import Competition and Response (Chicago: University of Chicago Press) Brecher, R.A. and E. U. Choudri (1994). ‘Pareto Gains from Trade, Reconsidered’, Journal of International Economics, 36, 223–38

Migration, dual labour markets and social welfare 189 Chiswick, B. (1978). ‘Americanisation and the Earnings of Foreign-born Men’, Journal of Political Economy, 86, 897–921 Licht, G. and V. Steiner (1994). ‘Assimilation, Labour Market Experience and Earnings Profiles of Temporary and Permanent Immigrant Workers in Germany’, International Review of Applied Economics, 8, 130–56 Winter-Ebmer, R. and J. Zweimüller (1995). ‘Internal Labour Markets and Firmspecific Determination of Earnings in the Presence of Immigrant Workers’, Economics Letters, 48, 185–91 (1997). ‘Unequal Assignment and Unequal Promotion in Job Ladders’, Journal of Labour Economics, 15, 43–71

8

Globalisation and migratory pressures from developing countries: a simulation analysis R ICCARDO FAINI, JE AN -M A R IE G R E T H E R A N D JAI M E DE ME L O

1

Introduction

Opposition to immigration in the North has been on the rise, notably in the EU and in the USA. This rising opposition can be traced to the regime shift in their labour markets which have moved from tight labour markets up to the early 1970s to rising unemployment (in the EU) and increasing wage inequalities (in the USA) since then. On the other hand, migratory pressures have not subsided. For many developing countries, stagnant growth in the wake of the debt crisis and explosive demographics have led to a marked deterioration in labour market conditions. The thawing of East–West relations has also contributed to greater migration pressure. Paradoxically, Western European governments, who used to criticise socialist regimes in Eastern Europe for imposing draconian restrictions on people mobility, reacted to the 1989 events by swiftly implementing new and more effective migration control measures. As pointed out by Schiff (1996), the change in attitude in the North towards immigration from the South is well exemplified by the change in attitudes in the International Labour Organisation (ILO). Not surprisingly, during the period of tight labour markets in the North, the ILO recommended attracting suitable labour from the South (ILO, 1949). But by the mid-1980s, the ILO was recommending that the receiving countries should endeavour to cooperate more fully in the development of such countries by appropriate intensified capital movements, the expansion of trade, the transfer of technical knowledge. (ILO, 1984)

More recently, the ILO (1992) has recommended that developed countries provide foreign assistance to developing countries to reduce migratory pressures. This policy shift on migration can be criticised on both ethical and economic grounds (see, for example, Bhagwati, 1992). Yet, migration policy is 190

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not made in a vacuum, but reflects the values and the attitudes of voters and pressure groups reflected in what Schiff (1996) calls `social capital’. The fact is that the attitude toward migration has changed markedly in industrialised countries. According to an EC survey, 64 per cent of respondents in Italy believe that migrants are ‘too many’. In France, Germany and the UK the percentage of those who believe migration to be excessive is over 50 per cent. Since 1989, Europe’s newspapers have been filled with stories of racial intolerance. Under these conditions, Europe’s policy-makers have little choice but to try to stem the flow of new immigrants while at the same time promoting the social and economic assimilation of old ones. This pressure is likely to subsist in spite of the ageing of European population. The issue then arises of how industrial countries can discourage massive and largely undesired population flows. That is the issue investigated in this chapter. The policy options appear to be limited. Migration controls can work in the very short run but are often ineffective in the medium to long run, as typified by the recurring use both in Europe and in the USA of migration regularisation programmes, invariably coupled with the promise that future controls will be tightened up. Foreign aid as well as trade policies have often been advocated as more effective tools to cope with rising migrations. Foreign aid can boost growth in sending countries, thereby reducing the incentive to emigrate to the North. Similarly, trade liberalisation can foster factor-price convergence and limit the incentive for factor mobility. The diffusion of North–South regional trade integration agreements during the 1990s has often been attributed to the desire to stem migration pressure, as epitomised by President Salinas’ quote that ‘Mexico wants to export goods, not people’. The EU’s drive toward signing Association Agreements with its close trading partners in the East and in the South has been similarly motivated. Two channels of action have been identified in the policy debate. The first are what one could call ‘direct measures’. These take the form of increased aid to raise income in the South. Increased costs to migration through, say, more effective border controls represent an alternative direct measure. The second channel includes ‘policy reform measures’ whose effects on migratory pressures are less direct. Paramount here are the trade reforms of the Uruguay Round and beyond, leading to a reduction in barriers to trade in goods (especially in agriculture and light manufactures such as textiles and apparel) and in services (a reduction in barriers to Foreign Direct Investment (FDI) and eventually to trade in services). The impact on migratory pressure of any measure will depend mostly on the determinants of migration in sending countries in response to changes in incentives to migrate. To take an example, one would expect that migrants from Sub-Saharan African (SSA) countries would be mostly low-skill labour whereas Southern Mediterranean migrants in Northern countries

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would be more predominantly medium- and high-skill labour. Migrants from SSA countries would also tend to be viewed as more permanent in receiving countries whereas migrants from Mediterranean countries would be more susceptible to responding positively to an improvement in economic conditions in their home countries, and thus would exhibit ‘return’ migration behaviour.1 If one considers SSA countries as typical of LowIncome (LI) economies and Southern Mediterranean countries as typical of Middle-Income (MI) economies, one would expect different patterns of migratory pressures in each group. This chapter uses simulation analysis to investigate if direct and indirect measures are likely to elicit different migratory pressures in different countries. Two questions are asked: (1) Would direct and indirect attempts to reduce migratory pressures yield qualitatively different migratory responses for an archetypical developing country, be it a LI or a MI economy? (2) Would identical measures have different effects in LI and MI economies? Simulations are carried out in a single-country framework with modelling efforts directed at the sending country. To this effect we build a Ricardo–Viner (RV) economy with traded and non-traded sectors.2 The economy is disaggregated on the labour and household sides with households offering labour services at home and abroad. Calibration is carried out for two ‘archetype’ LI and MI economies. The archetypes differ systematically in the structure of production, consumption, trade and factor supply across sectors while elasticities and the mapping of factor income to households is purposely kept the same. This allows us to investigate quite systematically the likely effect of differences in economic structure on migratory pressures. One might object that modelling should be carried out in a two-country North–South world. Such an approach would be desirable for an analysis of systemic changes in which repercussion effects are likely to be important. A North–South trade model would also be desirable to study factor-priceconvergence effects and for a more thorough analysis of the complementarity–substitutability issue between trade and migration. A more elaborate model than the one offered here would also be desirable to investigate some of the issues which the theoretical literature has identified such as migration in response to relative deprivation, risk and uncertainty and sunk costs in migration. We ignore or only partially address these issues. Nonetheless, our focus on a single-country model enables us to give a better road-map of the channels through which Southern countries’ migratory pressures exert themselves. Finally, since the receiving country is not modelled, increased migratory pressure in this single-country framework translates directly into an increased supply of workers abroad (in effect, we assume an infinitely elastic demand for labour from the sending country over the relevant range).

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The remainder of the chapter is organised as follows. Section 2 develops the modelling of migration in this RV framework. It also outlines the main features of the simulation model which is given in the appendix (p. 212). Section 3 describes the calibration to the two archetype economies and the simulations proposed to decompose the likely effects of globalisation on South–North migratory pressures. Section 4 reports on the simulation results comparing the effects on migratory pressures across archetypes for a base model cloture. Section 5 examines the sensitivity of results to changes in model cloture (elasticities and assumptions about the mapping of factor income to households). It also proposes likely orders of magnitude for what one might call the most relevant model for each ‘archetype’. Since much of the data is constructed or invented, it is probably best to interpret the results in relative terms – i.e. differences in results across archetypes or between measures. Section 6 draws some conclusions. 2

A Ricardo–Viner model of migration

The traditional reason for migration is earnings differential: the prospect of a higher net (of moving and other fixed costs) expected wage in the receiving country is the main reason for migration. In the traditional literature derived from Harris and Todaro (1970), risk-neutrality on the part of homogeneous migrants implies that expected earning differentials are the sole determinants of migration. It has been recognised, however, that migration costs are also a determinant of migration. These include nonmonetary costs (idiosyncratic tastes for location as in Djajic and Milbourne, 1988, or Faini and Venturini, 1994) and monetary costs (Lopez and Schiff, 1995). If agents are risk-averse, matters are somewhat more complicated. First, risk considerations may have an ambiguous impact even from the point of view of an individual agent. On the one hand greater uncertainty about perspectives in the destination region should deter migration. Conversely, higher income risk at home may encourage agents to move. However, if migration is at least partially irreversible, as would happen if it were subject to sunk costs, then potential migrants might prefer to wait for uncertainty to dissipate before making their location decision (Burda, 1993). At the household level, on the other hand, greater uncertainty may boost migration provided that incomes in different location are not perfectly correlated. Under these circumstances, the household can indeed reduce its total risk exposure by having some of its members migrate to a different location (Stark, 1991). The theoretical literature has also investigated additional factors, such as relative deprivation and asymmetric information, that might affect the migration decision. While there is some evidence to support these suggestions (see Schiff,

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1996, for a survey of the evidence and Daveri and Faini, 1996, for recent evidence from Southern Italy), by and large the evidence is scant. Also we have little knowledge of the relative importance of these (and other) factors in determining the supply of migrants. For this reason, we develop a simple model that accommodates the traditional motive based on earnings differentials and we assume that, in their location decision, households face concave costs to relocation. This implies that households will diversify, i.e. they will not locate entirely in one country. 2.1

Modelling migration

Consider a heterogeneous household (households are indexed over h ⑀ H) that maximises a utility function that includes leisure and the consumption of goods as arguments. In view of the numerical application that follows, for simplicity, we assume strong separability in the choice of labour supply and consumption of goods. This gives us a two-stage decision process. In a first stage the household decides on the amount of labour to supply, and in a second stage on the allocation of labour between the home and foreign labour markets. In the first stage, the supply of labour by household, LSh, is determined from the maximisation of the following LES utility function: Uh(.) ⫽

n

兿(C

␤i,h, i,h ⫺ ␦i,h)

(1)

i⫽0

where ⌺in⫽ 0␤i,h ⫽1 and C0 is leisure. Maximisation of (1) subject to the household’s budget constraint ((25) in table 8A.1) determines the household’s supply of labour services ((12) in table 8A.1) and the consumption of goods ((17) in table 8A.1). Given that we choose an LES, this means that leisure and goods are substitutes as are all goods. The allocation of labour services LSh between the domestic (Lh) and foreign (L*) h labour market takes place in the second stage. It depends on the relative wage in each destination with increasing costs to relocate from one labour market to the other. This gives a concave locus describing how the households’ labour services can be relocated. A convenient form is the familiar Constant Elasticity of Transformation (CET) function given by: 1⫹⍀h 1/(1⫹⍀h) LSh ⫽ Bh[(1⫺ ␯h)⫺⍀h(Lh)1⫹⍀h ⫹(␯h)⫺⍀h(L*) ] h ⫽⌿h(Lh,L*,⍀ ) h h ⫽⌿h(.),

(2)

where Bh and ␯h are positive parameters (0␯h1) and ⍀h is the elasticity of transformation. The CET function, ␺h(.), is concave implying increasing costs to labour

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Figure 8.1

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Labour-allocation decision

relocation. It has the advantage of tractability: it is easy to calibrate numerically as it requires only one parameter ⍀h for implementation. In ˜ LS , where W ˜ the second stage, household h maximises labour income, W h h h is the revenue-maximising wage under the condition of increasing reloca˜ ). Maximisation of tion costs ((11) in table 8.A1 gives the expression for W h wage income is subject to the constraint that labour relocation between the home and foreign labour markets takes place under increasing costs, i.e. max L(Lh,L*, ¯ *L ␭h⌿h(.), h ␭h)⫽whLh ⫹ERw h *⫺ h

(3)

where ␭h is a Lagrange multiplier, ER is the conversion factor of foreign currency units into domestic currency units, and wh is the domestic wage. In this maximisation, the foreign wage, w ¯ *h is exogenous, reflecting an infinitely elastic foreign demand for labour over the relevant range. The result of the maximisation of (3) is the allocation of labour services, Lh and L*h ((13) and (14) in table 8A.1). Figure 8.1 depicts the allocation of labour services for a given aggregate household labour supply, LSh. Wage-income-maximisation leads to the solution (Lh, L*). Since by the choice of numéraire, a price index of non-traded h goods is kept fixed (see (28) in table 8A.1), ER is in effect the value of the real exchange rate – i.e. the relative price of tradables. Hence, we assume in (3) that the household makes its labour-allocation decision on the basis of the purchasing power of foreign wages in terms of home (non-traded) goods.

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Labour will then be reallocated either in response to a change in the domestic wage, or to a change in the value of the real exchange rate, ER. In the above formulations, we are modelling a medium-term labour-allocation decision rather than an irreversible migration decision. As argued above, this ‘guest-worker’ view of migration is perhaps more prevalent among MI than LI developing countries. There is recent evidence in the case of Mexican migration to the USA that Mexico–US migration patterns are responsive to changes in the Mexican-US bilateral exchange rate (see Markusen and Zahniser, 1997, table 1). As an alternative, we assume that migration is more permanent at least in the sense that the household does not consider the domestic currency purchasing power of foreign wages. This amounts to fixing ER to its initial value in (3). We shall call this version the ‘permanent-migration’ view. It is offered here both as an alternative relevant to the migration decision in LI economies and as a way of isolating the real exchange rate component of migratory pressures.3 It is considered in section 5. Whether these views of the labour allocation are realistic or not is a moot point: all that can be said is that they are ‘consistent’ with observations on household diversification.4 As will be confirmed in the simulations below, this formulation implies that there is a resource cost to a relocation of labour across the border because of the concavity of the CET function.5 2.2

The simulation model

In the specification of the RV simulation model, atomistic firms with constant-returns-to-scale (CRS) production functions maximise profits and atomistic households maximise utility. Each agent has a constraint, and the economy has an external constraint. Firms have a Cobb–Douglas technology for value-added and Leontief technology for intermediates and between intermediates and value-added. As in the traditional RV model, the economy is a price-taker in the markets for traded goods. There are however, non-traded activities as well, for which there is an endogenous market-clearing price. To accommodate the fact that much of imports in developing countries are non-competitive with local production (the structure of imports reveals that intermediates and capital goods account for the bulk of imports), we assume that each sector also uses non-competitive imports. Firms pay their mobile factors, the different categories of labour, their value marginal product. As some sectors are non-traded, the real exchange rate adjusts to maintain external and internal balance. In turn, adjustments in the real exchange rate affect both the allocation of labour as depicted in figure 8.1 as well as the domestic-currency value of remittances. For traded goods, domestic and foreign-produced goods are perfect substitutes which would tend to lead to extreme specialisation among traded activities in response to relative price

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changes. It is the presence of sector-specific factors that gives enough concavity to the production possibilities frontier to prevent extreme specialisation. The mapping from factor to household income is described below in section 3 (see table 8.2, p. 200), and in the appendix, which gives the full specification of the model. Suffice it to note here that, to simplify, each household only supplies one type of labour, and we exclude the possibility that households would invest capital income abroad. The income from capital (the specific factor in each sector) is distributed across households (see table 8.2). This mapping of factor income to households implies that there is some diversification in each household’s source of income, a diversification which attenuates household income fluctuations. It is clear that this model is very close to the standard RV model with non-traded goods, except that it is augmented to include migration and that there are several mobile factors of production and several households. To approximate the standard model as closely as possible, the government’s only role is to tax trade (tariffs and export taxes are the only distortions in the model). Government revenue is redistributed lump-sum to each household in proportion to that household’s income. Remittance income adjusted for the (exogenous) trade deficit in foreign-currency units is distributed to households, also according to each household’s share in total income. Thus changes in trade policy do not have a direct effect on income distribution via government transfers. In this set-up, policy changes such as a trade liberalisation that alters relative prices affects both the aggregate supply of labour on the part of each household according to the resulting changes in household wage income and total income and the allocation of labour between the domestic and foreign labour market depending on changes in relative wages in the home and foreign labour market. An appreciation of the real exchange rate, for example, will make the home labour market more attractive if there is no compensating change in the domestic wage. On the other hand, the home market wage rate for each labour category will change following traditional Heckscher–Ohlin (HO) factor- intensity differentials across sectors. When protection is reduced, for example, if export sectors are relatively intensive in the use of medium-skill labour, the wage rate for medium-skill labour will rise relative to other wages. 3

Decomposing the effects of globalisation on the supply of migrants for two archetype economies

We now examine numerically how changes in the economic environment via either changes in policy or in the external environment are likely to affect the supply of migrants from the South to the North. This section

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describes the two archetype economies to which the RV model is calibrated and the set of simulations to decompose the direct and indirect channels through which policy changes and changes in the external environment are likely to affect South–North migratory pressures. 3.1

The archetype economies

The RV model is calibrated to data for two archetypical developing economies. The data are adapted from Bourguignon et al. (1992). As explained in the appendix, these data are representative (in the sense of Chenery and Syrquin, 1986) of a low-income (LI) developing economy (say, a SSA economy) and a middle-income (MI) developing economy (say, a Latin American or North African economy). The details on the data are provided in the appendix. To control for the dimension along which the MI and LI economies differ, we assume that the two archetypes are of equal size, have the same sectoral disaggregation, the same factor-use mapping by sectors and the same household composition. This limited difference between archetypes makes it much easier to interpret simulation results. The two archetypes differ in structure in the following stylised way. The principal structural characteristics of the LI and the MI economies are given in tables 8.1a and 8.1b (also see tables 8A.3 and 8A.4 in the appendix). Tables 8.1a and 8.1b show the difference in production structure, trade, trade barriers and labour allocation across sectors and abroad. The two economies engage in the same activities: subsistence agriculture for the LI economy which is a non-traded activity by definition and import-competing agriculture in the MI economy. In the LI economy, the output of the export agriculture sector (which could also represent a mining activity) is entirely exported as there is no domestic final and no intermediate consumption (cocoa or copper). It is taxed and is the only export activity in the calibrated scenario for the LI economy. This representation of the LI economy corresponds to the traditional stylised description of small LI economies that export only a few commodities (i.e. ‘monoculture’ economies).6 Two manufacturing activities (light and heavy manufacturing) are distinguished, the latter essentially a non-competing import-substituting activity, the former representing the typical HO labour-intensive exports. Note the structure of trade taxes in each archetype: imports and exports are taxed, with taxation higher in the LI archetype. Otherwise, the archetypes also differ in their inter-industry linkages, these being weaker in the LI economy which also has a larger share of non-competitive imports in total imports (see tables 8A.3a and 8A.3b in the appendix). This calibration results in the LI archetype having a much larger share of activity in

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Table 8.1. Structure of production, demand and factor allocation a low-income (L1) archetype

Sub. ag. Exp. ag. Light mfg. Heavy mfg. Services Informal Lab abroada Lab abroadb

Out. struc (1)

Net exp. out. (2)

Tariff exp. tax (3)

Low skill (4)

Medium skill (5)

High skill (6)

0.20 0.10 0.22 0.04 0.31 0.13

0.0 1.0 ⫺ 0.2 ⫺ 1.5 0.0 0.0

0.0 ⫺ 0.2 0.5 0.4 0.0 0.0 (0.2)c

0.65 0.0 0.0 0.0 0.0 0.26 0.09 0.63

0.0 0.25 0.17 0.0 0.31 0.17 0.09 0.32

0.0 0.0 0.31 0.07 0.57 0.0 0.05 0.05

b middle-income (M1) archetype

Sub. ag. Exp. ag. Light mfg. Heavy mfg. Services Informal Lab abroada Lab abroadb

Out. struc (1)

Net exp. out. (2)

Tariff exp. tax (3)

Low skill (4)

Medium skill (5)

High skill (6)

0.09 0.05 0.24 0.14 0.33 0.15

⫺ 0.3 0.4 0.2 ⫺ 0.3 0.0 0.0

0.2 ⫺ 0.1 0.0 0.4 0.0 0.0 (0.1)c

0.46 0.0 0.0 0.0 0.0 0.45 0.09 0.35

0.0 0.06 0.19 0.0 0.46 0.21 0.09 0.47

0.0 0.0 0.18 0.33 0.45 0.0 0.05 0.18

Notes: Share of migrants in skill category. b Share of skill category in total migrants. c Tariff on non-competitive imports. a

agriculture. However, to control for the sources of differences in economic structure, the same Cobb–Douglas technology for value-added is imposed for each archetype (see table 8A.4 in the appendix). Both the Service and the Informal sectors are non-traded activities in both economies. Thus, a substantial share of GDP is non-traded in both calibrated archetypes. These differences in production structure are reflected in the allocation of the three labour categories – (low-skill⫽ LSL), (medium-skill ⫽ MSL), (high-skill ⫽ HSL) – across sectors. (The percentage distribution across

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Table 8.2. Factor–household mapping: L1 and L2 archetypes Lowskilled LS HH

Mediumskilled MS HH

Highskilled HS HH

Capitalist household CAP HH

Mobile factor: LSL MSL HSL

1 0.0 0.0

0.0 1 0.0

0.0 0.0 0.75

0.0 0.0 0.25

Specific factor: Sub. ag. Exp. ag. Light mfg. Heavy mfg. Services Informal

0.5 0.0 0.0 0.0 0.0 0.5

0.0 0.5 0.25 0.0 0.25 0.5

0.0 0.0 0.25 0.25 0.25 0.0

0.5 0.5 0.5 0.75 0.5 0.0

sectors is given in columns (3)–(6) in tables 8.1a and 8.1b.) Note in row 7 of the table, the percentage of each category of labour abroad. These figures are assumed to be the same for each archetype, even though the composition of migrants abroad from the LI and MI archetype is different (see row 8). Finally, table 8.2 gives the mapping from factor to household income. It is the same for both archetypes. The top part of the table gives the mapping of the mobile factor to each one of the four households (LS HH, MS HH, HS HH, CAP HH) and the bottom part of the table gives the mapping of the fixed factor to these households. Except for the HSL labour category which is supplied by both the HS HH (75 per cent) and the CAP HH (25 per cent), each labour category is supplied by only one household. LSL is the least diversified labour category as it is employed in only two sectors, both of which are non-tradable in the LI archetype. The other labour categories are employed in three or four sectors, with a split between tradable and non-tradable activities, so that the effects of changes in the relative price of tradables on household income is dampened by this assumed diversification in sectoral employment. 3.2

Decomposing the effects of globalisation

To study the determinants of migratory pressures in this single-country framework three sets of policy experiments are carried out to find out the

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Table 8.3. Policy experiments Direct intervention E-1 Increased transfer of resources [ITR] to the South (a relaxation of the external constraint by 10 per cent) E-2 Increase of migration costs (E ⫺1 ⫹ decrease in the wage in the North by 10 per cent) Trade liberalisation in the South E-3 Trade liberalisation in the South [TLS] (removal of tariffs on imports and taxes on traditional exports) E-4 Increase in FDI in the south [FDI] (E-3⫹10 per cent increase in capital stock in agricultural export and light manufacturing with profit repatriation to the North) Trade liberalisation in the North E-5 Agricultural trade liberalisation in the North [ATLN] (a 10 per cent increase in the world price of agricultural exports) E-6 Manufacturing trade liberalisation in the North [MTLN] (a 10 per cent increase in the world price of light manufactures) E-7 Across-the-board trade liberalisation in the North [TLN] (E-5⫹ E-6) Increased globalisation E-8 Global trade liberalisation in North and South [GTL] (combination of E-7 and E-4)

best way to achieve the ‘Export goods, not people’ objective. These are described in table 8.3. Within each set, experiments are usually cumulative. In the first experiments (E-1 and E-2), the attempt is direct: increase in foreign aid to the South or raise migration costs by lowering the (exogenous) effective wage in the North. In the second set (E-3 and E-4), trade liberalisation in the South is examined with the potential by-product of an increase in Northern FDI in the actual (and potential) exporting sectors. The third set (E-5–E-7) attempts to capture the effects of a reduction in the protection of agricultural and manufactured products exported by the North. Finally we consider the potential effects of increased globalisation of economic activity by combining increased openness to trade in the North and the South (E-8). In this single-country model, it is difficult to capture the effects of a trade liberalisation in the North. It is done here by an exogenously imposed improvement in the terms of trade for the South (except in E-6 for the LI archetype which is a net importer of light manufactures – see tables 8.1a and 8.1b). Arguably, this may not be an accurate description of the likely effects of trade liberalisation in the North, as it is not clear that it would improve the terms of trade for the South, thereby

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presumably stemming migratory pressures. We are aware of this, but wished to capture the hoped-for increase in the demand for exports of manufactures from the South that increased integration of world markets would presumably bring about. In any event, it is these simulations that are carried out for the two archetype economies mentioned above. 4

Simulation results

In this RV model, the simulations described above affect the supply of migrants to the North through several channels. At the macro level, changes in purchasing power (via transfers or changes in the terms of trade) affect the aggregate supply of labour as the relative price of leisure changes. At the household level, income changes result from changes in the purchasing power (in terms of home goods) of remittances and from changes in remunerations via adjustments in relative wages across labour categories and in sectoral rents. Finally there is also a redistribution of purchasing power via changes in the cost of living as a given change in relative prices has a differential impact across households (here mostly via Engel effects in consumption as LS HH have both a lower income and a lower price elasticity of demand for agricultural products). In addition to changes in purchasing power, there are also changes in relative rewards for fixed and mobile factors which affect household income and hence both the supply and the location of labour activities. We report first the aggregate effects, then the compositional effects at the household and sectoral levels. 4.1

Aggregate migratory pressures

Tables 8.4a and 8.4b give the aggregate results in terms of total labour supply, its allocation at home and abroad, along with the changes in the equilibrium value of the real exchange rate and real GDP. A first glance at the results in tables 8.4a and 8.4b reveal both that economic structure matters and that the objective of decreased migration is not always met for the LI archetype. In fact, because trade liberalisation in the LI economy is accompanied by a strong real depreciation, it becomes more profitable to seek employment abroad. While FDI attenuates this effect, and trade liberalisation in the North as well, one still gets an increase in migratory pressure with globalisation. It would appear that LI economies are more prone to exhibit trade–migration complementarity than MI economies. Indeed, for the MI economy, under all scenarios, there is a reduction in aggregate labour supply abroad even though some labour categories increase their allocation abroad (see table 8.5b, p. 206). The contrast between the two archetypes has several causes, but the prominent one is the different effect of trade liberalisation in the South

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Table 8.4. Macro results: labour supply and home–foreign-labour allocation a L1 archetypea

E-1 E-2 E-3 E-4 E-5 E-6 E-7 E-8

ITR IMC TLS FDI ATLN MTLN TLN GTL

TLab.b

TFLab.c

TDLab.d

⫺0.1 ⫺0.3 0.1 0.0 ⫺0.4 0.1 ⫺0.3 ⫺0.2

⫺ 1.5 ⫺ 9.3 8.0 2.6 ⫺ 7.5 ⫺ 3.8 ⫺ 10.6 ⫺ 7.5

0.2 1.6 ⫺1.5 ⫺0.5 1.1 0.9 1.9 1.4

TLab.b

TFLab.c

TDLab.d

⫺0.1 ⫺0.4 ⫺0.2 ⫺0.4 ⫺0.2 ⫺0.3 ⫺0.5 ⫺0.9

⫺ 0.8 ⫺ 11.4 ⫺ 2.0 ⫺ 5.6 ⫺ 3.9 ⫺ 7.5 ⫺ 10.4 ⫺ 14.6

RERe ⫺1.4 ⫺0.2 18.7 13.4 ⫺6.0 ⫺4.2 ⫺9.5 2.8

RGDPf 0.1 0.8 ⫺ 3.1 ⫺ 1.3 0.5 0.3 0.9 ⫺ 0.3

b M1 archetype

E-1 E-2 E-3 E-4 E-5 E-6 E-7 E-8

ITR IMC TLS FDI ATLN MTLN TLN GTL

0.0 1.8 0.1 0.6 0.6 1.1 1.5 1.9

RERe

RGDPf

⫺0.9 ⫺0.8 ⫺0.2 ⫺3.7 ⫺3.3 ⫺7.7 ⫺10.1 ⫺13.5

0.0 0.9 ⫺ 1.9 ⫺ 0.7 0.1 0.3 0.6 ⫺ 1.1

Notes: Percentage changes from initial values. b Aggregate labour supply. c Foreign labour allocation. d Domestic labour allocation. e Real exchange rate index. f Real GDP. See table 8.3 for definition of policy experiments. a

(TLS) on the equilibrium value of the real exchange rate. Whereas for the LI economy TLS is accompanied by a strong real exchange rate depreciation (18.5 per cent), for the MI economy, TLS brings about a slight real exchange appreciation. This is because of greater supply response to the change in relative prices in the MI economy than in the LI economy which exhibits what is called ‘structuralism’. Indeed, the elimination of the export tax on agricultural exports generates a stronger export-supply response in

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the MI economy as agriculture exports (or mining) are also consumed domestically whereas in the LI economy agriculture exports are not. Hence a removal of the export tax induces a strong export- supply response in the MI economy which must be matched by an increase in imports to meet the exogenous current-account constraint. Hence the real exchange rate appreciation to induce the resource shift out of import-competing activities (see also the results in table 8.6, p. 207).7 On the other hand, there are similarities in the pattern of results. This is so because we have only allowed for selected differences between the two archetypes. Consider for instance trade liberalisation in the North (TLN). For both archetypes, there is approximately the same 10 per cent reduction in labour supply abroad. This is because this simulation results in the same improvement in the terms of trade for both economies which induces the same amount of real exchange appreciation. For both economies, a decline in real GDP occurs for the simulations that involve large labour relocations. As explained in section 2, this is due to the concavity of the labour allocation frontier and reflects adjustment costs. The same pattern of results obtains when one compares ITR with IMC and TLS with FDI which are also cumulative experiments. Compare for example increased resource transfer (ITR) with IMC (increased migration costs) in which the increase in foreign transfer is also accompanied by increased migration costs. Reducing the wage received abroad (perhaps by tighter immigration controls) naturally increases the amount of return migration. This larger return migration induces a larger decline in the home wage which lowers the aggregate supply of labour. Finally note the general equilibrium effects at work in the global trade liberalisation (GTL) experiment. Though GTL⫽FDI⫹TLN in design, the reduction in migratory pressure is less than would have been predicted in a partial equilibrium calculation that would have aggregated the results from FDI and TLN separately. 4.2

Household and sectoral effects

The aggregate results have identified the role of differential changes in the real exchange rate in the LI and MI economies, and its implications for the pattern of migratory pressures. These aggregate changes, however, mask composition effects at the household level. Also they are the result of different patterns of resource reallocation across sectors. Tables 8.5a and 8.5b give, for each household, the change in real income, the foreign relative wage expressed in domestic-currency units, the change in labour supply abroad and the change in the distribution of income. Table 8.6 compares the resource shifts in the two archetypes for the TLS and GTL simulations.

Table 8.5. Household incomes and labour-allocation decisions a L1 archetypea

E-1 E-2 E-3 E-4 E-5 E-6 E-7 E-8

ITR IMC TLS FDI ATLN MTLN TLN GTL

Gini coef.b

LSK INCc

LSK RWd

LSK FLSe

MSK INC

MSK RW

MSK FLS

HSK INC

⫺0.1 2.9 ⫺5.3 ⫺5.7 0.4 2.7 2.8 ⫺2.9

1.4 ⫺ 1.0 0.1 2.5 2.6 ⫺ 3.3 ⫺ 0.7 1.7

⫺ 1.5 4.1 9.7 5.1 ⫺ 5.5 ⫺ 2.1 ⫺ 7.3 ⫺ 2.0

⫺ 1.6 ⫺ 6.6 10.0 3.2 ⫺ 6.0 ⫺ 1.9 ⫺ 7.7 ⫺ 1.9

1.0 2.4 10.6 12.4 4.9 ⫺ 1.4 3.2 15.6

⫺ 0.8 ⫺ 0.1 ⫺ 5.9 ⫺ 10.1 ⫺ 7.9 ⫺ 4.6 ⫺ 11.6 ⫺ 19.8

⫺1.1 ⫺13.4 ⫺7.8 ⫺13.4 ⫺10.7 ⫺5.9 ⫺15.3 ⫺26.0

Gini coef.f

LSK INCc

LSK RWd

LSK FLSe

MSK INC

MSK RW

MSK FLS

0.0 2.9 ⫺ 6.5 ⫺ 6.9 ⫺ 0.5 3.0 2.4 ⫺ 3.0

0.8 0.3 ⫺ 5.2 ⫺ 4.3 ⫺ 0.0 ⫺ 2.3 ⫺ 2.4 ⫺ 7.8

⫺ 0.3 2.0 11.2 10.0 ⫺ 0.5 ⫺ 0.4 ⫺ 0.8 8.9

⫺ 0.4 ⫺ 9.2 12.3 10.9 ⫺ 0.6 ⫺ 0.3 ⫺ 0.7 10.1

1.2 1.4 12.9 15.2 3.5 3.9 6.8 20.3

⫺ 0.8 0.6 ⫺ 15.8 ⫺ 19.3 ⫺ 5.9 ⫺ 9.6 ⫺ 13.7 ⫺ 29.4

⫺1.1 ⫺11.8 ⫺20.0 ⫺24.4 ⫺7.4 ⫺12.1 ⫺17.4 ⫺37.1

HSK RW

HSK FLS

CAP INC

CAP RW

CAP FLS

1.3 ⫺1.2 4.4 ⫺2.2 ⫺ 22.3 50.0 ⫺ 19.8 42.4 1.8 ⫺4.0 3.1 ⫺9.1 4.6 ⫺12.1 ⫺ 15.5 24.3

⫺ 1.9 ⫺ 17.2 79.9 67.2 ⫺ 5.9 ⫺ 13.1 ⫺ 17.3 38.1

1.3 3.9 ⫺3.7 ⫺2.7 4.3 0.6 4.5 1.9

⫺1.2 ⫺2.2 50.0 42.3 ⫺4.0 ⫺9.1 ⫺12.1 24.3

⫺ 1.9 ⫺ 17.1 75.4 63.4 ⫺ 6.2 ⫺ 12.8 ⫺ 17.3 35.1

HSK INC

HSK FLS

CAP INC

CAP RW

CAP FLS

⫺ 0.8 ⫺ 14.6 17.1 11.3 ⫺ 1.2 ⫺ 10.1 ⫺ 10.8 ⫺ 4.3

0.9 3.5 ⫺3.6 ⫺3.2 1.2 2.4 3.2 0.8

b M1 archetype a

E-1 E-2 E-3 E-4 E-5 E-6 E-7 E-8

ITR IMC TLS FDI ATLN MTLN TLN GTL

Notes: a Percentage changes from initial values. b Initial value G ⫽0.41. c Real income. dw ¯ *h ER/wh. e Foreign labour supply. f Initial value G⫽ 0.26. See table 8.3 for definition of policy experiments.

1.0 2.7 ⫺ 4.5 ⫺ 2.7 0.0 3.5 3.3 0.9

HSK RW ⫺0.5 ⫺0.5 11.9 8.0 ⫺0.8 ⫺7.1 ⫺7.6 ⫺3.0

⫺0.5 ⫺0.5 11.9 8.0 ⫺0.8 ⫺7.1 ⫺7.6 ⫺3.0

⫺ 0.8 ⫺ 14.7 16.9 11.3 ⫺ 1.4 ⫺ 9.9 ⫺ 10.8 ⫺ 4.4

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Table 8.6. Micro results: net price and sectoral output shiftsa TLS LI Experiment Net archetype price Sub. ag. Exp. ag. Light mfg. Heavy mfg. Services Informal

TLS LI Sec. out.

4.3 ⫺3.6 70.6 35.3 ⫺32.7 ⫺32.7 ⫺35.7 ⫺18.7 ⫺1.2 ⫺1.1 13.9 ⫺2.5

TLS MI Net price

TLS MI Sec. out.

GTL LI Net price

⫺ 21.8 76.9 20.1 ⫺ 42.5 3.6 3.6

⫺12.9 3.7 49.3 63.7 16.8 ⫺ 33.6 ⫺35.6 ⫺ 53.6 0.8 5.7 0.4 15.1

GTL LI Sec. out.

GTL MI Net price

GTL MI Sec. out.

