Migration, dual labour markets and social welfare in a small open economy: Comment. Rudolf Winter-Ebmer

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1 Migration, dual labour markets and social welfare in a small open economy: Comment Rudolf Winter-Ebmer This is a very interesting paper and a paper I certainly enjoyed reading. Looking at the topic, I even wondered why nobody else tackled this problem earlier. Tobias Müller starts from the observation that the assimilation process of immigrants is different in, say, the U.S. from Western Europe. The famous Chiswick (1978) study suggests that foreign-born 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. This paper 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 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 overcompensated for by the (welfare-enhancing) impact of less inequality. Furthermore, the more inequality-averse 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 ε. But we don t. One indication could be the interpretation of ε: A value of

2 ε=0 (0.2, 1, 2) would mean: 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 bureaucratic losses, the policy-maker is willing to incur in order to redistribute. If lawmakers had a social welfare function in mind with ε=0.2, they should be prepared to accept bureaucratic losses of up to 14 % of transfers given. Such a low value of ε 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 labour-intensive 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 this paper, Müller tries to understand why different policy options have been used in the 60s and in the 80s: A guest-worker system with discrimination proofed profitable in the 60s 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 them became less 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 as well. The 60s were a period of labour shortage, whereas the 80s are characterised by chronic unemployment in Western Europe. This example illustrates nicely the tension between longrun 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 second sector. It would be interesting to see, if a different modelling of the efficiency wage mechanism would change matters considerably. Suppose, e.g. 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,

3 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 this paper, if capital would be mobile between sectors in a Heckscher-Ohlin world, a similar result would restrain welfare gains from immigration: Immigration would only increase native employment 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 in the last section shows that competing assumptions, like all capital income to the skilled reduces the admissible ε -values for welfareimproving migration considerably. I suppose, this would even be more so if all capital income would go to a separate capitalist class. Finally, it might be interesting to compare the results of this paper 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 is 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 Tobias paper, but it is certainly important for political economy aspects of migration legislation.

4 Coming to the empirical implementation, I am a little bit worried by the nested CES-specification. Basically, the set-up restricts the substitution possibilities, e.g. there is no room for complementarity relations, because two factors each form a composite factor with separability assumptions. Especially 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 a little bit 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 paper!). Similarly, the introduction of primary and secondary labour markets for unskilled workes only, is somewhat 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 form practitioners of the labour market. In an empirical study for Austria, we found related evidence: native workers employed in firms without foreigners had flatter earningsexperience profiles than those being employed in firms with a considerable presence of immigrants (Winter-Ebmer 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) due 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 big. Moreover, immigration gets even more favourable, the higher the stock of immigrants is already. Immigration in the guestworker system is doubly beneficial for natives: i) it enables more natives to find a job in the primary

5 sector and ii) 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. Tobias went a considerable step on this road. I would guess - given the great many extensions which suggest themselves - that others will follow in due course. References: Bhagwati, Jagdish N.: Shifting Comparative Advantage, Protectionist Demands, and Policy Response, in: Bhagwati, J.N. (ed.): Import Competition and Response, University of Chicago Press (Chicago), Brecher, Richard A. and Ehsan U. Choudri: Pareto Gains from Trade, Reconsidered. Journal of International Economics 36, 1994, Chiswick, Barry: Americanisation and the Earnings of Foreign-born Men. Journal of Political Economy 86, 1978, Licht, Georg and Viktor Steiner: Assimilation, Labour Market Experience and Earnings Profiles of Temporary and Permanent Immigrant Workers in Germany. International Review of Applied Economics 8, 1994, Winter-Ebmer, Rudolf and Josef Zweimüller: Internal Labour Markets and Firm-specific Determination of Earnings in the Presence of Immigrant Workers, Economics Letters 48, 1995,

6 Winter-Ebmer, Rudolf and Josef Zweimüller: Unequal Assignment and Unequal Promotion in Job Ladders, Journal of Labour Economics 15, 1997/1.