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1 Dscusson Paper Seres CDP No 3/8 The Effect of Immgraton along the Dstrbuton of Wages Chrstan Dustmann, Tommaso Frattn and Ian Preston Centre for Research and Analyss of Mgraton Department of Economcs, Unversty College London Drayton House, 3 Gordon Street, London WCH AX

2 CReAM Dscusson Paper No 3/8 The Effect of Immgraton along the Dstrbuton of Wages Chrstan Dustmann, Tommaso Frattn, and Ian Preston Centre for Research and Analyss of Mgraton, Department of Economcs, Unversty College London Non-Techncal Abstract Ths paper analyses the effect mmgraton has on wages of natve workers. Unlke most prevous work, we estmate wage effects along the dstrbuton of wages. We derve a flexble emprcal strategy that does not rely on pre-allocatng mmgrants to partcular skll groups. In our emprcal analyss, we demonstrate that mmgrants downgrade consderably upon arrval. As for the effects on natve wages, we fnd that mmgraton depresses wages below the th percentle of the wage dstrbuton, but leads to slght wage ncreases n the upper part of the wage dstrbuton. The overall wage effect of mmgraton s slghtly postve. The postve wage effects we fnd are, although modest, too large to be explaned by an mmgraton surplus. We suggest alternatve explanatons, based on the dea that mmgrants are pad less than the value of what they contrbute to producton, generatng therefore a surplus, and we assess the magntude of these effects. Centre for Research and Analyss of Mgraton Department of Economcs, Drayton House, 3 Gordon Street, London WCH AX Telephone Number: +44 () Facsmle Number: +44 ()

3 The Effect of Immgraton along the Dstrbuton of Wages Chrstan Dustmann, Tommaso Frattn, and Ian Preston Department of Economcs and Centre for Research and Analyss of Mgraton (CReAM) Unversty College London Abstract: Ths paper analyses the effect mmgraton has on wages of natve workers. Unlke most prevous work, we estmate wage effects along the dstrbuton of wages. We derve a flexble emprcal strategy that does not rely on pre-allocatng mmgrants to partcular skll groups. In our emprcal analyss, we demonstrate that mmgrants downgrade consderably upon arrval. As for the effects on natve wages, we fnd that mmgraton depresses wages below the th percentle of the wage dstrbuton, but leads to slght wage ncreases n the upper part of the wage dstrbuton. The overall wage effect of mmgraton s slghtly postve. The postve wage effects we fnd are, although modest, too large to be explaned by an mmgraton surplus. We suggest alternatve explanatons, based on the dea that mmgrants are pad less than the value of what they contrbute to producton, generatng therefore a surplus, and we assess the magntude of these effects. We are grateful to the Low Pay Commsson and the ESRC (grant RES--3-33) for fundng ths research. We are also grateful to George Boras, Davd Card, Andrew Chesher and Smon Lee for helpful comments and dscussons.

4 . Introducton Ths paper analyses the effect of mmgraton on the wages of natve born workers. Our analyss s for the UK, whch experenced an ncrease of ts foregn born populaton equal to three percent of the natve populaton over the perod between 997 and 5. We focus on the effect of mmgraton on wages of natve born workers along the natve wage dstrbuton. Importantly, the estmator we develop does not rely on pre-allocaton of mmgrants to skll categores. Our estmaton strategy s motvated by two observatons. Frst, we beleve that the dstrbutonal effect of mmgraton on wages s a matter of consderable polcy nterest. Secondly, we beleve that estmaton of relatve wage effects across skll groups s problematc, at least n the case of the UK, as mmgrants consderably downgrade after arrval, and pre-allocaton to skll groups may therefore lead to consderable msclassfcaton error. Our paper adds to the current lterature on mmgraton n varous ways. Frst, we propose a smple estmaton method that allows assessng the effect mmgraton has on natve workers at each pont n the natve wage dstrbuton, wthout pre-assgnng mmgrants to partcular skll groups. Secondly, we provde a clear theory-based nterpretaton to the estmated parameter, and show that t s exactly proportonal to the densty of mmgrants along the natve wage dstrbuton. Our analyss gves a fresh nterpretaton to the latest work by Manacorda, Mannng and Wadsworth (6) for the UK, suggestng that the ncomplete substtutablty of mmgrants and natves wthn age and educaton cells they fnd s much related to a substantal downgradng of mmgrants on arrval. Fnally, we address the overall postve wage effect that we fnd, and we propose, and assess, alternatve explanatons for these. We commence wth a general theoretcal dscusson. Frst, we note that the common noton that mmgraton depresses average wages of natve workers s See Ottavano and Per (5, 6) for a smlar argument for the US, and Boras, Grogger and Hanson (8) for a crtcal re-assessment.

5 3 based on a smple one ndustry model, where captal s fxed. 3 We develop a model wth not ust two, but many skll types and captal as factors of producton. We show that, whenever the mmgrant skll composton dffers from that of the natve labour force, and f captal s elastc n supply, the effect on average wages of natve workers should be zero or even slghtly postve. Ths result s unsurprsng as t s based on a smple surplus argument, but has, n our vew, not receved suffcent attenton n the lterature on the effects of mmgraton, where captal supply s usually assumed as beng fxed, so that the surplus goes manly to captal owners. Although the overall wage effect of mmgraton may therefore be close to zero, the effects of mmgraton should be dfferently felt along the wage dstrbuton, possbly depressng wages of workers who are n segments of the labour market where the densty of mmgrants s hgher than that of natve workers. Ths calls for an emprcal approach that nvestgates the mpact of mmgraton along the wage dstrbuton. Earler papers do dstngush between wage effects on sklled and unsklled workers (see e.g. Alton and Card 99, Boras 3, Card, Dustmann et al. 5, Fredberg and Jaeger 7a), and/or analyse the effect of mmgraton on relatve wages (see e.g. Card 5, 7, Card and Lews 7, Manacorda et al. 6, Ottavano and Per 6, Gltz 6). These approaches requre pre-allocaton of mmgrants to skll groups, based on ther observable characterstcs. 4 We demonstrate for the case of the UK that mmgrants downgrade upon arrval, and that pre-allocaton of mmgrants accordng to ther measured sklls would place them at dfferent locatons across the natve wage dstrbuton than where we actually fnd them. Ths s partcularly problematc when estmaton s based on dfferences between tme perods defned as years rather than decades, as only recent arrvals wll affect estmates. We suggest a strategy that crcumvents ths problem. Based on our theoretcal framework, where we allow for many dfferent skll types, we derve an estmable model where we allocate mmgrants to skll groups accordng to 3 See Ottavano and Per (6) and Lews (5) for a smlar crtcal assessment of ths assumpton. 4 Card (8) defnes skll groups accordng to the quartle of the wage dstrbuton where a worker would be predcted to be located. Ths s smlar n sprt to our approach.