⫺ 1.1 40.6 ⫺ 29.1 ⫺ 43.8 2.7 ⫺ 0.7

⫺36.6 ⫺ 20.2 77.3 59.3 19.0 25.3 ⫺53.5 ⫺ 47.9 8.5 3.9 1.0 2.5

Notes: Percentage change from initial values. See table 8.3 for definition of policy experiments.

a

Start with the effects on households. As noted above, the largest differences between the two archetypes are for the TLS and GTL simulations. Comparing the effects of trade liberalisation, there a striking difference in the effects across households even though TLS reduces income inequality by approximately the same amount for both archetypes. In the LI economy the purchasing power of the low-skill household (LS HH) does not fall whereas it declines by 5 per cent for the MI economy. This is because the real depreciation lowers the cost of living following the fall in the price of non-traded subsistence agriculture. However, in the absence of HO effects, one would have also expected that the relative wage (RW) for the LS HH would have fallen more in the LI economy (because of the depreciation). But TLS increases the demand for low-skill labour (LSL) in the LI economy, thereby attenuating the decline induced by the real exchange rate depreciation. In fact, the fall in the relative wage is approximately the same for both economies. The HS HH is the great loser of TLS in the LI economy as the fall in the domestic wage exacerbates the effect of the real depreciation. Not surprisingly, TLS (and to a lesser GTL) brings an exodus of HS and CAP HH. However, because both households are only a small fraction of migrants abroad, the net effect on migratory pressure is small. Except for the TLS and FDI results for the LI economy, we have seen that all other measures generate a net decrease in migratory pressure. Inspection of tables 8.5a and 8.5b indicates that return migration occurs for all HH groups. There are however some differences in the pattern of changes across HH. For example, even though the CAP and HS HH face the same relative wage, their incomes deviate because of their different pattern of specific-factor

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ownership. Again TLS in the LI economy barely affects the income of CAP HH while decreasing the income of HS HH by 20 per cent. Also in the agricultural trade liberalisation in the North (ATLN), return migration is more pronounced for the LI economy. This is because the terms of trade improvement is not dampened in the LI economy as there households do not consume this good. Other patterns could be drawn from a closer inspection of the results in tables 8.5a and 8.5b. Two will be mentioned here. First, insofar as migratory pressure could respond positively to increases in relative deprivation (see Stark, 1991), then TLS in the South, especially if accompanied by FDI in exporting activities, could lead to a decrease in migratory pressure as the distribution of income becomes less unequal. Second, migratory pressure affects the skill composition of the labour force. Here TLS in the LI economy has a particularly strong adverse effect on the skill composition of the labour force because of the Stolper–Samuelson (SS) effects leading to an exodous of HSL. Insofar as there are positive externalities associated with a higher skill content of the labour force in LI economies, trade liberalisation in the South could have adverse effects on future growth. Table 8.6 compares the resource-pull effects of TLS and GTL across the two archetypes. Inspection of the results confirms the contraction in nontraded sectors in the LI economy (subsistence agriculture and informal sectors). A comparison of net price and output shifts does not give a clear pattern. This is mostly because, although both economies have the same Cobb–Douglas technology for value-added, the MI economy is more intensive in the use of intermediates and is better endowed in MS and HS labour. 5

Sensitivity analysis

It is obvious that the simulation results described above are likely to be sensitive to the choice of elasticities and, more importantly, to the modelling assumptions. In this section, we report briefly on the sensitivity of the results to changes in elasticities and in assumptions about migration. This is far from systematic sensitivity analysis as only a few parameter values are varied and only one change in model cloture is contemplated.8 The results of these simulations are reported in table 8.7 using the following notation: ES-1(LI) indicates the results of sensitivity analysis on E-1 for the LI economy. Multiple variations are indicated by letters (a for fixed labour supply, b for financial constraints, etc.). In all the results in table 8.7, the initial calibrated solution is the same as in tables 8.4a and 8.4b so the results in table 8.7 are directly comparable with those in tables 8.4a and 8.4b.

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Table 8.7. Sensitivity analysis: labour supply and home–foreign-labour allocationa

ES-1a(M1)b ES-8a(LI) ES-3b(LI) ES-3c(LI) ES-5d(MI) ES-3e(LI) ES-8e(LI)

ITR GTL TLS TLS ATLN TLS GTL

TLab. sup.

TFLab. sup.

TDLab. sup.

Real ER

RGDP

⫺ 0.0 ⫺ 0.2 0.0 0.1 ⫺ 0.2 ⫺ 0.1 ⫺ 0.3

⫺0.6 ⫺7.5 1.1 8.1 ⫺5.9 ⫺7.0 ⫺9.8

0.1 1.4 ⫺0.2 ⫺1.6 0.8 1.4 1.8

⫺0.9 2.6 22.9 19.3 ⫺3.3 21.7 3.2

0.1 ⫺ 0.3 ⫺ 2.4 ⫺ 3.1 0.3 ⫺ 1.6 ⫺ 0.1

Notes: a Percentage change from initial values. b Archetype in parenthesis. See table 8.3 for definition of policy experiments.

a

Fixed labour supply

We consider first the sensitivity of the results to changes in the household elasticity of labour supply by assuming a zero income elasticity of labour supply for each HH. This change is done for the ITR and GTL simulations. In the aggregate for the ITR simulation for the MI economy, there is no change in labour supply. This is because the fall in the returns to working abroad are compensated by an increase in the domestic wage, leaving the ˜ unchanged. aggregate HH wage W b

Financial constraints to migration

The theoretical literature has pointed out that outmigration may be constrained by financial costs, especially for low-income potential migrants (see, for example, Schiff, 1995; Lopez and Schiff, 1995). There is also evidence that financing constraints and migration costs can be significant in the migration decision.9 To test the sensitivity of our results to a potential financial constraint, we suppose that low-skill households face a financing constraint. We assume that only the LS HH faces a migration constraint – i.e. ⍀h ⫽0 for this HH group. This means that this household cannot emigrate (or return home) in response to a change in relative earnings. Introducing a financial constraint on the migration of LS HH in the TLS for the LI economy has drastic effects as the aggregate migration pressure falls from 8 per cent to 1 per cent. This is because migratory pressure is from the LS HH.

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Concentrated factor ownership

Though the mapping matrix of factor to household income is guesswork, it represents a view of the world in which households have some asset diversification as they receive both income from activities in several sectors and from several factors. While this is certainly closer to reality than the textbook case in which there is no asset-ownership diversification, it is interesting to see how sensitive results are to this assumption. To this end, we modified the factor ownership shares in table 8.2, assuming that the CAP HH receives all its income from the ownership of specific factors. Hence, it does not supply labour services, and therefore cannot migrate. In the aggregate, increased concentration of factor ownership does not affect migratory pressure. This is so because the CAP HH represents an insignificant share of migrants. However, this modification leads to a weaker improvement in income distribution (Gini decrease by 3.4 per cent versus 5.3 per cent). d

Reduction in migration costs

A reduction in migration costs should increase both relocation of labour to relative wage changes and lead to less loss in GDP. In ES-5d(MI) (ATLN), for all households the value of ⍀h is increased from 1.5 to 2.5. As expected, there is a magnification effect on return migration. Also GDP increases more than in the corresponding scenario with higher migration costs. e

Permanent migration

Finally we consider the effects of a household labour-allocation decision that does not take into account variations in the purchasing power of foreign wages in terms of domestic goods. As argued in section 2, this corresponds more closely to a permanent view of migration and is probably more applicable to LI economies. Hence we consider only the effects of this option for the LI economy for two scenarios: TLS and GTL. Now the HO wage effects of trade liberalisation dominate the results and instead of an 8 per cent increase in emigration, there is a 7 per cent decrease in foreign labour supply due the increase in the unskilled wage caused by the expansion of unskilled labour-intensive export industries. The same effects are at work in the GTL experiment with a magnification effect of return migration compared with the results in table 8.4a. In the simulations and sensitivity analysis, the approach has been taxonomic, with variations in only one parameter at a time. If one were to choose the model most appropriate for a LI and MI economy, one could argue that a ‘return migration’ model is more relevant for a MI economy

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while a ‘permanent migration’ model with a financial constraint for unskilled labour migration is the more relevant model for a LI economy. Since the permanent migration closure results in return migration in the TLS and GTL experiments, the financial constraint cloture would not be binding. Thus the results from rows 6 and 7 of table 8.7 would probably be the more representative expected results for a LI economy. One would therefore conclude that direct or indirect channels to stem migration, at least as modelled in this chapter, would likely achieve their objective of reducing migratory pressure. 6

Conclusions

Whether direct and indirect measures aimed at reducing South–North migratory pressures are effective cannot be determined on a priori grounds, although for direct measures (e.g. foreign aid and tighter controls on migration), in the absence of financial costs to migration, the net impact is most likely a reduction in migratory pressure. It is for the indirect measures that both theoretical and empirical results are ambiguous. For example, at the theoretical level, the effect of a more liberal trade regime is ambiguous, since if trade and factor movements are substitutes (complements), then trade liberalisation will (will not) discourage migration. This chapter shows that empirically, even in the context of a simple RV model, the effects of trade liberalisation are quite complex and could lead to ambiguous effects on migratory pressures. If the responsiveness of exports to the new set of incentives is strong enough, trade liberalisation will be accompanied by a real appreciation which could lead to return migration, at least if migration is not permanent, a prediction that has been corrobated by data on Mexican–US migration. However, if exports are slow to respond to the new trade regime, trade liberalisation will be accompanied by a strong real exchange rate depreciation. This depreciation will increase migratory pressure. It would thus appear that trade liberalisation in LI economies is more likely to lead to an increase in migratory pressure than in MI economies. However, differences in structure and constraints between LI and MI economies should also be taken into account. Migration cost constraints for low-skill workers in LI economies will alleviate migratory pressure. Also, for LI economies, it is likely that the pattern of migratory pressure resulting from indirect measures such as trade liberalisation will adversely affect the skill composition of the labour force, as it is the medium and high-skill workers that will lose in relative terms and will find migration more attractive. At a more general level, there are many analogies between the ‘trade and jobs’ controversy and the debate on how to cope with growing migration

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pressure. Growing trade and investment links with developing countries are often faulted for the fall in unskilled wages in the USA and the growth in unemployment in Europe. There is indeed some evidence that trade with labour-abundant countries has been somewhat inimical to unskilled workers in industrial countries, albeit its effects are limited. Similarly, additional migration is typically resisted on the ground that it would lead to a marked deterioration in the labour market conditions of the unskilled. However, by creating jobs for the household groups most probably wishing to emigrate, FDI is likely to reduce South–North migratory pressure. The simulations in this chapter have identified only some of the channels through which policies and environmental changes might affect migratory pressures from the sending country. At the very least, a more complete analysis should also attempt to take into account adjustments during the transition. It is easy to imagine that changes in the human capital stock resulting from out- (or return) migration would have effects on investment and hence on transitional growth. More than the numerical results and the differences across MI and LI archetypes and differences in institutional settings, what is to be retained from this chapter is that trade and migration policies cannot be assessed separately. A liberal trade regime is probably likely to lead, under most circumstances, to less migration. Conversely, a shift toward protectionism will add to migration pressure. Those opposing trade liberalisation with developing countries should reflect on the fact that protection breeds further migration, both by discouraging labour-intensive exports in sending countries and by boosting the demand for foreign labour in receiving countries. Moreover, in the light of the current debate, those favouring a cut in foreign aid to developing countries on the basis of its inefficiency should think about its consequences on migratory pressure. Hence industrial countries face a dilemma. They cannot reduce aid and become more protectionist with developing countries and still hope to reduce migratory pressures: they must make a choice.

APPENDIX The appendix specifies the full set of equations of the model sketched in the main text and describes how we assembled the data for each archetype economy. 1

The simulation model

The model is a standard general equilibrium RV model. The economy is divided into i ⫽1, …, N sectors. These include traded and non-traded

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sectors with corresponding subscripts t and nt. There are v⫽ 1, …, V categories of labour and h⫽1, …, H categories of households. Sectors are indexed over i,j, factors of production over v and households over h. Prices denoted in foreign currency units have an asterisk – e.g. P*t is the foreigncurrency price of tradables. An asterisk is also used to denote labour allocated abroad – e.g. L*h (L*v) is the amount of labour by household h (of category v) allocated abroad. Finally a bar over a variable indicates an exogenous variable. The equations describing the simulation model used in the text are contained in table 8A.1. Table 8A.2 lists the endogenous variables and the exogenous variables and parameters. The first block of equations in table 8A.1 indicates a multi-factor Cobb–Douglas technology for value-added and a Leontief technology for intermediates and between intermediates and value-added ((4), (5)). Factor demands are determined by the firstorder conditions for profit-maximisation (6) with (7) determining rents for the fixed factors. Note the presence of non-competitive imports in the definition of net prices (5). The second block gives the factor-to-household mapping. In the notation used in (8) and (9) ␭L is a (V,H) matrix indicating the mapping of labour by category to labour ownership by household. In this application this is a matrix of ones and zeroes as each household only supplies one category of labour, though it may receive income from more than one factor and some labour categories are supplied by more than one household. Equation (10) gives the mapping of capital from sectors to households. The third block describes the allocation of household labour between domestic and foreign destinations according to the description in the main text. Equation (11) is the cost function associated with (2). Maximisation of (3) gives the division of labour between home and foreign markets given by (13) and (14). The wage rate for each category of labour is determined by (16). The following block determines net trade from the material balances for the traded sectors (19) while the material balance equations for non-traded sectors determines prices for the non-traded sectors (20). All final demand is for household consumption as in the standard trade-theoretic models. The small-country assumption is embodied in eq. (21) and (22). The exogeneity of the current account (24) insures that there are no free lunches while the choice of normalisation (28) insures that the value of ER is the equilibrium value of the real exchange rate (the price of tradables in terms of non-tradables). Finally the determination of household income (25) indicates that government and remittance redistributions do not affect the distribution of income between households. In the simulations with FDI, the stock of capital in the agricultural export and light manufacturing sectors is exogenously increased with the

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Table 8A.1. Model equations Technology and factor demand Xi ⫽ A¯iK¯

兿(L

␣i i

d )␥i,v i,v

(4)

兺a¯ P ⫺b¯

(5)

v

兺␥

i,v ⫹ ␣i ⫽1

v

PNi ⫽ Pi ⫺

i,j

j

0,iP0

i

Ldi,v ⫽ (␥i,vPNiXi)/wv

(6)

Ri ⫽ ␣i(PNiXi)/K¯i

(7)

Factor-household income mapping

兺w ␭ w ¯ * ⫽ 兺w ¯ *␭* lK¯ ⫽ 兺HK wh ⫽

L v v,h

(8)

v

h

L v,h

v

(9)

v

i

(10)

i,h

h

Household home–foreign-labour allocation 1⫹⍀h (1/(1⫹⍀h)) ˜ ⫽ 1/B¯ [(1⫺ ␯ )⫺⍀h(w )1⫹⍀h ⫹(␯ )⫺⍀h(w W ¯ *ER) ] h h h h h h

˜ )((Y ⫺ ␾ )/(1 ⫺ ␤ )) LSh ⫽MHh ⫺(␤0,h/W h h h 0,h Lh ⫽ (1/␤h

)(1⫹⍀h)((1 ⫺ ␯

⫺⍀h ˜ LSh h )Wh/wh )

⫺⍀h ˜ /w L*h ⫽(1/␤h )(1⫹⍀h)(␯h W LSh h ¯ h*ER)

(11) (12) (13) (14)

Wage determination

兺LS ␭ L ⫽ 兺L Lvs ⫽

L h v,h

(15)

h

s v

d i,v

(16)

i

Demand and material balances Ci,h ⫽ ␦i,h ⫹(␤i,h/Pi)(Yh ⫺ ␾h)/(1 ⫺ ␤o,h) n

␾h ⫽

兺P

i,h␦i,h

i⫽1

(17)

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Table 8A.1. (cont.)

兺␤ ⫹ ␤ ⫽ 1 ID ⫽ 兺a¯ X X ⫽ 兺C ⫹ID ⫹ NE X ⫽ 兺C ⫹ID 0,h

h

i

i

i,j

(18)

j

j

t

t,h

t

(19)

t

h

nt

nt,h

(20)

nt

h

Trade and external balance constraint Pt ⫽P¯*ER(1⫹ T¯t) t

(21)

¯ ) P0 ⫽ P¯*ER(1⫹T 0 0

(22)

兺P¯*N E ⫺ 兺b¯ P¯*X CA ⫽TRB⫹ 兺L*w ¯ *ER

TRB⫽

t

0

t

t

0

(23)

i

i

h

(24)

h

h

Government revenue and income–expenditure constraint ˜ ⫹ Yh ⫽ LShW h

兺R HK i

i,h ⫹sh[GR ⫺ CA.ER]

(25)

i

GR ⫽⫺

兺T¯ P¯*NE ER ⫹ 兺T¯ b¯ P¯*X t

t

0 0

t

t

0

(26)

i

i

˜ ⫹ sh ⫽ (LShW h

兺R HK / 冢兺冤LS W˜ ⫹ 兺R H¯K¯ 冥冣 i

i,h

i

h

h

h

i

i,h

(27)

i

Price normalisation PNORM ⫽

兺(P X ) / 冢兺P X 冣 nt

nt

0 nt

0 nt

nt

0 nt

(28)

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Table 8A.2. Variables and parameters Endogenous variables Pnt NEt Yh ER Xi PNi Ldi,v wv wh Ri ˜ W h LSh Lh L*h Ci,h sh IDi NEt CA Yh GR

Non-traded price Net trade Household income Real exchange rate Sectoral gross output Net price Labour demand for category v Wage for labour category v Wage for labour category h Rental for fixed factor in sector i Aggregate wage income for household h Labour supply for household h Home-labour supply for household h Foreign-labour supply for household h Consumption by household h Income share for household h Intermediate demand for sector i Net exports for sector t Current account Income for household h Government revenue

nt t H l N N N.V V H N H H H H N.H h N t l H l

Exogenous variables and parameters P¯*t P¯*0 ¯B T¯R ¯ Ki ¯H ¯ M h w ¯ *h ⍀h ␾h ␦i,h ␤i,h ␥i,v ␣i

World price for competitive imports World price for non-competitive imports Trade balance Specific factor Maximum number of hourts available to h Household wage abroad Elasticity of transformation Non-discretionary expenditure for household h Exogenous consumption of i Marginal budget share of i Output elasticity for factor v Factor-specific share in value-added

t l l N H H h h N.H N.H N.V N

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Table 8A.3. Output and final demand structure a L1 archetype

Sub. ag Exp. ag Light mfg. Heavy mfg. Services Informal

Output

Hous. cons.

Net exp.

Intm. sal.

Valueadded

Non-comp. imports

30.0 15.7 33.0 6.4 47.3 20.0

17.9 20.0 24.9 25.4 36.4 18.0

0.0 15.7 ⫺6.6 ⫺9.6 0.0 0.0

12.1 20.0 14.7 10.6 10.9 22.0

18.3 11.0 15.1 21.8 27.2 14.7

6.0 1.9 2.3 1.9 1.9 0.0

Output

Hous. cons.

Net exp.

Intm. sal.

Valueadded

Non-comp. imports

15.5 29.0 40.7 24.0 55.4 26.0

27.8 22.7 11.1 11.9 37.4 20.6

⫺4.7 3.6 8.1 ⫺7.2 0.0 0.0

12.3 22.7 21.5 19.3 18.0 25.4

27.7 22.3 13.8 12.4 33.8 15.3

0.8 0.3 2.0 2.4 0.6 0.0

b M1 archetype

Sub. ag Exp. ag Light mfg. Heavy mfg. Services Informal

share of profits corresponding to the foreign-owned capital being repatriated abroad. In the simulations with a zero elasticity of labour supply to the foreign market ⍀LSK ⫽0, L* LSK is fixed, and (14) is dropped for this household. 2

The data

The data for the structure of production, for input–output coefficients and for the structure of trade are largely inspired from Bourguignon et al. (1992). In turn, these data were assembled from Chenery and Syrquin (1987), who construct what they call ‘archetypical’ primary and manufacturing exporters (they also consider a third archetype, the ‘large’ economy with a population over 20 million which is less open to trade). Roughly speaking, the two archetypes correspond to what Chenery and Syrquin call ‘low-income’ and ‘middle -income’ economies. Both economies are calibrated to be of the same size, but the LI archetype has a much larger share of resources in agriculture, a less dense input–output structure, and a larger

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Table 8A.4. Factor shares in value-added

Sub. ag Exp. ag Light mfg. Heavy mfg. Services Informal

Low skill

Medium skill

High skill

Capital stock

0.5 0.0 0.0 0.0 0.0 0.25

0.0 0.5 0.25 0.0 0.25 0.25

0.0 0.0 0.25 0.5 0.25 0.0

0.5 0.5 0.5 0.5 0.5 0.5

share of non-competitive imports in total imports (see table 8A.3). The same sectoral technology was imposed for both archetypes. Output elasticities (and factor shares in value-added for the Cobb–Douglas technology specified here) are given in table 8A.4. Except for the sensitivity analysis, the same values for ⍀h⫽1.5, the elasticity of transformation for labour allocation between home and foreign markets, was set for all households for both archetypes. Household consumption patterns were calibrated in the usual way starting from income elasticities of demand for each household along with estimates of the Frisch parameter, Fh (Fh ⫽⫺Yh/(Yh ⫺ ␾h) ranging from ⫺3.0 for the LS HH to ⫺1.5 for the CAP HH. NOTES We thank Sanoussi Bilal, Marcelo Olarreaga, André Sapir, Alessandra Venturini and Klaus F. Zimmermann for helpful comments on a draft and the FNRS for support under grant no. 12-42011.94. 1 For evidence of return migration in Southern European countries (Southern Italy, Spain and Turkey over the period 1962–88, see Faini and Venturini (1995). 2 For an empirical justification of the RV model, see Kohli (1993), who showed that it performs better than the HO framework in explaining the US experience. 3 Although this is a static model, the ‘temporary-migration’ view could also be interpreted as the inclusion of perfect foresight expectations about the exchange rate in the migration decision. 4 It is hard to predict to what extent households would diversify across countries in the absence of barriers to migration. It is likely, though, that heterogeneity within the household would be important enough to insure some diversification, even though one observes agglomerations of ethnic groups (e.g. Chinatowns and Little Italys) which suggests convex relocation costs. 5 It could be shown that risk-aversion by risk-neutral households receiving stochastic incomes from different sources would lead to concave iso-risk loci. These could be viewed as consistent with this approach as households would spread their labour services across destinations to reduce risk.

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6 A large LI economy like Bangladesh would have a more diversified economic structure that would call for a different archetype representation. The choice of agriculture as import-competing in the MI economy is, of course, arbitrary. It turns out, however, to be convenient in the simulations capturing the effects of trade liberalisation as it gives the same number of sectors with net imports for both archetypes. 7 Neary (1988), discusses the conditions under which a transfer and a change in the terms of trade will lead to an appreciation of the real exchange rate and Edwards and van Wijnbergen (1987) give conditions under which trade liberalisation in a RV model will lead to a depreciation of the real exchange rate. Neither study includes migration, but the reasoning is broadly applicable to the discussion here. 8 A systematic analysis of alternative cloture rules would have included the role of economies of scale in the possibility of generating a complementarity relationship between trade and migration. See Venables (1997) for a summary of the results in the trade-theoretic literature on the substitutability–complementarity relationship between trade and migration. 9 See, for example, Adams (1996); Freeman (1993); Funkhouse (1992). REFERENCES Adams, R. (1996). ‘Remittances, Inequality and Asset Accumulation: The Case of Rural Pakistan’, in D. O’Connor and L. Farsakh (eds.), Development Strategy, Employment and Migration: Country Experiences (Paris: OECD Development Centre), 149–70 Bhagwati, J. (1992). ‘Free Traders and Free Immigrationists: Strangers or Friends?’, Working Paper, 20 (New York: Russell Sage Foundation) Bourguignon, F., J. de Melo and A. Suwa (1992). ‘Distributional Effects of Adjustment Policies: Simulations for Archetype Economies in Africa and Latin America’, World Bank Economic Review, 5, 339–66 Burda, M. (1993). ‘The Determinants of East–West German Migration’, European Economic Review, 37, 452–61 Chenery, H. and M. Syrquin (1987). ‘Typical Patterns of Transformation’, in H. Chenery, S. Robinson and M. Syrquin (eds.), Industrialization and Growth (Oxford: Oxford University Press) Daveri, F. and R. Faini (1996). ‘Where Do Migrants Go? Risk-Aversion, Mobility Costs and the Locational Choice of Migrants’, University of Brescia, mimeo Djajic, S. and R. Milbourne (1988). ‘A General Equilibrium Model of GuestWorker Migration’, Journal of International Economics, 25, 335–51 Edwards, S. and S. van Wijnbergen (1987). ‘Tariffs, the Real Exchange Rate and the Terms of Trade: On Two Popular Propositions in International Economics’, Oxford Economic Papers, 39, 458–64 Faini, R. and J.M. Grether (1994), ‘ L’ouverture au commerce, peut–elle réduire la migration Nord–Sud?’, University of Neuchâtel, mimeo Faini, R. and J. de Melo (1995). ‘Trade Policy, Employment and Migration: Some Simulation Results from Morocco’, CEPR, Discussion Paper, 1198 (1994). ‘Migration and Growth: The Experience of Southern Europe’, CEPR, Discussion Paper, 964

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Faini, R. and A.Venturini (1995), ‘Trade, Aid and Migration: Some Basic Policy Issues’, European Economic Review, 37, 435–42 Freeman, R. (1993). ‘Immigration from Poor to Wealthy Countries: Experiences from the US’, European Economic Review, 37, 443–51 Funkhouse, E. (1992). ‘Mass Migration, Remittances and Economic Adjustment: The Case of El Salvador’, in G. Borjas and R. Freeman (eds.), Immigration and the Work Force: Economic Consequences for the United States and the Source Areas (Chicago: University of Chicago Press for the NBER) Harris, J. and M. Todaro (1970), ‘Migration, Unemployment, and Development: A Two–Sector Analysis’, American Economic Review, 60, 126–42 ILO (1949). Migration for Employment Recommendation (Geneva: ILO) (1984). Employment Policy Recommendation (supplementary provision) (Geneva: ILO) (1992). ‘ODA as a Means to Reduce Economic and Social Emigration Pressure’, paper for joint ILO–UNHCR Meeting in International Aid as a Means to reduce the Need for Emigration: Informal Summary Record, Geneva Kohli, U. (1993). ‘US Technology and the Specific–factors Model’, Journal of International Economics, 34, 115–36 Lopez, R. and M. Schiff (1995). ‘Migration and the Skill Composition of the Labour Force: The Impact of Trade Liberalisation in LDCs’, PRWP, 1493 (Washington, DC: World Bank) Markusen, J. (1983). ‘Factor Trade and Commodity Trade as Complements’, Journal of International Economics, 13, 341–56 Markusen, J. and S. Zahniser (1997). ‘Liberalisation and Incentives for Labour Migration: Theory with Applications to NAFTA’, Boulder, University of Colorado, mimeo Massey, D.S. (1989). ‘Theories of International Migration: A Survey’, Population and Development Review, 19, 431–66 Melo, J. de and Tarr, D. (1992). A General Equilibrium Analysis of US Foreign Trade Policy (Cambridge, MA: MIT Press) Neary, P. (1988). ‘Determinants of the Equilibrium Real Exchange Rate’, American Economic Review, 78, 211–15 Schiff, M. (1995). ‘Trade Policy and International Migration in the Short and the Long Run’, Revue d’économie du Development, 4, 3–25 (1996). ‘South–North Migration and Trade: A Survey’, PRWP, 1696 (Washington, DC: World Bank) Stark, O. (1991). The Migration of People (Oxford: Basil Blackwell) Venables, A. (1997). ‘Trade Liberalisation and Factor Mobility:An Overview’, LSE, mimeo; see also chapter 2 in this volume Wong, K.–Y. (1995). International Trade in Goods and Factor Mobility (Cambridge, MA: MIT Press)

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Discussion A LESSANDRA V E NT URI NI Chapter 8 by Faini et al. is very interesting. It adds to the ongoing debate on whether it is possible to reduce migration through trade liberalisation. It begins with the premise that the countries of destination would like, if possible, to find a way of reducing immigration pressures. Before I consider the specific case described in the chapter, it is necessary to point out that if this assumption is generally true, in the future it will be less tenable in the case of Europe, where the population is ageing rapidly. In fact, generational factors in Europe will create a short-term demand for immigrants. In Northern Italy, the area with the highest proportion of aged people, there will be one-and-a-half jobs available for every young person who enters the labour market in 2006, because of the number of workers reaching retirement age at that date. Thus, if the participation rate does not change dramatically and technological change does not cause the number of available jobs to fall by more than 30 per cent, then there will be a relatively strong demand for immigrant labour. Let us return to the Faini et al. model. It provides a useful framework but suffers some weaknesses.: • First, as with all simulation models,the results are strictly determined by the parameters of the specification. • Second, it explains migratory flows only in terms of supply-side decisions, in fact the destination model is very static. For instance, the skill composition of emigrants’ pull will be determined only by changes in the pattern of production induced by ‘trade policies’adopted in the country of origin and not by changes in the demand in the country of arrival. • Last, the time-horizon of the model is not very clear. In principal a general equilibrium model is not actually a short-run model; here, however, capital accumulation and intersectoral capital mobility are not considered, as they should be in a medium-run model. Still, the model has many interesting features – for instance, the fact that the wage differential is expressed in term of the consumption basket in the country of origin gives a role to the real exchange rate both affecting emigration and return migration. A crucial issue from the policy-maker’s point of view is if the model provides an adequate description ofreal cases, for instance, the Mediterranean case – the main source of immigration to Europe.

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Discussion by Alessandra Venturini

In the Faini et al. simulation, any trade and foreign direct investment (FDI) liberalisation in the Mediterranean countries, which are middleincome (MI) countries (figure 8.3b), is found to have a positive effect on the domestic balance of payment deficit. This means the exchange rate appreciates and emigration is discouraged. Such a result is closely linked to the kind of tax system adopted, and if it is mainly concentrated on exports, a reduction of taxes will favour exports more than imports, inducing the positive effects already mentioned. However, at least in the short run, imports will react more swiftly to changes in incentives and thus may lead to a short-run current account deterioration and this is why the researches of Cogneau and Tapinos (1995) for Morocco and Kebabjian (1994) for Tunisia shows after a trade liberalisation in the South a devaluation of the exchange rate, with the effect of making emigration more attractive, and a rise in the interest rate to compensate the balance of payment deficit which reduces investment (see table 8.1a, 8.1b). A further example comes from the US–Mexico case where trade liberalisation introduced by the NAFTA will sweep away traditional Mexican agriculture, increasing urbanisation and emigration out of agriculture (Martin, 1994). In Faini et al., when trade flows are less price-elastic, trade liberalisation leads to more migration but only in the low-income (LI) countries’ case. Income distribution considerations play a crucial role. In the MI countries’ case, medium-skill households are concentrated in exportable agriculture and light industries (see table 8.2), both sectors which are favoured by the different intervention policies suggested in the model, and the incentive to emigrate is clearly reduced. The opposite is true for the other three groups, which ends in the final case – global trade liberalisation (GTL) – with a higher propensity to emigrate both in LI and MI countries. It is unlikely that this will occur, because migration is not usually frequent in either the lowest- or the highest-skill household, but in the medium-skill one and it is the result of the only positive effect of Trade Liberalisation (TL) and increase of foreign direct investment (FDI) in the South where there is a push to emigrate except for the medium-skill household. One way of getting a more reliable result would be to assume a different sectoral distribution of households or to allow for the low-skilled constraints to emigration. The authors are somewhat aware of this fact and in one simulation they introduce the liquidity constraint for low-skill household. As expected, the best results for migration pressure are obtained in the case of trade liberalisation in the North (TLN), and no ‘policy’ changes being introduced in the South, a result which suggests that any Global free

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trade agreement (GTL) imposes high restructuring costs on the South and in the short run could also make things worse for the North. FDI provides us with surprisingly poor results, and it should be pointed out that reductions in the cost of adopting technological advance and the falls in the risk premium of capital movement, both of which have positive multiplier effects – as the work of Cogneau et al. (1996) shows for the Mediterranean case – have not been considered, while the overall scenario is less optimistic than it might be. Even with these limitations, the results of the research are important because they combine emigration and trade-development policies within a single interactive framework. Although migration decisions are more complex and do not respond only to wage differentials, the trend of potential migrants is down. Migration will be less the more the Northern countries open their markets to goods produced in the developing countries. The result will probably not be reached in the short run, as the model shows, but in the medium term; and potential increases in emigration during the transition period can be reduced by specific intervention in favour of lowskill workers in the South. Restrictions should also be introduced to reduce the immigration-chain mechanism which fosters mobility even when the incentives to emigrate are disappearing. REFERENCES Cogneau, D. and G. Tapinos (1995). ‘Libre-échange, répartition du revenu et migrations au Maroc’, Revue d’Economie du Dévelopment, 1 Cogneau, D., J.C. Dumant and P. Izzo (1996). ‘Regional Integration, Direct Investment and Migration in the European Mediterranean Area: Results Obtained from a Computable General Equilibrium Model’, in Migration, Free Trade andRegional Integration in the Mediterranean Basin, proceedings from a seminar jointly organised on 31 October and 1 November 1996 by the OECD and the Greek authorities Kebabdjian, G. (1994). ‘Les Pays du Maghreb ont-ils intéret à une zone de libreéchange avec l’Union Européenne?’, in Vers une zone de libre-échange EuropeMaghreb, cahier du GEMDEV, 22, Paris, 59–77 Martin, P. (1994). ‘Immigration to the United States: Journey to an Uncertain Destination’, Population Bulletin, 49

Part Three Historical and contemporary evidence

9

Were trade and factor mobility substitutes in history? WILLIAM J. C OL L I NS, KE V IN O ’ RO U R K E A N D JE F F RE Y G. W IL L I AMS O N

Did the growth of protection in the late nineteenth century in North America stimulate the large labour and capital inflows of that period (assuming land to have been the abundant factor)? Did the increased protection in Britain in this century stimulate capital export? Did the breakdown in international factor movements in the interwar period stimulate trade? (Mundell, 1957, p. 335)

1

Introduction

Robert Mundell’s seminal article on ‘International Trade and Factor Mobility’ was published 40 years ago, and its conclusion threw down a challenge: Can history tell us whether (and when) trade and factor mobility are substitutes? 40 years seems long enough to wait, so this chapter finally rises to Mundell’s challenge by interpreting trade theory in the light of history and by investigating empirically the connection between trade and factor flows in the Atlantic economy between 1870 and 1940. The epoch prior to the First World War is especially interesting in this regard since it is a liberal world environment providing a good natural experiment. In the 40 years since Mundell wrote, trade theorists have come to understand that theory is ambiguous on this issue. Whether trade and factor mobility are complements or substitutes depends on the assumptions made in the theory. If ever there was an open invitation for empirical research, this surely is it. Yet, few efforts have been made to identify econometrically the complementarity or substitutability between factor flows and international trade (see Wong, 1988). Perhaps history may prove to be a valuable guide to choosing among these assumptions. But if theory is ambiguous, history may be, too: the appropriate model for one historical period may not be the appropriate model for another. After all, there may be regime switches in history which correspond to alternative assumptions which trade theorists invoke to yield complementarity or substitutability. Nonetheless, even if history cannot identify the ‘right’ model for thinking 227

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about international trade and factor mobility in the 1990s, it certainly can provide valuable insights into the nature of the connection and, by extension, illuminate important aspects of the contemporary phenomenon. The first section of this chapter briefly discusses the theoretical ambiguity concerning trade and factor mobility within relatively simple models: it overlaps somewhat with Anthony Venables’ chapter 2 in this volume, but we need to cover the same ground independently so as to motivate the economic history. The remainder of the chapter will use that theory to explore the experience of three New World countries and seven Old World countries between 1870 and 1940. We approach the data from two angles. First, we focus on business cycles and what the literature of the 1950s and 1960s called ‘long swings’, the latter exhibiting booms and busts over 15–20-year periods. Our interest is whether there was strict substitutability over the long swing between trade on the one hand and capital and migration flows on the other and, if not, whether there is any evidence of complementarity; whether the resource-abundant New World and resource-scarce Old World obeyed the same laws of complementarity or substitutability; and whether there was a regime switch around the First World War, after which frontiers are said to have ‘disappeared’ and the world economy de-globalised. Second, we investigate the trade versus factor-flow relationship using decade-averaged panel data, thus shifting the focus from shorter-run relationships generated by macro-instability in the time series to longer-run relationships manifested over decades and across trading partners of widely different endowments. Finally, the chapter turns to policy experience, and asks: Did New World policy-makers act as if they viewed migration and trade as substitutes? 2

