EC336 Economic Development in a Global Perspective

1. EC336Economic Development in a Global Perspective Abhishek chakravarty 2013-14 Lecture 10

2. Lecture Outline • Migration in a One-Good Model • Effects on source and destination countries. Who gains and who loses? • The Brain Drain • All the material is from Panagariya (2006) and Feini (2003).

3. Introduction – Causes and Effects of Migration • Most researchers agree that, in general, it is explained by income differentials, prospects of finding a job and improvement in living standards. • Clark, Hatton and Williamson (WD 2004) - the main variables that explain international migration are: • income per capita differences • education differences • distance between countries • language (English-speaking) • civil wars (or unrest in the source country) • past stock of migrants (friends and relatives effect) • age of the migrants (15-29 years old).

4. Introduction – Causes and Effects of Migration • The debate is not on the causes of international migration but on the welfare effects for both the source and destination country. • Main questions: Does unskilled migration necessarily worsen the situation of unskilled natives in the destination country? Is skilled migration a brain drain or a brain gain? • The evidence is mixed for both source on destination country on whether migration is beneficial. The only somewhat conclusive finding is that migrants benefit after arriving in the destination country. What happens to wages, remittances, and education levels due to migration is up for debate.

5. Panagariya (2006) – One Good Model • Suppose that there are only two important factors of production: capital (K) and labour (L). The North (N) is capital abundant and the South (S) is labour-abundant. • Assume a concave production function Q = F(K,L). If the amount of capital is fixed (short-term scenario), the marginal product of labour (MPL) declines with one additional worker. • Assume perfect competition so the real wage paid to workers equals their marginal product. As L increases (with fixed capital), the MPL decreases and so the real wage.

6. Panagariya (2006) – One Good Model With a given the level of capital, the MPL curve determines the real wage. The area under the MPL curve equals the value of output produced, which equals the value of wages and rental income paid to the other factors of production.

7. Panagariya (2006) – One Good Model Only one good is produced with price equal to 1 and there is no international trade. R is the initial allocation of labour between North and South. Total labour in North is ONR. Real wage in North is WN at A. Workers in the South have incentive to move to North until real wages between countries are equal (E). Migrants do not own any capital.

8. Panagariya (2006) – One Good Model • Emigration from South raises the real wage of the remaining workers there. It increases the quantity of labour and decreases the real wage in the North. • Labour migration from South to North will also increase world output. The value of world output is maximized when the marginal product of labour is the same across countries. • This is because when MPL in South < MPL in North, then a small transfer of labour from South to North increases the total world income.

9. Panagariya (2006) – One Good Model What happens if finite number of people migrate (RR’) such that the new labour allocation between the countries is R’? South: Loses area FGH in income. Workers gain WS W’SHG. Capitalists lose rent = FHWS W’S North: Gain area ABC in income. Native workers lose WN W’NAB. Capitalists gain WN W’NAC. Migrants gain area BCFG (they retain FGRR’) Therefore, World income increases by ACHF = -FGH + ABC + BCFG

10. Panagariya (2006) – One Good Model • The effect of this migration on national welfare depends on whether the welfare of migrant is included in the source or the destination country. • If migration is temporary, then it makes sense to incorporate welfare of the migrants in the source country and: • Source country is better off: welfare of migrant is larger than those left behind • Destination country is better off: native population benefits (net gain = ABC) • If migration is permanent, the effects on welfare are less clear cut because it is not possible to make the welfare of the migrant a part of the welfare of the destination country because of ties between the migrant and the source country, e.g. remittances of income.

11. Welfare Implications for Source Country • Using the above one good model, Panagariya (2006) suggests that when there are large differences in wage between the source and the destination country, then the potential gains from temporary migration are large. • Therefore, developing countries should request an agreement on temporary movement of workers and that this should be incorporated in the Doha Round. However this is political unviable for developed countries and not likely to happen. • There are differing implications for welfare when we extend the model to account for international trade, small countries, and skilled and unskilled labour.

12. Welfare Implications for Source Country • Size of the country: Assume a two-good, two-factor (capital and labour), small-country model. Good prices and factor prices are given by world markets with free trade so finite emigration will not change factor prices. • Those left behind in the source country are not worse or better off post-migration, so small remittances will improve their welfare. • If the source country is large (it affects world prices), then migration will change the terms of trade and hence, factor prices and the welfare of those left behind.