6 4 ther observed poston n the natve wage dstrbuton rather than pre-allocatng them to skll groups accordng to ther observed characterstcs. We then estmate wage effects of mmgraton across the dstrbuton of natve wages. Wth our approach no ex-ante restrcton s mposed on where mmgrants compete wth natves. Our emprcal nvestgaton frst demonstrates that mmgrants to the UK over the perod we consder are on average much better educated than natves. But whle perfect substtutablty of mmgrants wth natves wthn measured age-skll groups would mply that mmgrants are located at the upper and mddle part of the wage dstrbuton, ther observed locaton after arrval s at the lower end of ths dstrbuton. Our estmated wage effects along the wage dstrbuton are strkngly n lne wth the locaton of mmgrants: whle mmgraton depresses wages below the th percentle, t contrbutes to wage growth above the th percentle. We also fnd that the average effects of mmgraton on wages are postve. Although ths s n prncple possble wthn a model where captal supply s elastc, smulatons of our model, based on the actual dstrbuton of mmgrants across the wage dstrbuton, suggest that the average wage effects we fnd, although relatvely modest, are too large to be explaned by a surplus argument. In the last secton of the paper, we dscuss a number of possble mechansms that may explan our estmates. The underlyng dea of all explanatons s that mmgrants are pad less than the value of what they contrbute to producton, generatng therefore a surplus. We then assess emprcally the magntude of ths surplus for our data. The structure of the paper s as follows. In the next secton we explan our theoretcal framework, and dscuss our estmaton strategy. In secton 3 we present the datasets we use n the analyss and descrbe the man features of the mmgrant populaton. Secton 4 presents the results. Secton 5 dscusses mechansms of surplus generaton and presents some smulatons and secton 6 concludes.

7 5. Theoretcal and Emprcal Framework We commence by settng out the overall theoretcal and emprcal framework on whch our analyss s based. Our model s based on standard economc theory, where as a startng pont an equlbrum s consdered where all workers are fully employed. The most general model would not restrct the number of ndustres that may produce dfferent products, and allow for any number of labour nput types, as well as allowng for any number of captal nputs nto producton. We develop such a model n Appendx A.. Here we elaborate a smplfed verson of ths model, where we allow only for one output and make the assumpton that producton follows a nested CES technology. We analyse the model under dfferent assumptons about the elastcty of captal supply. We then develop the emprcal mplcatons of the model.. Theory Followng much of the lterature on the effect of mmgraton on wages, 5 we assume that the number of output types (output beng denoted y) s equal to one. However, we allow for a multtude of labour types, =,,L. Let the output be traded on world markets at a fxed prce whch we normalse to equal. We adopt a nested CES producton functon whereby f labour suppled by the th type s l and captal used s K then s s / [ βh + ( β ) K ] s y = (-a) σ / [ α ] σ H = (-b) l where H s a CES aggregate of purely labour nputs, α determnes productvty of the th type of labour and σ determnes the elastcty of substtuton between labour types, whle β determnes relatve productvty of labour and captal and s determnes the elastcty of substtuton between captal 5 See e.g. Alton and Card (99), Boras (3), Card and Lews (7), Manacorda, et al. (6) and Ottavano and Per (6). We therefore exclude possble alternatve adustments to mmgraton n a world wth traded goods, through factor prce equalsaton, as dscussed by e.g. Lews (4). We also exclude adustment through technology, see Lews (5).

8 6 and labour. We assume wthout loss of generalty, a numberng of labour types such that α > α for >. Frms can employ ether natve labour l or mmgrant labour l of each type. We assume that natve and mmgrant labour of the same type are both perfect substtutes and equally productve: l = l + l. 6 For the markets for each labour type to clear 7, l =n for all, where n s the supply of labour of the th type. The labour supply s made up of natves n and mmgrants n, n = n + n, so that n = N( + m) where N = n s total natve labour supply, = N s the fracton of natve labour of the th type, n / = n / n s the fracton of mmgrant labour of the th type and m = n N s the rato of the / mmgrant to natve labour force. Frst order condtons for cost-mnmsng nput choce mply that the real wage of the th type of labour, w, equals the margnal product of labour. Smlarly, the prce of captal, ρ, equals the margnal product of captal. Dervng the frst order condtons and takng logs results n equlbrum nput prces of all labour types: ln w y = ln l H σ where ln = ln( α ( m) ) N σ ( ) βα σ σ H N = ln + ( ) ln( + m) + ln + s K + ln β + ( β ) s H (-a) and 6 Note that we do not dentfy labour types wth educaton-age cells; thus, we do not make the assumpton crtcsed by Ottavano and Per (6) and Manacorda et al. (6) that mmgrants and natves are perfect substtutes n a gven educaton-age cell. 7 We assume the exstence of an equlbrum n whch wages w are ordered across types smlarly to productvty α. It s possble that f low sklled types were n suffcently short supply the wages requred to equate ther supply and demand would exceed wages of the hghly sklled. If the hghly sklled are able to do low sklled obs then clearly ths would not be an equlbrum. Strctly, the approprate equlbrum condton would requre that for each skll type the demand for those wth sklls no lower than that type should be no less than the supply of those wth sklls no lower than that type. We assume away ths complexty.