Theory

In order to guide the economic history in this chapter, this section will discuss whether and when trade and factor mobility should be substitutes or complements within the context of standard trade theory. Venables’ contribution to this volume (chapter 2) tackles the question by deriving the effects of (possibly small) reductions in the costs of trade or factor mobility. We are interested in the same issues but, for the sake of simplicity, consider more dramatic changes in transport costs. Throughout, we are interested in two questions: First, when countries move from autarchy to free trade, does the incentive for factors to migrate increase or diminish? Second, when countries move from factor immobility to active participation in global factor markets, does the volume of trade increase or diminish? Unlike chapter 2, we only consider constant-returns-to-scale (CRS) models, so that trade is due solely to endowment or technology differences

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between countries. This is more likely to have been true for our period than for the late twentieth century; Estevadeordal (1993) shows that endowments do a very good job of explaining international trade on the eve of the First World War. 2.1

2⫻2 models

The relationship between trade and factor mobility in the standard 2x2 model is well known. (We refer to the 2x2 model rather than the Heckscher–Ohlin (HO) model, since Heckscher and Ohlin had in mind a far richer structure than that developed by Lerner, Samuelson, Rybczynski and the rest of their followers.) Let Britain and Ireland produce machines and textiles, using labour and capital. Textile production is relatively labour-intensive, and Ireland is relatively labour-abundant. Wages are initially low in Ireland and high in Britain, while profits are higher in Ireland. When trade opens up, Ireland exports textiles and imports machines. Wages rise in Ireland and fall in Britain, while profits fall in Ireland and rise in Britain, implying that trade induces factor-price convergence (Ohlin, 1924, reprinted in Flam and Flanders, 1991). Under restrictive circumstances, there will be complete factor-price equalisation (FPE) (Heckscher, 1919; Lerner, 1952; Samuelson, 1949). Trade reduces or completely eliminates the incentive for labour to move to Britain and for capital to flow to Ireland; trade and factor mobility are therefore substitutes. Alternatively, it is clear that factor mobility tends to equalise endowments across countries, raising Irish capital–labour ratios and lowering British capital–labour ratios. Factor mobility thus erodes the basis for trade (Mundell, 1957). Once again, the conclusion is that trade and factor mobility are substitutes. As Markusen (1983) has shown, these classic results are derived from the assumption that factor endowments alone are the basis for trade: countries are assumed to be otherwise identical. If the basis for trade is some other difference between countries, trade and factor flows can be complements, even in the context of 2 ⫻2 models. Markusen’s most intuitive demonstration of this principle concerns differences in technology between countries. Now let Ireland and Britain have identical factor endowments, but also let technology in the British machine industry be (Hicks-neutral) superior to that in the Irish machine industry. Britain will have a comparative advantage in machine production. When trade opens up, Britain will export machines: an increase in capital-intensive machine production will increase the demand for capital in Britain, hence raising British profits and lowering British wages. When Ireland specialises in textiles, Irish wages rise and Irish profits fall. Markusen shows that in trade equilibrium, wages are

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higher in Ireland, while profits are higher in Britain.1 Now allow factors to flow in response to factor-price differentials. Capital will flow from Ireland to Britain, and labour from Britain to Ireland. In line with the Rybczynski theorem (1955), machine production in Britain will expand, and British textile production will contract, while the opposite production responses will occur in Ireland. This will further increase British exports of machines and imports of textiles. Factor mobility has increased trade. Thus, trade and factor mobility are complements. 2.2

The specific-factors and 3⫻2 models

Heckscher and Ohlin were motivated by the intercontinental exchange of food for manufactured goods that characterised the late nineteenth century. Land-scarce and labour-abundant Europe exported manufactures to the resource-abundant, labour-scarce New World, in exchange for grain, wool, raw cotton and other agricultural products. Obviously, it is difficult to rationalise such trade in the context of simple 2⫻2 models: land, labour and capital were all relevant factors of production. In 1966, an economic historian, Peter Temin, wrote a chapter on ante bellum Anglo-American industry in which he assumed that manufactured goods were produced with labour and capital, while food was produced with labour and land. This model was fully developed by Jones (1971), and dubbed the specific-factors model of trade. We draw attention to the cliometric antecedents of this model not just out of team spirit, but in order to highlight a theme of this chapter: the ‘correct’ trade model may vary with the period being studied. The relationship between trade and factor mobility in the specific-factors model is ambiguous. Imagine two economies, Europe and America, and to keep matters simple, assume that they differ only in their land endowments: America has more land. What does this imply for American autarchic factor prices, relative to European factor prices?2 One way to answer this question is to distinguish between factor mobility responses and price effects due to differences in land availability (following Corden and Neary, 1982).3 With more land, the marginal product of labour in agriculture increases. Wages increase in both sectors, as labour moves into agriculture, and profits as well as rents decline. On the other hand, more land increases the supply of food relative to manufactured goods. This will lower the relative price of food, tending to lower rents but increase profits. American rents will definitely be lower than European rents, but American profits may be higher or lower than profits in Europe. Profits in the USA will be higher if the manufacturing sector’s labourforce and output are larger than Europe. More land and higher incomes mean a greater demand for manufactures, while a lower relative price of

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food implies the opposite. The net impact of an increased land endowment on profits thus depends on the relative size of these income and substitution effects. Thus, there are two possibilities. Either land and capital are cheaper in the USA than in Europe (while labour is more expensive); or US land is cheap, while US capital and labour are expensive (the dual-scarcity case). In the first case, US capital should flow to Europe, while European labour should migrate to the USA; in the second (dual-scarcity) case, there is an incentive for both labour and capital to flow from Europe to America. What does a move from autarchy to free trade imply for these migration incentives? The USA exports food, and the relative price of food in the USA increases. This increases US rents, and lowers US profits; meanwhile, trade increases European profits, but lowers European rents. In the first case (land and capital cheaper in the US) the incentive for US capital to emigrate has increased. Thus, trade and factor mobility are complements. In the second case (cheap US land but expensive US capital), the incentive for European capital to emigrate has declined. In effect, trade and factor mobility are substitutes. As for labour, the impact of relative price changes on real wages is ambiguous: trade could be a substitute or a complement to migration. The same ambiguity emerges where the impact of factor flows on trade is the issue. Labour migration’s impact on trade is ambiguous because it depends on the migration’s impact on relative outputs in Europe and the USA. Similarly, if capital is cheaper in the USA than in Europe, then capital flows from America to Europe will increase trade (lowering relative supplies of food in Europe, and increasing them in the USA); but in the ‘dualscarcity’ case, capital flows to the USA will increase US manufacturing and diminish US agriculture, lowering the volume of trade. This ambiguity has been rigorously demonstrated by Neary (1995). Clearly, the relationship between trade and factor mobility is ambiguous in the specific-factors model. Indeed, from the above discussion it is clear that trade could be complementary to migration, but a substitute for capital flows, or vice versa. To take just one example from a range of possibilities, in the dual-scarcity case, capital flows and trade are substitutes; this does not preclude the possibility that emigration would increase the supply of manufactures relative to food in Europe, and that immigration would increase the supply of food relative to manufactures in the USA (in which case, migration and trade are complements). Going from the specific-factors model to a more general 3⫻2 model (in which land and capital are mobile between sectors) only increases the range of uncertainty. Thompson (1985, 1986), for example, has shown that price movements can have paradoxical effects on rents and profits.

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Frontier arguments

The existence of a third factor like land and other natural resources is not enough per se to generate a strong presumption of complementarity between trade and factor mobility. Such a presumption can emerge in the context of models where the effective supply of the third factor is endogenous – a natural assumption in the context of late nineteenth-century New World frontier economies or of labour-scarce Southeast Asian colonies. In particular, as food prices rise due to trade, there is an incentive to extend the frontier and to increase the effective supply of land. However, extending the frontier requires heavy capital inputs (e.g. financing the railroads) and even labour (e.g. building the new towns). When the USA opens to trade, and the relative price of food increases, the specific-factors model may conclude that US profits fall. In the dual-scarcity case, this lessens the incentive for capital to flow from Europe. However, if the increase in the demand for capital associated with frontier extension is not completely offset by the decline in manufacturing’s demand, then the return to capital in the USA, and even the US–Europe profit differential, might increase. In this case, the incentive for capital to flow to the USA would also increase. Similarly, if extending the frontier sufficiently increased the US demand for labour, this might create the presumption that US–Europe wage gaps would also increase. The existence of an endogenous frontier seems to increase the likelihood that trade and factor mobility will be complements, rather than substitutes. However, the elegant and simple models of an endogenous New World frontier which Findlay (1995) has constructed show that even in this case, trade and factor mobility can be substitutes. Very stylised models of North–South trade can produce unambiguous complementarity. If the North exports manufactures and imports natural resources, and if northern investment in the South is required for the exploitation of the South’s resources, then complementarity is assured. Such a model was outlined by Kemp and Ohyama (1978), even though they were interested in a different set of issues. Schmitz and Helmberger (1970) argued strongly for complementarity between capital flows and trade, on the basis that capital inflows are required to develop the exports of extractive industries in LDCs. Williams (1929) also argued that capital mobility and trade in resources were complements rather than substitutes. This argument resembles the frontier argument just put forward: in both cases, there are surplus resources which require foreign investment before they can be vented onto world markets. The complementary frontier argument can be extended to a third-world context, too. City-building is very capital-intensive, and to the extent that globalisation generates an export boom of labour-intensive manufactures

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in the third world, it also induces city growth (Kelley and Williamson, 1984; IBRD, 1995). This, in turn, generates heavy social overhead demand, high returns to capital and foreign investment (Lewis, 1978). Thus, trade and capital flows are complements, not substitutes. Of course, this argument has its reverse. With the disappearance of nineteenth-century frontiers, town-building slowed down and railroad and other ‘population-sensitive’ investment dropped off, and this, in turn, may have caused international factor mobility to subside, complementarity to vanish and substitutability to emerge. Likewise, with the completion of twentieth-century urban social overhead in the third world, factor mobility may subside, complementary may vanish and substitutability may emerge. Three morals emerge from this survey of what standard theory has to say about the substitutability versus complementarity question. First, theory is ambiguous, as chapter 2 confirms. The ambiguity can be resolved only with evidence, and history is certainly a good place to look for that evidence. Second, endogenous-frontier models seem to offer a clear and historically relevant case where trade and factor mobility are more likely to be complements. To the extent that frontier settlement is a transition process, we should look to disequilibrium transitions for evidence of complementarity. A transition has ended when a frontier has disappeared or an economy is fully urbanised. Third, the ‘correct’ model will vary with the period being studied. Regime switches are likely to be common, especially at the beginning and the end of a transition. With this brief survey of theory to guide us, we are ready to look at preSecond World War history. We start with macro-instability and the long swing. 3

Time series: macro-instability and the long swing, 1870–1940

In 1968, Moses Abramovitz gave a University Lecture at the London School of Economics on ‘The Passing of the Kuznets Cycle’, that special form of macro-instability which characterised so much of the Atlantic economy prior to 1914. Abramovitz preferred to call these events Kuznets cycles, after their discoverer (Kuznets, 1930, 1958). But these 15–20-year growth surges and slowdowns were also called ‘long swings’ and, unless interrupted by war, they typically ended in severe depressions (e.g. the mid1870s, the mid-1890s, and the 1930s). Abramovitz and other scholars (Lewis and O’Leary, 1955; Abramovitz, 1961; Easterlin, 1966, 1968) documented long swings in the rate of frontier settlement, accumulation, labourforce growth, productivity advance, city-building and other underlying fundamentals associated with long-run growth.

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These booms and busts were global in scope. Given that primary product markets always exhibit greater instability during global booms and busts, it is not surprising that the long swings were most dramatic in the resourceabundant New World. Nonetheless, they were also apparent in much of Europe where they generated waves of urbanisation and industrial growth, typically producing Old World long swings in domestic accumulation rates which moved inversely with those in the New World. The global character of these long swings also manifested itself in factor flows, relative prices and, to some extent, trade. The pattern appeared in the rhythm of the mass migrations, which recorded spectacular flows from Europe to the New World during booms, and net return migration during busts (Thomas, 1941; Thomas, 1954; Easterlin, 1961; Wilkinson, 1967; Williamson, 1974; Hatton and Williamson, 1997). It also appeared as waves in net international capital movements, which recorded massive outflows from Germany, France and especially Britain during booms abroad (slumps at home) and a flight back home during slumps abroad (booms at home) (Cairncross, 1953; Williamson, 1964). It appeared in relative prices (Abramovitz, 1961; Williamson, 1964; Rostow, 1978) and, for some primary product exports at least, in trade. Transport costs fell globally so every trading partner could have enjoyed an improved terms of trade prior to the First World War. But around that trend, the New World terms of trade improved during New World booms, while it slumped in Europe. We have always thought that the growth in primary product exports from the New World surged and collapsed over these long swings, but in the long run commodity market globalisation was achieved (Williamson, 1996). Figures 9.1–9.4 illustrate these ‘long swings’ for the two most important economies in the Atlantic community, the USA and the UK, where the epochs are broken up into the pre-war globalisation phase and the post-war de-globalisation phase. These figures show clearly the enormous instability in the time series, that migration (mig) and capital flows (rlCA) are highly correlated (capital chases after labour), but that aggregate trade levels (rltrade) are, somewhat surprisingly, not well correlated with either. Designing an empirical framework to capture the complementarity or substitutability of trade and factor flows is challenging, and the dearth of empirical investigations of this phenomenon must be due in large part to the seeming intractability of the problems at hand: issues of endogeneity, measurement and interpretation are formidable obstacles. Undaunted, we pursued two means of measuring the association of trade volumes with factor flows in each country’s time series. First, we simply asked whether relatively large (small) factor flows are associated with relatively small (large) trade flows ceteris paribus, regardless of the direction of the factor flows. The focus in this first approach was on magnitudes alone, and the

Were trade and factor mobility substitutes in history?

Figure 9.1

235

Long swings in trade and factor flows: USA, 1872–1913

Note: All series are three-year moving averages and rescaled for presentation.

Figure 9.2

Long swings in trade and factor flows: USA, 1920–39

Note: All series are three-year moving averages and rescaled for presentation.

absolute values of factor flows were entered in the regressions. But with a given endowment, should a factor inflow and a factor outflow of the same magnitude be expected to have the same impact on trade volumes? It could be argued that if trade and factor flows are substitutes, then emigration (or capital exports) is expected to lessen trade only if labour (or capital) is leaving a relatively labour- (or capital-) abundant country. Our second approach incorporated a notion of factor scarcity and abundance based on measurements of land, labour and capital for each country in the sample. This approach asked whether factor flows in the ‘right’ direction (into a factor-scarce country or out of a factor-abundant country) were associated

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Figure 9.3

Long swings in trade and factor flows: UK, 1870–1913

Note: All series are three-year moving averages and rescaled for presentation.

Figure 9.4

Long swings in trade and factor flows: UK, 1920–37

Note: All series are three-year moving averages and rescaled for presentation.

with more or less trade. The determination of factor abundance/scarcity was based upon the country’s share in the sample’s total endowment of a given factor relative to the country’s share in the sample’s total GDP.4 Since it turned out that these two approaches yielded much the same results, we present only the first in what follows. Table 9.1a reports results when real trade values are regressed on absolute real values of factor flows (gross immigration or emigration mig and net capital flows as measured by the current-account balance rlCA), plus additional variables to be discussed in a moment; table 9.1b reports results when first differences in trade values are regressed on first differences in factor flows; and table 9.1c reports results when first differences in trade

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Table 9.1. Factor mobility correlates with trade, 1870–1913 and 1919–36 a Dependent variable: rltrade; factor mobility variables: ambig, abrlCA Migration AUS: 1870–1913

0.169 (3.11) AUS: 1919–36 0.681 (2.24) CAN: 1870–1913 0.810 (1.18) CAN: 1919–36 0.121 (0.02) USA: 1870–1913 0.882 (4.29) USA: 1919–36 ⫺ 2.73 (1.18) DEN: 1870–1913 1.37 (0.31) DEN: 1919–36 18.94 (1.09) FRA: 1870–1913 .— FRA: 1919–36 GER: 1870–1913

.—

3.39 (0.90) GER: 1919–36 115.14 (8.95) ITA: 1870–1913 5.93 (2.02) ITA: 1919–36 11.78 (1.97) NOR: 1870–1913 0.0001 (0.14) NOR: 1919–36 0.0071 (1.10) SWE: 1870–1913 0.874 (0.91) SWE: 1919–36 41.48 (1.84) UK: 1870–1913 0.427 (4.38) UK: 1919–36 3.34 (4.12)

Curr. act

Trans. cost

⫺ 0.584 ⫺ 000.021 (2.49) (0.14) ⫺ 1.06 ⫺ 0.274 (2.38) (0.66) ⫺ 0.219 2.11 (0.53) (0.51) ⫺ 0.075 32.11 (0.05) (1.13) 0.063 5.01 (0.31) (1.07) 3.70 68.07 (2.84) (1.33) 0.263 1.08 (1.09) (1.00) 3.17 9.79 (2.60) (1.32) 0.153 7.04 (0.94) (0.87) ⫺ 0.501 ⫺ 150.2 (0.49) (2.23) ⫺ 0.511 20.01 (1.56) (1.78) 1.40 175.62 (5.97) (7.09) ⫺ 0.580 ⫺ 4.02 (2.29) (0.15) 1.68 71.63 (3.19) (1.51) 0.193 ⫺ 0.0377 (0.71) (0.06) ⫺ 1.69 4.18 (2.59) (3.54) 0.337 2.85 (1.05) (2.50) 1.84 ⫺ 1.33 (2.14) (0.17) ⫺ 0.0001 ⫺ 0.262 (0.00) (0.44) 0.803 ⫺ 5.72 (1.04) (2.17)

Tariff ⫺ 162.6 (1.97) ⫺ 271.9 (3.12) 10812. (1.52) 4649. (0.25) ⫺ 2530. (1.53) ⫺ 26639. (2.33) ⫺ 1515. (1.60) ⫺ 43684. (3.66) ⫺ 31405. (3.55) ⫺ 68824. (5.18) ⫺ 16617. (0.97) ⫺ 85107. (45.21) ⫺ 58523. (7.92) ⫺ 51277. (2.06) ⫺ 759.3 (2.18) ⫺ 4892. (3.08) ⫺ 3017. (2.41) ⫺ 12551. (2.68) ⫺ 3703. (3.03) ⫺ 1934 (3.26)

N

R2

32

0.95

15

0.78

13

0.96

17

0.22

42

0.95

17

0.65

37

0.68

13

0.79

43

0.72

16

0.88

33

0.61

10

0.99

43

0.94

17

0.84

29

0.59

17

0.67

43

0.88

15

0.80

43

0.94

17

0.90

Notes: The dependent variable (rltrade) is the deflated sum of imports and exports. The migration variable (abmig) measures the absolute value of gross immigration for

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Table 9.1. (cont.) a (cont.) New World countries (except Australia which reports net immigration) or gross intercontinental emigration for Old World countries. Adequate migration data are not available for France. The current account variable (abrlCA) measures the absolute value of the deflated overall current balance. The transport cost measure is the same for all countries. The tariff measure is customs revenue divided by import values. Time and time-squared terms are not reported in the table. All regressions are Cochrane–Orcutt. t-statistics are in parentheses. b Dependent variable: Change in rltrade; factor mobility variables: change in abmig, abrlCA Migration AUS: 1870–1913

0.111 (1.22) AUS: 1919–36 ⫺ 0.0877 (0.20) CAN: 1870–1913 0.499 (0.58) CAN: 1919–36 3.04 (0.37) USA: 1870–1913 0.894 (4.02) USA: 1919–36 0.163 (0.07) DEN: 1870–1913 1.51 (0.34) DEN: 1919–36 12.73 (0.62) FRA: 1870–1913 .— FRA: 1919–36 GER: 1870–1913 ITA: 1870–1913 ITA: 1919–36 NOR: 1870–1913

.— 5.53 (0.08) 2.12 (0.81) 13.60 (2.42) 0.0001 (0.16)

Curr. act ⫺ 0.0636 (0.20) ⫺ 0.383 (0.93) ⫺ 0.205 (0.38) ⫺ 0.691 (0.52) ⫺ 0.0070 (0.04) 1.95 (2.58) 0.242 (1.01) 4.00 (2.63) 0.277 (1.62) 0.408 (0.41) ⫺ 0.459 (1.37) 0.0988 (0.37) 1.35 (2.92) ⫺ 0.154 (0.54)

Trans. cost 0.238 (0.12) ⫺ 0.222 (0.58) ⫺ 0.267 (0.04) 30.40 (1.39) 0.317 (0.07) ⫺ 3.85 (0.31) 1.04 (0.95) 12.37 (1.28) 8.08 (0.99) ⫺ 11.03 (0.16) 21.17 (1.92) ⫺ 22.58 (0.89) ⫺ 48040 (1.88) 0.0835 (0.13)

Tariff ⫺ 152.46 (1.52) ⫺ 110.47 (1.42) 4507 (0.44) ⫺ 14819 (0.82) ⫺ 2226 (1.23) ⫺ 40327 (2.73) ⫺ 1785 (1.86) ⫺ 52751 (3.63) ⫺ 35070 (3.91) ⫺ 9280 (0.42) ⫺ 19254 (1.10) ⫺ 13737 (0.86) 31.48 (0.73) ⫺ 718 (1.79)

N

R2

29

0.24

14

0.30

12

0.12

17

0.22

41

0.40

17

0.71

35

0.44

11

0.85

42

0.40

15

0.29

32

0.46

42

0.22

17

0.83

27

0.40

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Table 9.1. (cont.) b (cont.) Migration NOR: 1919–36 SWE: 1870–1913 SWE: 1919–36 UK: 1870–1913 UK: 1919–36

0.0079 (0.85) 0.686 (0.72) 35.14 (1.07) 0.436 (4.41) 1.76 (2.14)

Curr. act 0.914 (0.96) 0.424 (1.39) 1.99 (2.54) 0.129 (0.52) 0.549 (0.65)

Trans. cost 1.45 (0.61) 1.97 (1.77) ⫺ 3.73 (1.41) ⫺ 0.373 (0.61) 1.97 (1.41)

Tariff ⫺ 4820 (1.45) ⫺ 2837 (2.54) ⫺ 11017 (1.97) ⫺ 4218 (3.10) ⫺ 2872 (2.64)

N

R2

17

0.24

42

0.32

14

0.79

42

0.59

17

0.72

Notes: The dependent variable (change in rltrade) is the first difference of the deflated sum of imports and exports. The migration variable (change in abmig) measures the first difference of the absolute value of gross immigration for New World countries (except Australia which reports net immigration) or gross intercontinental emigration for Old World countries. Adequate migration data are not available for France. The current account variable (change in abrlCA) measures the first difference of the absolute value of the deflated overall current balance. Data limitations preclude estimation for inter-war Germany. The transport cost measure is the same for all countries and is also first-differenced. The tariff measure is the first difference in customs revenue divided by import values. Time and time-squared terms are not reported in the table. All regressions are Cochrane–Orcutt. t-statistics are in parentheses.

c Dependent variable: change in rltrade; factor mobility variables: abmig and abrtlCA Migration ⫺ 0.0083 (0.15) AUS: 1919–36 0.250 (1.04) CAN: 1870–1913 ⫺ 0.460 (0.76) CAN: 1919–36 0.126 (0.02) USA: 1870–1913 0.383 (1.60)

AUS: 1870–1913

Curr. act

Trans. cost

⫺ 0.0821 (0.36) ⫺ 0.819 (4.00) 0.713 (2.54) 0.728 (0.59) 0.032 (0.13)

0.124 (0.59) 0.010 (0.04) ⫺ 8.86 (1.81) 19.29 (1.22) ⫺ 1.16 (0.23)

Tariff ⫺ 140.6 (1.37) ⫺ 119.16 (3.01) ⫺ 13040 (1.43) ⫺ 4212 (0.39) ⫺ 2982 (1.48)

N

R2

29

0.19

15

0.76

13

0.53

17

0.20

41

0.18

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Table 9.1. (cont.) c (cont.) Migration ⫺ 7.42 (2.08) DEN: 1870–1913 2.05 (0.72) DEN: 1919–36 31.07 (1.43) FRA: 1870–1913 .— USA: 1919–36

FRA: 1919–36 GER: 1870–1913

.—

2.75 (1.13) GER: 1919–36 119.2 (3.27) ITA: 1870–1913 2.24 (1.29) ITA: 1919–36 32.87 (2.22) NOR: 1870–1913 ⫺ 0.0003 (0.56) NOR: 1919–36 0.020 (2.39) SWE: 1870–1913 0.676 (1.06) SWE: 1919–36 45.28 (3.57) UK: 1870–1913 0.215 (1.87) UK: 1919–36 ⫺ 0.867 (0.63)

Curr. act 1.053 (0.51) ⫺ 0.163 (0.65) 2.09 (1.69) 0.183 (1.48) 0.709 (0.54) 0.600 (1.62) 0.704 (1.01) 0.182 (1.02) ⫺ 0.116 (0.12) ⫺ 0.356 (1.96) ⫺ 1.31 (2.09) ⫺ 0.306 (1.14) ⫺ 0.216 (0.19) 0.383 (1.86) 1.58 (1.18)

Trans. cost 0.967 (0.02) 1.52 (1.57) 9.92 (1.50) 3.75 (0.47) ⫺ 11.16 (0.17) 14.57 (1.36) 169.7 (3.14) ⫺ 12.68 (0.51) 30.96 (0.30) 0.0011 (0.002) ⫺ 4.12 (3.55) 2.16 (1.87) ⫺ 8.86 (3.72) ⫺ 0.372 (0.52) 0.501 (0.29)

Tariff ⫺ 13678 (1.23) ⫺ 1853 (2.04) ⫺ 31387 (3.41) ⫺ 30751 (3.30) ⫺ 9198 (0.42) ⫺ 46931 (2.82) ⫺ 49832 (4.84) ⫺ 8790 (0.57) ⫺ 79047 (2.21) ⫺ 632.29 (1.68) ⫺ 2585 (1.18) ⫺ 3148 (2.80) ⫺ 13153 (3.91) ⫺ 4846 (2.94) ⫺ 4900 (3.71)

N

R2

17

0.45

37

0.43

13

0.74

42

0.28

15

0.29

32

0.57

9

0.97

42

0.23

17

0.58

27

0.52

17

0.71

42

0.33

14

0.93

43

0.37

17

0.63

Notes: The dependent variable (change in rltrade) is the first difference of the deflated sum of imports and exports. The migration variable (abmig) measures the first absolute value of gross immigration for New World countries (except Australia which reports net immigration) or gross intercontinental emigration for Old World countries. Adequate migration data are not available for France. The current account variable (abrlCA) measures the absolute value of the deflated overall current balance. The transport cost measure is the same for all countries. The tariff measure is the customs revenue divided by import values. Time and time-squared terms are not reported in the table. All regressions are Cochrane–Orcutt. t-statistics are in parentheses.

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values are regressed on factor flows. The dependent trade variable is simply the deflated sum of exports and imports (rltrade).5 All of the regressions use the Cochrane–Orcutt procedure to account for serial correlation in the error terms. The results in tables 9.1a–9.1c appear to be consistent. Furthermore, the results seem to be robust to many other specifications we tried.6 The regressions were estimated with time and time squared (coefficients not reported in tables 9.1a–9.1c) to isolate macro-instability (e.g., long swings) from the trends in the country time series. Tariff rates (tariff) were introduced to reflect the fact that many of these countries retreated from globalisation in the late nineteenth century, and that all of these countries participated in the race towards de-globalisation after the First World War.7 We expected negative coefficients here, and our expectations are confirmed (with the odd exception of Canada). We also introduced a crude measure for transport costs (Isserlis, 1938);8 it almost always has the wrong sign in these long- swing regressions probably because transport costs were endogenous to trade volumes over the long swing, rising during booms as space in tramp bottoms got scarce, and falling during slumps as space in tramp bottoms got abundant. We expect different signs on transport costs when these cycles and swings are removed from the data, and thus where exogenous supply-side forces are more likely to dominate. The impact of the frontier and/or policy change is explored by estimating separately relationships for the pre-war years (1870–1913) and for the inter-war years (1919–39). Our expectation was that complementarity would appear more frequently in the pre-war decades than afterwards, especially for the resource-abundant New World. Most important for the purposes of this study are the factor-flow variables. Migration measures gross intercontinental emigration from the European countries and gross immigration to the New World countries (except for Australia, which reports net in-migration). The current-account variable is the overall current balance, deflated by a GDP deflator for the sake of intertemporal comparability. True, no respectable economic historian could possibly hold the view that mass migration (Hatton and Williamson, 1998) and international capital flows (Zevin, 1992; Taylor, 1996) were exogenous, and to the extent that endogeneity exists (for example, as a feedback from trade to the factor flows) the estimated coefficients on the factor-flow variables will be confounded. Yet, it is far easier to make that assertive statement than to construct instrumental variables annually to deal with endogeneity. In any case, we are not arguing that the regressions identify the causal mechanism running from factor mobility to trade. Rather, we are only exploring correlations, and tables 9.1a–9.1c are titled accordingly.

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Table 9.2. Trade and factor mobility, time-series complements or substitutes? a c or s is determined at the 10 per cent level of significance from Table 9.1a 1870–1913

AUS CAN USA DEN FRA GER ITA NOR SWE UK

1919–36

Labour

Capital

Labour

Capital

c n c n — n c n n c

s n n n n n s n n n

c n n n — c c n c c

s n c c n c c s c n

Source: Taken from table 9.1a. A positive and significant (at the 10 per cent level) coefficient relating trade to the factor flow variable in table 9.1a is a designated ‘complementary’. A negative and significant (at the 10 per cent level) coefficient on the factor-flow variable is designated ‘substitutable’. Insignificant coefficients are designated ‘neutral’. b c or s is determined at the 10 per cent level of significance from Table 9.1b 1870–1913

AUS CAN USA DEN FRA GER ITA NOR SWE UK

1919–36

Labour

Capital

Labour

Capital

n n c n — n n n n c

n n n n n n n n n n

n n n n — — c n n c

n n c c n — c n c n

Source: Taken from table 9.1b. A positive and significant (at the 10 per cent level) coefficient relating trade to the factor flow variable in table 9.1b is a designated ‘complementary’. A negative and significant (at the 10 per cent level) coefficient on the factor-flow variable is designated ‘substitutable’. Insignificant coefficients are designated ‘neutral’.

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Table 9.2. (cont.) c c or s is determined at the 10 per cent level of significance from Table 9.1c 1870–1913

AUS CAN USA DEN FRA GER ITA NOR SWE UK

1919–36

Labour

Capital

Labour

Capital

n n n n — n n n n c

n c n n n n c s n s

n n s n — c c c c n

s n n n n n n s n n

Source: Taken from table 9.1c. A positive and significant (at the 10 per cent level) coefficient relating trade to the factor flow variable in table 9.1c is a designated ‘complementary’. A negative and significant (at the 10 per cent level) coefficient on the factor-flow variable is designated ‘substitutable’. Insignificant coefficients are designated ‘neutral’.

With these caveats firmly in mind, we next explore those results most relevant to the central question, namely: What are the coefficients on the factor mobility variables? Tables 9.2a–9.2c summarise the results in terms of the hypothesis being tested: complements or substitutes? Deriving any table 9.2 from the relevant table 9.1 is straightforward: a positive and significant coefficient is interpreted as complementarity, a negative and significant coefficient is interpreted as substitutability and any coefficient not statistically different from zero is deemed neutral.9 Neutral entries dominate all three tables (53, 78 and 68 per cent in tables 9.2a, 9.2b and 9.2c, respectively, or 66 per cent overall), suggesting that the theoretical ambiguities highlighted above find their match in empirical ambiguities. Nevertheless, complementarity is far more common than substitutability, and it accounts for 26 per cent of the entries in all three tables combined. In addition, complementarity is associated almost twice as often with migration (34 per cent) than with capital flows (19 per cent). Substitutability appears in only 8 per cent of the cases, and all but one of those cases involves capital flows, not migration. This distinction between capital flows and migration suggests that some factor flows are more closely related to trade than others.