13. Welfare Implications for Source Country • Skilled and unskilled labour: Developing countries have large amounts of unskilled workers. Emigration of unskilled workers from the LDCs to the DCs is not seen as bad by LDCs. This view is reinforced by remittances, which are larger from unskilled migrants. • Skilled migration (doctors, engineers, etc.) is viewed as bad for LDCs because they will not only lose income but also the cost incurred in training and education and any positive externality from these workers to the rest of the population. • Reduction of the available externality reduces productivity and hence shifts the marginal product of labour curve down and make the loss larger than the triangle FGH.

14. Welfare Implications for Source Country Wages of skilled workers in LDCs tend to be set below the market wage either because of government regulation, lack of purchasing power of the poor etc. If the wage effectively paid to skilled workers does not reflect their true social marginal product, then emigration of these workers lead to a loss larger than triangle FGH. SMB: Social marginal benefit of doctors’ services as a function of doctors’ services. L is the initial supply of doctors and doctors’ fee set at Ws below SMB. LL’ is doctors emigration, the loss to those left behind is not EJH but also the EFGJ.

15. Welfare Implications for Host Country • First concern:Unskilled immigration affects negatively the wages of unskilled labour in the host country and hence, worsens income distribution. But, according to Panagariya, empirical studies are not highly supportive of this. • Borjas (2003): Estimates that immigration into the United States between 1980 and 2000 lowered average wages by 3 % and unskilled wages by 8%. This assumed that immigration had no effect on the stock of capital. • However if increased labour force through immigration raises the return to capital, it should also raise stock of capital. If this is included, immigration has no effect on the average wage, but lowered unskilled wages by less than 5 %.

16. Welfare Implications for Host Country • Ottaviano and Peri (2006) found that even within the same skill category natives and immigrants are imperfect substitutes and do very different jobs. • Allowing for the imperfect substitutability, immigration between 1980 and 2000 actually raised the average wage of native workers by 2 % and the effect on unskilled wage was insignificant or just moderately negative. • Card (2005) assumes that if immigrants have a negative effect on unskilled wages, the effect must be most visible in cities, where immigrants are disproportionately located. But, he found no such effect.

17. Welfare Implications for Host Country • Is there any theoretical viewpoint that can explain little or none adverse effect of immigration on host country wages? If the host country is small, factor prices may not change as we have seen. • Technology differences: North is an exporter of capital-intensive goods but an importer of labour-intensive goods. Assume the North has superior Hicks-neutral technology in the labour intensive good. At the original prices, when labour migrates from the South to the North, the North can produce more labour intensive good and reduce imports, thus transferring production of the good from the South to the North. (continued)

18. Welfare Implications for Host Country • As the technology in the labour intensive good is superior in the North, the impact of the transfer of migrant labour on total world supply of the labour intensive good relative to the capital intensive good is ambiguous. Therefore if the price of the good increases, the wage rate in both North and South will increase due to migration. • Skilled labour vs. Unskilled labour: If we consider skilled and unskilled workers, it is possible for immigration of unskilled workers to expand the supply of skilled workers in the destination country (e.g. by releasing mothers from childcare), and hence to increase the demand for unskilled labour. Hence wages of unskilled workers may not fall.

19. Welfare Implications for Host Country • Second Concern:Unskilled migrants often enter illegally and do not pay taxes but they consume all public services paid by the native population worsening the overall welfare of the native population. • While immigrants may impose this fiscal burden, they also generate benefits for it. For instance when they perform housework that allows native families to participate more fully in the labour force, they help the latter earn income. These gains can be large if the wage at which natives would perform the same services is prohibitively high so that the households would end up doing their own housework. • A proper evaluation of the impact of immigrants on the native population must therefore take into account this benefit side and not just the cost side on which the literature to-date has focused.

20. Skilled Migration and Brain Drain • Faini (2003) argues that the size of the brain drain is large. Migration rates are large among educated people.

21. Skilled Migration and Brain Drain • Is this brain drain a concern in the sender countries? • Arguments in favour of brain drain: • Earnings of skilled labour are large so their remittances are substantial. • Skilled workers eventually return home and bring with them valuable skills. • Given that the returns to skill are higher abroad, the prospects of migration may foster investment in education in the source country. • Faini’s argument: These benefits, or brain gain, are unproven and that the concerns about the negative effect of skilled migration from the poor countries are justified.