9 7 y ln ρ = ln K = ln( β ) + ( s )ln K H + ln β + ( β ) s ln K Let us suppose an elastcty of supply of captal gven by θ =. 8 ln ρ K H s (-b) Then the equlbrum change n natve log wages as a reacton to changes n the mmgrantnatve rato s shown n Appendx A. to be gven by: d ln w dm (3) = ( σ ) φ ω m= where ω = α ( ) α σ σ ( ) s the contrbuton of the th type to the labour aggregate H σ, s βh ψ = s s βh + ( β ) K s the contrbuton of labour to the overall CES aggregate y s and ( s)( ψ ) φ = + θ ( s) ψ + σ s a parameter dependng on captal moblty θ, captal-labour substtutablty s and the labour share ψ. The pattern of the effects of mmgraton along the natve wage dstrbuton therefore depends upon the relatve densty of mmgrants and natves dstrbuton. along that Consder frstly the case φ =, whch arses f captal s perfectly moble (θ= ), captal and labour are perfectly substtutable (s=) or the captal share s zero (ψ=). Snce ω =, the expresson n parenthess n (3) s the dfference at that pont n the dstrbuton between the relatve densty of mmgrants and natves and a weghted average of these relatve denstes across the entre skll dstrbuton. The wage of any skll type s decreased by mmgraton f and only f the ntensty of mmgraton at that pont n the dstrbuton of types exceeds an 8 All dscusson below covers the full range for possble values for θ, and s therefore compatble wth Ottavano and Per s (6) observaton to allow for moblty of captal.

10 8 approprately weghted average of mmgraton ntensty across the whole dstrbuton. If the dstrbuton of skll types n the mmgrant nflow exactly matches that n the natve labour force, = for all, then the effect on wages s everywhere zero. If captal s used, mperfectly moble and mperfectly substtutable wth labour then φ < and even mmgraton whch matches the natve labour force n composton wll result n wage losses. However the pattern of wage effects along the dstrbuton wll stll be drven n ust the same way by the relatve densty of mmgrants and natves. The frst order effect of mmgraton on mean natve wages derved n Appendx A. s, also w d w dm σ φ w ω m= = ( )( ). (4) where w s mean natve wage before mmgraton. The frst order effect s negatve unless φ = or σ=. Natve labour on average s harmed by mmgraton, though obvously some labour types may gan f the composton of mmgrant and natve labour dffer. However f captal s perfectly moble so that φ = then the frst order effect s zero. Captal nflows follow the nflow of labour to keep margnal product of captal constant, mmgrant labour s pad the value of ts margnal product and there s no change at the margn n payments to natve labour. Turnng for ths case to second order effects, we obtan (as shown n Appendx A.) d w = ( σ ) w ω ω dm m =

11 9 so that second order effects on the mean natve wage are postve f the mmgrant nflow dffers at all from natve labour n ts mx of skll types. Note that the last term n parentheses s a weghted varance: t s larger the larger the dsparty between the mmgrant and natve skll dstrbuton and dsappears only f = for all. For small levels of mmgraton we should therefore expect to fnd mean natve wages rsng f captal s perfectly moble. Indeed, there can be a postve surplus for labour f captal s farly moble and mmgrant labour suffcently dfferent to natve labour, as we show quanttatvely n secton 6. Ths s the conventonal mmgraton surplus argument establshng that mmgraton s benefcal to natve factors mmgratng labour s pad less than the value of what t adds to producton and the surplus must be returned to natve factors f profts are zero 9. That does not, of course, mean that n ths case wages ncrease throughout the natve skll dstrbuton. Wages fall at any pont n the dstrbuton at whch exceeds the weghted average. In partcular t wll be those who ω compete wth mmgrants who wll suffer wage losses.. Emprcal Specfcaton We turn now to emprcal mplementaton of the CES model as outlned above. Take the factor return equatons n (-a)-(-b), combne wth a captal supply equaton and let ρ be the equlbrum return to captal at m=. Takng a frst order Taylor expanson of (-a) around m= usng the earler d ln w dm expresson ( ) = σ φ ω m= expresson for the wage of the th type: we obtan an approxmate 9 Appendx A. establshes that these qualtatve observatons apply n a much more general model wth many outputs and many perfectly moble captal nputs, assumng only constant returns to scale. For example, any natve subgroup of dentcal composton to mmgrants must lose as shown n Appendx: A. d w dm = ( ). σ w ω φ ω m =

12 σ ( ) σ βα σ α ρ σ + ( σ ) φ ω m ln w ln + ( )ln + ln ( ) + G( ) (5) where s /( s) ρ s ρ β G( ρ) = ln + ln. β s β β β Our data come from dfferent regons at dfferent ponts n tme and our emprcal approach s based on usng varaton n mmgrant nflows across dfferent regons n the UK. We therefore observe a dstrbuton of natve and mmgrant wages n dfferent regons at dfferent ponts n tme. We choose to dentfy dfferent skll types wth dfferent locatons n the observed dstrbuton of natve wages. In other words, f W prt denotes the pth percentle of the natve wage dstrbuton n regon r at tme t then, n terms of the earler theory, we dentfy ths wth w where s the smallest value such that p. Accordngly, we adopt a model γ + ε (6) lnw prt a pr b pt c p X rt p m rt prt where at each pont n the dstrbuton p we nclude regon and tme effects, a pr + b pt. The former capture the role of technologcal parameters gven the ntal skll dstrbuton and captal prce n the regon, whereas the latter capture the nfluence of changes n natonal captal prces on the chosen captal-labour rato. Controls for changng age and skll composton of the natve labour force are ncluded n X rt. The coeffcent on the regon-specfc mmgrant-natve rato s then the key parameter of nterest: ( ) γ p = σ φ ω. Constancy of ths across regons reflects an assumpton that mmgrant skll composton relates