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So far, history soundly rejects substitutability. However, there are two unpleasant surprises that also appear in tables 9.2a–9.2c. First, and contrary to prediction, complementarity was not more pervasive in the resource-abundant New World (19 per cent in all three tables combined) than in the resource-scarce Old World (29 per cent in all three tables combined). Second, and again contrary to prediction, complementarity was three times more common in the ‘post-frontier’ period: complementarity occurred 36 per cent of the time during 1919–39 but only 12 per cent of the time during 1870–1913. Our priors strongly suggested complementarity and regime switch away from complementarity and towards substitutability. Much to our surprise, the evidence rejects the latter in the sense that it supports a regime switch towards complementarity, when the ‘disappearing frontier’ thesis predicted a regime switch from complementarity. Perhaps the complementarity is actually driven by policy, the simultaneous breakdown of international commodity and factor markets. And although there is some evidence to support complementarity, we expected stronger and more comprehensive confirmation given the plausible inferences emerging from the newer endogenous-frontier models and the older long-swing literature. Another blow to any endogenous-frontier model favouring complementarity is the finding that the New World with the frontier offers no evidence of stronger complementarity than the Old World without the frontier. In any case, the long- swing evidence certainly rejects substitutability. 4

Panel data from history: the Atlantic community, 1870–1940

This section takes another step towards filling the empirical void in the substitutability versus complementarity debate by exploring long-run relationships in panel data for the Atlantic community (plus Australia) between 1870 and 1940.10 Trade volume is now measured as the sum of imports and exports relative to GDP (as opposed to section 3, which measured ‘real’ trade levels for each country). One important advantage of this new tradevolume measure is that it provides a simple metric for comparison across countries which does not require the difficult translation of each country’s trade into a common (real) currency via exchange rates and import and export price indices. One potential disadvantage of the new measure, however, is that it departs from HOV theory which relates the volume of a country’s trade, unscaled by GDP, to the gap between its factor endowment and its factor consumption. Nevertheless, an effort will be made to develop a measure of the distance between endowment and factor consumption points which includes the necessary scaling. In particular, three endowments

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are measured for each of the 10 countries: population, arable land and capital stock proxied by coal consumption.11 The calculation of distance, D, through three-dimensional space is complicated by the different units of measurement along each of the three endowment axes, and so all units are converted to proportions of the sample total. Distance is calculated as follows: Di2 ⫽(Popi /Popw ⫺ ␥i)2 ⫹(Land i /Landw ⫺ ␥i )2 ⫹(Ki /Kw ⫺ ␥i)2, where i denotes a particular country, w denotes the sample total, and gi represents GDPi /GDPw. If the dependent variable in the panel were simply total trade (unscaled) in a constant and common currency, then we would use D (unscaled) to help explain the volume of trade. But because the dependent variable is trade/GDP, we scale D by ␥.12 For a given gap between the factor consumption and endowment points, a simple substitutable relationship between factor flows and commodity trade would suggest that larger factor flows would be associated with smaller commodity flows. A higher level of tariffs is expected to decrease the volume of trade, and this expectation was confirmed over long swings in section 3. We have only a rough guide to tariff levels: (customs revenue)/imports. But depending on the mix of tariffs, quotas and prohibitions, this measure can still serve as a useful proxy for protection over time and across countries. It is well known that transport costs declined substantially over the full course of this period, and the Isserlis index of these costs is included in the regressions. However, since the index number is identical for each country, it can be useful, potentially at least, only in explaining variation in trade/GDP over time. The explanatory variables of greatest interest to this chapter are average annual net migration rates and the current account relative to GDP for each decade between 1870 and 1940. With three exceptions, the migration rate used in this section is a net rate calculated using the following method:13 first, the period’s average rate of natural increase is applied to the beginning-of-period population, which provides an estimate of the end-of-period population if no one has emigrated or immigrated; second, the actual end-of-period population is subtracted from the counterfactual end-of-period population to provide an estimate of net migration over the period. This is expressed as an annual rate per thousand population in the base year. Table 9.3 pursues a simple question: ceteris paribus, do larger flows of people and capital tend to be associated with higher or lower volumes of trade?14 The table reports several specifications of the same basic regression equation, where Endow is the distance between the endowment point and

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consumption point in three-dimensional space calculated as described above. The basic regression is specified as follows: (Trade/GDP)it ⫽ ␣ ⫹ ␤1*Emig.Rateit ⫹ ␤2*(CA/GDP)it ⫹ ␤3*Tariffit ⫹ ␤4*Transportt ⫹ ␤5*Endowit ⫹ ⑀it. A formidable challenge for such a simple empirical strategy is to account for the endogeneity of the factor-flow variables. Certainly, the relationship between factor-flows and trade is not a one-way street, and this must be kept in mind when interpreting the coefficient estimates of ␤1 and ␤2. An instrumental-variables approach could be useful in meeting this challenge, although it is extremely difficult to identify truly exogenous variables that are correlated with the factor flows but not affected in turn by the volume of trade or by omitted variables which might affect both trade and factor mobility.15 Column (1) of table 9.3 reports regression results from simply pooling all of the available decade-averaged observations (N⫽58). The measure of tariffs enters strongly negative, as expected, and the measure of the endowment point’s distance from the assumed factor-consumption point enters positively and surpasses the 10 per cent significance level. The transport cost variable has no discernable correlation with trade/GDP. Both the current-account variable and the emigration rate are statistically insignificant in the pooled sample. Very similar results are attained in column (2) when using fixed effects by period, thus relying on variation across countries, to estimate the coefficients. This fact suggests that variation across countries dominates variation over time in determining the pooled regression results. Using the panel in column (3) to carry out fixed-effects estimation by country, however, provides a view of the data that is more compatible with the long-swing analysis in section 3. The tariff coefficient is still statistically significant and negative, but it is less than half the size of the coefficient estimated in the pooled regression. The endowment distance variable enters positively at approximately the same size as in columns (1) and (2), but it is far from statistically significant. The current-account variable is positive and statistically significant, whereas the migration rate is negatively (but not significantly) associated with the level of trade/GDP. Employing a full set of country and period dummies yields column (4)’s results, which again find a negative correlation between trade/GDP and labour flows, but a positive relationship between trade/GDP and capital flows. Even in columns (3) and (4), where the factor-flow variables receive their largest coefficient estimates, the coefficients imply a weak economic link between factor flows and trade flows. A one-standard-deviation

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Table 9.3. Trade and factor mobility correlations: decade averaged panel data for the Atlantic Economy, 1870–1940 Dependent variable: trade/GDP (1) Emig. rate GA/GDP Tariff Trans. cost Endow. Constant Country dum. Time dum. N R2

0.00169 (0.56) ⫺ 0.131 (0.23) ⫺ 1.07 (4.94) ⫺ 0.000140 (0.24) 0.0341 (1.77) 0.449 (6.53) No No 58 0.33

(2) 0.000550 (0.14) ⫺ 0.491 (0.73) ⫺ 0.999 (4.57) — 0.0355 (1.85) 0.438 (13.67) No Yes 58 0.34

(3) ⫺ 0.00218 (1.09) 1.08 (3.35) ⫺ 0.382 (3.49) 0.000212 (0.83 0.0349 (0.85) 0.315 (6.04) Yes No 58 0.91

(4) ⫺ 0.0318 (1.87) 0.522 (2.16) ⫺ 0.190 (1.94) — 0.0120 (0.29) 0.430 (12.47) Yes Yes 58 0.95

Notes: The factor-flow variables are the absolute value of the net emigration rate and the absolute value of the current account divided by GDP. The transport cost variable is the same for all countries (and therefore drops out when time dummies are included). The tariff variable is customs revenue divided by import values. The calculation of the ‘endowment distance’ variable is described in the text. Standard errors are adjusted for heteroscedasticity. t-statistics are in parentheses.

increase in the absolute value of the emigration rate (3.46) decreases trade/GDP by only 0.009 according to column (3). A one-standarddeviation increase in the absolute value of the current-account/GDP (0.020) increases trade/GDP by only 0.023 according to column (3). These magnitudes appear to be small relative to the average trade/GDP share (0.34). Like the long-swing analysis in section 3, the panel data provide virtually no support for the substitutability hypothesis. The panel data do provide some limited support (once country dummies are included) for complementarity between capital flows and trade. Even when significant, however, the size of all the estimated coefficients indicates a weak economic link between factor and trade flows.16

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Political-economy connections: tariffs and immigration restrictions17

International trade takes pride in emphasising the endogeneity of many variables. In that spirit, this section reports an effort to endogenise New World immigration policy. Did New World immigration policy behave in a fashion which suggests that the decision-makers of that time viewed trade and factor flows as substitutes? 5.1

The stylised policy facts

After the 1880s, there was a gradual closing of New World doors to immigrants. The doors did not suddenly slam shut on American immigrants with the Congressional over-ride of President Wilson’s veto of the immigrant literacy test in February 1917 or by the Emergency Quota Act of May 1921. The USA started imposing restrictions on what had been free immigration not too long after the Civil War, a half-century prior to the Literacy Act. Furthermore, the USA was hardly alone. Australia, Argentina, Brazil and Canada did the same, although the timing was often different and it often took the form of an enormous drop in or even disappearance of what had been large immigrant subsidies rather than of outright exclusion. In short, there was considerable variance in immigration policy across these five New World countries over the half-century; it was not simply one big policy switch around the First World War. And what was true of immigration policy was also true of trade policy. Globalisation proceeded in fits and starts in the three decades after 1846 when Britain repealed the Corn Laws and started a liberal trend towards free trade on the Continent. Add to that enormous declines in international transport costs, and you have the ingredients for the first great globalisation boom. As we have seen, it took the form of a trade boom, mass migrations and international capital flows at levels never reached before or since. The liberal trend did not last long, however, and there was a globalisation backlash. Tariffs started to rise on the European Continent, while immigration and trade restrictions started to rise in the New World. With the end of the First World War, the world economy plunged into a dark age of deglobalisation and hostile policy towards open factor and goods markets. This long inter-war period of darkness was followed by a liberal renaissance embedded in Bretton Woods, GATT, guest worker arrangements in Europe, the 1965 repeal of national origins quotas in the USA, foreign capital market deregulation and other policy events consistent with globalisation, especially after the early 1970s. What explains changing immigration, tariff and external capital market

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policy, and how are they related? For world globalisation to persist, rich nations must play the liberal game. After all, typically they have the big markets. Poor nations, in turn, are dependent on those big markets to sell their labour-intensive exports, to secure finance for projects in their capitalscarce economies and to vent their surplus labour on rich countries willing to absorb unskilled immigrants. The problem for rich countries is that globalisation can reduce high real wages there, or at least produce inequality. So, what determined trade and immigration policy in the rich, labourscarce nations in the late nineteenth century when there was still a frontier? Did these nations pursue legislation then which suggests that politicians and voters believed that trade and immigration were substitutes? If they thought so, then they would have believed that it was no use restricting just one when workers’ living standards were under threat, but rather that they had to restrict both. Alternatively, if trade and factor flows were complements, then restricting either trade or immigration would have done the trick. The USA was indeed protectionist, especially after the Civil War when landed and slave interests in the South had been defeated. And Canada was protectionist, especially after 1878. The fact that both countries gradually moved to restrict immigration is consistent with our earlier suggestion that, as the frontier closed, trade and factor flows moved from being complements to being substitutes. However, the closing of the frontier may have mattered more directly for the immigration debate. Americans thought the Western frontier had disappeared in the 1890s, Argentinians thought the Pampas had filled up shortly thereafter, Brazilians in São Paulo must have thought the same as coffee prices collapsed in the 1920s and Canadians must have shared this view when declining grain prices brought an end to their Prairie boom. Simple theory would predict that the closing of the frontier had an impact on attitudes towards immigration: the wage impact of immigration should have been lower when elastic supplies of land were available, since they could absorb new workers. The timing of New World immigration restrictions seems roughly consistent with this view. Is the timing of immigration restrictions adequately explained by the less elastic New World demand for labour implied by closing frontiers? Or did a changing relationship between trade and factor flows – first complements, then substitutes – also play a role? Were immigration restrictions positively associated with tariffs, as would be true if trade and factor flows were substitutes, and did the association between tariffs and migration policy change over time? More generally, what explains immigration restriction itself ? The answer

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ought to be consistent with the correlations invoked elsewhere in this chapter, but three candidates dominate all others – rising inequality, greater awareness of that inequality by the politically powerful and greater voting power in the hands of those hurt most by liberal policy – the working poor. Surprisingly, there have been few attempts to introduce these long-run fundamentals into explicit models of immigration policy, although there have been many attempts to make trade policy endogenous. Furthermore, we are aware of only three efforts to test immigration policy models with historical evidence (Shughart et al., 1986; Foreman-Peck, 1992; Goldin, 1994). Two papers by Ashley Timmer and one of the present authors (Timmer and Williamson, 1996, 1997) add to this new literature. Their results will be summarised in a moment, but only to the extent that the complements-versus-substitutes issue can be placed in proper perspective. 5.2

Policy complements or substitutes? An empirical test

Unskilled labour at the bottom of the distribution is scarce and expensive in rich countries, and that fact by itself should make income distributions more egalitarian than in poor countries. Immigration, especially lowquality immigration from poor countries, should erode unskilled labour scarcity in rich countries and raise inequality. Labour-intensive commodity imports should do the same. How should policy respond? If, driven by the presence of a frontier, trade and immigration were complements in the pre-1914 rich New World, protection and immigration restriction need not have gone hand in hand. Such a correlation might have emerged as the frontier disappeared. Among the many results reported by Timmer and Williamson (1996), table 9.4 presents just one which captures the central issue in this chapter. The underlying panel data are for five countries – Argentina, Australia, Brazil, Canada and the USA, from about 1860 to 1930, and where the unit of observation is a half-decade. The dependent variable measures the extent to which policy is pro-immigration (POLICY): the index varies from -5 to⫹5, the former reflecting severe anti-immigration restriction, including discrimination in labour markets, the latter reflecting strong pro-immigration, including large subsidies, while 0 reflects neutrality. The econometric estimation uses fixed effects, with the lagged dependent variable on the right-hand side (see table 9.4). Four variables matter most. First, policies persist: the lagged dependent variable is large and significant. However, politicians were not total prisoners of the recent political past, since the coefficient on the lagged dependent variable is 0.8, not one. Second, the lagged relative position of the unskilled at the bottom of the distribution matters. The numerator in the wage–GDP-per-worker ratio is the unskilled wage, so the ratio measures

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Table 9.4. The determinants of immigration policy, c.1860–1930 Dependent variable: POLICY

Variable

Coefficient (t-statistic)

Lagged dependent variables: POLICY (⫺ 1)

0.809*** (9.744) Lagged ratio wage to GDP per worker: w/y (⫺1) 0.015*** (2.646) Lagged real wage of the unskilled: WAGER (⫺ 1) 0.005 (0.637) Unemployment rates: UNEMP 0.009 (1.242 Trade share measure of ‘openness’: [X ⫹M]/Y 0.005 (0.800) Lagged unskilled wage, immigrant origin: IMWAGE (⫺1) ⫺ 0.028* (1.896) Lagged immigrant supply threat: THREAT (⫺1) ⫺ 0.847** (2.573) R2 0.867 Adjusted R2 0.839 SE of regression 0.911 No. of observations 56. Notes: *** refers to 1, 5 and 10 per cent significance levels. POLICY measures liberal (⫹5) versus restrictive (⫺ 5) policies toward immigration. Unit of observation is half-decade. Estimated by fixed effects, although the fixed effects coefficients are excluded from the table. See text for further discussion. Source: Timmer and Williamson (1996).

the economic distance between the bottom and the average. When the unskilled were relatively scarce (w/y was high), policy was more liberal towards immigration. When the unskilled were relatively abundant (w/y was low), New World policy was relatively restrictive. Third, a lagged rise in an immigrant threat to unskilled workers’ wages tends to generate more restrictive policy (the coefficient on lagged THREAT is negative), where THREAT is the combined influence of the immigration rate and the inverse of immigrant quality. Fourth, the quality of the immigrants relative to natives (and previous immigrants) matters with a lag. IMWAGE is calculated as the wage difference between receiving and sending countries, and the bigger the ‘quality difference’, the more restrictive the immigration policy.

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The remaining right-hand-side variables are insignificant, so we will not discuss them here, except for one: the ratio of trade to GDP ([X⫹ M]/Y). Any economist who has explored trade policy knows how difficult it is to construct a satisfying summary statistic of ‘protection’ and ‘openness’ (Anderson and Neary, 1994; Sachs and Warner, 1995; O’Rourke and Williamson, 1997; O’Rourke, 1997). We confess that the openness measure used here, [X⫹M]/Y, is a crude index of trade policy. Nonetheless, there is no evidence of a significant positive correlation between trade and immigration policy. Between 1860 and 1930, policy did not behave as if New World politicians and voters thought trade and immigration were substitutes. 6

History’s bottom line

The elegant model associated with Eli Heckscher and Bertil Ohlin makes the unambiguous statement that trade and factor mobility are substitutes. In the absence of factor mobility, trade can serve as an indirect substitute. In the presence of factor mobility, trade is no longer necessary. The issue is important for the policy implications it generates. If immigration threatens egalitarian distributions by creating labour abundance at the bottom of the distribution, immigration quotas will simply provoke more trade and a flood of ‘unfair competition’ from unskilled workers making labourintensive goods in distant lands of labour surplus from which they can no longer emigrate. If rich countries retreat behind tariff walls, there will be far more immigrants hammering at their gates since opportunities for making labour-intensive export goods at home have dried up. The economics is so plausible that it survived with little challenge over the four decades from the early post-First World War years, when Heckscher and Ohlin were writing, to 1957 when Robert Mundell published his seminal piece. In the four decades since, the challenges to that conventional wisdom have been so many that nothing but theoretical ambiguity remains. The ambiguity invites empirical analysis. It is all the more surprising, therefore, that there has been so little econometric work on the question. This chapter has started to fill the vacuum by exploring the historical experience of the Atlantic economy between 1870 and 1940. The historical bottom line is this: when we look at the long swings embedded in the time-series data, we find that trade and capital flows were rarely substitutes and often complements. The same was true for trade and migration. When we look at longer-run relationships in the panel data, we find once again that trade and capital flows were rarely substitutes and often complements. Trade and migration were never substitutes. When we

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look at immigration policy in the New World, it appears that policymakers never acted as if they viewed trade and migration as substitutes either. The history of the Atlantic economy between 1870 and 1940 rejects the thesis that trade and factor mobility were substitutes. It is a little more comfortable with the thesis that they were complements. Whether the same is true of the late twentieth century is another matter entirely, but we have attempted to show a way to discriminate between the propositions.

APPENDIX Most of the data is available in the following volumes of historical statistics compiled by B.R. Mitchell: International Historical Statistics: Europe 1750–1988 (1992, hereafter IHSE); International Historical Statistics – The Americas (1993, hereafter IHSA); International Historical Statistics – Africa, Asia and Oceania (1995, hereafter IHSAAO); and International Historical Statistics – The Americas and Australasia (1983, hereafter IHSAA). Imports and exports Generally, statistics are for merchandise trade only, and imports are valued c.i.f., whereas exports are valued f.o.b. European figures are from Mitchell, IHSE. Complete data are unavailable for Germany before 1880, and from 1871 to 1918 Alsace Lorraine is included in Germany rather than in France. Trade between Ireland and Britain is treated as international trade beginning in 1923. Canadian and US figures are from Mitchell, IHSA. Australian figures are from Mitchell, IHSAAO. GDP deflators are used to convert nominal trade figures to real trade figures in the ‘long-swing’ section of the chapter. GDP (nominal) Current-price GDP (or GNP) figures are used to scale the current-price trade figures in the panel data section of the chapter. European figures are from Mitchell, IHSE. Germany’s statistics are for net national product. Ireland is excluded from the UK total beginning in 1921. US figures are from Mitchell, IHSA. Canadian figures were extracted from data provided by Michael Bordo and used in Bordo and Jonung (1987). Australian figures are from Mitchell, IHSAAO.

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Transport costs Calculated from Isserlis (1938, table VIII). The nominal freight index (column (2)) is deflated by the Statist wholesale price index (column (6)). GDP (real) GDP levels measured in million 1990 Geary–Khamis dollars are taken from Maddison (1995, appendix C). Maddison (1995) reports GDP for the Federal Republic area only, and so overall German figures were calculated by multiplying per capita income (Maddison, 1995, appendix D) by the population figures described below. Population For Australia, Denmark, France, Italy, Norway and Sweden, annual population figures are from Maddison (1995, appendix A). For Canada, Germany, the UK and the USA, annual population figures are from Maddison (1991, appendix B). The UK figures include Ireland (from Maddison, 1995) throughout the period. Land Agricultural land is taken from Estevadeordal (1993, p.64). The figures are based on a League of Nations study for 1913 which defined agricultural land as ‘arable land, pasture, meadow and prairie, trees, shrubs and bushes, but not forests’ (Estevadeordal, 1993, p.21). These quantities are assumed constant over time. Coal Coal consumption is calculated as the sum of coal production plus coal imports minus coal exports. Brown coal is converted to hard coal equivalents using conversion factors taken from Darmstadter (1971, p.828) for each country. European data for production and trade are from Mitchell, IHSE. Canadian and US production and trade figures are from Mitchell, IHSAA. Australian production figures are from Kalix et al. (1966) and trade figures are from Mitchell, IHSAA. Tariff revenue European figures are from Mitchell, IHSE. Italian tariffs for 1870 to 1929 were kindly provided by Giovanni Federico. Canadian and US data are

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from Mitchell, IHSA. Tariff rates for Australia prior to 1901 are constructed from customs and import data available in the Victorian YearBook (various editions) for Victoria. Beginning in 1901 Australian customs revenue figures are available in Mitchell, IHSAAO. Current account The overall current balance for European countries is from Mitchell, IHSE. Australian, Canadian and US figures are from Mitchell, IHSAA. The Canadian series does not begin until 1900. Gross migration (annual) Gross annual emigration (Old World) or immigration (New World) figures are used in the time-series analysis. These statistics relate to inter-continental migration. In general, it is not possible to construct reliable net migration figures on an annual basis. European statistics are from Mitchell, IHSE. Canadian and US statistics are from Mitchell, IHSA. Australian migration figures are reported as net immigrants (that is, immigration and emigration are not reported separately) in Mitchell, IHSAAO. Net emigration (decade) For most countries these figures were estimated using a combination of census population figures and average annual rates of natural increase as described in detail in the text. However, Italian figures are taken from Bacci (1978), Australian figures are derived from the net immigration series in Mitchell, IHSAAO, and the US figures are from Eldridge and Thomas (1964). The UK figures are constructed to include Ireland throughout the period using Mitchell (1988). The panel data section of the chapter uses net emigration rates where average annual emigration is expressed as a rate per 1,000 population at the period’s beginning. NOTES We acknowledge with thanks the help of Don Davis, Riccardo Faini, Elhanan Helpman, Arye Hillman, Jim Markusen, Giani Toniolo, Tony Venables, Klaus Zimmermann and participants at the Venice conference (25–26 January 1997). This chapter has been revised extensively from the conference version. 11 Textile production is higher in Ireland than in Britain. It follows that capital–labour ratios are higher in Irish than in British textile production, which implies higher wages and lower profits in Ireland. 12 The treatment here follows Findlay (1995, ch. 1).

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13 Corden and Neary (1982) consider the impact of a Hicks-neutral technological improvement in one sector, and distinguish between the resource movement and spending effects of the associated boom. 14 As section 4 will show at greater length, this alternative approach relied on assumptions about which way factors ‘should’ flow based on Heckscher– Ohlin–Vanek (HOV) reasoning. Relative abundance or scarcity was determined by using endowment measures of labour, land and capital for each of the 10 countries in combination with the country’s share in the sample’s total GDP. As the text indicates, this second approach yielded roughly the same results as those implied by tables 9.1a–9.1c, and thus are not reported here. 15 Data sources are discussed in the appendix (p. 253). 16 The same results emerged when trade shares in GDP were regressed on factormobility rates. Furthermore, the same results emerged whether we estimated the regressions separately for mig and rlCA, or together as in tables 9.1a–9.1c in the text. 17 The tariff rate measure is crude, customs revenues relative to imports, but it should be effective enough over a long swing in the time series. 18 It is, appropriately, a deflated freight-rate index, but it is a generic world-wide index rather than a country-specific index. 19 Tables 9.2a–9.2c use a 10 per cent level in the hypothesis testing, but the same qualitative results emerge when a 5 per cent level is used. The only difference is that in the latter case some complementarity results fall into the neutral category. In short, the substitutability hypothesis is still soundly defeated. 10 As in section 3’s long-swing analysis, the sample includes Australia, Canada, Denmark, France, Germany, Italy, Norway, Sweden, the UK and the USA. 11 See Estevadeordal (1993, p.20) or Landes (1969, p. 293) for examples and justifications of this proxy. 12 If country A0 has endowment vector V and country B has endowment vector 2V, we would expect B to have a larger (unscaled) volume of trade and a larger measure of D, but the countries should have the same amount of trade/GDP and we would want them to have the same measure of D/␥, ceteris paribus. 13 Italian emigration is taken from Bacci (1978, p. 39). The US rate is taken from Eldridge and Thomas (1964). The Australian rate is calculated using net immigration figures from Mitchell (1983). We calculated net migration rates for the other seven countries using the method described in the text. 14 A previous version of this chapter took account of the direction of factor flows, rather than focusing on size exclusively. Each country in each time period was designated ‘abundant’ in a factor if its share in the total sample’s endowment exceeded its share in the total sample’s GDP. Abundant countries are expected to export that factor to close the gap between its endowment point and its factor-consumption point (assumed to be along the diagonal of the world factor ‘box’). Observing the direction of actual factor flows, we then asked whether factor flows in the ‘right’ direction decreased trade flows, as a substitutable relationship would suggest. 15 The previous version of this chapter attempted to use the lagged rate of natural increase and a New World dummy variable to instrument for the emigration rate, and used the dependency rate (proportion of population under age 15) to instrument for the current account balance (Taylor and Williamson, 1994). The current framework, which employs the absolute value of factor-flow measures, is not well suited for these instruments. Moreover, such instruments are far from exogenous.

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16 This finding is echoed in the empirical literature on trade, foreign domestic investment and multinational corporations (Grubert and Mutti, 1991). 17 This section draws heavily on Timmer and Williamson (1996).

REFERENCES Abramovitz, M. (1961). ‘The Nature and Significance of Kuznets Cycles’, Economic Development and Cultural Change, 9, 225–48 Anderson, J. and J. P. Neary (1994). ‘Measuring the Restrictiveness of Trade Policy’, The World Bank Economic Review, 8, 151–69 Bacci, M. L. (1978). ‘Fattori Demographici Dello Sviluppo Economico’, in G. Fua (ed.), Lo Sviluppo Economico in Italia, vol. II (Milan: F. Angeli) Bordo, M. and L. Jonung (1987). The Long-Run Behavior of the Velocity of Circulation (Cambridge: Cambridge University Press) Cairncross, A. (1953). Home and Foreign Investment (Cambridge: Cambridge University Press) Corden, W. M. and J. P. Neary (1982). ‘Booming Sector and De-Industrialization in a Small Open Economy’, Economic Journal, 92, 825–48 Darmstadter, J. (1971). Energy in the World Economy (Baltimore: Johns Hopkins University Press) Easterlin, R. A. (1966). ‘Economic–Demographic Interactions and Long Swings in Economic Growth’, American Economic Review, 56, 1063–4 (1968). Population, Labor Force and Long Swings in Economic Growth (New York: NBER) Eldridge, H. and D. Thomas (1964). Population Redistribution and Economic Growth, United States, 1870–1950: Demographic Analyses and Interrelations (Philadelphia: American Philosophical Society) Estevadeordal, A. (1993). ‘Historical Essays on Comparative Advantage’, PhD thesis, Harvard University, unpublished Findlay, R. F. (1995). Factor Proportions, Trade, and Growth (Cambridge, MA: MIT Press) Flam, H. and M. J. Flanders (1991). Heckscher–Ohlin Trade Theory (Cambridge, MA: MIT Press) Foreman-Peck, J. (1992). ‘A Political Economy Model of International Migration, 1815–1914’, The Manchester School, 60, 359–76 Goldin, C. (1994). ‘The Political Economy of Immigration Restriction in the US, 1890 to 1921’, in C. Goldin and G. Libecap (eds.), The Regulated Economy: A Historical Approach to Political Economy (Chicago: University of Chicago Press) Grubert, H. and J. Mutti (1991). ‘Taxes, Tariffs and Transfer Pricing in Multinational Corporate Decisions Making’, Review of Economics and Statistics, 73, 285–93 Hatton, T. J. and J. G. Williamson (1998). The Age of Mass Migration: An Economic Analysis (New York: Oxford University Press) Heckscher, E. (1919). ‘The Effect of Foreign Trade on the Distribution of Income’, Ekonomisk Tidskrift, 21, 497–512

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International Bank for Reconstruction and Development (1995). World Development Report 1995 (New York: Oxford University Press) Isserlis, L. (1938). ‘Tramp Shipping Cargoes and Freights’, Journal of the Royal Statistical Society, 101, pt. 1, 304–417 Jones, R. W. (1971). ‘A Three-Factor Model in Theory, Trade, and History’, in J. N. Bhagwati et al. (eds.), Trade, Balance of Payments, and Growth (Amsterdam: North-Holland), 3–21 Kalix, Z. (1966). Australian Mineral Industry: Production and Trade, 1842–1964 (Canberra: Bureau of Mineral Resources, Geology and Geophysics) Kelley, A. C. and J. G. Williamson (1984). What Drives Third World City Growth? (Princeton: Princeton University Press) Kemp, M. C. and M. Ohyama (1978). ‘On the Sharing of Trade Gains by Resource Poor and Resource-Rich Countries’, Journal of International Economics, 8, 93–115 Kuznets, S. (1930). Secular Movements in Production and Prices (New York: NBER) (1958). ‘Long Swings in the Growth of Population and in Related Economic Variables’, Proceedings of the American Philosophical Society, 102, 25–52 Landes, D. S. (1969). The Unbound Prometheus (Cambridge: Cambridge University Press) Lerner, A. P. (1952). ‘Factor Prices and International Trade’, Economica, 19, 1–15 Lewis, W. A. (1978). The Evolution of the International Economic Order (Princeton: Princeton University Press) Lewis, W. A. and P. J. O’Leary (1955). ‘Secular Swings in Production and Trade, 1870–1913’, The Manchester School, 13, 113–52 Maddison, A. (1991). Dynamic Forces in Capitalist Development: A Long-Run Comparative View (New York: Oxford University Press) (1995). Monitoring the World Economy, 1820–1992 (Paris: OECD) Markusen, J. R. (1983). ‘Factor Movements and Commodity Trade as Complements’, Journal of International Economics, 13, 341–56 Mitchell, B. R. (1983). International Historical Statistics: The Americas and Australasia (Detroit: Gale Research Co.) (1988). British Historical Statistics (New York: Cambridge University Press) (1992). International Historical Statistics: Europe, 1750–1988 (New York: Stockton Press) (1993). International Historical Statistics: The Americas, 1750–1988 (New York: Stockton Press) (1995). International Historical Statistics: Africa, Asia & Oceania, 1750–1988 (New York: Stockton Press) Mundell, R. A. (1957). ‘International Trade and Factor Mobility’, American Economic Review, 47, 321–35 Neary, J. P. (1995). ‘Factor Mobility and International Trade’, Canadian Journal of Economics, 28, special issue, S4–S23 O’Rourke, K. H. (1997). ‘Measuring Protection: A Cautionary Tale’, Journal of Development Economics, 53, 169–83

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O’Rourke, K. H. and J. G. Williamson (1997). ‘Around the European Periphery 1870–1913: Globalization, Schooling and Growth’, European Review of Economic History, 1, 153–90 Rostow, W. W. (1978). World Economy: History and Prospect (Austin: U n ive rs i t y of Texas Press) Rybczynski, T. M. (1955). ‘Factor Endowments and Relative Commodity Prices’, Economica, 22, 336–41 Sachs, J. D. and A. Warner (1995a). ‘Economic Reform and the Process of Global Integration’, Brookings Papers on Economic Activity, 1, 1–118 (1995b). ‘Economic Convergence and Economic Policies’, NBER, Working Paper, 5039 Samuelson, P. A. (1949). ‘International Factor–Price Equalization Once Again’, Economic Journal, 59, 181–97 Schmitz, A. P. and P. Helmberger (1970). ‘Factor Mobility and International Trade: The Case of Complementarity’, American Economic Review, 60, 761–7 Shughart, W., R. Tollison and M. Kimenyi (1986). ‘The Political Economy of Immigration Restrictions’, Yale Journal on Regulation, 51 Taylor, A. M. (1996). ‘International Capital Mobility in History: The Saving–Investment Relationship’, NBER, Working Paper, 5743 Taylor, A. M. and J. G. Williamson (1994). ‘Capital Flows to the New World as an Intergenerational Transfer’, Journal of Political Economy, 102, 348–71 Temin, P. (1966). ‘Labor Scarcity and the Problem of American Industrial Efficiency’, Journal of Economic History, 26, 277–98 Thomas, B. (1954). Migration and Economic Growth (Cambridge: Cambridge University Press) Thomas, D. S. (1941). Social and Economic Aspects of Swedish Population Movements (New York: Macmillan) Thompson, H. (1985). ‘Complementarity in a Simple General Equilibrium Production Model’, Canadian Journal of Economics, 18, 616–21 (1986). ‘Free Trade and Factor–Price Polarization’, European Economic Review, 30, 419–25 Timmer, A. and J. G. Williamson (1996). ‘Racism, Xenophobia or Markets? The Political Economy of Immigration Policy Prior to the Thirties’, NBER, Working Paper, 5867 (1997). ‘Immigration Policy Prior to the Thirties: Labor Markets, Policy Interactions and Globalization Backlash’, Department of Economics, Harvard University, March United States Bureau of the Census (1975). Historical Statistics of the United States, Colonial Times to 1970 (Washington, DC: GPO) Urquhart, M. C. (1965). Historical Statistics of Canada (Cambridge: Cambridge University Press) Venables, A. J. (1997). ‘Trade Liberalisation and Factor Mobility: An Overview’, chapter 2 in this volume Wilkinson, M. (1967). ‘Evidences of Long Swings in the Growth of Swedish Population and Related Economic Variables 1860–1965’, Journal of Economic History, 27, 17–38

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Williams, J. H. (1929). ‘The Theory of International Trade Reconsidered’, Economic Journal, 39, 195–209 Williamson, J. G. (1964). American Growth and the Balance of Payments, 1820– 1913 (Chapel Hill, NC: University of North Carolina Press) (1974). ‘Migration to the New World: Long Term Influences and Impact’, Explorations in Economic History, 11, 357–90 (1996). ‘Globalization, Convergence, and History’, Journal of Economic History, 56, 277–306 Wong, K.-Y. (1988). ‘On Choosing among Trade in Goods and International Capital and Labor Liability: A Theoretical Analysis’, Journal of International Economics, 14, 223–50 Zevin, R. B. (1992). ‘Are World Financial Markets More Open? If So Why and With What Effects?’, in T. Banuri and J. Schor (eds.), Financial Openness and National Autonomy (Oxford: Oxford University Press)

Discussion G IA NNI T ONI OL O Before reading chapter 9, the introduction of an endogenous frontier had proved to be a useful tool in my economic history classes, helping undergraduates, trained in 2⫻2 trade models, make sense of the late nineteenthcentury apparent paradox: the prima facie evidence that labour and capital flowed in the same direction, while at the same time the volume of international trade rapidly increased. After reading Collins et al., I will have to revise my syllabus. Or will I? It was over 10 years ago when Jeff Williamson embarked upon what soon became a major effort in describing, understanding and explaining the multifarious aspects of the so-called ‘first globalisation’ – the one, that is, that came to an abrupt end in August 1914. Since then, Williamson and his numerous co-authors have patiently constructed an incredibly large database on flows of goods, labour and capital as well as on prices of products, factors of production, transport and communication services. Armed with such a powerful tool, they set out systematically to tackle the many convergence issues underlying the very notion of globalisation. This effort resulted in an incredibly large output of papers – only few of which feature as references to this chapter – dealing in the first place with individual

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Williams, J. H. (1929). ‘The Theory of International Trade Reconsidered’, Economic Journal, 39, 195–209 Williamson, J. G. (1964). American Growth and the Balance of Payments, 1820– 1913 (Chapel Hill, NC: University of North Carolina Press) (1974). ‘Migration to the New World: Long Term Influences and Impact’, Explorations in Economic History, 11, 357–90 (1996). ‘Globalization, Convergence, and History’, Journal of Economic History, 56, 277–306 Wong, K.-Y. (1988). ‘On Choosing among Trade in Goods and International Capital and Labor Liability: A Theoretical Analysis’, Journal of International Economics, 14, 223–50 Zevin, R. B. (1992). ‘Are World Financial Markets More Open? If So Why and With What Effects?’, in T. Banuri and J. Schor (eds.), Financial Openness and National Autonomy (Oxford: Oxford University Press)

Discussion G IA NNI T ONI OL O Before reading chapter 9, the introduction of an endogenous frontier had proved to be a useful tool in my economic history classes, helping undergraduates, trained in 2⫻2 trade models, make sense of the late nineteenthcentury apparent paradox: the prima facie evidence that labour and capital flowed in the same direction, while at the same time the volume of international trade rapidly increased. After reading Collins et al., I will have to revise my syllabus. Or will I? It was over 10 years ago when Jeff Williamson embarked upon what soon became a major effort in describing, understanding and explaining the multifarious aspects of the so-called ‘first globalisation’ – the one, that is, that came to an abrupt end in August 1914. Since then, Williamson and his numerous co-authors have patiently constructed an incredibly large database on flows of goods, labour and capital as well as on prices of products, factors of production, transport and communication services. Armed with such a powerful tool, they set out systematically to tackle the many convergence issues underlying the very notion of globalisation. This effort resulted in an incredibly large output of papers – only few of which feature as references to this chapter – dealing in the first place with individual

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markets and then, as in the present case, with the interaction among markets. Here the question is: were trade and factor mobility complement or substitute during the first great wave of globalisation? Collins et al. remind us that, as far as theory is concerned, ‘the relationship between trade and factor mobility is ambiguous’, so that ‘trade could be complementary to migration, but a substitute for capital flows, or vice versa’ . Neither does the introduction of an endogenous frontier per se guarantee complementarity. The latter depends on the underlying assumptions; in the economic historian’s parlance, ‘the “correct” model will vary with the period being studied’ (a point as obvious as it is overlooked). So, what was the ‘correct’ model for the Atlantic economy between 1870 and 1940? The authors’ prior derived from the economic historian’s received wisdom, the one we teach our undergraduate classes: complementarity would prevail in the presence of an endogenous frontier and would decline with its slow disappearance (that is, they argue, after 1914). The empirical findings in this chapter show that this was not the case: if anything, complementarity between trade and factor flows appears more often after the Great War than before it. Neither did policy-makers believe in substitution between trade and factor mobility. In fact, empirical analysis seems to be consistent with theory in that they both remain ambiguous. Neutrality rather than complementarity or substitutability prevailed throughout: most coefficients in the trade-factormobility regressions are not significant at the 10 per cent confidence level. The authors are themselves surprised by their own results and offer only scanty tentative explanations for the unexpected outcome of their efforts. One question suggested by the results regards the most appropriate level of aggregation in dealing with the complex questions raised by the authors at the beginning of the chapter. On the one hand, ‘total trade’ is likely to be too aggregate a variable in testing complementarity or substitutability with factor mobility. Capital may be positively linked with trade if an element of transfer of embodied technology is involved but this would be captured only by imports and exports of technology-intensive goods. Likewise, labour migration may indeed increase trade in idiosyncratic consumption goods (Irish migrating to America will probably increase the imports of their favourite beer brands, at least until they learn to brew them in the host country, Italians will do the same with pasta and peeled tomatoes). At the same time, there might be sectors where substitution prevails, particularly those where large multinational companies operate. At the aggregate level these two effects may simply offset each other and disappear. On the other hand, a multi-country approach may be too disaggregate meaningfully to test the frontier hypothesis. Here it might prove fruitful to lump together in

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a single geographic unit the New-World countries on the one hand and the European countries on the other. This would be a more accurate way of testing a 2⫻3 model, by controlling – so to speak – for infra-frontier and infra-European trade and factor movements. But, of course, there are many more candidate explanations than just the frontier to account for the apparent paradox of over-time increasing (rather than decreasing) complementarity between capital flows and trade. Was it not American capital (first private then in the form of inter-allied loans) that financed those large convoys defying German U-boats? And what about Schuker’s ‘American Reparations to Germany’: were they not the engine of transatlantic trade throughout the 1920s? Then, in the 1930s, the flows of both goods and capitals dried up as a result of all sorts of barriers to trade in ‘foreign exchange controls’ : this pattern, too, would appear in the regression as a (?pseudo-)complementarity. Perhaps, for the time being, I shall just add a number of caveats to the part of my syllabus dealing with the international economy in the forty-odd years before the Great War rather than throwing it altogether into the dustbin. Incidentally, this would be very educational: a good teacher is measured by the number of problems he raises, by the food for thought he gives his students rather than by the answers–solutions he provides. The last part of the chapter deals with the intriguing issue of the end of the first globalisation, raised elsewhere by Williamson, again in a problematic way. Here I have one minor reservation about the appropriateness of the tariff variable included in the regression since, after the mid-1890s, while nominal tariffs did not change, real import duties were significantly lowered by commercial treaties and by moderate inflation. At this stage Collins et al. raise more questions than they answer and nobody is more aware of it than the three authors themselves. This chapter is nonetheless important as a yet another building block in the huge construction undertaken by Williamson et al. They are assembling facts and explanations about the zenith and nadir of the first globalisation: sooner rather than later we shall be able to see the solid and coherent building already discernible in most of its constituent parts.