22. Brain Drain and Remittances • Remittances play a key role as a source of foreign exchange in several countries. However, how are remittances influenced by the skill composition of emigration? • Simple OLS on remittances show that: • Remittances are a positive function of the stock of migrants. • Remittances decline with income per capita of the sending country. • Remittances decline as the share of migrants with tertiary education increases. This is consistent with the idea that more skilled migrants tend to move more permanently.

23. Brain Drain and Remittances

24. Brain Drain and Return Migration • Does return migration mitigate the brain drain? • The idea here is that: • Returnees bring back not only their original skills but other valuable skills acquired • Temporary migration can help to overcome domestic market failures e.g. credit market imperfections (temporary stay abroad can allow the person to raise enough capital to undertake the project that cannot be financed at home). • But are returnee migrants that have not been able to succeed abroad? This negative selection of returnees may also occur in skilled workers. If skills are imperfectly rewarded at home, the returnees will tend to be those with more limited skill initially and lesser skill accumulation abroad.

25. Brain Drain and Return Migration • Borjas and Bratsberg (1996) provide a model of return migration showing that under fairly general conditions, return migration will tend to amplify the initial selection bias. • If migrants were negatively selected to begin with, then returnees will be relatively more skilled. Conversely, if migrants were initially relatively skilled, then the least skilled will most likely return to their home country. • There is considerable evidence about the negative selection bias of return migration. Solimano (2002) reports that, at least in science and engineering, a large fraction of PhD graduates from developing countries tend to remain in the US after graduating.

26. Brain Drain and Return Migration • National Science Foundation data show that, four years after graduation, 88 and 79 percent of respectively China’s and India’s graduates in S&E are still working in the United States. • More comprehensive evidence comes from Lindstrom and Massey (1994) for Mexican migrants, Reagan and Olsen (2000) for the US, Bauer and Gang (1998) for Egypt, Steiner and Velling (1994) and Schmidt (1994) for Germany. • The bottom line of this literature is that return migration will not provide much consolation to a country suffering from a brain drain problem. Only if initial migrants were mostly unskilled, as in Puerto Rico’s case, will returnees be positively selected.

27. Brain Drain and Education in Source Country • Does the brain drain foster growth by increasing educational achievement? • The brain drain may hurt the sender country even in the case where skilled workers are involuntarily unemployed in the sender country because: • In the absence of possible migration, doctors may be moved to inner cities where his social marginal productivity is high. • The increased return to education might prompt other workers to increase education. This is more the case if home wages tend to catch up with foreign wages and hence, it might increase skilled unemployment in the sender country if the increased supply of skilled workers and the fall in their demand more than offset the impact of skilled migration. • Per capita income of the left behind would fall on the account of large cost of education and the fall in skilled employment.

28. Brain Drain and Education in Source Country • Faini estimates a regression relating educational achievement to a set of explanatory variables including emigration. The indicator of the emigration is the probability of migration which is both country and skill specific. He finds that: • Higher migration probability for workers with secondary education does not explain home country secondary achievement. • Higher migration probability for workers with tertiary education has a positive and significant effect on secondary enrolment. • Higher migration probability for workers with tertiary education has a negative effect on tertiary enrolment. Perhaps migrants pursue graduate studies abroad to increase their chances of staying in that country so they might have an incentive to emigrate earlier on.

29. Conclusions • Panagariya argues that is difficult to generalise if the sender or the destination country grains/losses from migration. E.g. Small sender countries might be hurt from skilled migration; however large countries (like India) are most likely to gain. • He also cast doubts if immigration has caused lower wages, increased income inequality and imposed high cost in the destination country. • Faini finds little support for the view that skilled migration may benefit the sender developing country. In fact, skilled migration might threaten the growth prospects of the sender countries.

30. Conclusions • Additional points to consider in the debate: • The loss of future tax contributions (especially skilled workers) from the sender country which might be larger than the reduction in public spending as people migrate. • Migration externalities in the destination country: • Costs in the destination country: Congestion costs and social friction. • Benefits: migrants carry knowledge (artistic talents, advanced technology, plumbing skills, etc.) which could be transferred to the destination country. • Developed countries have migration laws which discriminate migrants according to skills and income. Poor countries can benefit from unskilled migration but many developed countries are implicitly opposed it.