13 smlarly to natve skll composton n dfferent regons and perods. Fnally ε prt s a random error term. 3. Background, Data and Descrptves 3. Mgraton to the UK In, the last census year, 4.8m mmgrants lved n the UK, whch amounts to 8.47 percent of the total populaton. Over 3.5m of them were of workng age (6-65), so that they counted for 9.75 percent of the workng age populaton. Snce then, Brtan has experenced a further ncrease n ts foregn born populaton, and the share of foregn born n the total workng age populaton n 5 was.5%. The share of foregn born populaton n the UK s thus smlar to the correspondng share n the US, whch was.9% n 4. Untl the late 99s almost one thrd of the foregn born populaton n the UK used to be from Western European countres, one ffth from the Indan Sub-contnent, and less than percent from Eastern Europe. Snce the late 99s mgraton from Eastern Europe has ntensfed, and Eastern Europeans consttute now over 5% of the total foregn born populaton, whle Western Europeans are less than one fourth and mmgrants from the Indan Sub-Contnent are stll about %. 3. The Data The man dataset we use for our analyss s the UK Labour Force Survey (LFS) over the perod from 997 tll 5. The LFS, establshed n 973, s a sample survey of households lvng at prvate addresses n Great Brtan, conducted by the Offce for Natonal Statstcs (ONS). We restrct our analyss to Great Brtan, and omt Northern Ireland. Snce 99, the LFS has been a rotatng It seems reasonable to assume that captal s perfectly moble between regons (but not necessarly nternatonally). In that case the captal prce would be the same n all regons and any nfluence of mmgraton on natonal captal prce would be absorbed fully n the tme effects. In such a case t would make sense to dentfy σ a ( ) ln( ) ln ( ( σ pr = σ + α ) ) and σ bpt = ln βα + G( ρ) and to have γ p = ( σ ) ω. Source: US Census Bureau Current Populaton Survey.

14 quarterly panel. Each sampled address s ntervewed for 5 consecutve tmes at 3 monthly ntervals. The sample sze s about 55, respondng households n Great Brtan every quarter, representng about.% of the populaton. The LFS collects nformaton on respondents' personal crcumstances and ther labour market status durng a reference perod of one to four weeks mmedately pror to the ntervew. From the wnter quarter onwards the LFS contans nformaton on gross weekly wages and on number of hours worked. Intally ths nformaton was asked only n the fnal wave, but from the 997 sprng quarter onwards questons on wages were asked durng the frst and the ffth ntervew. Spatal nformaton s avalable at regonal level, where regon s determned accordng to usual resdence. The LFS orgnally dentfes regons 3. We unfy Inner and Outer London nto Greater London, and Strathclyde and the Rest of Scotland nto Scotland, to create terrtorally homogeneous regons, and lmt our analyss to Great Brtan, droppng Northern Ireland. We have therefore 7 regons, and the usual average sample sze for the perod we consder s about 9,97 4. We combne nformaton from the LFS wth nformaton from varous years of the UK Populaton Census. The Census s a decennal survey of all people and households. The most recent Census was n. Although provdng nformaton on age, educaton, and employment status, the UK Census has no nformaton on wages. Moreover comparablty across Census years s not always possble, as varable classfcatons change qute often. Ths s for nstance the case for occupaton and educaton between the 99 and Census. In our analyss below, we use nformaton from the 99 and 98 Census to construct varables for mmgrants geographcal dstrbuton. 3 Tyne & Wear, Rest of Northern Regon, South Yorkshre, West Yorkshre, Rest of Yorkshre & Humbersde, East Mdlands, East Angla, Inner London, Outer London, Rest of South East, South West, West Mdlands (Metropoltan countes), Rest of West Mdlands, Greater Manchester, Merseysde, Rest of North West, Wales, Strathclyde, Rest of Scotland, Northern Ireland. 4 The average populaton sze n a regon s,63,.

15 3 3.3 Descrptve Evdence In 97, the percentage of foregn born ndvduals on the total populaton n Great Brtan was 5.9%, or 3 mllon ndvduals. Over the next decades ths number ncreased to 6.3% (98), 6.8% (99) and 8.47% (). Between 989 and 997, the foregn born workng age (6-65) populaton on the total workng age populaton ncreased by only.7 percentage ponts. In contrast, between 997 and 5 the percentage of the foregn born n the workng age populaton ncreased by almost 3 percentage ponts. Ths s the perod we consder for our analyss, and we concentrate on the workng age populaton only. Table reports some characterstcs of the natve born and foregn born populaton n Brtan, where among the foregn born we dstngush between earler and more recent mmgrants. We defne as earler mmgrants all foregn born who have been n the UK two years or more at the tme of ntervew; we defne as recent mmgrants all mmgrants who arrved n the UK over the last two years. Ths dstncton s mportant as our emprcal analyss s based on varaton n the stock of mmgrants between two subsequent years; ths varaton s drven by recent arrvals. [Table here] In Table, we report average age and educatonal attanments for 997 and 5, the frst and the last year of our observaton perod. Natves and earler mmgrants are very smlar n ther average age (around 4) whle new mmgrants are about years younger. The percentage of females on the other hand s roughly smlar, wth a slght drop for more recent mmgrants between 997 and 5. The lower panel of the table reports educatonal attanment of the dfferent groups. We base our measures on nformaton about the age at whch the ndvdual left full tme educaton 5, and we classfy ndvduals n three groups: 5 The LFS has two alternatve measures for educatonal achevements, age at whch ndvduals left full tme educaton, and hghest qualfcaton acheved. The problem wth the latter measure