10

Liberalisation and incentives for labour migration: theory with applications to NAFTA JA MES R. M ARKUSE N AND STEVE N Z AHNISE R

1

Introduction

Regionalism has been an important phenomenon in the world of international trade in the last decade. Groups of countries, typically geographically concentrated, are banding together to liberalise trade and investment among themselves. The EU is surely the furthest along, with relatively liberal provisions for labour migration added to trade and investment liberalisation. One interesting and relatively novel feature of some of the new regional trade agreements (RTAs) is that they combine partners of very different levels of development. Typically this was not the case during previous decades, when such agreements tended to be among countries of similar per capita income levels. The NAFTA was pioneering in this respect, and may be expanded to include other Latin American countries in the next few decades. Similarly, the EU will surely consider substantial liberalisations in the future with countries from Eastern Europe and the former Soviet Union. Factors which motivate and encourage these new ‘North–South’ or ‘East–West’ agreements may also differ from the older agreements among highly developed countries. The latter were in large part motivated by the objective of creating large internal markets in order to capture scale economies and other production efficiencies. But the newer agreements have a somewhat different focus. First, the developed partner(s) may be seeking a low-wage partner who can provide low-cost labour for labourintensive tasks of the developed country’s firms. The less-developed partner(s) may be seeking access to inward investment and newer technologies. A somewhat more subtle motive for the less-developed country (LDC) is to obtain ‘insurance’ against capricious policy changes by the developed countries. Lastly, the developed partner(s) may be seeking to reduce the pressures of immigration and migration from the developing partner(s).1 Some 263

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Table 10.1. Legal immigration to the USA by persons born in Mexico and deportations of Mexicans by the US border-patrol, FY 1981–95

Fiscal year

Total legal immigration

Total minus IRCA legalisations

No. of Mexicans apprehended and deported by the US border patrol

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

101,268 256,106 259,106 257,557 261,290 266,533 272,351 295,039 405,172 679,068 946,167 213,802 126,561 111,398 289,932

101,268 256,106 259,106 257,557 261,290 266,533 272,351 295,039 266,445 256,549 252,866 291,332 109,027 106,995 286,960

1,797,923 1,795,362 1,076,345 1,104,429 1,218,695 1,635,702 1,123,725 1,928,278 1,830,985 1,054,849 1,045,122 1,168,946 1,230,124 1,965,144 1,381,465

Sources: INS (various issues); INS (1996).

observers believe that influxes of workers from LDCs cause various social and economic problems in the developed countries, and the underlying strategy is to help create jobs in the LDCs in order to keep these persons and their families at home. Both the USA and the EU have experienced this type of inward movement of labour. Between 1986 and 1995, the USA admitted over 2.8 million legal immigrants from Mexico (see table 10.1). This number includes some 2 million individuals who entered the USA illegally but were granted amnesty under the terms of the 1986 Immigration Reform and Control Act (IRCA). Barring any dramatic reform of US immigration law and any substantial long-term improvement in the Mexican economy, it is not unreasonable to expect that the USA will continue to admit sizable numbers of additional legal immigrants from Mexico each year for some time to come, especially as persons originally admitted under IRCA become entitled to seek the entrance of their relatives. Undocumented migration from Mexico to the USA also continues to be substantial. No one knows with any great precision just how many Mexicans reside illegally in the USA, but widely circulated ‘guesstimates’ range between 4 and 10 million. What is certain is that undocumented

Liberalisation and incentives for labour migration 265

Mexican migration now extends to virtually every region of the USA and that this phenomenon often outmatches the resources allocated by the US government to control it. Of course, not everyone sees undocumented migration from Mexico to the USA as a problem because illegal migrants are a source of considerable profit for many US firms and farmers. The purpose of this chapter is to consider the links between trade and investment liberalisation on the one hand and the incentives for the migration of less-skilled labour on the other. The analysis will be mostly theoretical, using models firmly rooted in the stylised facts of NAFTA. Our discussion focuses largely on Mexico and the USA but not Canada, which hopefully is a forgivable transgression since undocumented migration from Mexico is a more prominent concern in the USA than in Canada. The principal question at hand is whether we should expect that trade and investment liberalisation between a developed and a less-developed partner will lead to convergence in the wages of unskilled workers between the two countries and hence reduce the incentives of workers to migrate from the less-developed to the developed country. In other words, will trade and investment liberalisation substitute for migration? Section 2 of the chapter presents a few background facts about NAFTA and the Mexican economy, especially with respect to the Mexican labour market and the country’s agricultural sector. Although it is far too early to judge the effects of NAFTA, especially in the wake of a major macroeconomic downturn in Mexico in late 1994 and 1995, we echo the widely held view that NAFTA will do little to achieve wage convergence in the next decade or two. We then outline the basic mechanism of the Heckscher–Ohlin (HO) model which argues in the other direction, in favour of wage convergence. The HO model suggests that the wages of unskilled labour in Mexico should rise and that of unskilled labour in the USA should fall following trade and/or investment liberalisation. The next three sections of the chapter outline some of the reasons why the gap between wages in the USA and Mexico may not fall, and indeed why the gap between skilled and unskilled wages may actually rise in both countries, as some evidence seems to suggest. Section 3 considers a model and associated evidence presented in two chapters by Feenstra and Hanson (1995a, 1995b). Section 4 examines a mechanism proposed by Markusen and Venables (1995, 1997a, 1997b) and Markusen (1997). Both of these models focus on a crucial role played by investment liberalisation, and both suggest the possibility of a rising skilled–unskilled wage gap in both the developed countries and LDCs. Section 5 considers three other mechanisms, all of which operate in traditional competitive, constant-returns models and all of which seem empirically relevant to NAFTA. The first is a model based on multiple techniques

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of production in agriculture – maize in particular – motivated by the observation that maize production is very capital-intensive in the USA (relative to other US sectors) and very labour-intensive in Mexico (relative to other Mexican sectors). The argument is similar to but not quite the same as one suggested by Schiff (1996), which relates tangentially to Burfisher et al. (1994) as well. The second is a simple specific-factors model developed by Neary (1995) and Markusen (1983) in which trade in goods and and trade in factors are complements. An alternative version of the specificfactors argument is presented by Schiff (1996). The final model is drawn from a suggestion by Martin (1996) that Mexican agriculture requires public infrastructure more than some other sectors, such as maquiladora assembly plants. Hence maize is a disadvantaged sector in Mexico despite being intensive in the use of the abundant factor, namely unskilled labour. Section 6 draws some conclusions. 2

NAFTA

NAFTA took effect on 1 January 1994, following the Canadian–American Free Trade (CAFTA) of the late 1980s and early 1990s. In the simplest terms, NAFTA lowered trade and investment barriers within North America but contained only minor provisions regarding labour migration. Mexico undertook substantial unilateral liberalisations during the period following 1985, so the actual reforms introduced by NAFTA were not profound in some overall sense. Most estimates put US tariffs against Mexico prior to NAFTA at about 4 per cent and Mexican protection levels at something over 10 per cent, with a variety of non-tariff barriers (NTBs) also in place. The leaders of the three signatories to NAFTA stated that the agreement aimed to increase the growth and income levels of all three countries. Trade and investment liberalisation were predicted to lead to higher incomes, investment, growth, employment and all things bright and beautiful. But it is widely believed that there was a sub-agenda guiding the agreement that was rarely stated in public, in particular regarding the USA and Mexico. Four things may have been important from the US point of view. First, there was the hope that NAFTA would improve wages in Mexico, thereby reducing the tendency of unskilled Mexican workers to migrate to the USA. But others wonder how confident the US government really was about this, and perhaps it was privately sceptical that NAFTA would have much of an impact over one or two decades on illegal migration. Second, US firms argued fairly persuasively that they needed a low-wage partner for routine, less-skilled operations such as assembly in order to compete with suppliers or branches of Japanese multinationals in LDCs. They argued, perhaps genuinely in many cases, that jobs going to Mexico would displace jobs in

Liberalisation and incentives for labour migration 267

Table 10.2. Canadian, Mexican and US civilian employment, by economic activity, 1994 (thousand persons and per cent) Agriculture, hunting, forestry and fishing ,545 Mining and quarrying ,157 Manufacturing 1,949 Electricity, gas and water ,144 Construction ,750 Wholesale and retail trade, 3,151 restaurants and hotels Transport, storage and communication ,835 Financing, insurance, real estate 1,611 and business services Community, social and personal services 4,149 Activities not adequately defined — Total

13,292

4.1 1.2 14.7 1.1 5.6 23.7

8,361 25.8 ,152 0.5 5,127 15.8 ,80 0.2 1,828 5.6 6,962 21.5

3,586 2.9 ,669 0.5 20,157 16.4 1,216 1.0 7,493 6.1 27,163 22.1

6.3 12.1

1,467 1,111

4.5 3.4

6,750 5.5 13,566 11.0

31.2

7,337 22.6 ,14 0.0

42,460 34.5 —

32,439

123,060

Source: OECD (1996b),

Asia, not in the USA. Third, some believe that the USA was greatly frustrated with the slow pace of traditional multilateral negotiations and wanted to create something of an example in order to get things moving again. A fourth explanation, and one that we favour, is that a foreign-policy objective dominated the economic ones: the USA had witnessed substantial liberalisation in Mexico in both the economic and political arenas and wanted to do something to help lock-in these reforms. Under this explanation, it is quite possible that US policy-makers had little confidence in their own statements about growth, jobs and reduced inward migration. Those issues were irrelevant. The Mexican government did make clear statements about its desire to reduce undocumented migration to the USA (‘we want to export goods, not people’), but these may have been issued largely to cultivate support for NAFTA in the USA. Many analysts believe that the Mexican government also saw NAFTA as a way to lock-in reforms that it had brought into effect. NAFTA was thus ‘insurance’ against domestic backsliding. But it is at least as likely that the Mexican government viewed NAFTA as insurance against US backsliding. The fact that late in the game Mexico seemed to give in on many bargaining points (in the face of a scare that NAFTA might not pass the US Congress) in the opinion of many reinforces this view. In any case, our point is that it is not necessarily true that either government really believed that NAFTA would reduce migration in the span of one or even two decades. Some statistics may help set the context for this chapter. Table 10.2 gives

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Table 10.3. Comparison of US and Mexican employment structures, 1988, per cent Sector of work force

Mexico

USA

Rural labour Urban unskilled labour Urban skilled labour White-collar workers Total

223.8 214.1 237.1 225.0 100.0

221.1 217.7 248.5 232.7 100.0

Source: Burfisher et al. (1994).

the distribution of civilian employment within the Canadian, Mexican and US economies. Mexico’s labour force is far more concentrated in agriculture than that of either Canada or the USA. In 1994, 25.8 per cent of the Mexican work force was occupied in agriculture, as compared to 4.1 and 2.9 per cent for Canada and the USA, respectively. In fact, the number of persons working in agriculture in Mexico is more than double that of Canada and the USA combined (8,361,000 versus 4,131,000). Moreover, agriculture’s share of the Mexican work force has held steady between 1991 and 1994.2 In contrast, the US and Canadian labour forces are distinguished by relatively high proportions employed in two categories: (1) finance, insurance, real estate and business services; and (2) community, social and professional services. Using 1988 data, Burfisher et al. (1994) further identify that Mexico’s urban labour force is much less skilled than that of the USA (see table 10.3). When one considers both urban and rural workers, it is clear that Mexico is abundant in unskilled labour relative to the USA and Canada. Although agriculture employs roughly one-quarter of Mexico’s work force, it accounts for only about 6 per cent of the country’s gross domestic product (GDP) (INEGI, 1997). Depending on the region, much of rural production is concentrated in one crop: maize (referred to as corn in the USA). Most Mexican farmers grow maize in some amount, perhaps for their private consumption if nothing else. But production is inefficient and yields are low, averaging about 2.4 metric tons per hectare (see table 10.4). Mexican yields begin to approach US and Canadian levels of roughly 7 tons per hectare for producers during the Spring–Summer growing season and when farmers have access to irrigation. Maize is also a highly protected sector in Mexico. Mexico’s bilateral import barrier on US food corn is 45.0 per cent, while the corresponding US barrier on Mexican food corn is nil (Burfisher et al., 1994). Thus we have an odd situation where the crop that uses Mexico’s abundant factor

Liberalisation and incentives for labour migration 269

Table 10.4. Canadian, Mexican and US maize production, 1992–6

Country

Year/Growing season

Area harvested (000 hectares)

Canada

1994 1993 1992 1996 1996 Spring/Summer 1995/1996 Fall/Winter 1995 1995 Spring/Summer 1994/1995 Fall/Winter 1994 1993 1992 1994 1993 1992

,955 ,985 ,858 5,921 5,059 ,862 5,855 4,748 1,107 7,853 7,536 7,249 29,508 25,464 29,169

Mexico

USA

Production (000 metric tons)

Yield (metric tons per hectare)

7,043 6,501 4,883 14,000 10,840 3,160 13,421 9,678 3,744 19,193 18,648 16,929 256,629 160,954 240,719

7.4 6.6 5.7 2.4 2.1 3.7 2.3 2.0 3.4 2.4 2.5 2.3 8.7 6.3 8.3

Note: Mexican data for 1955 and 1996 may not be strictly comparable with 1992–4 data. Sources: For 1992–4, Food and Agriculture Organization (1995); for 1995–6, Secretaria de Agricultura, Ganaderia, y Desarrollo Rural (1997).

intensively is an import-competing sector. The USA lobbied hard for reform to the various forms of maize protection and basically got its way, phased in over a number of years (initially 15, but Mexico has apparently speeded this up). Mexico also has high protection levels on what are sometimes called ‘program crops’ in the USA because they are subject to special agricultural programmes. These include feed corn, food grains, soybeans and cotton. Mexico’s bilateral barrier on such crops from the USA is 12.9 per cent, while the corresponding US barrier is again zero. This characterisation of a major part of Mexican agriculture as highly protected yet intensive in unskilled labour is both tremendously important for discussing the possible effects of NAFTA on migration to the USA and also somewhat of a puzzle for economic theory. Most trade economists’ quick intuition about trade policy is derived from the HO model. In that simple, two-sector, two-good, two-country model, each country exports the good whose production intensively uses its abundant factor. This apparently contradicts the Mexican situation if we think of two goods, maize and

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a ‘composite’ good, and two factors, unskilled labour and a composite factor. Trade liberalisation should raise the return to each country’s abundant factor, and hence unskilled labour in Mexico should benefit. Few analysts seem to believe that the HO story is the right one. There is the problem with maize and several other crops, as we just noted. We will attempt to model this more in section 5. But there are also doubts regarding the prospects for workers in Mexican manufacturing. Some believe that liberalisation will tend to favour more-skilled Mexican workers rather than the less-skilled in manufacturing. These ideas will be discussed in sections 3 and 4. Three additional aspects of the Mexican economy further complicate the evaluation of NAFTA. First, the Mexican population is much younger that that of its two NAFTA partners and is growing at a faster, albeit decelerating, rate (see table 10.5). In 1995, the median age in Mexico was 21.7 years, in contrast to 34.7 in Canada and 34.2 in the USA. Mexico implemented family-planning policies a decade or two later than other middle-income countries such as Taiwan and South Korea, and this delay is reflected in the high growth rate of its population. Mexico has made tremendous strides in this area, and recent figures indicate that the country’s population growth rate has slowed to 1.8 per cent (Associated Press, 1996). Nevertheless, the large number of young Mexicans who enter the work force each year both expands the pool of prospective migrants and is likely to exert a downward pressure on Mexican wages. Second, high rates of unemployment and under-employment are enduring features of the Mexican economy. During the last 10 years, Mexico’s combined rate of unemployment and under-employment has never dipped below 20 per cent, and the rate often exceeded 25 per cent (see table 10.6). In the face of such phenomena, along with the demographic characteristics described above, less-skilled Mexican workers may not experience dramatic increases in their wages or employment levels, even if post-NAFTA changes in the relative demand for their labour conform to those found in the HO model. Third, Mexico suffered a devastating macroeconomic disruption in late 1994 and 1995, less than a year after NAFTA’s implementation.3 We do not believe that NAFTA was the primary cause of this crisis, but we do view the agreement as one of a multitude of factors that entered into play. It is also important to note that the crisis abruptly terminated a sixyear period during which real per capita income in Mexico rose modestly. Between 1988 and 1994, real income climbed from 17,327 to 18,491 new pesos per capita, as expressed in 1995 prices (see table 10.6). This period of rising incomes falls neatly within the broader period of

Table 10.5. Population, median age and population growth in the three NAFTA countries, estimates and projections, 1970–2025 Total population (000)

Median age (years)

Population growth rate (per cent)

Year

Canada

Mexico

USA

Canada

Mexico

USA

Period

Canada

Mexico

USA

Estimates 1970 1975 1980 1985 1990

24,324 22,727 24,070 25,181 26,639

250,328 258,876 267,046 275,594 284,486

205,051 215,972 227,757 238,466 249,975

26.0 27.5 29.3 31.4 33.1

16.6 16.6 17.5 18.6 20.0

27.9 28.7 30.0 31.5 32.9

1965–70 1970–5 1975–80 1980–5 1985–90

1.61 1.27 1.15 0.90 1.13

3.21 3.14 2.60 2.40 2.22

1.08 1.04 1.06 0.92 0.94

Projectionsa 1995 2000 2005 2010 2015 2020 2025

28,537 30,425 32,293 34,070 35,674 37,125 38,356

293,670 102,555 110,810 118,455 125,484 131,885 137,783

261,138 275,324 285,931 296,089 305,622 314,541 322,007

34.7 36.2 37.2 37.9 38.6 39.2 39.9

21.7 23.2 24.8 26.5 28.3 30.1 32.0

34.2 35.5 36.6 37.4 38.1 38.8 39.5

1990–5 1995–2000 2000–5 2005–10 2010–15 2015–20 2020–5

1.38 1.28 1.19 1.07 0.92 0.80 0.65

2.06 1.81 1.55 1.33 1.15 0.99 0.83

1.03 0.90 0.76 0.70 0.63 0.57 0.47

Note: a Projections are the medium-variant projections. Source: United Nations (1993).

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Table 10.6. Selected economic statistics for Mexico, 1980–95

Year

GDP (millions of new pesos, 1995 prices)

Population (mid-year estimate, millions)

Real GDP per capita (new pesos, 1995 prices)

Under-employment and unemployment rate (per cent)

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

1,323,964 1,429,169 1,420,066 1,360,750 1,408,615 1,444,146 1,391,585 1,416,837 1,435,337 1,482,613 1,549,565 1,605,943 1,650.285 1,661,285 1,719,879 1,600,953

69.66 71.35 73.02 74.67 76.31 77.94 79.57 81.20 82.84 84.27 86.15 87.84 89.54 91.21 93.01 94.78

19.006 20.030 19.448 18.224 18.459 18.529 17.489 17.449 17.327 17.594 17.987 18.283 18.431 18.219 18.491 16.891

— — — — — — — 25.6 24.1 21.8 22.1 21.2 23.6 23.5 27.8 27.2

Note: Under-employment and unemployment rate indicates proportion of economically active population that was either unemployed or employed for less than 35 hours per week in sampled urban areas. The figures displayed are for the second quarter of the given calendar year. Sources: For GDP and population figures, International Monetary Fund (1997); for under-employment and unemployment rate, INEGI, Encuesta Nacional de Empleo, as cited in INEGI (1997).

Mexican liberalisation that we outlined above. However, even at the end of this six-year period, real per capita income still had not returned to its 1980 level. We end this section on a note of caution. Unfortunately, it is much too early to assess the effects of NAFTA. After all, even given the various complexities of the Mexican economy, the agreement is still only three years old. However, there is some hope for prompt empirical work on the subject of Mexican liberalisation, insofar as many Mexican reforms predated NAFTA by as much as 10 years. In any case, we expect that most experts would concur that NAFTA is unlikely to have much of an effect in reducing Mexico–US migration over at least the next decade.

Liberalisation and incentives for labour migration 273

3

Investment liberalisation and income distribution: I – the Feenstra–Hanson model

In this section and the next, we focus largely on manufacturing. We consider some evidence and associated theory that suggests that NAFTA may do little to help less-skilled workers in Mexico and hence have little effect on the tendency for these workers to seek jobs in the USA over the short to medium term. Evidence is present in a number of studies, including Feenstra and Hanson (1995a, 1995b), Aitken et al. (1994), Aitken et al. (1995), Hanson and Harrison (1995) and OECD (1996a), that foreign firms pay higher wages, with a higher share of wages going to more-skilled workers, and that wages gaps in manufacturing between skilled and unskilled workers have increased since Mexican liberalisation began in the mid-1980s.4 Table 10.7 reproduces data from Feenstra and Hanson (1995b). They use production and non-production workers as proxies for skilled and unskilled workers which is subject to limitations of which they are surely aware. The table shows the ratio of non-production to production wages and the share of non-production wages in total wages. The years 1970–85 were years of high protection in Mexico, with substantial liberalisations beginning about 1984. The data indicate that the ‘wage gap’ (the ratio of non-production to production wages) fell in all regions between 1975 and 1985, and that the share of non-production wages rose modestly. The big change occurred after 1985, with the wage gap rising significantly in all regions and the non-production share rising in all regions except the North. The largest increases in both measures is in the Mexico–US border region, where liberalisation in both trade and investment barriers had by far the largest impact. Tables 10. 8 and 10.9 present more recent data on changing compensation levels in the Mexican economy. Between 1985 and 1993, the overall pattern is one of shrinking levels of real compensation per employee from 1985 to 1988 and recovering levels thereafter (see table 10.8). The net increase in the average annual compensation per salaried employee over this eight-year period was a mere 1.8 per cent. Workers in agriculture fared extremely poorly. The average level of real anuual compensation in the sector dropped by 35.8 per cent between 1985 and 1993, to a meagre 2,776 new pesos per salaried employee. Workers in construction and commerce also experienced a net decline in their average compensation, while manufacturing employees received a net increase. More detailed evidence pertaining to the manufacturing sector is found in table 10.9. These data indicate that the average real compensation level in Mexican manufacturing climbed 45.0 per cent between 1987 and 1994,

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Table 10.7. Relative wage and wage shares, by Mexican region, 1975–88 Non-production wage/ Production wage

Non-production share of total wages

Region

Year

Level

Change (per cent)

Level

Change (per cent)

Border

1975 1980 1985 1988

2,104 2,048 2,073 2,517

⫺ 0.537 0.245 6.464

0,342 0,365 0,373 0,415

0.477 0.154 1.398

1975 1980 1985 1988

1,963 1,964 1,813 2,085

0.011 ⫺ 1.599 4.659

0,304 0,335 0,358 0,353

0.632 0.453 ⫺ 0.178

1975 1980 1985 1988

1,838 1,824 1,719 2,085

⫺ 0.156 ⫺ 1.181 3.048

0,313 0,330 0,341 0,363

0.329 0.230 0.733

1975 1980 1985 1988

2,145 2,022 1,772 2,137

⫺ 1.185 ⫺ 2.634 6.237

0,416 0,410 0,435 0,466

⫺ 0.117 0.482 1.055

1975 1980 1985 1988

2,090 1,518 1,530 1,699

⫺ 6.400 0.159 3.490

0,288 0,292 0,313 0,330

0.075 0.425 0.568

North

Centre

Mexico City

South

Source: Feenstra and Hanson (1995b, table 2).

from 3,180 to 4,610 new pesos per month, as measured in June 1995 prices. The three manufacturing sectors that provided the highest levels of compensation in 1994 are also ones that require workers with particular technical skills: chemicals, petroleum derivatives and rubber and plastic products (V); non-metallic mineral products (VI); and basic metal industries (VII). Table 10.9 also contains separate measures of compensation for production and non-production workers. For manufacturing as a whole, the compensation gap between the two groups widened between 1987 and 1994, from 1,830 to 3,820 new pesos per month. In the three manufacturing sectors mentioned above, as well as in metal products, machinery and equipment (VIII), the difference in compensation between production and

Table 10.8. Average annual compensation, by sector, 1980–93 (new pesos per salaried employee, 1995 prices)

Year

Total

Agriculture, poultry and fishing

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 (P) 1993 (P)

22,290 29,892 25,753 20,783 18,010 19,571 17,633 17,352 15,810 16,606 17,076 17,643 19,009 19,922

4,658 6,376 5,391 4,563 3,957 4,321 4,315 4,030 3,433 3,281 3,143 2,911 2,831 2,776

ManuMining facturing

Electricity gas and Construction water

40,562 52,917 43,118 34,775 29,579 35,545 30,383 30,074 28,248 27,897 27,056 27,091 29,129 27,044

26,912 34,744 27,929 23,705 20,249 21,958 19,508 18,911 16,587 15,838 15,743 16,036 16,709 17,219

37,332 49,076 43,192 35,055 30,012 32,782 30,028 29,883 29,709 31,681 32,820 34,562 37,502 38,952

282,998 108,897 101,189 279,547 261,940 264,072 255,706 261,516 251,473 251,435 251,401 253,582 259,532 264,894

Transportation Commerce, warehouses, restaurants and commuand hotels nication

Financial services, insurance and real estate

Community social and personal services

23,031 29,836 24,225 20,826 17,711 19,040 17,093 16,197 14,323 14,756 14,696 15,017 15,306 16,057

51,635 68,672 58,987 47,145 41,097 45,385 42,301 44,097 40,066 42,518 46,280 50,685 56,879 63,396

26,662 36,246 31,850 25,149 22,063 23,832 20,715 20,575 18,438 19,995 20,523 21,700 24,097 26,030

31,023 41,712 34,634 30,409 26,233 28,756 26,290 25,921 25,629 25,592 24,496 24,965 26,171 26,531

Note: P ⫽Provisional. Source: INEGI, Dirección General de Contalbilidad Nacional, Estudios Socioeconómicos y Precios; and Dirección de Contabilidad Nacional, Sistema de Cuentas Nacionales de Mexico (various years); both as cited INEDI (1996), Cuadro 4.5.

Table 10.9. Monthly compensation per worker in Mexican manufacturing, 129 classes of activity, 1987–95

All manufacturing

Food products, beverages and tobacco (I)

Textiles, clothing and leather industry (II)

Wood industries and wood products (III)

Year

NonNonNonNonProduction production Production production Production production Production production Total workers workers Total workers workers Total workers workers Total workers workers

1987 1988 1989 1990 1991 1992 1993 1994 1995 (P)

3.18 3.26 3.53 3.64 3.96 4.21 4.43 4.61 3.99

1.71 1.70 1.76 1.79 1.79 1.91 1.97 2.05 1.66

3.54 3.71 4.10 4.41 4.87 5.32 5.64 5.87 5.08

Paper, paper products, printed matter and editorial material (IV)

2.76 2.47 2.80 2.85 3.08 3.34 3.75 3.90 3.26

1.46 1.51 1.59 1.60 1.62 1.68 1.80 1.83 1.52

2.74 2.76 3.21 3.45 3.71 4.04 4.42 4.66 3.72

Chemicals, petroleum derivatives, and rubber and plastic products (V)

2.14 2.21 2.41 2.35 2.49 2.60 2.66 2.82 2.16

1.49 1.49 1.57 1.45 1.43 1.49 1.49 1.56 1.18

2.48 2.51 2.78 2.92 3.18 3.55 3.63 3.79 2.88

Year 1987 1988 1989 1990 1991 1992 1993 1994 1995 (P)

3.27 3.51 3.66 3.61 5.21 4.18 4.15 4.16 3.45

3.51 3.97 4.10 4.39 4.76 5.41 5.42 5.53 4.65

Basic metal industries (VII)

4.03 4.21 4.53 4.68 4.97 5.60 5.65 6.05 5.47

2.01 2.05 2.16 2.11 2.19 2.39 2.30 2.44 2.08

4.11 4.36 4.84 5.02 5.45 6.08 6.55 6.85 6.13

3.93 4.14 4.21 4.52 4.92 5.36 5.59 5.78 5.16

Metal products, machinery, and equipment (VIII)

2.01 2.00 1.91 1.93 1.96 2.12 2.24 2.36 2.02

Other manufacturing industries (IX)

Year 1987 1988 1989 1990 1991 1992 1993 1994 1995 (P)

4.19 4.14 4.55 4.74 5.27 5.78 6.26 6.05 5.22

3.99 4.49 4.57 5.02 5.99 6.31 6.67 6.78 5.66

3.22 3.23 3.52 3.69 3.91 4.18 4.46 4.58 3.97

1.63 1.57 1.63 1.84 1.80 1.93 2.05 2.13 1.62

3.63 3.71 4.17 4.60 5.19 5.59 5.94 6.24 5.53

2.53 2.41 2.77 2.89 3.20 3.26 3.45 3.74 2.77

4.63 4.92 5.24 5.85 6.43 7.28 7.87 7.79 7.35

NonNonNonProduction production Production production Production production Total workers workers Total workers workers Total workers workers 2.11 2.14 2.08 2.04 2.01 2.23 2.30 2.41 2.08

1.35 1.21 1.22 1.31 1.33 1.34 1.34 1.24 0.95

Non-metallic mineral products except those derived from petroleum or carbon (VI)

NonNonNonProduction production Production production Production production Total workers workers Total workers workers Total workers workers 1.94 1.81 1.93 1.81 1.85 1.98 1.97 1.90 1.60

2.05 1.97 2.05 2.17 2.27 2.35 2.49 2.47 1.89

2.47 2.40 2.64 2.58 2.81 3.09 3.41 3.56 3.22

1.26 1.22 1.29 1.27 1.32 1.53 1.68 1.65 1.29

3.44 3.40 3.78 3.96 4.27 4.72 5.06 5.20 4.39

Notes: Observations are for the month of June of each calendar year. Figures for total compensation per worker include benefits, while those for production and non-production workers do not. P⫽Provisional. Source: INEGI, Encuesta Industrial Mensual, as cited in INEGI (1997).

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Table 10.10. Foreign investment in Mexico, 1980–95 (millions of US dollars) Direct foreign investment (flows) Year

Total

USA

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

1,622.8 1,701.1 ,626.5 ,683.7 1,429.8 1,729.0 2,424.2 3,877.2 3,157.1 2,499.7 3,722.4 3,565.0 3,599.6 4,900.1 8,026.2 6,534.4

1,078.6 1,072.1 ,426.1 ,266.6 ,912.0 1,326.8 1,206.4 2,669.6 1,241.6 1,813.9 2,308.0 2,386.1 1,651.7 3,503.6 4,004.5 4,176.3

Canada 17.5 5.2 8.1 22.1 32.5 34.9 40.6 19.3 33.9 37.4 56.1 74.2 88.4 74.2 163.5 77.9

Net foreign investment (stock) Total

USA

Canada

8,458.8 10,159.9 10,786.4 11,470.1 12,899.9 14,628.9 17,053.1 20,930.3 24,087.4 26,587.1 30,309.5 33,874.5 37,474.1 42,374.2 50,400.4 —

5,836.6 6,908.7 7,334.8 7,601.4 8,513.4 9,840.2 11,046.6 13,716.2 14,957.8 16,771.7 19,079.7 21,465.8 23,117.5 26,621.1 30,625.6 —

126.9 132.1 140.2 162.3 194.8 229.7 270.3 289.6 323.5 360.9 417.0 491.2 579.6 653.8 817.3 —

Notes: Net foreign investment does not include investments in the stock market nor foreign capital derived from authorisations granted by the Comisión Nacional de Inversiones to firms that participate in the stock market. 1995 figures for direct investment include certain maquiladora imports. Source: SECOFI, Dirección General de Inversión Extranjera, as cited in INEGI (1997).

non-production workers exceeded 4,000 new pesos per month in 1994, with a gap of 5,430 new pesos existing in the non-metallic mineral products sector. Two broad patterns in wage movements are thus apparent during the first decade of Mexican liberalisation (1985–94). First, wages diverged across different sectors of the Mexican economy. Compensation levels in agriculture, construction and commerce actually shrank during the 1985–93 period, and these sectors have high concentrations of less-skilled workers. A similar pattern of divergence existed among various sectors within manufacturing. Second, the compensation gap for production and non-production workers within manufacturing widened, particularly in sectors where overall compensation levels increased the most. Finally, we

Liberalisation and incentives for labour migration 279

note that there was a large jump in foreign investment following liberalisation after 1985 (table 10.10), coincident with the wage movements just discussed. Econometric analysis by Feenstra and Hanson provides strong support for the hypothesis that foreign investment leads to an increase in the wage gap and the non-production wage share in Mexican manufacturing. But this is again apparently at odds with the HO model, insofar as less-skilled labour would seem to be Mexico’s abundant factor. Furthermore, it has been widely observed that the wage gap is rising in the USA (reviews of the literature and evidence are found in Freeman, 1995; Richardson, 1995; Wood, 1994, 1995). According to HO theory, the factor–price ratios should move in opposite directions in the two countries, as the return to the abundant factor rises in each country. Feenstra and Hanson provide an intriguing model, and indeed a model that is very much in the tradition of HO, to explain this phenomenon. The model has three factors: capital, skilled labour and unskilled labour. There is a single composite consumption commodity that is ‘assembled’ from a continuum of intermediate inputs. All these intermediate inputs have the same capital intensity but may be ranked according to skilled-labour intensity. The authors assume that initially Mexico has a higher return to capital than the USA. There is a dividing point in the continuum of intermediates, with less-skilled-labour-intensive goods produced in Mexico and moreskilled-labour-intensive goods produced in the USA. The effect of investment liberalisation is to move capital from the USA to Mexico. This lowers the cost of producing all intermediates in Mexico and raises it in the USA. In equilibrium, it shifts the dividing line in the continuum toward Mexico. More goods are produced in Mexico. The situation is illustrated in figure 10.1, where the horizontal axis indexes the commodities, with the least-skilled-labour-intensive goods on the left. There is some initial (pre-liberalisation) dividing line in the continuum as shown. Liberalisation shifts this dividing line to the right. But now we have the crucial insight. The goods shifted are relatively skilled-labour-intensive from Mexico’s point of view (they are to the right of the goods that Mexico was producing), but they are unskilled-labour-intensive from the US point of view (they are to the left of the goods that the USA continues to produce). The effect is thus to raise the relative demand for skilled labour in both Mexico and the USA. The relative wage of skilled labour will rise in both countries in equilibrium. Empirical results in the chapter provide support for the simple, ingenious model. However, they do not provide support for the notion that NAFTA will mitigate the problem of unskilled-labour migration to the USA.

