Lecture 12 - Immigration's Economic Effects and Fiscal Implications
Overview of the Lecture
This lecture examines the economic consequences of immigration with a particular focus on labour markets and fiscal impacts. The analysis combines empirical evidence, economic theory, and policy debate to evaluate how immigration affects wages, national income, and public finances.
Four core themes structure the discussion:
- Empirical facts about immigration, with emphasis on the UK.
- The labour market effects of immigration.
- The economic logic behind migration decisions.
- The fiscal consequences of immigration.
The central insight of the lecture is that immigration affects different groups in different ways. While it may generate an aggregate economic gain for the host country, the distribution of gains and losses across workers, firms, and taxpayers is uneven.
1. Immigration and National Income
The Immigration Surplus
This diagram illustrates the concept of the immigration surplus, a standard result from labour economics. Initially, the labour supply is
However, immigrants receive wages equal to area
Immigration surplus
The increase in national income accruing to native residents resulting from immigration, after paying wages to immigrant workers.
Immigration expands the labour force. Because labour demand is downward sloping, additional workers lower the equilibrium wage slightly. Firms hire more labour at the lower wage, increasing output. The extra output exceeds the wages paid to the additional workers, generating a small net gain for natives.
Key implications
- Immigration increases total economic output.
- Wages may fall slightly due to increased labour supply.
- Firms and consumers benefit from lower labour costs.
- Native workers may experience income losses.
Why the Immigration Surplus Exists
The immigration surplus arises because immigrants typically produce more value than they receive in wages, except for the marginal worker.
In competitive labour markets:
-
Firms hire workers up to the point where
-
With immigration, wages fall slightly below the previous level, allowing firms to hire additional workers.
This generates a wedge between:
- The marginal product of labour
- The wage paid to workers
The difference contributes to the surplus accruing to natives.
The immigration surplus emerges because labour demand is downward sloping. When supply increases, wages fall but output rises. The additional output generated by inframarginal immigrant workers exceeds their wage payments, creating surplus captured primarily by capital owners and consumers.
The Role of Labour Demand Elasticity
The magnitude of the immigration surplus depends crucially on the elasticity of labour demand.
If labour demand were perfectly elastic:
- Wages would not fall.
- Immigrants would be paid exactly their marginal product.
- The immigration surplus would equal zero.
In contrast, if labour demand is relatively inelastic:
- Wage reductions are larger.
- Firms capture a greater share of the additional output.
- The immigration surplus increases.
Confusing total gains with distributional gains.
Immigration may increase total national income while still reducing wages for some native workers.
Who Gains and Who Loses?
The immigration surplus represents a net gain, but it masks important distributional effects.
Economic groups affected include:
Winners
- Firms (lower labour costs)
- Consumers (lower prices)
- Owners of capital
Potential losers
- Native workers who compete with immigrant labour
- Workers in sectors with high immigrant labour supply
The loss to native workers is represented by area
Typical short-answer exam question:
"Explain the immigration surplus using a labour market diagram."
Key points to include:
- Labour supply shift
- Wage reduction
- Increase in national income
- Distribution between workers and firms
- Triangle representing surplus
2. How Large Is the Immigration Surplus?
Quantifying the Surplus
The immigration surplus can be approximated using the formula:
Where:
To express this relative to national income:
Empirical estimates suggest:
- Wage reduction: about 3%
- Immigrant workforce share: 10%
- Labour share of income: 70%
Result:
Even though immigration increases national income, the surplus is typically small relative to the overall economy. Most gains and losses are redistributive rather than purely additive.
Key insights about the immigration surplus
- Immigration increases national income.
- Firms capture most of the gains.
- Some native workers may lose due to wage effects.
- The net gain is typically small relative to GDP.
3. Fiscal Effects of Immigration
Immigration also raises important questions about public finances. The fiscal impact depends on whether migrants pay more in taxes than they receive in public services.
Two opposing narratives dominate public debate.