16 4 low (left full tme educaton before the age of 7), ntermedate (left full tme educaton between 7 and ), and hgh (left full tme educaton after age ). For natves and earler mmgrants, the table shows an mprovement n educatonal attanment between 997 and 5. However, earler mmgrants are better educated than natves n both years, wth a hgher percentage n the hghest category, and lower percentages n the lowest category. Nearly one n two of new arrvals s n the hghest educatonal category, and slghtly more than one n n the lowest category. The educatonal attanment of new arrvals have roughly remaned constant over the perod consdered. Recent mmgrants may not be able to make use of ther educatonal background to ts full potental, as they may lack complementary sklls lke language, or they may have to start searchng for ther best ob match (see Ecksten and Wess 4). In Table we dsplay the occupatonal dstrbuton of mmgrants n 4 and 5, where we dstngush between 6 occupatonal categores usng the Natonal Statstcs Soco-economc Classfcaton (NS-SEC). We exclude employers and the self-employed because we do not have nformaton on ther wages. The last column shows the average wage by occupaton n the years consdered, expressed n 5 prces 6. [Table here] The occupatonal dstrbuton of those who have been n the country for at least years s smlar to the natve born, except for the hgher mmgrant concentraton n the hghest pad category, and the slghtly hgher concentraton of natves n the two ntermedate categores. However, recent mmgrants,.e. those who arrved wthn years of the ntervew, although beng better educated than the overall mmgrant populaton (see table ), tend to be n lower occupaton categores, wth the partal excepton of hgher manageral and professonal occupatons: 47% are n the lowest three occupatonal groups, compared wth 7% of natves and of earler mmgrants. Ths suggests that new arrvals, unable to put ther human captal nto mmedate use, start lower down the occupatonal s that t s defned on the Brtsh educaton system and classfes all foregn classfcatons as other qualfcaton (see the dscusson n the appendx of Manacorda et al. (6)). 6 We dscount wages usng the 5-based CPI.

17 5 dstrbuton, and compete wth natve workers much further down the dstrbuton. Ths fndng mrrors results for Israel on consderable downgradng of new mmgrants - see the work by Ecksten and Wess (4). In table 3 we break down the occupatonal dstrbuton by educatonal attanment, usng the same groupng. The fgures show that wthn each educaton group, recent mmgrants are dstrbuted more towards the lower end of the occupatonal dstrbuton. For nstance, whle among hghly sklled natves, only 5% work n the lowest two occupatonal categores, ths s the case for % of earler mmgrants, but 6% of recent mmgrants. The respectve numbers for the ntermedate educaton category are 9%, 9% and 63%. Agan, ths suggests consderable downgradng of recent mmgrants wthn educatonal categores. [Table 3 here] In our emprcal analyss, we wll assocate the changes n wages across dfferent spatal unts wth the changes n the stock of mmgrants. Our theoretcal model above suggests that the mmgrant populaton wll exert pressure on wages of natves at those parts of the dstrbuton where the relatve densty of mmgrants s hgher than that of the weghted relatve densty of natves. Where we actually fnd mmgrants n the natve wage dstrbuton can be straghtforwardly estmated from the data: n each year, and for each mmgrant, we can calculate the proporton of natves wth a lower wage. In fgure, we dsplay the dstrbuton 7 of mmgrants along the wage dstrbuton of natve workers, where agan we dstngush between mmgrants who have been n the country for less than years, and mmgrants who have been n the country for less than 6 years. [Fgure here] 7 These are kernel densty estmates. Gven that the varable n queston s bounded, by constructon, between and, conventonal kernel estmaton wth fxed wndow wdth would gve msleadng estmates at the extremes. The kernel estmates are therefore calculated on the log of the odds of the poston n the non-mmgrant dstrbuton and approprately transformed.

18 6 The dashed lne shows the densty of recent mmgrants along the wage dstrbuton of natves. Contrary from what we should expect based on nformaton on ther educatonal background, the densty of recent mmgrants s hgher than that of natves everywhere below the 5 th percentle of the wage dstrbuton. On the other hand, t s lower between the 5 th percentle and the 9 th percentle, and hgher agan afterwards. The dotted lne shows the dstrbuton for mmgrants who have been n the country for less than 6 years. The overall pattern s stll smlar, but t s apparent that some upgradng has taken place, wth less mass below the 5 th percentle. Based on these fgures, we should expect therefore that mmgrants put a pressure on wages below the 5 th percentle of the natve wage dstrbuton. Where would we fnd mmgrants along the natve wage dstrbuton f we had allocated them accordng to ther observed age and educaton dstrbuton? We llustrate that n Fgure. Fgure s obtaned by estmatng a flexble log wage regresson for natves, where we condton on fve age categores and four educatonal categores, as well as nteractons between the two 8. We estmate that equaton separately for males and females. If mmgrants and natves are perfect substtutes wthn age and educaton categores, then mmgrants should be located n the natve wage dstrbuton accordng to ther predcted wages. We predct wages for all recent mmgrants, where we add an error term to the predcton whch s drawn from a normal dstrbuton, wth heteroscedastc varance accordng to age, educaton and gender. We then draw the densty of mmgrants across the natve wage dstrbuton. [Fgure here] The dfference between fgure and s strkng. In fgure, mmgrants are strongly present at the very low end of the wage dstrbuton; however, above the 7 th percentle, ther densty s much lower than that of natve workers. On the other hand, the densty becomes ncreasngly larger above the 6 th percentle. 8 Our regressors nclude fve age categores (6/5, 6/35, 36/45, 46/55, 56/65), four educatonal categores, based on age at whch ndvduals left full tme educaton (before 6, 6/8, 9/, after ), nteracton between the two, a dummy for London resdents, and quarter dummes. We ft separate models for men and women and for dfferent years.