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Figure 10.1 Investment liberalisation and wage gaps: the Feenstra–Hanson model

4

Investment liberalisation and income distribution: II – the Markusen–Venables model

A second approach to the wage-gap issue explicitly considers the role and structure of multinationals (Markusen and Venables, 1995, 1997a, 1997b; Markusen, 1997). Some features of the basic model, expanded in the latter paper to include vertical multinationals, are as follows: 1. Two homogeneous goods, X and Y Two countries, h and t Two factors, unskilled labour: L skilled labour: S 2. Y – competitive, constant returns to scale, L-intensive 3. X – imperfectly competitive, increasing returns to scale, S-intensive overall ‘Headquarters’ and ‘plant’ may be geographically separated; A firms may have plants in one or both countries 4. There are six firm types, with free entry and exit into and out of firm types; regime denotes a set of firm types active in equilibrium: Type mh – horizontal multinationals which maintain plants in both countries, headquarters is located in country h Type mf – horizontal multinationals which maintain plants in both countries, headquarters is located in country f Type nh – national firms that maintain a single plant and headquarters in country h; type-nh firms may or may not export to country f

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Type nf – national firms that maintain a single plant and headquarters in country f; type-nf firms may or may not export to country h Type vh – vertical multinationals that maintain a single plant in country f, headquarters in country h; type-vh firms may or may not export to country h Type vf – vertical multinationals that maintain a single plant in country h, headquarters in country h; type-vf firms may or may not export to country f Crucial to the story are assumptions concerning the factor intensities of various activities. In this we draw indirect inferences from a number of empirical sources, including Feenstra and Hanson (1995a, 1995b), Blomstrom and Wolff (1994); Slaughter (1995). First, assume that X-sector production is skilled-labour-intensive overall relative to the Y-sector. The second crucial assumption is that branch plants (e.g. plants of US firms in Mexico) are more skilled-labour-intensive than the Y-sector but less skilled-labour-intensive than local integrated X-producers. The branch plants need local managers, engineers, technicians and so forth, and these requirements make them more skilled-labour-intensive than composite Yproduction. But much of the branch plants’ skilled-labour requirements are nevertheless supplied from the home firm (e.g. the US parent). There is a transfer of ‘producer services’ from the home firm to the subsidiary in the form of research and development and other assets. The third assumption is that two-plant multinational firms require more skilled labour in their headquarters than the one-plant firms. These represent the ‘technology transfer’ costs of doing business abroad. Fourth, headquarters’ activities are more skilled-labour-intensive than a production plant (indeed, headquarters use only skilled labour in the model). The full set of factor-intensity assumptions are as follows: Factor-intensity assumptions: ranked from most skilled-labour-intensive to least skilled-labour-intensive Activities [headquarters] ⬎[integrated X]⬎[branch plant]⬎[Y] Firm Types [type-m firms]⬎[type-v and type-n firms] Operations within a country [local type-v firm]⬎[local type-m firm]⬎[local type-n firm]⬎ [plant of foreign type-m or type-v firm]⬎[Y] The consequences of trade and investment liberalisation in this model depend very much on the initial parameters. If trade costs are high, investment liberalisation involves the creation of type-m firm if the two countries

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Figure 10.2 Investment liberalisation and wage gaps: the Markusen–Venables model (activity shifts)

are not extremely different, with headquarters concentrated in the skilled-labour-abundant country. If trade costs are low, investment liberalisation results in the entry of type-v firms if countries differ significantly in relative endowments, with their headquarters in the skilled-labourabundant country and their single plant in the unskilled-labour-abundant country. Consider a parameterisation of the model which resembles the US–Mexico situation, with the countries referred to as the north and the south. The north is skilled-labour-abundant and large, and the south is unskilled-labour-abundant and small. Figure 10.2 presents a general outline of the effects of investment liberalisation given such an initial situation. These results are qualitatively independent of whether or not trade is also liberalised or restricted. The horizontal axis of Figure 10.2 ranks three activities according to their skilled-labour intensity, Y-production being the least skilled-labour-intensive, then final X-production and then headquarters’ services. In the initial protected situation in which multinationals cannot exist, the south produces little or no X, since it is severely short of skilled labour for headquarters’ activities. Investment liberalisation leads to branch plants of type-m (higher trade costs) or type-v firms (lower trade costs) headquartered in the north. But since the south was not producing much or any X initially, resources for the branch plants are drawn from the Y-sector. But

Liberalisation and incentives for labour migration 283

Figure 10.3 Investment liberalisation and wage gaps: the Markusen–Venables model (factor-price effects)

the branch plants are more skilled-labour-intensive than Y, since the plants require managers, engineers, technicians and so forth, as we noted above. Thus investment liberalisation increases the demand for skilled labour in the south. Under the assumptions noted, local skilled labour is a complement, not a substitute, for the imported producer services produced with northern skilled labour. The relative wage of skilled labour can rise in the south in equilibrium. The situation in the north is perhaps more intuitive. It is the skilledlabour-abundant region, and initially it has a relatively low price for skilled labour. Investment liberalisation leads to a shift of headquarters toward the north and a shift of X-production toward the south. Even if all headquarters are initially in the north (no southern X-production), liberalisation is analogous to a cost reduction or positive technical change, so the sector expands with more headquarters’ activities in the north in the new equilibrium. This, of course, increases the relative demand for skilled labour in the north, with some of the unskilled labour released from the X-production being ‘soaked up’ by the Y-sector. Figure 10.3 presents for the sake of completeness the ‘world’ factor box, with country h measured from the southwest corner and the country f from the northeast corner. This is a rough composite of the results of investment liberalisation for different levels of trade costs. We see substantial regions

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in which the wage of skilled labour rises in both countries. This is particularly likely to occur when one country is both larger and skilled-labourabundant. If we are near the top and to the right of centre of the box, for example, country h is the north (e.g. the USA) and country f is the south (e.g. Mexico). One final point should be noted. In this type of model, it is quite possible for the efficiency gains associated with liberalisation to lead to an increase in the prices of both factors. Still, the overall message of this model is not to assume that the HO mechanism will operate in favour of unskilled labour in the south and decreased incentives for migration. 5

Technology and the maize sector

In this section, we focus on some aspects of the maize sector in Mexico, since the reforms in that sector plus trade liberalisation through NAFTA are possibly the greatest force operating to send more, not fewer, unskilled Mexicans northward. The first feature about this sector is that it is very labour-intensive in Mexico and very capital-intensive in the USA. While we do not have precise statistics on this point, we believe that is true not just in the cross-country comparison, but also within in each country. That is, cereal grain production in the USA is relatively capital-intensive relative to many other US tradable sectors, and maize production is labour-intensive in Mexico relative to other tradable sectors there. This suggests a model based on multiple techniques of production in the maize sector. A very capital-intensive technique exists (and is clearly available to Mexican farmers) and a labour-intensive technique exists. The technique adopted in a country depends on factor prices, which in turn depend on relative endowments. The situation is shown in figure 10.4, for an initial equilibrium with positive protection. There is the agricultural sector and a composite Y-sector. The unit value isoquant for Y lies between the unit-value isoquants for the more capital-intensive technique and the labour-intensive technique. There exist two ‘cones of diversification’ in the diagram, one producing Y and agriculture with the capital-intensive technique and one producing Y and agriculture with the labour-intensive technique. We assume in the initial equilibrium that the north’s factor endowment lies in the former (upper) cone and that the south’s factor endowment lies in the latter (lower) cone. The initial factor–price ratios are as shown in figure 10.4, with the north having a relatively high wage–rental ratio and the south having a low wage–rental ratio. Note that from each country’s point of view, the unused technique is not profitable at equilibrium factor prices. We assume that in

Liberalisation and incentives for labour migration 285

Figure 10.4 Competitive model with multiple techniques of agricultural production

the initial protected equilibrium, the north exports agriculture and imports the composite (in fact, Mexican protection was so high that there was virtually no trade in maize). Now consider tariff reduction for one or both countries, using Y as the numeraire for expositional convenience. The results are shown in figure 10.5. The price of agriculture (maize) rises in the north, shifting its unitvalue isoquant inward. The price of maize falls in the south, shifting its unit value isoquant outward. The effect of these changes on the relative prices of factors moves in the same direction in the two countries. The wage–rental ratio falls in both the north and the south because, from each of their points of view, the price of the capital-intensive good has risen. Mexican labour may of course still gain somewhat relative to US unskilled labour, but the effect is not going to be dramatic and could go the other way. In order to verify that such an outcome is indeed possible, we constructed a simple numerical example using Rutherford’s (1994, 1995) non-linear complementarity solver. Complementarity is necessary for the problem, because we need to verify that each country does not choose to use the other available technique and more generally that the proposed solution is indeed the equilibrium. The model was benchmarked initially with 20 per cent import tariffs in both directions.

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Figure 10.5 Competitive model with multiple techniques of agricultural production: trade liberalisation

Results for the simulations are shown in table 10.11, where the first row for tariff 0.20 is the benchmark replication. Factor prices are reported in real terms, the nominal price divided by the consumer price index (the unit expenditure function). At all levels of protection, neither country shifts to the alternative maize technique. Results of the simulations are as suggested in figure 10.5. Tariff reduction reduces the real wage of labour in both countries, but raises the real return to capital. The real wage is reduced somewhat proportionately less in the south, but there is little wage convergence. Specialisation is reached at a tariff rate of about 0.08. Note that for further reductions in the tariff, the relative factor prices in the two countries remain unchanged, but the real prices of all factors rise somewhat, reflecting the capture of further gains from trade (eliminating the consumption distortions even though production ceases to change). The countries are sufficiently different in this example that there is no factor-price equalisation (FPE) at free trade. This example is suggestive, but obviously needs some empirical work. But as in the case of the Feenstra–Hanson model, it is firmly rooted in traditional HO theory, if differing from the very narrow HO model. The latter has been used by several authors to argue that factor-proportions trade theory is false, because it is inconsistent with the stylised facts.

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Table 10.11. Simulation results for the alternative-technologies model Tariff

wh

wf

rh

rf

wh /rh

wf /rf

0.20 0.18 0.16 0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00

2.00 1.91 1.83 1.74 1.66 1.58 1.56 1.57 1.59 1.60 1.62

1.00 0.98 0.95 0.93 0.91 0.89 0.89 0.90 0.91 0.92 0.93

1.00 1.03 1.06 1.09 1.12 1.15 1.17 1.18 1.19 1.20 1.21

2.00 2.08 2.17 2.25 2.35 2.44 2.49 2.52 2.54 2.56 2.59

2.00 1.86 1.73 1.61 1.47 1.37 1.33 1.33 1.33 1.33 1.33

0.50 0.47 0.44 0.41 0.39 0.36 0.36 0.36 0.36 0.36 0.36

Notes: a Factor prices are in real units: price divided by the consumer price index. b Specialisation is reached at a tariff near 0.08. After that point, trade liberalisation does not affect relative factor prices in the two countries.

A second way of thinking about the maize sector uses the specific-factors model, drawing on ideas in Markusen (1983) and Neary (1995). Suppose that we once again view the Mexican economy as having a maize sector and a composite sector. Maize uses a specific factor, R, and the composite sector uses a specific factor, K. Labour is homogeneous, and can be used in maize (M) or the composite sector (C) or it can migrate to the USA. Assume that initially, trade protection raises the price of maize and that investment restrictions limit foreign investment in C. Figure 10.6 gives the familiar cross-diagram, with the value-of-marginalproduct curves for maize and the composite, with the labour input to maize measured from the left-hand axis and the labour input to C measured from the right-hand axis. The heavy lines give the initial marginal product curves in the protected equilibrium. The twist on the standard story is that there is an ‘outside option’, indicated by the US wage, drawn as a horizontal line in figure 10.6. The initial equilibrium allocation of Mexican labour between M, C and migration is given by the intersection of the M and C value-ofmarginal-product curves with the US wage line. There are some complicated issues here about price indices in determining real wages, such as whether or not migrant workers use US prices or Mexican prices to evaluate their wages. Indeed, one should probably use different urban and rural price indices within Mexico. In order to get the idea across, we will ignore this important difficulty here and assume that

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Figure 10.6

Specific-factors model with an outside opportunity

the same price index is used regardless of whether one is a C-worker, an Mworker or a migrant. This assumption in turn allows us to ignore the price index altogether: the price index affects real income, but not the allocation of labour among the three activities. Adopt the price of C, as the numeraire. Trade liberalisation drops the price of the protected good, in this case maize. This is shown as a downward shift in the value-of-marginal-product curve (the price of maize times the physical marginal product) for maize in figure 10.6. Under the assumption that the US wage does not change, the new equilibrium must involve a shift in Mexican labour from the rural maize sector to the USA, with no change in the labour allocated to C. Trade liberalisation worsens the migration problem. Investment liberalisation, on the other hand, shifts up the value-of-marginal-product curve for C in figure 10.6 by bringing sector-specific capital into the C-sector. The C-sector expands and all of the expansion is in the form of reduced labour migration, rural employment is held constant. Investment liberalisation can in this way relieve some of the migration pressure. Many variations on this theme can be presented. Obviously, many factors are ignored, including the price-index issue and the issue of the multiple types of labour which formed the focus of section 4. Our purpose here is not to suggest what the exact effects of NAFTA might be, but rather to suggest some empirically relevant possibilities, as we noted earlier. Figure 10.6 also serves the function of emphasising that trade and

Liberalisation and incentives for labour migration 289

Figure 10.7

Model with a public intermediate good: public infrastructure

investment liberalisation might have quite different effects, contrary to the symmetry between the two in the HO model. A final suggestion about the agriculture–migration dilemma is drawn from Martin (1993, 1996). He notes the importance of public-sector infrastructure in agriculture, particularly roads and other transportation inputs. It is somewhat unclear to us what the general proposition is, but it seems to be that these are more important in agriculture than in maquiladora-type manufacturing plants in the US–Mexico border region, and that is clearly plausible. The second point is that this infrastructure is far better developed in the USA than in Mexico. The lack of infrastructure in Mexico is analogous to having a poorer technology in that sector relative to the USA. Figure 10.7 illustrates the ideal with two production frontiers, one with a high level of public transport-sector capital and one with a low level. Maize (or agriculture more generally) is assumed to be more sensitive to this capital stock, and that turns into a source of comparative advantage and disadvantage. Markusen (1983) notes that in such a situation in which one country has a superior technology in one sector with all other things being equal, the real return to the factor used intensively in that sector will be higher in the advanced country. In the present situation, the real wage to unskilled rural Mexican workers will be less than the corresponding real

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wage in the USA. This difference may not be eliminated by free trade, even if Mexico is abundant in unskilled labour (specialisation is now a necessary condition for FPE). It is only by moving Mexican workers to the USA to work with US ‘technology’ (infrastructure) that wages can begin to equalise. Martin presents evidence that this productivity difference is relevant, with Mexican workers being significantly more productive in the USA on the same crops. 6

Summary and conclusions

The purpose of this chapter is to consider the migration of unskilled, rural Mexican workers to the USA and how migration incentives may be altered by NAFTA. We have not yet done any formal empirical work, and it is far too early to infer such effects from an agreement that has just turned four years of age, even though Mexican liberalisation began in the mid-1980s, as we noted. This task is further compounded by a major macroeconomic disruption in Mexico in late 1994 and 1995. Yet what evidence does exist plus the opinions of many experts suggests that NAFTA is not likely to have much of an effect on the incentives to migrate. The chapter therefore more or less accepts this conclusion and inquires into the reasons why it might be true. After all, it apparently contradicts our most cherished trade model, the HO model, despite the considerable broadening of the theory. Several models are presented, all of which imply that NAFTA may not raise the wages of unskilled Mexican workers very much relative to their potential wages as legal or illegal immigrants to the USA. While there are potentially an unlimited number of such models, we believe that the ones we present are all empirically plausible and relevant. The first one is due to Feenstra and Hanson and involves a continuum of goods ranked by their intensity in skilled labour. The effect of investment liberalisation is to move to the south production of goods which are skilled-labour-intensive from the south’s point of view, but unskilled-labour-intensive from the north’s point of view, therefore raising the relative demand for skilled labour in both countries. The second one is by Markusen and Venables, where the ‘unbundling’ of activities permitted by investment liberalisation raises the relative demand for skilled labour in both countries (but may increase the real incomes of all factors as well). The final three models focus on the maize sector and consider the role of production technologies, specific factors and public infrastructure. We might note again that, with the exception of the Markusen–Venables model, all of these explanations are solidly within the tradition of HO, if

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differing from the very specific model of that name. This is of some importance insofar as some economists have used the inconsistency of certain stylised facts within the HO model to dismiss all factor-proportions trade theory. More exotic explanations are then sought in terms of industrialorganisation features and/or ‘technical change’. The latter is almost never estimated, an unexplained residual is just defined to be technical change. At this point, all models remain candidates for explaining the wage-gap phenomenon, and of course all of them could plausibly be contributing to the observed data. NOTES Markusen acknowledges support from a National Science Foundation grant. Zahniser acknowledges a grant from the Social Science Research Council’s International Migration Program, funded by the Andrew W. Mellon Foundation. The authors also thank Rose Ellen Flandes for her assistance in collecting statistics used in this chapter. 1 We distinguish between legal immigration, in which persons obtain legal residency and even citizenship from their new country of residence, and undocumented or illegal migration, in which persons enter a country without its government’s expressed permission and reside there for an indefinite period of time. 2 The available statistics measuring civilian employment in Mexico do not allow an easy comparison with years prior to 1991. Specifically, some sort of methodological change appears to have occurred between the generation of the 1990 and the 1991 statistics, perhaps in conjunction with the 1991 Mexican census. In fact, the data for years prior to 1991 probably under-estimate agricultural employment in Mexico, as OECD (1996b) indicates that civilian employment in agriculture was 5,300,000 in 1990 and 7,532,000 in 1991. The Mexican data for five of the other economic activities listed in table 10.2 also experience a profound shift between 1990 and 1991. 3 Although the crisis manifested itself in full force in December 1994, when the Mexican government sharply devalued the peso, various statistics presented in this chapter indicate that the Mexican economy was slowing down during the course of 1994. 4 For related labour market issues, see Hinojosa-Ojeda and McCleery (1992); Hinojosa-Ojeda and Robinson (1992); Leamer (1993); Tan and Batra (1995); Brainard and Riker (1995); and Riker and Brainard (1996). REFERENCES Aitken, B., A. Harrison and R. E. Lipsey (1995). ‘Wages and Foreign Ownership: A Comparative Study of Mexico, Venezuela and the USA’, Journal of International Economics, 40, 345–76 Aitken, B., G. Hanson and A. Harrison (1994). ‘Spillovers, Foreign Investment, and Export Behavior’, NBER, Working Paper, 4967 Associated Press (1996). ‘Population Rises to Estimated 93 million’, 16 December

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Blomstrom, M. and E. Wolff (1994). ‘Multinational Corporations and Productivity Convergence in Mexico’, in W. Baumol, R. Nelson and E. Wolff (eds.), Convergence of Productivity: Cross–National Studies and Historical Evidence (Oxford: Oxford University Press) Brainard, S. L. and D. Riker (1995). ‘Are US Multinationals Exporting US Jobs?’, MIT, Working Paper Burfisher, M. E., S. Robinson and K. E. Thierfelder (1994). ‘Wage Changes in a US–Mexico Free Trade Area: Migration Versus Stolper–Samuelson Effects’, in C. Shields and J. Francois (eds.), Modelling Trade Policy: AGE Models of North American Free Trade (Cambridge: Cambridge University Press), 195–209 Feenstra, R. C. and G. H. Hanson (1995a). ‘Foreign Investment, Outsourcing, and Relative Wages’, in R. C. Feenstra, G. M. Grossman and D. A. Irwin (eds.), Political Economy of Trade Policy: Essays in Honor of Jagdish Bhagwati (Cambridge, MA: MIT Press) (1995b). ‘Foreign Direct Investment and Relative Wages: Evidence from Mexico’s Maquiladoras’, NBER, Working Paper, 5122 Food and Agriculture Organization (FAO) (1995). FAO Yearbook, Production, 1994, vol. 48, FAO Statistics Series, 125 (Rome: FAO) Freeman, R. B. (1995). ‘Are Your Wages Set in Beijing?’, Journal of Economic Perspectives, 9, 15–32 Hanson, G. H. and A. Harrison (1995). ‘Trade, Technology, and Wage Inequality’, NBER, Working Paper, 5110 Hinojosa–Ojeda, R. and R. McCleery (1992). ‘US–Mexican Interdependence, Social Pacts, and Policy Perspectives: A Computable General-Equilibrium Approach’, in J. Bustamante, C.W. Reynolds and R. Hinojosa–Ojeda (eds.), US–Mexico Relations: Labour Market Interdependence (Stanford: Stanford University Press) Hinojosa–Ojeda, R. and S. Robinson (1992). ‘Labour Issues in a North American Free Trade Area’, in N. Lustig, B. Bosworth and R. Lawrence (eds.), North American Free Trade: Assessing the Impact (Washington, DC: Brookings Institution) Immigration and Naturalization Service (INS) (various issues). Statistical Yearbook of the Immigration and Naturalization Service (Washington, DC: INS) (1996). INS Home Page, Statistical Information, web site, last modified 17 October, http://www.usdoj.gov/ins/public/stats Instituto Nacional de Estadística, Geografía, e Informática (INEGI) (1997). Banco de Información Económica INEGI, web site http://dgcnesyp.inegi.gob.mx/bie.html–ssi (1995). Anuario Estadístico de los Estados Unidos Mexicanos, 1995 International Monetary Fund (IMF) (1996). International Financial Statistics Yearbook 1996 (Washington, DC: IMF) Leamer, E. E. (1993). ‘Wage Effects of a US–Mexican Free Trade Agreement’, in P. M. Garber (ed.), The Mexico–US Free Trade Agreement (Cambridge, MA: MIT Press) Markusen, J. R. (1983). ‘Factor Movements and Commodity Trade as Complements’, Journal of International Economics, 13, 341–56

Liberalisation and incentives for labour migration 293 (1997). ‘Asymmetric Effects of Trade and Investment Liberalisation’, Working Paper Markusen, J. R. and A. J. Venables (1995). ‘Multinational Firms and the New Trade Theory’, NBER, Working Paper, 5036 (1997a). ‘Multinational Production, Skilled Labour, and Real Wages’, in R. Baldwin and J. Francois (eds.), Dynamic Issues in Applied Commercial Policy Analysis (Cambridge: Cambridge University Press) (1997b). ‘The Role of Multinational Firms in the Wage-Gap Debate’, Review of International Economics, 5, 435–51 Martin, P. L. (1993). Trade and Migration: NAFTA and Agriculture (Washington, DC: Institute for International Economics) (1996). ‘Trade and Migration Linkages: The Case of NAFTA’, University of California, Davis, Working Paper, Neary, J. P. (1995). ‘Factor Mobility and International Trade’, Canadian Journal of Economics, special issue, 28, S4–S23 Organisation for Economic Cooperation and Development (OECD) (1996a). ‘Evidence on Trade and Wages in the Developing World’, Development Centre Technical Paper, 119 (1996b). Labour Force Statistics, 1974–1994 (Paris: OECD) Richardson, J. D. (1995). ‘Income Inequality and Trade: What to Think, What to Conclude’, Journal of Economic Perspectives, 9, 33–56 Riker, D. and S. L. Brainard (1996). ‘US Multinationals and Competition from Low Wage Countries’, MIT, Working Paper Rutherford, T. F. (1994). ‘Applied General-Equilibrium Modelling with MPS/GE as a GAMS subsystem’, Working Paper (1995). ‘Extensions of GAMS for Complementarity Problems Arising in Applied Economics’, Journal of Economic Dynamics and Control, 19, 1299–1324 Secretaria de Agricultura, Ganadería, y Desarrollo Rural, Centro de Estadística Agropecuaria (1997) Centro de Estadística Agropecuaria web site, http://www.sagar.gob.mx/cea.htm Schiff, M. (1996) ‘Trade Policy and International Migration: Substitutes or Complements’, in J. E. Taylor (ed.), Development Strategy, Employment and Migration: Insights from Models (Paris: OECD Development Centre) Slaughter, M. J. (1995). ‘Multinational Corporations, Outsourcing, and American Relative Wage Divergence’, NBER, Working Paper, 5253 Tan, H. and G. Batra (1995). ‘Technology and Industry Wage Differentials: Evidence from Three Developing Countries’ (Washington, DC: World Bank) United Nations (1993). World Population Prospects, The 1992 Revision (New York: UN) Wood, A. (1994). North–South Trade, Employment and Inequality (Oxford: Clarendon Press) (1995). ‘How Trade Hurt Unskilled Workers’, Journal of Economic Perspectives, 9, 57–80

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Discussion by Pasquale M. Sgro

Discussion PASQUAL E M . SGRO Chapter 10 by Markusen and Zahniser argues that NAFTA and more recent regional trade agreements (RTAs) have a different focus to the older agreements, which were essentially concerned with trying to achieve large internal markets to capture economies of scale. Among the reasons for such agreements, which also now involve countries with different levels of development, might be the motive to reduce immigration pressures since migrants from LDCs may create various kinds of social and economic problems in the developed country. If this is indeed a motive for NAFTA, it is rather ironic that in all these regional agreements one of the important clauses is the freeing up of cross-border migration and trade. This is yet another example of the gap between rhetoric and practice. The chapter goes on to consider the theoretical link between trade and investment liberalisation on the one hand and the incentives for the migration of less-skilled labour on the other. Will there be a convergence of wages between Mexico and the USA, and hence less migration? Putting this proposition another way, will trade and investment substitute for migration? The chapter postulates four particular reasons that the USA had for forming NAFTA, one of which is to improve the Mexican wages of unskilled workers to reduce pressures on migration to the USA. The other three reasons, which appear more substantial and achievable, are: provide a low-wage partner for US firms to compete with third-world suppliers and Japanese multinationals, set an example of speed in multinational negotiations and help Mexico lock in its economic reforms. The authors argue that the wage-convergence motive was the main driving force in the agreement. What appears clear about Mexico is that it is abundant in unskilled labour relative to the USA, the rural areas are poor and the agricultural sector is highly protected. A number of theoretical models, in the Heckscher–Ohlin (HO) tradition, are considered that all imply a rising skilled–unskilled wage gap in both the developed and the developing country. The models discussed are the Feenstra–Hanson model, the Markusen–Venables model and three more specific models to do with technology and public infrastructure. The Feenstra-Hanson model concludes that foreign investment leads to an increase in the wage gap and in the unskilled wage share of Mexican manufacturing. This leads to an increase in demand (and the relative wage) for

Liberalisation and incentives for labour migration 295

skilled labour in both the USA and Mexico. The Markusen–Venables model deals with the role of multinationals and plant location. They find, inter alia, that the price of skilled labour would increase in both Mexico and the USA. The three specific models are concerned with (1) multiple techniques of production in agriculture, (2) the specific-factor model, with capital and land as specific factors and (3) the public- infrastructure (roads and other transport inputs) model. In all of these models, the tendency is towards non-wage convergence. Although NAFTA has been in existence for only four years and extensive hard data are still not available, there is some evidence that the wage gap has widened rather than narrowed. All the models discussed by Markusen and Zahniser provide theoretical reasons why one might expect the wage gap and migration to persist despite NAFTA. What would be of interest in this case would be to examine if the relocation by US firms of their plant and production processes across the border to take advantage of the cheaper labour has had an impact. One presumes that US firms would prefer to employ the cheaper Mexican labour rather than pay the same labour a higher wage when it came to the USA. Having a common border, the problem of illegal migration and the crossflows of such migrants along with repatriation of income presents some definitional and data-collection problems. For example, it is not unusual for Mexicans to cross and re-cross the border to return home for various festivals like weddings, anniversaries and carnivals. Another class of HO-type trade models concerned with distortions in either product or factor markets (the ‘old’ trade theory) also have features that lead to non-wage convergence. As more hard data become available, these models also merit attention if one is looking for a theoretical explanation for non-convergence. For example, models that emphasise the role of exchange rate movements between Mexico and the USA ought to play a role. All of the models tend to concentrate on wage differences as the main motivation for migration. In general, other factors do play a role – for example, public-good provision, educational and social infrastructure. A more complete explanation would need to incorporate these and other factors. What is clear is that there are a large number of HO-type factorproportions’ models quite capable of providing a reasonable explanation for the observed non-wage convergence. It is difficult to come to any firm conclusion on whether NAFTA has achieved or will in fact achieve wage convergence (and hence reduce migration pressures) until more hard data is available. Markusen and Zahniser do present some models and argue (based on what little data is available) that convergence will be unlikely in the medium term (10 years). However, such a conclusion is premature, it is still too early for any firm conclusions.

11

East–West trade and migration: the Austro–German case RU DOL F W INT E R-E B M E R A N D K L AU S F. ZIMME RMANN

1

Introduction

The demise of the political system in Central and Eastern Europe (CEE) and the Former Soviet Union (FSU) has created a new challenge for the EU – economic integration and enlargement. Eastern enlargement concerns the association of 10 CEE countries (CEECs), the Visegrád-4 (Czech Republic, Hungary, Slovak Republic and Poland), the Balkan-3 (Bulgaria, Rumania and Slovenia) and the Baltic-3 (Estonia, Latvia and Lithuania). The integration issue, however, also covers the other states from the FSU. While enlargement is seen both as a political necessity and a historical opportunity, the economic consequences are not yet well understood. A rising number of EU Member States seem more reluctant to take in new members, often because they fear that such a move will be expensive. One major concern stems from the potential labour market effects of integration and enlargement. Opening markets will encourage factor flows and trade, and hence very likely cause adjustments in wages and employment opportunities in EU economies. Given the ever-rising unemployment rates, and the relative decline of unskilled wages in Western Europe, the Eastern enlargement is seen as a threat to native labour markets. As a result of geography and historical ties, Austria and Germany have already received disproportionately more immigrants and stronger increases of trade flows than other countries. It has to be expected that this trend will continue in any process of economic integration in the East. Hence, the objective of this chapter is to assess present and potential future developments against the background of the Austro-German case. Two largely separated strands of literature have investigated the effects of trade and migration on native labour markets. Labour economists have examined the hypothesis that immigration is causing a decline in wages and an increase in unemployment among natives, especially among low-skilled workers. However, they did not find much support for these concerns. Trade 296

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297

economists and labour economists have investigated the issue whether trade, in particular with the developing world, has caused the measured negative trends in the labour market, especially for its manual and unskilled segments. However, mostly trade economists seem to believe that this is not true but can be attributed to skill-biased technical progress. So far, only few studies have dealt with these issues in the context of Eastern integration and EU enlargement. Section 2 of the chapter will survey the literature on the labour market effects of trade and migration, with an emphasis on existing European – especially Austrian and German – studies. Section 3 documents major trends in East–West migration and trade flows, largely for Austria and Germany. Section 4 will present econometric sectoral panel studies for both countries to measure the employment and wages effects in the recent decade. Section 5 draws some conclusions. 2

Trade, migration and the labour market consequences

The empirical literature on the labour market impacts of migration is concentrated on the US experience as a major immigration country. Furthermore, NAFTA and the high US trade deficit in recent years has triggered further research on trade. In many cases, both lines of research are unconnected. We offer a selective review of empirical studies with a heavy concentration on European cases (see also Zimmermann, 1995a and 1995b for a review and evaluation of European studies). This differentiation is very important, because of the different labour market organisation. Krugman (1995) paradigmatically distinguishes an ‘American model’ from a ‘European model’ in the way globalisation interacts with the labour market. (Zimmermann, 1994, makes the case for a specific European migration problem.) In the more flexible USA, wage effects should be more prominent; in the European case unemployment effects should be more important. US immigration studies generally use regional variation in immigration as the major explanatory variable – i.e. they compare local labour markets with differing immigration rates. (Freeman and Katz, 1991, find a positive, though insignificant, association between the share of immigrants and the change in annual hours worked in an estimation for a panel of 428 US industries.) LaLonde and Topel (1991) and Altonji and Card (1991) use US Census data in a regional context, and both find very small unemployment effects. Borjas et al. (1997) use California as a prime example of a high-immigration state and compare the development of California with other states. These studies may suffer from reverse causality: immmigrants tend to concentrate in states or cities with favourable labour market conditions. Furthermore, regional out-migration (or reduced in-migration) of native workers from regions hit by migration

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streams might counteract the immediate impact of migration (Filer, 1992). Borjas et al. (1997, p. 25) are themselves critical about the spatial concept: spatial correlation[s] between changes in native outcomes and immigration do not, in fact, measure what we want them to measure. The inconsistency in the signs of the correlations over time provides little information about the structural impact of immigration on the native labour market.

They suggest instead using occupations as units, but cannot apply this idea because of data problems. This possible simultaneity bias is circumvented in historical case studies of an exogenous influx of immigrants such as the ‘Mariel boatlift’ of Cubans to Miami in 1980 (Card, 1990) or the repatriation of French citizens from Algeria to southern France in 1962 (Hunt, 1992). Both studies find only minor transitory adaptation problems in these labour markets. In the French case, the labour force rose by 1.6 per cent in the regions concerned. In the early years significantly lower wage growth resulted, as well as higher unemployment. The quantitative effect was modest, though. More severe negative impacts are found by Carrington and de Lima (1996) for Portuguese ‘Retornados’ from Africa. Here, labour supply rose by almost 10 per cent, and the new workers were on average highly qualified. Using comparisons with France and Spain, the authors conclude that unemployment in Portugal rose significantly between 1974 and 1980. The situation in Austria and Germany after the fall of the Iron Curtain could also be considered a sort of historic experiment because of the massive inflow of immigrants and the sudden change in the trade regime. Labour market reactions to immigration and trade are especially interesting, therefore. In contrast to studies for the USA, most studies use industries instead of regions as the unit of measurement. One reason is – of course – the smallness of the countries, another is a more rigid employment structure across industries. Table 11.1 summarises recent econometric studies for Austria and Germany. Winkelmann and Zimmermann (1993) use micro panel data for Germany and the count data methodology to find that immigration in the 1970s increases the frequency of unemployment spells. However, no negative impact for the 1980s could be detected in a later study using a panel probit approach (Mühleisen and Zimmermann, 1994). This is explained by a sufficient wage flexibility that is also obtained in the study by De New and Zimmermann (1994). Pischke and Velling (1993) use aggregate data for German counties. Simple regression analyses reveal high employment effects, but the effect vanishes once the mean reversion process of unemployment rates is accounted for. Hatzius (1994) uses a two-stage approach to study immigration effects in Germany. In a first stage he

Table 11.1 Empirical studies on the effects of trade and migration on the labour market in Austria and Germany, 1990–7 Authors A Austria Aiginger et al. (1996)

Data, methods and dependent variables Social security records, manufacturing workers, individual unemployment rate, ⌬w

Time period

Findings

1988–91

u: exports (⫺), imports (~) ⌬w: exports (⫹), imports (~) u: migrant share (⫹)

Pichelmann and Walterskirchen (1995)

Macro model

Pollan (1990)

Aggregate time series, wage dispersion (␴(w))

1965–89

␴(w): migrant share (⫹)

Winter-Ebmer and Zweimüller (1996)

Social security records, young workers, w, ⌬w

1981–91

w: migrant share (⫹) ⌬w: migrant share (~)

Winter-Ebmer and Zweimüller (1998)

Social security records, manu1988–91 facturing workers, unemployment risk, unemployment duration

u risk: migrant share (~), imports(~), exports (~) u duration: migrant share (⫹), imports (~), export share (~)

German labour-force survey, estimation of a Translog production function; wages

Small elasticities of complementarity. Most of the immigrant groups are complements to natives.

B Germany Bauer (1997)

1990

1984–9 German socio-economic panel (SOEP), micro panel with sectoralmigrant share; wages (w) Haisken-De New and Zimmermann (1999) SOEP, panel with migrant share 1984–92 differentiated according to industry and state (Bundesländer); wages (w) and mobility (m)

w: migrant-labour share total (⫺), blue-collar (⫺), white-collar (⫹) w: migrant-labour share (⫹) trade-deficit ratio (⫺) m: migrant-labour share (~) trade-deficit ratio (⫺)

Hatzius (1994)

Regional-migrant share

w: migrant share (⫺) u: migrant share (~)

Lücke (1996)

32 industries w for unskilled labour

Mühleisen and Zimmermann (1994)

SOEP, individual unemployment, 1984–9 sectoral-migrant shares

De New and Zimmermann (1994)

1970–92

Pischke and Velling (1994)

County data, unemployment rate 1985–9

Winkelmann and Zimmermann (1993)

SOEP, unemployment risk, sectoral-migrant share

Notes: (⫹) The coefficient is positive and significant in most reported specifications. (⫺) The coefficient is negative and significant in most reported specifications. (~) The coefficient has mixed sign or is not significant in most specifications.