Concern about fiscal burden
Some critics argue that certain migrant groups:
- Have higher welfare usage
- Place pressure on public services
- Increase government expenditure
Argument for fiscal contribution
Others argue migrants often:
- Are younger
- Have higher employment rates
- Pay taxes for many years before claiming benefits
This leads to a positive net fiscal contribution.
Age Structure and Fiscal Contributions
Migration tends to involve young working-age individuals, which has important fiscal implications.
Children typically receive public transfers through:
- Education
- Child benefits
Older people tend to receive:
- State pensions
- Health care
- Social care
Young adult migrants therefore often contribute more in taxes than they receive in public spending.
From a lifecycle perspective, governments incur large costs during childhood and old age. Migrants who arrive during working age bypass the childhood spending phase, effectively importing workers whose education was financed abroad.
4. Immigration and Local Public Services
Fiscal pressures from immigration may arise at the local government level.
Local authorities must provide services such as:
- Schools
- Housing
- Healthcare
- Social services
Central government funding often relies on population forecasts. If migration is underestimated:
- Local governments may receive insufficient funding.
- Infrastructure and services may become strained.
Importantly, these issues arise from planning failures, not immigration itself.
Immigration increases population quickly. If government planning is slow or inaccurate, public services may struggle to adjust in the short run even if the long-run fiscal effect is positive.
5. Immigration and Ageing Populations
The UK population pyramid illustrates demographic ageing. Over time, the share of elderly individuals in the population increases while the proportion of working-age individuals declines.
This demographic shift creates economic pressures because older individuals:
- Pay less tax
- Receive more government spending
Major expenditure categories include:
- State pensions
- Health care
- Long-term care
Immigration can partially mitigate this problem by increasing the working-age population.
Ageing populations create a dependency ratio problem. When the number of retirees rises relative to workers, tax revenues fall while pension and healthcare costs rise. Immigration can increase the labour force and temporarily stabilise this ratio.
6. Evidence on Fiscal Impacts
Empirical studies on the fiscal effects of immigration often reach different conclusions. However, most estimates suggest the effects are small relative to GDP, generally within ±1%.
Three prominent studies illustrate this variation:
| Study | EEA migrants | Non-EEA migrants | Recent migrants |
|---|---|---|---|
| Oxford Economics (2018) | Positive | Negative | Not reported |
| Migration Watch (2016) | Negative | Negative | Mixed |
| Dustmann & Frattini (2013) | Positive | Negative | Positive |
Differences arise because results depend heavily on:
- Definitions of migrants
- Time horizons
- Methodological assumptions
Static vs dynamic analysis
Static estimates measure current tax payments and benefits.
Dynamic estimates account for:
- Future tax contributions
- Long-term labour market integration
- Contributions of migrants' children.
Dynamic studies tend to find more positive fiscal impacts.
Ignoring time horizons.
Short-run fiscal effects may differ substantially from long-run effects.
Fiscal effects of immigration
- Most studies find small net fiscal impacts.
- Young migrants often contribute positively.
- Results depend on assumptions and methodology.
- Long-run dynamic analyses tend to be more favourable.
7. Overall Economic Interpretation
The economics of immigration reveals several key insights:
- Immigration increases aggregate output.
- The immigration surplus creates a small net gain to natives.
- Distributional effects can create winners and losers.
- Fiscal impacts depend heavily on migrant characteristics.
- Immigration may help mitigate the economic effects of population ageing.
From a policy perspective, debates about immigration often revolve less around the total economic effect and more around distributional consequences and political perceptions.
Bibliography
Borjas, G. J. (1999) ‘The Economic Analysis of Immigration’, Handbook of Labor Economics, 3A, pp. 1697–1760.
Dustmann, C. and Frattini, T. (2013) ‘The Fiscal Effects of Immigration to the UK’, Economic Journal, 124(580), pp. F593–F643.
Migration Watch (2016) The Fiscal Effects of Immigration to the UK.
Oxford Economics (2018) The Fiscal Contribution of EEA Migrants.
Riley, R. and Weale, M. (2018) Migration and Fiscal Sustainability. National Institute of Economic and Social Research.