19 7 Based on ths fgure, we would expect mmgrants to exert a pressure on wages at the bottom of the natve wage dstrbuton, and above the medan. The fgure shows clearly that t may be msleadng to pre-allocate recent mmgrants across the natve skll dstrbuton based on ther observable characterstcs. 4. Estmaton 4. Implementaton and Identfcaton In our emprcal analyss, we estmate the effects of mmgraton along the dstrbuton of wages. Our startng pont s the emprcal model that derves drectly from our theoretcal framework, as n (6). The parameter we estmate n that model s a combnaton of the elastcty of substtuton between skll groups, and the relatve densty of mmgrants at the partcular part of the natve wage dstrbuton. As we explan above, the relatve sze of the parameter should drectly correspond to the densty of mmgrants, as we have llustrated n Fgure. The way we mplement that model s to regress dfferences over tme n percentles of log wages across dfferent regons n the UK on changes n the fracton of mmgrants to natves mrt, tme dummes β t, and changes n the average age of mmgrant and natve workers n the regon as well as the rato of hgh (ntermedate) to low educated natve workers, c prt : ln W = β + c + γ m + ε (7) prt t prt p rt prt It s mportant to note that our approach does not depend n any way on pre-assgnment of mmgrants to partcular skll cells. For estmaton, we use varaton across spatal unts r and across tme. Ths approach may potentally lead to an overly optmstc pcture of mmgraton on natve outcomes f natves leave labour markets that experenced n-mgraton. However, f ths occurs, t s lkely to be less relevant n our case, as the large regonal defntons we use n our analyss make t more lkely that any movements wll be nternalsed (see Boras

20 8 et al. 997 for a smlar argument). We nevertheless check ths by usng an extenson of the methodology n Card (), adapted to our quantle approach, and fnd no evdence for natve responses to mmgraton 9 (detals are avalable on request). In addton, we condton on natve skll group proportons, whch should take account of changes n the natve skll group over tme. Of course, there are obvous concerns about whether such proportons ought themselves to be regarded as endogenous n such a settng and there are less obvous nstruments to deal wth the ssue. A further problem s the endogenous allocaton of mmgrants nto partcular regonal labour markets. One soluton s to use nstrumental varables estmaton. We follow the lterature and use settlement pattern of prevous mmgrants as nstruments. Ths nstrument has been used n varous studes n ths lterature, followng Alton and Card (99), and s motvated by a number of studes (see for nstance Bartel 989, Jaeger 7b, Munsh 3) showng that settlement patterns of prevous mmgrants are a man determnant of mmgrants locaton choces. When estmatng equaton (7) we use years 997-5, and we compute the rato of mmgrants to natves for each year n each of the 7 regons. Estmaton n dfferences elmnates regon specfc permanent effects that are correlated wth mmgrant settlement patterns and economc condtons alke. We nstrument the change n ths rato usng two alternatve but closely related nstruments: the 99 rato of mmgrants to natves for each of these regons, from the Census of Populaton, and four perod lags of the rato of mmgrants to natves n each regon from the LFS. Both nstrumental varables are strongly correlated to the rato of mmgrants to natves. The frst stage regresson of the change n the mmgrant-natve rato on the 99 rato and tme dummes gves a coeffcent of.68 wth a t-statstc of 9.5, whle the partal R of excluded nstruments s.9, and the F-test for ther sgnfcance s A regresson of the endogenous varable on the fourth lag of the mmgrants-natves rato and on tme dummes gves a coeffcent of.43, wth a t-statstc of., whle the 9 Absence of counterbalancng natve outflows s also detected by Card and DNardo (), Card () and Cortes (6) among others. Boras et al. (997) on the other hand do fnd sgnfcant dsplacement effects of mmgrants on resdent natves. See among others Card (), Card and Lews (7), Cortes (6), Cortes and Tessada (8), Lews (5), Ottavano and Per (6, 7) and Saz (7) for a smlar strategy. Standard errors are clustered by regon.

21 9 partal R of excluded nstruments s.3 and the F-test for ther sgnfcance s The nstruments are vald under the assumpton that economc shocks are not too persstent. We report n table 4 the results of Arellano-Bond tests for frst and second order seral correlaton n the resduals of regressons for all the dependent varables we consder. Absence of second order seral correlaton cannot be reected for all varables except for the medan wage and the 75 th percentle. [Table 4 here] In addton we perform several robustness checks, usng nstruments that are based on settlement patterns further aback. We use further lags of the rato of mmgrants to natves (gong back to the 4th lag) and the 98 mmgrant-natve rato. We also construct a seres of nstruments based on the predcted nflow of mmgrants n each regon, along the lnes of Card (). We take account of the area of orgn of mmgrants and desgn a varable whch predcts the total mmgrant nflow n each regon n every year, net of contemporary demand shocks. In order to do so we dvde mmgrants nto 5 areas of orgn and calculate the number of mmgrants from each area who entered the UK n every year. We then allocate every group of mmgrants across regons accordng to the locaton of prevous mmgrants from the same area 3. Results obtaned wth these alternatve nstrumental varables are very smlar to those obtaned wth the nstruments descrbed above, whch we report n the tables (see Table A for estmaton results for average wages. Results along the dstrbuton are avalable on request). Irsh Republc, Old Commonwealth, Eastern Afrca (New Commonwealth, NC), Other Afrca (NC), Carbbean (NC), Bangladesh, Inda, Pakstan, South East Asa (NC), Cyprus, Other New Commonwealth, European Communty (99 members), Other Europe, Chna, Rest of the World. 3 If we defne M ct as the number of new mmgrants from area c n year t, and M λ = as the fracton of mmgrants from area c n regon n a base perod, then λ s the predcted M c ct c c M number of new mmgrants from area c n regon n year t. As base perods, we experment wth dfferent years: 98, 985, and 99, usng data from the LFS and for 99 from the Census. Fnally, we sum over all orgn groups to obtan a predcted total mmgrant nflow nto regon whch s cleansed of local demand shocks : c λ M c ct. Fnally, we dvde ths predcted nflow by the number of natves n the regon at tme t-, to normalze by regon sze. c