1974–84

w: relative price of unskilledlabour-intensive goods (~) u risk: migrant-labour share (~) u: ⌬migrant-population share (~) u risk: migrant-labour share (⫹)

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regresses individual unemployment on a set of region-by-period dummies and individual characteristics. He then uses the estimated coefficients in a second regression: differentiating between foreigners, East Germans and ethnic Germans he finds no significant effect of the presence of any of these immigrant groups on unemployment probabilities of natives. He thereby confirms the findings of Mühleisen and Zimmermann (1994). Gang and Rivera-Batiz (1993) offer an interesting exercise in political economy: in accordance with the above-mentioned studies they find that unemployment risk is not furthered by the presence of foreigners, but the individual assessment by workers is different. Unemployed workers believe that the presence of foreigners is responsible for their dismal situation, a belief that is not shared by employed workers. Wage impacts are studied by De New and Zimmermann (1994) who use data from the German socio-economic panel together with industry concentration of foreigners. They find large negative impacts on hourly wages in a random-effects panel model for blue-collar workers, but positive effects for white-collar workers.They hence conclude that foreigners are substitutes to native blue-collar workers, but complements to native whitecollar workers. These results are corroborated by Hatzius (1994), who uses regional variation in foreign shares. More recent studies investigating wage effects include Bauer (1997) and Haisken-De New and Zimmermann (1999). The former contribution estimates a Translog production function to calculate elasticities of complementarity, while the latter chapter is an update of De New and Zimmermann (1994) using a longer time series of a panel of individuals, more detailed data on immigrants and different measures of highskilled/unskilled work. Both contributions suggest that the degree of complementarity is much more strongly present than was found in previous exercises. Hence, immigration hardly affects native wages, at least not negatively, and mostly positively. The effect of trade on the German labour market was investigated by Lücke (1996) and Haisken-De New and Zimmermann (1999). Lücke (1996) cannot detect a relevant effect of the relative price of unskilled-labour-intensive goods on wages. Haisken-De New and Zimmermann (1999) study wage and mobility effects of trade and migration, and find that trade matters more than migration. Wages are affected negatively by a relative increase in imports (relative to exports). Trade seems to depress occupational mobility and movements within firms, but stimulates inter-firm changes. For Austria, several studies with very different methodologies exist. Pichelmann and Walterskirchen (1995) simulate increased migration using a standard Keynesian macro-model. The increased labour-supply result is split up approximately equally between increased employment and

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unemployment. Brandel et al. (1994) study turnover processes in firms and conclude that the recent surge of new immigrants into Austria led to a significant displacement of guest-workers of earlier generations, but also of natives: 60 per cent of all firms in their sample with shrinking employment of natives extended the engagement of foreigners in the period 1989–91. However, the latter study uses only descriptive techniques rather than regression analysis. Moreover, their measure of shrinking firms does not correspond exactly to the notion of displacement, because firm size can change for a variety of reasons: retirement, voluntary quits, etc. In an econometric study using individual data for workers, Winter-Ebmer and Zweimüller (1998) conclude that increased immigration did not result in higher unemployment entry of Austrian manufacturing workers, although it increased the duration of unemployment: an increase in the immigrant share by one percentage point increased unemployment duration by approximately 5 per cent – i.e. five days. Wage impacts in Austria are studied by Pollan (1990), who found that the dispersion of industry wages in the 1965–89 period was positively associated with the share of foreigners in the economy at large. Winter-Ebmer and Zweimüller’s (1996) analysis concentrates on young blue-collar workers. In cross-section, wages correlate positively with foreigner shares at a regional, industry or even firm level. The pattern is more mixed in a wage-growth formulation: Mobile workers – those who changed industry or region – can profit from higher foreign shares, whereas immobile workers lose. The authors explain these results by a bargaining model: the presence of foreign workers in a firm will reduce the bargaining power of insiders because of ‘threat effects’; on the other hand, insiders may benefit from a high share of immigrants if they are able to exploit them in a two-tier wage system. Assessing the impact of international trade on the labour market – in line with the equilibrium character of trade theory – would ideally call for the use of a computable general equilibrium (CGE) model. (See, for example, Kohler, 1991, for an application to trade liberalisation in Austria; see Brown, 1992, for a survey of CGE models applied to the consequences of NAFTA.) These studies typically analyse the effects ex ante rather than ex post. Some recent studies in the USA use simulation techniques to infer wage effects from trade (see Borjas et al., 1992 and Murphy and Welch, 1991; Baldwin, 1995, provides a survey of trade effects on employment and wages). In a recent update Borjas et al. (1997) attribute a significant proportion of the wage decline of US high-school dropouts to increased immigration, but less to trade impacts. Factor-content studies have been heavily criticised by several authors (e.g. Wood, 1995; Bhagwati and Deheijia, 1994; Leamer, 1996). The main problems are: (1) Are trade flows the right measures or only prices? (2) Is it possible to measure the right competing groups of workers? (3) What unit-

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labour coefficients should be used? Furthermore, a significant element of trade competition is a simple threat of re-location of industries abroad, which can change wages significantly without any trade flows at all (and also without any foreign direct investment (FDI) flows). Rodrik (1997) argues that these effects make labour and product demand functions more elastic in the home country and labour more vulnerable to demand shifts. For Europe, only a few studies on employment effects of trade with Eastern Europe exist. Cadot and de Melo (1994) provide simulation results for the regional distribution of possible job creation and destruction caused by CEEC trade with France. Looking only at emerging trade patterns with the CEECs, no general problems for EU markets as a whole as well as for specific industries, like metals or textiles, are found by a study edited by Faini and Portes (1995) – mainly because the level of EU–CEEC trade is still very low. The Austrian Institute of Economic Research (WIFO) (Aiginger, 1993), based on industry studies, calculates a positive employment balance of Austrian trade with the CEECs. This is mainly due to higher exports as well as cheaper inputs for manufacturing firms. Aiginger et al. (1996) look at a panel of Austrian workers in manufacturing and conclude that individual unemployment rates over a period of three years react significantly negatively to increased export volumes and (only insignificantly) positively to import volumes. However, significant positive import impacts are found for sub-groups of blue-collar workers, the elderly and low-income earners. These results are based on the period from 1988 to 1991 – i.e. the immediate aftermath of the fall of the Iron Curtain. As the trade structure was heavily distorted before that time, these results have to be considered as transitional adaptation processes, far away from equilibrium. In any case, they have to be complemented by more recent data. By calculating the labour content of trade flows using industry-specific productivity data, Altzinger (1995) finds that increased net exports to CEECs have lead to positive employment effects on the Austrian labour market. For Germany, Lücke (1996) analysed 32 industries in the period 1970–92 and found that wages for non-skilled labour did not react to relative price changes of unskilled labour-intensive goods. Apart from the relation between trade and migration, capital flows have to be considered as well. Growing FDI can influence export performance significantly. The traditional Heckscher–Ohlin (HO) trade theory views FDI as export of capital motivated by higher returns abroad, and it suggests that FDI substitutes for exports, thus lowering the production of capital-intensive goods in the home country. Re-allocation of capital in the East can be viewed in this sense as a further impediment to the employment in capital-intensive industries. This conclusion is questioned by new models with monopolistic competition and horizontally differentiated products (e.g. Helpman, 1984). If endogenous growth is based on an expanding stock

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of knowledge, one can show that FDI, the number of multinational firms and exports, increase complementarily because of increasing product variety. Pfaffermayr (1996) tests for complementarity or substitutability of exports and FDI using a panel of Austrian industries. The results indicate a significant – although numerically small – complementarity between FDI and exports in the 1980s and early 1990s. 3

East–West flows of goods and people

This section investigates the flow of factors and trade between Austria and Germany and the East, and documents the performance of both countries. A summary of the economic conditions in the major countries in CEE is given in table 11.2, where we provide data on real growth, inflation and unemployment. The situation has improved considerably in many countries, although unemployment remains high. It seems that there is a large potential for out-migration and trade. According to gravity models (Holzmann and Zukowska-Gagelmann, 1996) trade with Eastern Europe is still much below equilibrium projections. These expectations about trade creation have yet to be augmented by the effects of EU East enlargement. Figure 11.1 studies the evolution of the foreigner share in the labour force and the import ratio (total imports divided by GNP) for West Germany and Austria between 1986 and 1994. In total, there is a trend in favour of immigration, while the evolution of trade is stagnating. Both countries are similar in the sense that immigration and trade was expanding until 1990, but afterwards only the immigration level increased while the import share declined. Austria always had a higher import share, but its foreigner share was significantly below the foreigner share in Germany at the end of the 1980s, before it increased to the German level in the mid-1990s. Since in the German case, immigration of ethnic Germans is not covered by the data, figure 11.1 underreports this fact for Germany. Figure 11.2 investigates the issue using data on migrants (the share of East European workers as a percentage of total foreign workers) and trade from Eastern Europe (the share of imports from the East in total imports). Both shares have increased for Germany, while for Austria, the increase is only in trade. In general, figure 11.2 demonstrates that Austria was and still is much more involved with the East than Germany, although this is true only in relative terms and the differences are shrinking. 3.1

Austria

Table 11.3a summarises the main developments in Austria’s labour market performance with respect to internationalisation between 1986 and 1995.

Table 11.2. Economic development in Central and Eastern Europe,a 1991–7

Poland

Czech Republic

Slovakia

Hungary

Slovenia

Rumania

Bulgaria

Russia

Real Growth 1991 1992 1993 1994 1995 1996 1997

1⫺7.0 ⫺12.6 ⫺13.8 ⫺15.2 ⫺17.0 ⫺16.1 ⫺15.5

⫺14.2 1⫺3.3 1⫺0.6 ⫺12.6 ⫺14.8 ⫺14.4 ⫺11.0

⫺11.2 1⫺6.5 1⫺3.7 ⫺14.9 ⫺16.8 ⫺17.0 ⫺15.0

⫺11.9 1⫺3.1 1⫺0.6 ⫺12.9 ⫺11.5 ⫺11.1 ⫺13.0

11⫺9.3 11⫺5.5 ⫺112.8 ⫺115.3 ⫺113.9 ⫺113.5 ⫺113.5

1⫺12.9 11⫺8.8 ⫺111.5 ⫺113.9 ⫺117.1 ⫺114.1 11⫺2.0

11⫺11.7 111⫺7.3 111⫺1.5 ⫺1111.8 ⫺1112.1 11⫺10.9 111⫺7.0

111⫺5.0 11⫺14.5 111⫺8.7 11⫺12.6 111⫺4.0 111⫺2.8 ⫺1110.5

Inflation 1991 1992 1993 1994 1995 1996 1997

⫺76.5 ⫺43.0 ⫺35.3 ⫺33.2 ⫺27.8 ⫺19.9 ⫺16.0

⫺56.7 ⫺11.1 ⫺20.8 ⫺10.0 ⫺19.0 ⫺18.8 ⫺19.0

⫺61.1 ⫺10.0 ⫺23.2 ⫺13.4 ⫺19.9 ⫺15.8 ⫺16.5

⫺34.8 ⫺23.0 ⫺22.5 ⫺18.9 ⫺28.2 ⫺23.5 ⫺18.0

⫺115.2 ⫺201.3 ⫺132.3 ⫺119.8 ⫺112.6 ⫺119.7 ⫺119.0

⫺174.4 ⫺210.4 ⫺256.1 ⫺136.8 ⫺132.3 ⫺138.8 ⫺150.0

1⫺338.5 ⫺1191.2 ⫺1172.8 ⫺1196.0 ⫺1162.1 ⫺1123.0 ⫺1100.0

⫺1193.0 ⫺1526.6 ⫺1873.5 ⫺1307.6 ⫺1197.5 ⫺1147.6 ⫺1115.0

Unemployment Rate 1991 ⫺19.2 1992 ⫺12.9 1993 ⫺14.9 1994 ⫺14.4 1995 ⫺13.3 1996 ⫺12.4 1997 ⫺11.5

⫺12.8 ⫺13.0 ⫺13.0 ⫺13.2 ⫺13.1 ⫺13.5 ⫺14.5

⫺17.1 ⫺11.3 ⫺12.9 ⫺14.8 ⫺13.1 ⫺12.5 ⫺12.5

⫺15.4 ⫺10.7 ⫺12.8 ⫺10.8 ⫺10.3 ⫺10.0 ⫺19.0

⫺118.2 ⫺111.5 ⫺114.4 ⫺119.1 ⫺117.4 ⫺117.3 ⫺117.0

— ⫺116.2 ⫺119.2 ⫺110.9 ⫺118.9 ⫺118.5 ⫺110.0

⫺1111.1 ⫺1113.2 ⫺1116.3 ⫺1112.8 ⫺1110.8 ⫺1112.5 ⫺1114.0

— ⫺1110.4 ⫺1111.0 ⫺1116.0 ⫺1118.0 ⫺1119.0 ⫺1110.0

Note: Real growth: GDP; inflation: consumer price index. All numbers in per cent. 1997: Estimates of the German Council of Economic Experts Source: Sachverständigenrat (1996/7, p. 33) and Sachverständigenrat (1997/8, p. 30). a

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Im

Figure 11.1

Immigration and trade, 1986–96

Note: Foreigner share: total share of foreigners of employment. Imports/GNP: total imports divided by GNP. Sources: See tables 11.3a and 11.3b.

Employment rose nearly constantly, albeit at a very slow pace. Three-quarters of the rise in employment was driven by increasing employment of foreign workers. The share of foreign workers almost doubled in this period, its increase being particularly high in the years 1990 and 1991. However, heavy restrictions for immigrants have damped its further development. Although the rise in foreign employment coincided with the fall of the Iron Curtain, most immigrants came from Austria’s main sending countries, namely Former Yugoslavia and Turkey; foreign workers from Eastern Europe have only a modest share in the foreign population at large. Unemployment increased slightly over the period with constantly higher rates for foreigners than for natives. Trade with Eastern Europe was almost unchanged over the period, with

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Figure 11.2

East–West migration and trade: Germany, 1986–94; Austria, 1990–4

Sources: See tables 11.3a and 11.3b.

an export and import share of between 2 and 3 per cent of domestic output. This general picture conceals important structural changes in terms of industries, as well as in terms of countries. Whereas trade with the FSU almost collapsed, trade with the CEECs increased considerably. Moreover, the import structure changed from raw materials mainly from the FSU, to more refined products. The development of FDI is shown in table 11.4. Between 1989 and 1994 Austria’s outward FDI into Eastern Europe rose by more than 30-fold. The main part of these investments went into the neighbouring countries – the Czech and Slovak Republics and Hungary: in 1992, Austrian firms participated in more than 20 per cent of all joint ventures in these countries. The high international capital inflow into Eastern Europe should lead – in principle – to enhanced competition for foreign capital. This competition has not affected Austria’s inward FDI’s very greatly. The opening of the Eastern borders had regionally different impacts.

Table 11.3. Labour, migration and trade, Austria and Germany, 1986–95 a Austria 1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

Employment (000)

12,780

12,785

12,765

12,815

12,881

12,940

12,964

12,956

12,972

12,970

Unemployment rate, natives (per cent)

1,1115.2

1,1115.6 1,1115.3 1,1115.0 1,1115.4 1,1115.8 1,1115.9 1,1116.8 1,1116.5 1,1116.6

Unemployment rate, foreigners (per cent)

1,1116.4

1,1115.7 1,1116.2 1,1115.9 1,1117.8 1,1117.1 1,1118.6 1,1119.1 1,1118.3 1,1117.9

Foreign share in employment (per cent)

1,1115.2

1,1115.3 1,1115.4 1,1115.8 1,1117.2 1,1118.6 1,1119.0 1,1119.0 1,1119.5 1,1119.8

Foreign workers from Former Yugoslavia as per cent of all foreigners

1,1157.3

1,1155.9 1,1155.0 1,1154.2 1,1150.7 1,1148.5 1,1149.6 1,1150.6 1,1148.9 1,1150.7

Foreigners from Eastern Europea as per cent of all foreigners

1,1113.0b

Eastern Europe exports as per cent of domestic output

1,1112.69 1,1112.411,1112.571,1112.66 1,1112.511,1112.571,1112.64 1,1112.65 1,1112.86

—

Eastern Europe imports as per cent of domestic output

1,1112.77 1,1112.191,1112.111,1112.14 1,1112.121,1112.131,1112.15 1,1112.07 1,1112.41

—

—

—

—

1,1114.5 1,1114.7 1,1115.6 1,1115.1 1,1114.7 1,1114.1

Table 11.3. (cont.) a Austria 1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

Eastern Europe exports as per cent of total exports

1,1119.63 1,1119.021,1119.141,1119.04 1,1118.841,1118.981,1119.68 1,1110.48 1,1111.00

—

Eastern Europe imports as per cent of total imports

1,1118.34 1,1116.801,1116.371,1116.06 1,1116.001,1116.041,1116.47 1,1116.76 1,1117.54

—

Notes: a Excluding workers from Former Yugoslavia, which is the major sending country for Austria. b 1981.

b Germany Employed workers (000)

23,910

24,141

24,365

24,750

25,460

25,920

26,066

25,611

25,242

25,022

Unemployment rate, natives (per cent)

1,1119.0

1,1118.9 1,1118.7 1,1117.9 1,1117.2 1,1116.3 1,1116.6 1,1118.2 1,1119.2 1,1119.3

Unemployment rate, foreigners (per cent)

1,1113.7

1,1114.3 1,1114.4 1,1112.2 1,1110.9 1,1110.7 1,1112.2 1,1115.1 1,1116.2 1,1116.6

Foreign share in employment (per cent)

1,1117.7

1,1117.6 1,1117.6 1,1117.8 1,1118.0 1,1118.2 1,1118.7 1,1119.5 1,1119.4 1,1119.4

Foreign workers from Eastern Europe as per cent of all foreign workers

1,1112.9

1,1113.1 1,1113.4 1,1113.8 1,1114.2 1,1115.5 1,1117.3 1,1118.1 1,1117.7 1,1117.8

Inflow of ethnic Germans (000)

1,1142.7

1,1178.5 1,1202.6 1,1377.0 1,1397.1 1,1122.0 1,1230.5 1,1218.9 1,1222.6 1,1217.9

Inflow of ethnic Germans from Russia as per cent of total inflow

1,1111.76 1,1118.5 1,1123.5 1,1126.0 1,1137.0 1,1166.4 1,1184.9 1,1194.7 1,1195.8 1,1196.1

per cent of domestic output

1,1111.04 1,1110.901,1111.001,1111.17 1,1111.031,1111.361,1110.81 1,1111.40 1,1111.51 1,1111.62

Eastern Europe imports as per cent of domestic output

1,1110.99 1,1110.801,1110.811,1110.90 1,1110.911,1111.151,1110.78 1,1111.14 1,1111.36 1,1111.62

Eastern Europe exports as per cent of total exports

1,1113.45 1,1113.131,1113.391111,3.71 1,1113.211,1115.361,1113.42 1,1116.30 1,1116.60 1,1116.85

Eastern Europe imports as per cent of total imports

1,1113.96 1,1113.361,1113.331,1113.44 1,1113.461,1114.531,1113.27 1,1115.29 1,1116.11 1,1117.11

Source: Statistisches Handbuch der Republik Österreich (various years); WIFO Data base, Vienna. Employment according to Hauptverband der Sozialversicherungstäger, excluding those below the minimum social security contributions level.

Table 11.4. Foreign direct investment (stocks in ECU million), 1989–95 1989

1990

1991

1992

1993

1994

Austria FDI into Eastern Europe Austrian inward FDI

11,147.6 —

11,240.7 —

11,516.9 12,137

11,733.9 12,028

111,043.2 113,230

111,558.0 114,408

Germany FDI into Eastern Europe German inward FDI

— 71,493

— 83,089

11,076 93,986

11,857 96,812

113,312 105,517

114,864 113,432

Source: Mitteilungen des Direktoriums der Österreichischen Nationalbank (various years); Statistisches Jahrbuch für die Bundersrepublik Deutchland (various years); Sachverständigenrat (1996/7). Own calculations.

1995 — — 116,599 122,284

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Austria’s North-eastern parts had suffered in the past from the ‘dead border’ and the severe trade and traffic restrictions. Now, employment in the Eastern parts, especially the counties in the Czech, Slovak and Hungarian borderland, increased disproportionately (Geldner, 1993), whereas employment growth between 1983 and 1989 had been slow. This employment growth is completely due to new immigration: between 1989 and 1992 foreign employment in Austria increased by 68 per cent, in the borderland by more than 200 per cent, dragging the foreign share there up to the national average. Consequently, native employment stayed almost constant. 3.2

Germany

Data on migration, trade and FDI in Germany are contained in tables 11.3b and 11.4. Table 11.3b indicates that employment in Germany was stagnating, with between 24 and 26 million workers. However, the size of foreign employment in general has increased, as well as the inflow of East Europeans and ethnic Germans. While the share of foreign employment was less than 8 per cent in 1986, it reached a level of more than 9 per cent in 1995. The share of foreign workers from Eastern Europe as a percentage of all foreign workers has increased from about 3 per cent to about 8 per cent. There was a dramatic increase (by a factor of 10) in the inflow of ethnic Germans per year from the mid-1980s to 1990. Since then, quotas set by the German government caused a decline, to a level of about 200,000 per year. Among ethnic Germans, the inflow has more and more concentrated on migrants from Russia; while there were fewer than 2 per cent Russians among ethnic German migrants in 1986, their share had increased to nearly 100 per cent in 1995. Native unemployment was comparatively low (less that 7 per cent) in the early 1990s, but returned to higher levels in the mid-1990s (9 per cent, as in 1986–7). The unemployment rates of foreigners were rising even more: they were about 14 per cent in 1986 and about 17 per cent in 1995; they were then nearly twice as high as those of the natives. This increase was primarily caused by differences in job composition (and the related unemployment risk) between natives and foreigners, and not by a higher unemployment risk of foreigners per se. Table 11.3b also suggests that trade with Eastern Europe (exports and imports) was expanding significantly, relative to both domestic output and total imports/exports. Exports and imports to and from Eastern Europe in Germany rose from about 1 per cent of domestic output in 1986 to 1.6 per cent in 1995; in terms of total imports or exports, the share rose in the same period from less than 4 per cent to about 7 per cent.

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Table 11.4 indicates that FDI in Eastern Europe has increased substantially in the last few years; it was been six times higher in 1995 than it was in 1991. In contrast, German inward FDI grew only by about 30 per cent over the same period. However, the size of German FDI into Eastern Europe is still somewhat modest in comparison with the Austrian involvement (only about 2–3 times larger), and in relationship to FDI in Germany. German FDI into Eastern Europe in 1994 was about 4 per cent of German inward FDI, whereas the figure for Austria is 11 per cent. 4

Effects on the labour markets

In this section, we investigate the effects of immigration change and export and import flows on employment and wage growth. Employment growth is also studied for natives only. The time period chosen is 1986–94 to cover a period before and after the demise of the socialist system. We use all available sectors at the two-digit ISCO level, excluding those that have no international trade. The data sets have a panel structure. The Austrian sample is somewhat larger, since we obtained a more complete set of information in this country. Owing to data problems and different structural issues, the model specification differs somewhat between both countries. We employ a reduced-form approach where growth rates of (total and native) employment and wages depend on a time trend and various measures of changes of foreigner shares and trade shares. The basic method is weighted regression, where we use the sectoral employment shares as weights. The migration flows are instrumented to capture endogeneity problems. The instruments were valid only for migration flows, and hence were not applied for the other regressors. 4.1

Austria

The data for Austria capture 30 industries for the years 1985–94. Employment and wage statistics were obtained from the Ministry of Labour. Contrary to Germany, the number of immigrant workers is not differentiated between those from Eastern Europe and elsewhere. As most immigrants to Austria are from the Former Yugoslavia and from Turkey, the human capital as well as the language knowledge of these immigrants can be assumed to be similar to that of the more recent immigrants from Eastern Europe. As an indicator for wage growth, we take the median monthly gross wage in the industry. Trade shares are nominal exports (imports) divided by nominal output in the industry, which in fact assumes equal price indices for imports and domestically produced goods. As the bulk of manufactured-goods trade with Eastern Europe took place with

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Table 11.5 Employment growth, Austria,a 1987–94

All industries

Low-wage High-import industries industries

Highimmigration industries

⌬ln (Foreign share)

⫺ 0.001 (0.04)

⫺ 0.031 (0.87)

⫺ 0.042 (1.12)

⫺ 0.030 (0.88)

⌬ln (East import share)

⫺ 0.036 (2.59)

⫺ 0.045 (2.12)

⫺ 0.019 (1.06)

⫺ 0.076 (3.05)

⌬ln (ROW import share)

⫺ 0.055 (1.25)

⫺ 0.150 (1.91)

0.049 (0.89)

⫺ 0.172 (1.93)

⌬ln (East export share)

⫺ 0.011 (0.98)

⫺ 0.009 (0.40)

0.016 (1.27)

0.001 (0.02)

⌬ln (ROW export share)

⫺ 0.038 (1.02)

⫺ 0.001 (0.02)

⫺ 0.039 (0.85)

⫺ 0.038 (0.54)

0.268 (5.90)

0.328 (4.73)

0.394 (7.51)

0.276 (3.76)

⫺ 0.001 (0.40)

0.001 (1.08)

⫺ 0.002 (1.66)

0.001 (0.64)

0.232

0.255

0.279

0.282

⌬ln (Output) Time trend R2 F N

11.33 240

7.22 128

8.05 128

8.13 128

Notes: a All regressions include a constant. Absolute t-values in parentheses. Regressions weighted by employment share. Time period 1987–94. ⌬ln (Foreign share) is instrumented. Instruments are lagged levels and changes in minimum wages, shares of blue-collar workers and EU output as well as lagged levels of immigrant shares. Low-wage industries refers to those with a mean wage level 1987–94 up to the industry median; respectively for high-import and high-immigration industries.

Czecho-Slovakia, Hungary and Poland, the Eastern trade measures in the Austrian regressions use only these three (four) countries. As trade data use the SITC nomenclature, while the labour market data apply the ISIC code, we had to use a concordance which was developed by WIFO; this concordance defines which ISIC code is nearest to an SITC code at the three-digit level. Results for the reduced-form regressions for employment and wage growth are in tables 11.5–11.7 for Austria. We present separate results for

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Table 11.6 Native employment growth, Austria,a 1987–94

All industries

Low-wage industries

High-import industries

Highimmigration industries

⌬ln (Foreign share)

⫺ 0.131 (4.01)

⫺ 0.143 (5.41)

⫺ 0.148 (3.28)

⫺ 0.183 (6.54)

⌬ln (East import share)

⫺ 0.033 (2.39)

⫺ 0.038 (1.86)

⫺ 0.024 (1.33)

⫺ 0.087 (3.67)

⌬ln (ROW import share)

⫺ 0.049 (1.11)

⫺ 0.170 (2.20)

⫺ 0.040 (0.71)

⫺ 0.125 (1.47)

⌬ln (East export share)

⫺ 0.008 (0.76)

⫺ 0.002 (0.08)

0.015 (1.18)

0.010 (0.47)

⌬ln (ROW export share)

⫺ 0.021 (0.58)

0.028 (0.44)

⫺ 0.030 (0.60)

0.012 (0.18)

⌬ln (Output)

0.313 (6.95)

0.402 (5.90)

0.381 (7.13)

0.373 (5.39)

Time trend

0.001 (0.21)

0.002 (1.44)

⫺ 0.003 (1.90)

0.001 (0.96)

0.324

0.373

0.297

0.466

R2 F N

17.39 240

11.28 128

8.66 128

16.84 128

Notes: a All regressions include a constant. Absolute t-values in parentheses. Regressions weighted by employment share. Time period 1987–94. ⌬ln (Foreign share) is instrumented. Instruments are lagged levels and changes in minimum wages, shares of blue-collar workers and EU output as well as lagged levels of immigrant shares. Low-wage industries refers to those with a mean wage level 1987–94 up to the industry median; respectively for high-import and high-immigration industries.

employment growth at large and for employment of domestic workers. As the pooled time-series cross-section approach assumes constant coefficients for all industries, we study also some sub-samples, who might be more endangered by increasing internationalisation. Immigrant shares are instrumented by industry minimum wages, shares of blue-collar workers and EU output growth. Immigration is found to have no impact on industry employment at large. This is equally so for the three sub-samples we study. In contrast to

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Table 11.7 Wage growth, Austria,a 1987–94

All industries

Low-wage industries

High-import industries

Highimmigration industries

⌬ln (Foreign share)

⫺ 0.164 (2.58)

⫺ 0.112 (1.94)

⫺ 0.099 (0.82)

⫺ 0.081 (1.36)

⌬ln (East import share)

⫺ 0.021 (0.78)

⫺ 0.009 (0.27)

⫺ 0.005 (0.14)

0.027 (0.64)

⌬ln (ROW import share)

0.098 (1.15)

0.019 (0.79)

0.139 (1.19)

0.062 (0.41)

⌬ln (East export share)

⫺ 0.021 (0.99)

⫺ 0.012 (0.35)

⫺ 0.045 (1.73)

⫺ 0.047 (1.23)

⌬ln (ROW export share)

0.240 (3.34)

0.189 (1.85)

0.311 (3.26)

0.348 (2.89)

⌬ln (Output)

0.307 (3.50)

0.227 (2.06)

0.250 (2.06)

0.178 (1.42)

⫺ 0.015 (7.41)

⫺ 0.013 (5.38)

⫺ 0.017 (5.51)

⫺ 0.013 (5.38)

0.316

0.259

0.328

0.267

Time trend R2 F N

16.75 240

7.35 128

9.86 128

7.60 128

Notes: a All regressions include a constant. Absolute t-values in parentheses. Regressions weighted by employment share. Time period 1987–94. ⌬ln (Foreign share) is instrumented. Instruments are lagged levels and changes in minimum wages, shares of blue-collar workers and EU output as well as lagged levels of immigrant shares. Low-wage industries are those with a mean wage level 1987–94 up to the industry median; the same principle is applied for high-import and highimmigration industries.

that, rising import penetration has employment costs. Interestingly, this applies mainly to imports from Eastern Europe. The quantitative impact is relatively low: a 1 per cent increase in the import share leads to reduced employment by 0.03 per cent. It has to be noticed that this elasticity applies to a very low import share of Eastern firms. The elasticity is somewhat higher in low-wage industries and especially in industries characterised by a high share of foreign workers. For these sub-groups, rising imports from ROW countries also have detrimental employment effects. Exports are

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never significant. Domestic industry output growth always has the expected positive employment impact, although with a rather small elasticity. This pattern is very similar for domestic employment growth, but we can see that a rising foreigner share with practically constant total employment will reduce domestic employment. A 1 per cent increase in the foreigner share in industry employment reduces domestic employment by 0.13 per cent. This means that increasing immigration led to an almost complete displacement of native workers in the industries concerned, with the highest effects in high-immigration industries. Again imports from Eastern Europe have a minor negative employment effect and ROW imports are significant only in low-wage industries. Wages react negatively to increased immigration with an elasticity of 0.16. The wage-depressing effects are lower in already low-wage industries and insignificant in industries with high-import as well as high-immigration shares. This might be explained by a higher tendency for binding minimum wages in low-wage industries; other explanations would refer to a higher potential for rent reductions in high-wage and often more unionised industries. Freeman and Katz (1991), for instance, find for the USA that wage responsiveness was higher in high-wage and highly unionised sectors. Industry-wage growth is not affected by rising imports. This corroborates results by Gaston and Trefler (1994), who study the Canadian employment and wage reaction to increased trade with the USA in a very similar framework to ours. Contrary to employment reactions, exports into ROW countries significantly further wage growth, with an elasticity of 0.24 and an even higher response rate in high-immigrant industries. As we observe only median wages for Austria, this differing response could be the result of a structural employment effect: the creation of relatively high-paying jobs in export industries. These issues can be resolved only by the use of more detailed data on income distribution within industries and is beyond the scope of the present study. Again, output growth has a significant positive wage impact. 4.2

Germany

Results for Germany are given in tables 11.8–11.10 for 12 industries in 1987–94. Wherever possible, the data refer to Western Germany, and the exceptions will be noted below. The regressions contain a time trend, output growth (measured as real gross value-added in per cent), and various growth rates of foreigner shares in the labour force and growth rates of export and import ratios. Wage, output, employment and trade data are from various sources of the German Statistical Office. Numbers on workers from Eastern Europe are from a report of the Council of Economic Experts, and the figures on ethnic Germans are from a government report.

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Table 11.8 Employment growth, Germany,a 1986–94

All industries Constant

0.010 (0.62)

0.023 (1.18)

0.006 (0.35)

0.035 (1.20)

⌬ln (Foreign share)

0.025 (1.16)

⫺ 0.007 (0.52)

0.470 (2.84)

⫺ 0.008 (0.36)

⌬ln (Eastern Europe foreigner share)

0.966 (2.82)

1.763 (3.43)

0.377 (1.12)

1.014 (1.67)

⌬ln (Share of ethnic Germans)

0.018 (0.62)

⫺ 0.051 (1.44)

0.045 (1.29)

⫺ 0.049 (0.84)

Russian share⫻⌬ln ⫺ 0.047 (Share of ethnic Germans) (0.89)

0.121 (2.11)

⫺ 0.147 (2.31)

⫺ 0.020 (0.22)

⌬ln (Import share)

0.074 (2.99)

0.039 (1.58)

0.110 (1.89)

0.106 (2.90)

⌬ln (Export share)

⫺ 0.056 (2.18)

0.015 (0.67)

⫺ 0.058 (1.34)

⫺ 0.069 (1.78)

⌬ln (East import share)

0.050 (0.94)

0.153 (2.08)

0.008 (0.14)

0.140 (1.35)

⌬ln (East export share)

⫺ 0.043 (1.06)

⫺ 0.115 (2.03)

⫺ 0.015 (0.36)

⫺ 0.102 (1.29)

0.238 (3.95)

0.321 (2.78)

0.235 (3.80)

0.294 (2.30)

⫺ 0.006 (1.72)

0.001 (0.30)

⫺ 0.005 (1.31)

⫺ 0.008 (1.56)

⌬ln (Output) Time trend R2 F N

0.600 14.56 108

0.665 8.52 254

High-import industries only

Highimmigration industries only

Low-wage industries only

0.867 28.02 254

0.550 5.25 254

Notes: a All regressions include a constant. Absolute t-values in parentheses. Regressions weighted by employment share. Time period 1987–94. All foreigner shares are instrumented. Instruments are lagged levels and changes in union wages, shares of blue-collar workers and EU output as well as lagged levels of immigrant shares. Low-wage industries are those with a mean wage level 1987–94 up to the industry median; the same principle is applied for high-import and high-immigration industries.

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Table 11.9 Native employment growth, Germany,a 1986–94

All industries 0.008 (0.49)

0.015 (0.53)

0.011 (0.62)

0.022 (0.70)

⌬ln (Foreign share)

⫺ 0.036 (1.53)

⫺ 0.059 (3.05)

0.421 (2.50)

⫺ 0.051 (2.05)

⌬ln (Eastern Europe foreigner share)

1.039 (2.77)

1.306 (1.74)

0.318 (0.93)

0.862 (1.32)

⌬ln (Share of ethnic Germans)

0.022 (0.69)

⫺ 0.022 (0.42)

0.030 (0.85)

⫺ 0.010 (0.16)

Russian share⫻⌬ln ⫺ 0.032 (Share of ethnic Germans) (0.56)

⫺ 0.107 (1.28)

⫺ 0.121 (1.86)

⫺ 0.032 (0.32)

Constant

High-import industries only

Highimmigration industries only

Low-wage industries only

⌬ln (Import share)

0.049 (1.82)

0.032 (0.89)

0.119 (2.01)

0.084 (2.12)

⌬ln (Export share)

⫺ 0.041 (1.45)

⫺ 0.009 (0.28)

⫺ 0.058 (1.32)

⫺ 0.055 (1.30)

⌬ln (East import share)

0.035 (0.61)

0.107 (0.99)

0.022 (0.39)

0.078 (0.69)

⌬ln (East export share)

⫺ 0.032 (0.71)

⫺ 0.076 (0.92)

⫺ 0.028 (0.64)

⫺ 0.055 (0.64)

0.250 (3.80)

0.394 (2.33)

0.243 (3.87)

0.366 (2.64)

⫺ 0.006 (1.78)

0.000 (0.02)

⫺ 0.006 (1.57)

⫺ 0.007 (1.24)

⌬ln (Output) Time trend R2 F N

0.574 13.05 108

0.484 4.03 54

0.867 27.92 54

0.558 5.42 54

Notes: a All regressions include a constant. Absolute t-values in parentheses. Regressions weighted by employment share. Time period 1987–94. Al foreigner shares are instrumented. Instruments are lagged levels and changes in union wages, shares of blue-collar workers and EU output as well as lagged levels of immigrant shares. Low-wage industries are those with a mean wage level 1987–94 up to the industry median; the same principle is applied for high-import and high-immigration industries.

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Table 11.10 Wage growth, Germany,a 1986–94

High-import industries only

Highimmigration industries only

All industries

Low-wage industries only

Constant

0.023 (2.39)

0.021 (1.30)

0.019 (1.29)

0.022 (1.37)

⌬ln (Foreign share)

0.019 (1.41)

0.009 (0.81)

⫺ 0.067 (0.49)

0.028 (2.18)

⌬ln (Eastern Europe foreigner share)

0.796 (3.72)

0.766 (1.87)

1.027 (3.68)

0.485 (1.44)

⌬ln (Share of ethnic Germans)

0.013 (0.70)

0.028 (0.98)

⫺ 0.030 (1.03)

0.031 (0.96)

Russian share⫻⌬ln (Share of ethnic Germans)

0.011 (0.33)

⫺ 0.020 (0.45)

0.083 (1.57)

⫺ 0.026 (0.51)

⌬ln (Import share)

⫺ 0.019 (1.21)

⫺ 0.022 (1.14)

0.033 (0.67)

⫺ 0.039 (1.93)

⌬ln (Export share)

0.003 (0.17)

⫺ 0.014 (0.79)

0.040 (1.10)

0.011 (0.51)

⌬ln (East import share)

⫺ 0.001 (0.02)

⫺ 0.008 (0.14)

⫺ 0.019 (0.42)

⫺ 0.011 (0.19)

⌬ln (East export share)

⫺ 0.008 (0.33)

⫺ 0.001 (0.03)

0.009 (0.27)

⫺ 0.005 (0.11)

⌬ln (Output)

0.140 (3.73)

0.186 (2.01)

0.216 (4.20)

0.061 (0.86)

Time trend

0.000 (0.10)

0.001 (0.40)

⫺ 0.000 (0.11)

0.002 (0.77)

R2

0.375

0.420

0.545

0.307

F

5.81

3.11

5.14

1.90

N

108

54

54

54

Notes: a All regressions include a constant. Absolute t-values in parentheses. Regressions weighted by employment share. Time period 1987–94. All foreigner sharers are instrumented. Instruments are lagged levels and changes in union wages, shares of blue-collar workers and EU output as well as lagged levels of immigrant shares. Low-wage industries refers to those with a mean wage level 1987–94 up to the industry median; the same principle is applied for high-import and highimmigration industries.