22 4. Measurement As we explaned n secton 3. the LFS s a natonally representatve survey, and snce the mmgrant populaton accounted for less than % of the total populaton for most of the years we consder (and much less so n some regons), the number of observatons for mmgrants may be qute small. Therefore measures of regonal mmgrant concentraton may suffer from measurement error due to small sample sze. As we estmate our equatons n frst dfferences, ths may amplfy the mpact of measurement error, resultng n a possbly severe downward bas. Instrumental varable estmaton accounts for the measurement error problem as long as the measurement error n the nstrumental varable s uncorrelated wth the measurement error n the varable of nterest. Aydemr and Boras (6) argue that, f the nstrument of choce s some lagged measure of the mmgrant share, and measurement error s correlated over tme, the nstruments may not be vald. In our case ths s not a concern because we use a mnmum of four lags as nstrument, therefore avodng any correlaton n the measurement error of the endogenous varable and the nstrument even n frst dfferences. Alternatvely we use as an nstrument the mmgrant concentraton from the Census, whose measurement error s ndependent from that n the LFS. We use four dfferent measures for average wages to test the robustness of our results. Frst we use the smple average regonal wage. Second, we compute a robust regonal average by trmmng n every regon and year the wage dstrbuton of natves at the regon- and year- specfc st and 99 th percentle. Ths measure reduces the mpact of outlers on our averages by consderng only central observatons n the wage dstrbuton. Thrd, we calculate a wage ndex constructed as the weghted sum of the average wages n each educaton group, defned as above n terms of years of educaton (see dscusson n secton 3.3). The educatonal composton of the natve populaton s kept constant by choosng as weghts the share of each educaton group n the natve populaton n a base year (whch we choose to be 998) 4. By holdng constant the skll composton 4 The wage ndex s constructed for each regon as follows. Frst we calculate et w, the average wage for educaton group e=,,3 n tme t=997,,5. Then we calculate the tme-nvarant

23 of the assessed populaton, ths measure s solated from compostonal ssues assocated wth changng natve sklls. The theoretcal results of earler sectons show that wage changes could rase average wages n the natve populaton (f captal s perfectly elastc) holdng skll composton fxed and ths measure comes closest to capturng that. Fnally, we use a robust verson of ths ndex based on wages n the trmmed sample. The robust ndex s constructed usng robust average wages for each educaton group, where the average wages by educaton group are computed on the same trmmed sample as explaned above. In table A n the Appendx we report means and standard devatons of all the varables we use, and n table A3 we show the year specfc means and standard devatons of the change n the mmgrant-natve rato. 5. Results 5. Effects along the wage dstrbuton We now turn to our analyss of mmgraton on wages of natve workers. We commence by estmatng the effect of mmgraton along the dstrbuton of wages. In table 5, we report results for the 5 th, th, 5 th, 5 th, 75 th, 9 th, and 95 th percentle of the wage dstrbuton. Columns and present OLS results and columns 3, 4, and 5, 6 present IV results, usng alternatve nstruments. Reported results are based on dfference estmatons. Columns, 4, and 6 control, n addton to tme effects, for average natves and mmgrants age, and the logarthm of the rato of natves n each educaton group to natves wth no qualfcatons. Estmaton s based on yearly data for the years and for 7 regons. [Table 5 here] The regresson results show a szeable negatve mpact of mmgraton on the lower wage quantles. Accordng to IV estmates n column 4, whch use the e 998 = N e N weghts 98 98, the proporton of natves n educaton group e n 998. Fnally, we defne the ndex I t = e=,, 3 e98 w et

24 99 settlement patterns of mmgrants drawn from the Census as nstrument and nclude all controls, the mpact of an nflow of mmgrants of the sze of % of the natve populaton would lead to a.6% decrease n the 5 th wage percentle and a.4% decrease n the th wage percentle. On the other hand, t would lead to an almost.7% ncrease n the medan wage and a.5% ncrease n the 9 th percentle. Estmates usng the fourth lag of the rato of mmgrants to natves (see columns 5 and 6) gve the same pcture, but wth slghtly smaller coeffcents. Both IV estmates ndcate a strong postve mpact of mmgraton around the medan wage, but a negatve effect at the bottom of the wage dstrbuton. Accordng to these estmates, mmgraton seems to put downward pressure on the lower part of the wage dstrbuton, but ncreases wages at the upper part of the dstrbuton. We note that the OLS estmates are smaller n absolute magntude than the IV estmates. Ths s not what we should expect f mmgrants allocate n regons whch experenced postve economc shocks. However, as we pont out above, nstrumentaton removes also measurement error, whch leads to a bas towards zero n the estmated parameters. 5 Our results suggest that the measurement error bas s larger n magntude than the selecton bas. 6 In terms of magntude, our estmates n column 6 of table 5 suggest that each percent ncrease n the mmgrant/natve workng age populaton rato led over the perod studed to a.5 percent decrease n wages at the st decle, a.6 percent ncrease n wages at the medan, and a.4 percent ncrease n wages at the 9 th decle. The average ncrease n the mmgrant/natve workng age populaton rato over the perod consdered was about.35% per year, whereas the real hourly wage ncreased over the perod by 8p (4.8%) per year at the st decle, by 5p (3.5%) per year at the medan, and by 53p (3.8%) per year at the 9 th decle (n 5 terms). Therefore mmgraton held wages back by.7p per hour 5 Aydemr and Boras (6) show that the measurement error nduced attenuaton bas becomes exponentally worse as the sample sze used to calculate the mmgrant concentraton declnes, and that adustng for attenuaton bas can easly double or trple the estmated wage mpact of mmgraton. 6 It s worthwhle to note that the standard errors of the IV estmator are smaller than the standard errors of the OLS estmator n dfferences. The reason s that standard errors are calculated on the assumpton of lack of seral correlaton n the resduals of the levels equaton so that the dfferenced equaton s assumed to have resduals wth a specfc pattern of frst order seral correlaton. OLS s not effcent gven such seral correlaton, even under exogenety of the regressors, and IV may accordngly gve lower standard errors.

25 3 at the th percentle, contrbuted about.5p per hour to wage growth at the medan and slghtly more than p per hour at the 9 th percentle. To obtan a more detaled pcture, we have estmated the model at a fner grd of wage percentles. In fgure 3 we plot the estmated coeffcents of regressons from the 5 th to the 95 th percentle, n ntervals of 5 percentage ponts for the IV regressons, usng the specfcaton n column 6 of the table. The dotted lnes are the 95% confdence nterval. The graph shows the negatve mpact on low wage percentles and the postve mpact on percentles further up the wage dstrbuton. [Fgure 3 here] The graph of wage effects llustrated n the fgure s strkngly smlar to the dstrbuton of mmgrants along the natve wage dstrbuton, as shown n Fgure. The wage effects curve s lke a mrror mage of the observed dstrbuton of recent mmgrants over the natve wage dstrbuton. The consonance of these two ndependent peces of evdence offers strong support for the pattern of effects as suggested by our theoretcal model. Overall, these results suggest that mmgraton tends to stretch the wage dstrbuton, partcularly below the medan. Our IV coeffcents mply that an ncrease n the mmgrant populaton by about percent of the natve populaton would ncreases the 5- dfferental by about percentage pont, but there s hardly any effect of mmgraton on the wage dstrbuton above the medan. 5.3 Immgraton and Average Wages In table 6 we present results on mean regressons from estmatng equaton (7), usng the dfferent measures for average wages whch we dscuss above. Results are consstent across all specfcatons, and show a postve mpact of mmgraton on natves average wages throughout. [Table 6 here]

26 4 The coeffcents on the wage ndex (n the thrd row), and on the robust wage ndex (n the fourth row) capture most closely the mean mpact at fxed skll composton correspondng to our theoretcal model (see secton 4.3). These estmates ndcate that an ncrease n the foregn born populaton of the sze of % of the natve populaton leads to an ncrease of between.% and.3% n average wages. As the average yearly ncrease n the mmgrant/natve rato over our sample perod (997-5) was about.35%, and the average real wage growth ust over 3 percent, mmgraton contrbuted about percent to annual real wage growth. These estmates are smlar n magntude to those obtaned n other studes fndng postve wage effects of mmgraton, such as Fredberg () and Ottavano and Per (7). 6. Explanng postve mean wage effects How can we explan the postve mpact of mmgraton on mean natve wages? One reason, as set out n recent work by Ottavano and Per (6), may be mperfect substtutablty of mmgrants and natves wthn skll groups 7 so that natve margnal product can be enhanced by expanson of the mmgrant labour force. We explore here a varety of possble reasons whch are not dssmlar n sprt. Common to each s the dea that mmgrants are pad less than the value of what they contrbute to producton, generatng therefore a surplus. Exactly who captures ths surplus depends upon assumptons made about producton decsons. Under condtons mplyng zero profts, such a surplus wll result n enhanced payments to pre-exstng factors of producton. If factors other than labour, and n partcular captal, are suppled suffcently elastcally, because for example of nternatonal moblty, then the surplus wll accrue n ncreased average wages to natve labour. We frst consder the possblty that a surplus arses f mmgraton takes the economy down ts labour demand curve. We dscuss ths surplus n secton.. We show that such a surplus s second order and may create an ncrease n natve wages at larger nflows, and f captal supply s elastc. Secondly, we 7 See also D Amur, Ottavano and Per (8) and Per (7) for a smlar argument, and Boras, Grogger and Hanson (8) for a reapprasal of Ottavano and Per (6).

27 5 explore arguments that rely on mmgrant wages fallng below margnal products and mply frst order surplus effects. We consder two such possbltes. In the frst of these, n the pre-mgraton stuaton, wages pad are dfferent from the margnal product n local labour markets. Ths stuaton could occur f wages are stcky, for nstance through nsttutons, natves are nsuffcently moble to reestablsh an equlbrum, and mmgrants tend to go to areas where the dfference between wage and margnal product s largest. In the second possblty, mmgrants work n obs approprate to lower sklls and are pad below the value of ther margnal product. We provde strong evdence for downgradng n secton 3.3. Ths wll also generate a surplus, whch wll be captured by natve workers. Below we wll explore each of these reasons n detal. Based on our data and the parameters we have estmated, we then assess through smulaton, whether mmgraton of the magntude observed n our data could account for wage effects of the sze found through such a means. We conclude that whle t seems unlkely that any of these arguments alone explan the sze of postve effects, t mght be explaned through a combnaton of the dfferent explanatons.. 6. Equlbrum mmgraton surplus We know from theoretcal consderatons (see Secton.) that postve effects on natve wages are compatble wth a standard equlbrum model wth dfferentated labour and elastcally suppled captal. Immgraton generates a surplus whch s pad to nelastcally suppled natve factors and whch wll accrue to labour f other factors are suppled elastcally. Such an effect s second order however the margnal mpact s zero. Can the postve mean wage effects of the magntude found n our analyss be accounted for by equlbrum surplus arguments for the sort of magntudes of mmgraton observe n our data? To nvestgate ths, we smulate our model for the dstrbuton of mmgrants we observe n the data, and establsh the overall effects on wages, for dfferent sets of model parameters. To do ths we frst need to augment the equatons of Secton. wth a captal supply equaton. Assumng a constant elastcty of captal supply θ, the system of equatons used for