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The growth rate of the foreigner share in the labour force is the change of foreign workers compared to the total change in the labour force. A separate term for the Eastern Europe workers in the labour force allows for an examination of the hypothesis whether this group of workers has effects different from the general group of foreigners. If they behave equally, the estimated coefficient for the East Europeans should not be statistically different from zero. While the total foreigner share in the labour force is differentiated according to industry, the employment of East Europeans is not available at the industry level. Hence, we have distributed the East Europeans using the sectoral-employment shares of the workers from the Former Yugoslavia, assuming that the employment structure is similar. The inflow of ethnic Germans into the labour market is not properly recorded. This is because the only statistic available is the total inflow of ethnic Germans according to sending regions. Since they immediately obtain German citizenship, they disappear into German statistics; there are no records about their labour-force participation and their sectoral involvement. Hence, we approximate the percentage change of the share of ethnic Germans in the labour force by the difference between (1) the inflow of ethnic Germans divided by lagged total employment and (2) the growth rate of employment. Import and export data are collected on a somewhat different classification scheme, but can be merged with sufficient precision. Imports and exports are measured in unit values, but are available only either on an industry breakdown (and not differentiated by regions) or differentiated for sending regions (but not disaggregated at the industry level). Hence, we decided to include variables that capture both levels of measurement. The import and export data at the sectoral levels were divided by the sectoral outputs (real gross value-added), respectively. We also included (real) total imports and exports from East Europe divided by real GDP. A further problem is that imports and exports after unification are not differentiated according to Western and Eastern Germany; this is not too much of an issue, since most of the trade seems to take place with Western Germany. The regressions for employment growth, native employment growth and wages are contained in Tables 11.8–11.10. All regressions are weighted with the industry employment shares, and migration flows are instrumented as detailed in the footnotes to the tables. As for the Austrian case, each table contains results for all industries and for those industries with low wages, high imports and many foreigners. Table 11.8 refers to total employment growth that is largely driven by output growth in all samples, where all the estimated parameters have large t-ratios, while the trend variable is hardly significant at conventional levels.

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There are no clear indications that immigration has affected total employment negatively. However, a clear negative effect (with significant t-values for low-wage and high-import industries only) was obtained for Russian ethnic German immigrants, while an increase in the foreigner share from Eastern Europe has exhibited a positive (and mostly significant) effect on total employment. The total foreigner share is statistically significant only for high-import industries with a positive parameter estimate. All import shares affect employment positively, and exports negatively, although not always with statistically significant t-values. Table 11.9 contains the same set of regressors, but using native employment growth as the dependent variable. Again, output growth is driving employment, and the time trend plays no effective role. However, the general foreigner share now exhibits a negative coefficient in three out of four cases (with the exception of high-import industries), and the negative parameters are even significant for low-wage and high-immigration industries. East European immigration does not exhibit much of a relevant additional contribution. Global trade shows up with the signs of the parameters as before; they are all positive for imports and negative for exports, but only few are statistically significant. In addition, all East European trade variables have insignificant parameter estimates. Table 11.10 studies wage growth, which again depends largely on output growth and is unaffected by the time trend. Here, foreigners (especially East Europeans) seem to have a positive effect on general wages, but the estimates are significant in only a few cases: for high-immigration industries and the growth rate of the general foreigner share; for high-import industries (and the total sample) and the growth rate of the East European foreigner share. Finally, none of the trade variables has any significant impact on wage growth. The simple labour market model would suggest that more foreigners should depress wages (if migrants are substitutes for natives), and increase total employment while native employment should remain constant (if markets are flexible). In the findings reported here, wages are not declining, at best they are increasing (especially if related to the inflow of East Europeans). Total employment is increasing, although mainly due to East Europeans. Native employment is somewhat (and negatively) affected by foreigners in general, but positively by East Europeans. This all suggests that East Europeans and German workers are complements, and that the overall effect of migrants on the German labour market is unproblematic. The results for the trade variables are also controversial. Traditional theory would expect a positive impact of exports on employment and wages, and the reverse for imports. Trade does not affect wages at all, perhaps because one should differentiate wages for qualification levels and

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trade for regions to obtain more sensible findings, but we cannot do this due to lack of data. In the employment equations, imports (exports) have a negative (positive) impact on employment, but the estimates are in most cases statistically insignificant. This can be explained by the relationship of trade to technical progress, which is insufficiently measured by the time trend. It is well known that technical progress is more intense in exporting industries, while importing industries are less innovative; hence, we may be unable to separate these effects. In sum, we cannot find harmful effects of trade on the German labour market. 5

Conclusions

Trade and migration have become more important in recent years for Austria and Germany. The transition in CEE has played an important role in this development. The derived labour market consequences are not fully clear so far. The Austrian findings suggest that immigration exhibits negative effects on native employment and wages, and has no effects on total employment. Imports affect employment negatively and exports have a positive effect on wages. The German results indicate that immigration and trade is not harming employment and wages. Natives seem to be complements to migrants, at least to those from East Europe. Trade does not affect wages at all, and hardly affects employment. These results are in line with recent findings for both Austria and Germany. Hence the conclusions are: while the Austrian labour market might be somewhat negatively affected by the Eastern enlargement of the EU, the German labour market is not. Further research and better data are needed to understand these findings properly. NOTE We wish to thank Thomas Bauer, Ralph Rotte, Andreas Million, Anja Thalmaier and Michael Vogler for able research assistance and conference participants, especially Riccardo Faini, for helpful comments.

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(eds.), Immigration, Trade, and the Labour Market (Chicago: University of Chicago Press for NBER), 201–34 Altzinger, W. (1995). ‘Beschäftigungseffekte des österreichischen Osthandels’, Working Paper, 34, Department of Economics, Vienna University of Economics and Business Administration Baldwin, R. E. (1995). ‘The Effect of Trade and Foreign Direct Investment on Employment and Relative Wages’, NBER, Working Paper, 5037 Bauer, T. (1997). ‘Native Wage Impacts of Foreign Labour: Further Evidence for Germany’, Mitteilungen zur Arbeitsmarkt- und Berufsforschung, 30, 652–6 Bhagwati, J. and V. H. Dehejia (1994). ‘Freer Trade and Wages of the Unskilled – Is Marx Striking Again?’, in J. Bhagwati and M. H. Kosters (eds.), Trade and Wages: Leveling Wages Down? (Washington, DC: American Enterprise Institute) Borjas, G. J., R.B. Freeman and L. H. Katz (1992). ‘On the Labour Market Effects of Immigration and Trade’, in G.J. Borjas and R.B. Freeman (eds.), Immigration and the Work Force (Chicago: University of Chicago Press), 213–44 (1997). ‘How much do Immigration and Trade Affect Labour Market Outcomes?’, Brookings Papers on Economic Activity, 1, 1–90 Brandel, F., H. Hofer and K. Pichelmann (1994). ‘Verdrängungsprozesse am Arbeitsmarkt’, Research Memorandum, 345 (Vienna: Institute for Advanced Studies) Brown, D. K. (1992). ‘The Impact of the North American Free Trade Agreement: Applied General Equilibrium Models’, in N. Lustig et al. (eds.), North American Free Trade: Assessing the Impact (Washington, DC: Brookings Institution) Cadot, O. and J. de Melo (1994). ‘France and the CEECs: Adjusting to Another Enlargement’, INSEAD, paper presented to a CEPR Conference, Brussels, mimeo Card, D. (1990). ‘The Impact of the Mariel Boatlift on the Miami Labour Market’, Industrial and Labour Relations Review, 43, 245–57 Carrington, W. I. and P. de Lima (1996). ‘The Impact of 1970s’ Repatriates from Africa on the Portuguese Labour Market’, Industrial and Labour Relations Review, 49, 330–47 De New, J. P. and K. F. Zimmermann (1994). ‘Native Wage Impacts of Foreign Labor: A Random Effects Panel Analysis’, Journal of Population Economics, 7, 177–92 Faini, R. and R. Portes (eds.) (1995). ‘European Union Trade with Eastern Europe: Adjustment and Opportunities’ (London: CEPR) Filer, R. K. (1992). ‘The Effect of Immigrant Arrivals on Migratory Patterns of Native Workers’, in G.J. Borjas and R. B. Freeman (eds.), Immigration and the Work Force (Chicago: University of Chicago Press), 245–70 Freeman, R. B. and L. F. Katz (1991). ‘Industrial Wage and Employment Determination in an Open Economy’, in J.M. Abowd and R. B. Freeman (eds.), Immigration, Trade and the Labour Market (Chicago: University of Chicago Press), 235–60

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Gang, I. N. and F. L. Rivera–Batiz (1993). ‘Unemployment and Attitudes against Foreigners in Germany’, Rutgers University, mimeo Gaston, and Trefler (1994). ‘Protection, Trade and Wages: Evidence from US Manufacturing’, Industrial and Labor Relations Review, 47, 574–93 Geldner, N. (1993). ‘Beschäftigungseffekte der Ostöffnung’, in K. Aiginger (ed.), Chancen und Gefährdungspotential der Ostöffnung (Vienna: Austrian Institute of Economic Research), 41–6 Haisken–De New, J. P. and K. F. Zimmermann (1999). ‘Wage and Mobility Effects of Trade and Migration’, forthcoming in M. Dewatripont and A. Sapir (eds.), International Trade and Employment: The European Experience (Oxford: Oxford University Press) Hatzius, J. (1994). ‘The Unemployment and Earnings Effects of German Immigration’, Merton College, Oxford, mimeo Helpman, E. (1984). ‘A Simple Theory of International Trade with Multinational Corporations’, Journal of Political Economy, 92, 451–71 Holzmann, R. and K. Zukowska–Gagelmann (1996). ‘Exportchancen und Importschocks: Eine Untersuchung zur Asymmetrie der Handelsanpassung der OECD-Länder im Gefolge der Marktöffnung in Mittel- und Osteuropa’, in R. Holzmann and R. Neck (eds.), Ostöffnung: Wirtschaftliche Folgen für Österreich (Vienna: Manz), 193–236 Hunt, J. (1992). ‘The Impact of the 1962 Repatriates from Algeria on the French Labour Market’, Industrial and Labour Relations Review, 45, 556–72 Kohler, W. (1991). ‘Multilateral Trade Liberalization: Some General Equilibrium Simulation Results for Austria’, Empirica, 18, 167–200 Krugman, P. (1995). ‘Growing World Trade: Causes and Consequences’, Brookings Papers on Economic Activity, at proof⬎ , 327–77 LaLonde, R. J. and R. H. Topel (1991). ‘Labour Market Adjustments to Increased Immigration’, in J.M. Abowd and R. B. Freeman (eds.), Immigration, Trade, and the Labour Market (Chicago: University of Chicago Press for NBER), 167–200 Leamer, E. E. (1996). ‘What’s the Use of Factor Contents?’, NBER, Working Paper, 5448 Lücke, M. (1996). ‘Has Trade with Low-Wage Countries Hurt Unskilled Labour in West Germany?’, Kiel, Institute of World Economics, mimeo Mühleisen, M. and K. F. Zimmermann (1994). ‘A Panel Analysis of Job Changes and Unemployment’, European Economic Review, 38, 793–801 Murphy, K. M. and F. Welch (1991). ‘The Role of International Trade in Wage Differentials’, in M.H. Kosters (ed.), Workers and their Wages (Washington, DC: American Enterprise Institute) Pfaffermayr, M. (1996). ‘Foreign Outward Direct Investment and Exports in Austrian Manufacturing: Substitutes or Complements?’, Weltwirtschaftliches Archiv, 132, 501–22 Pichelmann, K. and E. Walterskirchen (1995). ‘East–West Integration and its Impact on Workers: The Austrian Example’, Vienna, Institute for Advanced Studies, Reprint 14 Pischke, J.-S. and J. Velling (1993). ‘Ausländische Werkvertragsarbeitnehmer am Bau: Bauboom oder Verdrängungswettbewerb’, ZEW, Discussion Paper, 9315, Mannheim

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(1994). ‘Labour Market Effects of Foreign Employment in Germany’, CEPR, Working Paper, 935 Pollan, W. (1990). ‘Lohnunterschiede in der Industrie’, Monatsberichte des Österreichischen Instituts für Wirtschaftsforschung, 63, 616–22 Rodrik, D. (1997). ‘Has Globalisation Gone Too Far?’ (Washington, DC: Institute for International Economics) Sachverständigenrat (1996). Jahrgutachten 1996/7 des Sachsverständigenrates zur Begutachtung des gesamtwirtschaftlichen Entwicklung, Bundesdrucksache 13/6200, Bonn (1999). Jahrsgutachten 1997/8 des sachsverständigenrates zur Begutachtung des gesamtwirtschaftlichen Entwicklung, Bundestagsdrucksache 13/9090, Bonn Winkelmann, R. and K. F. Zimmermann (1993). ‘Ageing, Migration and Labour Mobility’, in P. Johnson and K. F. Zimmermann (eds.), Labour Markets in an Ageing Europe (Cambridge: Cambridge University Press), 255–83 Winter–Ebmer, R. and J. Zweimüller (1996). ‘Immigration and the Earnings of Young Native Workers’, Oxford Economic Papers, 48, 473–91 (1998). ‘Immigration, Trade and Austrian Unemployment’, in M. Landesmann and E. Streissler (eds.), Unemployment in Europe (London: Macmillan) Wood, A. (1995). ‘How Trade Hurts Unskilled Workers’, Journal of Economic Perspectives, 9, 57–80 Zimmermann, K. F. (1994). ‘Some General Lessons for Europe´s Migration Problem’, in H. Giersch (ed.), Economic Aspects of International Migration (Heidelberg: Springer-Verlag), 249–73 (1995a). ‘European Migration: Push and Pull’, Proceedings volume of the World Bank Annual Conference on Development Economics, 1994, Supplement to The World Bank Economic Review and The World Bank Research Observer, 313–42; reprinted in International Regional Science Review, 19 (1996), 95–128 (1995b). ‘Tackling the European Migration Problem’, Journal of Economic Perspectives, 9, 45–62; reprinted in M. N. Jovanovic (ed.), International Economic Integration. Critical Perspectives of the World Economy (London: Routledge, 1998)

Discussion MA R INA SCHE NKE L Chapter 11 is a good piece of empirical work, since it helps to understand the peculiarities of Austria and Germany, not only with regard to international migrations (i.e. their impact on employment and wages) but also as

East–West trade and migration: the Austro–German case

327

(1994). ‘Labour Market Effects of Foreign Employment in Germany’, CEPR, Working Paper, 935 Pollan, W. (1990). ‘Lohnunterschiede in der Industrie’, Monatsberichte des Österreichischen Instituts für Wirtschaftsforschung, 63, 616–22 Rodrik, D. (1997). ‘Has Globalisation Gone Too Far?’ (Washington, DC: Institute for International Economics) Sachverständigenrat (1996). Jahrgutachten 1996/7 des Sachsverständigenrates zur Begutachtung des gesamtwirtschaftlichen Entwicklung, Bundesdrucksache 13/6200, Bonn (1999). Jahrsgutachten 1997/8 des sachsverständigenrates zur Begutachtung des gesamtwirtschaftlichen Entwicklung, Bundestagsdrucksache 13/9090, Bonn Winkelmann, R. and K. F. Zimmermann (1993). ‘Ageing, Migration and Labour Mobility’, in P. Johnson and K. F. Zimmermann (eds.), Labour Markets in an Ageing Europe (Cambridge: Cambridge University Press), 255–83 Winter–Ebmer, R. and J. Zweimüller (1996). ‘Immigration and the Earnings of Young Native Workers’, Oxford Economic Papers, 48, 473–91 (1998). ‘Immigration, Trade and Austrian Unemployment’, in M. Landesmann and E. Streissler (eds.), Unemployment in Europe (London: Macmillan) Wood, A. (1995). ‘How Trade Hurts Unskilled Workers’, Journal of Economic Perspectives, 9, 57–80 Zimmermann, K. F. (1994). ‘Some General Lessons for Europe´s Migration Problem’, in H. Giersch (ed.), Economic Aspects of International Migration (Heidelberg: Springer-Verlag), 249–73 (1995a). ‘European Migration: Push and Pull’, Proceedings volume of the World Bank Annual Conference on Development Economics, 1994, Supplement to The World Bank Economic Review and The World Bank Research Observer, 313–42; reprinted in International Regional Science Review, 19 (1996), 95–128 (1995b). ‘Tackling the European Migration Problem’, Journal of Economic Perspectives, 9, 45–62; reprinted in M. N. Jovanovic (ed.), International Economic Integration. Critical Perspectives of the World Economy (London: Routledge, 1998)

Discussion MA R INA SCHE NKE L Chapter 11 is a good piece of empirical work, since it helps to understand the peculiarities of Austria and Germany, not only with regard to international migrations (i.e. their impact on employment and wages) but also as

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Discussion by Marina Schenkel

regards the broader picture of investments abroad and trade flows with Eastern Europe. In my opinion, however, some problems arise with regard to the interpretation of the econometric estimates. Even if the reduced-form approach is correctly carried out, the results are sometimes not easy to understand. Since an articulated model of the functioning of the labour market is not presented, one cannot appreciate if the specification which has been chosen is apt to assure that the coefficients capture just the additional effect of migrations (and segments of them), and of trade on the main labour market variables. In the case of Germany, we read in the chapter that between 1992 and 1995 almost 1 million jobs were lost, between 1986 and 1993 about 600,000 more foreign workers were employed, but in the following two years foreign workers decreased again by more than 480,000. During the same period, workers from Eastern Europe increased by more than 130,000 until 1993, and decreased by 27,000 thereafter. Since in the chapter nothing is said about the internal migration flows following reunification, it is possible to think that migration flows of a bigger entity and other origin can have contributed to produce those effects in the labour market. As far as various types of heterogeneity are concerned, the commodity composition of the trade flows is controlled for, since the study is performed on an inter-industry base. Also, it can be assumed that the temporary versus the permanent character of migration, which could not have been taken into account, makes little difference to labour market effects, at least in the short run. We can therefore agree with the chapter’s two main conclusions: (1) the migration consequences for the labour market are not yet fully clear and (2) the Austrian labour market is more significantly affected by the Eastern enlargment than the German one.

Index

Abramovitz, M. 233, 234 agglomeration 11 country size effect 39 from integration 51, 60–6 see also location decisions aggregation choice of 121–2 level 261 agriculture 15, 268, 273 public infrastructure 266, 289 tariff levels 285–6 technology 284–90 Aiginger, K. 303 Aitken, B. 273 Allen–Uzawa elasticities of substitution 118, 123–4, 135–6, 140 Altonji, J. G. 297 Altzinger, W. 303 Anderson, J. 252 Antille, G. 176 Argentinia 248–9, 250 Atkinson, A. B. 152, 154, 163, 176, 185 Atlantic economy (1870–1940) 227–57 panel data 244–7 Australia 82, 250 Austria 17, 80, 93, 188 links with the east 296–324, 327–8 Bacci, M. L. 255 Bairoch, P. 23 Baldwin, R. E. 302 Banerjee, B. 10 Basevi, G. 68–75 Bauer, T. 301 Begg, D. 23 Ben-David, D. 2 Benhabib, J. 86, 155 Berndt, E. R. 133 Bernholz, P. 82

Berry, R. A. 153 Bhagwati, J. 84, 93, 95, 151, 165, 166, 186, 190, 302 Blomstrom, M. 281 Bond, E. W. 84 Borjas, G. J. 84, 85, 155, 297, 298, 302 Bourguignon, F. 198, 217 brain drain 84, 94–5 Brandel, F. 302 Brazil 248–9, 250 Brecher, R. A. 95, 187 Brown, D. K. 302 Buckley, F. H. 87, 88 Bulow, J. I. 165 Burda, M. 193 Burfisher, M. E. 266, 268 Cadot, O. 303 Cairncross, A. 234 Canada 82, 87–8, 248–9, 250, 268 see also NAFTA capital market (1870–1940) 248–50 mobility 122, 148 movements 7, 234, 303–4: level of 245–7; measures of 241; policies on 77–80 see also foreign direct investment; investment liberalisation Card, D. 297, 298 Carrington, W. I. 298 chauvinism 80, 93 Chen, T. J. 84 Chenery, H. 198, 217 Chiswick, B. 185 Choudri, E. U. 187 Christensen, L. R. 130 Clark, R. L. 85 Cochrane–Orcutt procedure 241 Cogneau, D. 222–3 Collins, W. J. 15, 148, 227–57, 260–2

329

330

Index

Collinson, S. 7 competitive models 23–34 Constant Elasticity of Transformation (CET) 194, 196 Corden, W. M. 230 core–periphery 24, 39–45, 51–2 cost of living 37, 56 effects 39–45 index 24 country size 37–9, 74 see also market size culture 76, 92–3 preferences 80–3 as public good 81 cumulative causation 34–45 Dallas, H. 74 Darmstadter, J. 254 Daveri, F. 91–3, 194 Davies, J. B. 78 de Coulon, J. P. 152, 180 de Lima, P. 298 de Melo, J. 1–19, 190–219, 221–3, 303 De New, J. P. 298, 301 De Vries, C. G. 74 Deheijia, V. H. 302 demand-linkages 51–3 demography 6, 221, 254, 270–1 Dickens, W. T. 180 Diewart, W. E. 120, 131–2, 143 direct-democracy model 86, 155 discrimination 152–3, 155–8, 160–1, 185 Dixit, A. K. 35, 95 Djajic, S. 193 Docquier, F. 84 dual labour market 158, 165, 167–8, 186 see also discrimination; labour market segmentation Dustmann, C. 152, 165, 182 earnings differentials 193–4 see also wage gap Easterlin, R. A. 233, 234 efficiency 85, 152, 162 elasticities Allen–Uzawa 118, 123–4, 135–6, 140 CET 194, 196 Hicksian 118, 123–4, 135–6, 140 import demand 137–9 price and quantity 124–7, 129 resident labour demand 137–9 Eldridge, H. 255 employment equilibrium pattern 59–62 fluctuations 153 Epstein, G. 87, 88

Estevadeordal, A. 229, 254 Ethier, W. J. 84, 153 ethnicity 149–50 European Union (EU) 16–17, 263 CEEC trade 303 enlargement 66, 296 four-pillar freedoms 94 inward migration 264 liberalising sequence 74 politicians 48–51 stylised facts 62 European–US migration 28–9, 30, 227–57 factor flows 234–44 intensity assumptions 281 prices 26–7 scarcity and abundance 235–6 factor mobility 28, 261 falling barriers 51–2 incentives for 25–6, 36–7 trade complement or substitute 8–9, 94, 99–100, 140, 227–57, 261 see also immigration; migration factor-price equalisation (FPE) 29, 78, 94, 286 Faini, R. 1–19, 190–219, 221–3, 303 Favarger, P. 132 Feenstra, R. C. 265, 273, 281 Feenstra–Hanson model 273–9, 286, 290, 294 Ferenczi, I. 4 Filer, R. K. 298 financial constraints model 9–10 Findlay, R. F. 232 Finger, M. 3 Flam, H. 229 Flanders, M. J. 229 Flückiger, Y. 152, 163, 180 foreign aid 7, 191 foreign direct investment (FDI) 3, 49 Austria 308 and export performance 303–4 Germany 313–14 versus migration 191, 201, 204, 207, 212, 213, 222–3 see also investment liberalisation Foreman-Peck, J. 86, 250 Former Yugoslavia 314, 322 Fox, K. J. 131, 143 France 80, 93, 191, 234, 298, 303 Freeman, R. B. 279, 297, 318 Friedberg, R. 6 functional forms, flexibility of 120, 130–2, 143, 149 Gaillard, S. 176 Galeotti, M. 147–50

Index Gang, I. N. 149, 301 Gaston 318 Gatsios, K. 94–111 GATT 248 General Agreement on Trade in Services (GATS) 94 Uruguay Round 3, 94, 191 Geldner, N. 313 Germany 17, 80, 93, 152, 191, 234 links with the east 296–324, 327–8 globalisation effects decomposed 200–2 effects on migrant supply 197–202 see also trade liberalisation Goldin, C. 250 Greenwood, M. J. 147 Grether, J.-M. 14, 190–219, 221–3 Grossman, B. 117 Grubel, H. B. 160 guest-worker system 14, 88, 151–83, 180, 196 Haisken-De New, J. P. 301 Hamada, K. 95 Hamermesh, T. 182 Hammar, T. 152 Hanson, G. H. 265, 273, 281 Haque, N. U. 84 Harley, K. 23 Harris, J. 193 Harrison, A. 273 Hatton, T. J. 234, 241 Hatzipanayotou, P. 12, 94–111 Hatzius, J. 298, 301 Heckscher, E. 229, 230, 252 Heckscher–Ohlin (HO) model 24–34, 48–9, 77–9, 94, 186, 197, 265, 269–70, 284, 286, 290–1, 294, 303 3x2 229–31 Helmberger, P. 232 Helpman, E. 24, 37, 39–41, 45, 48, 303 Helpman–Krugman model 39–45, 48 Hicksian elasticities of complementarity 118, 123–4, 135–6, 140 Hillman, A. L. 6, 11, 12, 76–89, 91–3 Hoffmann-Nowotny, H.-J. 170 Holzmann, R. 304 Huddle, D. 85 Hungary 308, 315 Hunt, J. 6, 298 immigrants consumption of public goods 95 illegal 86–7, 92, 264, 266 as inputs 121 permanent 170–1, 174, 186, 196, 210–11

331

skill-mix 173–4, 191–2, 211 trade substitute or complement 117 see also migration immigration income distribution 78–9 quotas 128 unemployment 139–40, 151–2 versus protection 151, 166–8 immigration policy 5–6 (1870–1940) 248–52 direct and indirect 190–1 endogenous 76, 77–83, 85–8 imports demand for 121–4 as inputs 118 restriction 99–106 see also trade protection income distribution 151–2, 172–3, 222 after investment liberalisation 273–9, 280–4 from immigration 78–9 native 163 unskilled immigrants 154, 168–9 welfare effects 188 industrialisation, three-stage 52 inputs foreign labour 117 immigrants as 121 imports as 118 International Labour Organisation (ILO) 190 investment liberalisation 265, 288 and income distribution 273–9, 280–4 see also foreign direct investment (FDI) Isserlis, L. 241, 254 Jahn, A. 87 Jones, R. 79 Jones, R. W. 230 Kalix, Z. 254 Kanbur, S. M. 10 Katz, L. H. 297, 318 Kebabjian, G. 222 Kelley, A. C. 233 Kemp, M. C. 232 Kim, S. J. 84 King, M. 97 Kohler, W. 302 Kohli, U. 13, 117–45, 147–50 Krugman, P. 4, 11, 24, 35, 37, 39–41, 44–5, 48, 51–3, 59–60, 68, 69, 75, 297 Kuznets, S. 233 Kwok, V. 84

332

Index

labour displacement effects 128–9 extensive margin of 148 non-resident 138–9 see also guest-worker system labour demand foreign 121–4 low-skilled 266–7 model of 53–7 non-linear 69–74 labour market effects 158–62 segmentation 165, 167–8, 173 see also dual labour market labour mobility and agglomeration 65–6 imperfect 52–3 job displacement 117 redistribution effects 117 secondary to primary sector 157–8 labour supply 100–3 elasticity 60–2 fixed 209 international 51 model of 57–9 non-linear 69–74 LaLonde, R. J. 297 land 15–16, 230–1, 254 endogenous frontier 232–3, 260 Lang, K. 180 Lau, L. J. 148 Le Châtelier principle 138 Leamer, E. E. 302 Leland, H. 84 Lerner, A. P. 229 Lewis, W. A. 233 Licht, G. 185 location decisions efficiency 81–2 and factor prices 26–7 firms 37, 40 workers 56, 57, 75, 195 see also agglomeration long swings (1870–1940) 233–44 Lopez, R. 10, 193, 209 Lucas, R. E. 7 Lücke, M. 301 Ludema, R. D. 11, 51–68, 68–75 Maddison, A. 254 maize 266, 284–90 market size 24, 39–45 see also country size Markusen, J. R. 9, 16, 17, 25, 196, 229, 263–91, 294–5 Markusen–Venables model 280–4, 290–1, 294

Martin, P. L. 222, 266, 289 Mayer, W. 79 Mazza, I. 86 Mexico 50, 191, 263–91, 268 incomes 270, 272 maize 266, 284–90 migration to US 16, 18, 196, 211, 222, 264–91 population 270–1 Michael, M. S. 12, 94–111 migration 12–15 controls 7, 191, 211 costs 193, 209, 210, 211 countries of origin 87 globalisation effect 197–202 and import restriction 99–103 incentives 265 and income differentials 49–50 labour market consequences 297–304 mass 234 measures of 241 non-pecuniary benefits 57 rates 245–7, 255 return 85, 192 and trade liberalisation 17–18, 112–14 trends 3–5 and unemployment 211–12 welfare effects 93 see also factor mobility; immigrants; immigration; migrants migratory pressure 7, 15, 190–219, 290 aggregate 202–4 data 217–18 factors affecting 202 household and sectoral effects 204–8 and investment liberalisation 288 low-income and middle-income 192, 198–212 sensitivity analysis 208–11 simulation model 196–7, 212–17, 221 and trade liberalisation 211 Milbourne, R. 193 Mitchell, B. R. 253–5 Molle, W. 5 Mühleisen, M. 298, 301 Müller, T. 13–14, 151–83, 185–8 multinationals 280–4 Mundell, R. A. 2, 25, 48, 78, 94, 100, 227, 229 Murphy, K. M. 302 Musu, I. 112–14 NAFTA 7, 10, 16, 18, 74, 222, 263–91, 266–7, 294–5, 297 Neary, J. P. 155, 171, 230–1, 252, 266, 287

Index nested CES function 162, 187 Norman, V. D. 25, 95 Ohlin, B. 229, 230, 252 Ohyama, M. 232 O’Leary, P. J. 233 O’Rourke, K. H. 15, 227–57, 252, 260–2 ownership 79, 82–3, 210 Passel, J. S. 85 Pfaffermayr, M. 304 Pichelmann, K. 301 Piore, M. J. 152 Pischke, J.-S. 298 policy asymmetries 11–12, 77–80, 92 Pollan, W. 302 Portes, R. 303 price indices 287–8 production cost 36–7 production-theoretic approach 117–45, 147–50 aggregation choice 148 cost-function setting 124–5, 129 data 149 empirical results 133–40 estimation techniques 132–3 GNP-function setting 13, 126–7, 129, 137, 148–9 input prices 150 production-function setting 125–6 property rights 82–3 public choice model 85–6 public good, culture as 81 public goods 12 consumed by immigrants 95 and import restriction 103–6 model 96–9 and trade liberalisation 112–14 push–pull model 83–5 Rapoport, H. 84 regional integration 7, 51–68, 66, 263 restricted profit function 148–9 returns to scale constant 121, 196, 228 increasing 24, 34–45 variable 121 Ricardian models 9, 48 Ricardo–Viner model 14, 192, 193–7, 196, 198, 202, 212 Richardson, J. D. 78, 279 Rivera-Batiz, F. L. 149, 301 Rodrik, D. 303 Rodriquez, C. 93 Rostow, W. W. 234 Ruffin, R. 79

333

Rutherford, T. F. 285 Rybczynski, T. M. 229, 230 Rybczynski effects 9, 127, 138 Rybczynski theorem 78–9 Sachs, J. D. 4, 252 Salinas, President 7, 191 Samuelson, P. A. 229 Sapir, A. 17, 48–50 Schenkel, M. 327–8 Schiff, M. 6, 10, 190–1, 193, 209, 266 Schmidt, C. M. 153, 162 Schmitz, A. P. 232 Schultze, G. 77 Scott, A. D. 160 Sgro, P. M. 294–5 Shapiro, C. 156 Shephard, R. W. 123 Shughart, W. 250 Silber, J. 163 Simon, J. L. 88 Slaughter, M. J. 281 Slaughter, M. L. 78 Slovak Republic 308 social welfare data and calibration 176–82 effects 153–5 function 14, 154–5, 185–6 maximisation 169–70 policy experiments 164–6 sensitivity analysis 172 simulation: model 162–3, 175–6; results 166–74 see also welfare Soligo, R. 153 specific-factors model 9, 24, 29–34, 48, 101–3, 105–6, 108–9, 161, 186, 230–1, 266, 287 Stalker, P. 6 Stark, O. 84, 85, 193, 208 Steiner, V. 185 Stiglitz, J. E. 35, 156 Stilz, A. 84 Stolper–Samuelson effects 78, 127, 138, 139 Straubhaar, T. 87 Summers, L. H. 165 Swagel, P. 78 Swan, P. L. 82 Switzerland 13 data 132 immigration policy 170–1, 175 non-resident labour trends 119–20 production sector 117–45 social welfare 152, 160–2, 164, 166, 175–7 total factor productivity (TFP) 120, 131, 140–3 Syrquin, M. 198, 217

334

Index

Tapinos, G. 222 tariffs 262 (1870–1940) 241, 245, 248–50 and agriculture 285–6 revenue 254 rising 171–2 see also trade protection tax revenue 104–6 Taylor, A. M. 241 Taylor, J. E. 84 technology and agriculture 284–90 differences 229 progress 140–3 Temin, P. 230 theft 82–3 Thomas, B. 234 Thomas, D. 255 Thomas, D. S. 234 Thompson, H. 231 Tiebout, C. 80–3 Timmer, A. 250–1 Todaro, M. 193 Toniolo, G. 260–2 Topel, R. H. 297 Tornqvist index 132 trade costs 29, 33, 42, 53, 60–2 and factor mobility 8–9, 94, 99–100, 117–18, 227–57, 261 labour market consequences 297–304 policies on 77–80 trends 2–3 volumes 234–44, 245–7 trade liberalisation 7–8, 191 and agglomeration 11, 63–5 effects of 30–2, 33–4, 38–9, 45 and factor mobility 28 and migration 12–15, 17–18, 112–14, 211, 288 Pareto gains from 187 and public goods 95, 112–14 sequence 66, 74 see also globalisation trade protection 185–6 social welfare effect 155, 161–2 versus immigration 151, 166–8 see also imports; tariffs; trade liberalisation transport costs 23, 27, 51–2, 55, 56, 228, 234, 241 Trefler 318 unemployment 139–40, 151–2, 211–12, 270 United Kingdom 191, 234 United States 48–50, 212, 234, 250, 268

Amish 81 beneficial immigration 85 European migrants 28–30 immigration policy 87–8 Immigration Reform and Control Act (IRCA) 264 labour market 297–8 maize 266 protectionist 248–9 role of NAFTA 263–91, 294–5 stylised facts 62 see also Atlantic economy; Mexico; NAFTA van Winden, F. 86 Velling, J. 298 Venables, A. J. 9, 10, 11, 17, 23–47, 48–50, 52, 63, 103, 228, 265, 280 Venturini, A. 10, 193, 221–3 voter, median 79, 86 wage bargaining, insider-outsider model 153 wage gap 221 and foreign investment 279 sectoral 180–2 skilled–unskilled 265, 273, 280–4 see also earnings differentials wages, relative 57 Wales, T. J. 120, 131–2, 143 Walterskirchen, E. 301 Warner, A. 4, 252 Weiss, A. 6, 11, 12, 76–89, 91–3 Welch, F. 302 welfare analysis 151 effects 93, 188 utilitarian 6, 154–5, 158–62, 187 see also social welfare Wilkinson, M. 234 Willcox, W. 4 Williamson, J. G. 15, 227–57, 260–2 Wilson, President 248 Winkelmann, R. 298 Winter-Ebmer, R. 16, 153, 185–8, 296–324 Wolff, E. 281 Wong, K. 76, 94 Wong, K.-Y. 227 Wood, A. 78, 279, 302 Wooton, I. 11, 51–68, 68–75, 78 Zahniser, S. 9, 16, 17, 196, 263–91, 294–5 Zellner, A. 133 Zevin, R. B. 241 Zimmermann, K. F. 1–19, 83, 152, 296–324 Zukowska-Gagelmann, K. 304 Zweimüller, J. 153, 188, 302