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Open borders or fair wages: the left needs to make up its mind

Posted by on March 25, 2015 in Employment, Euro-zone, GDP, Immigration, Politics, Public Policy | 1 comment

Open borders or fair wages: the left needs to make up its mind

As published in the Guardian on Tuesday 24th March 2015 as part of their ‘Economics – Immigration Special’

Mass immigration increases inequality. This is the unpalatable fact the liberal left in Britain refuses to accept. Markets are imperfect instruments. But it is not necessary to subscribe to free market economic theory to believe that large increases in supply tend to drive down the price. And the price of labour is the wage.

Last Friday, the Guardian front page carried a report from the Office for Budget Responsibility, claiming that higher net immigration increased the UK’s economic growth rate. According to the mainstream theory of economic growth, this is undoubtedly true. Higher growth can be created by sustained increases of either capital or labour.

But underlying the theory is the assumption that supply and demand balance in these markets, that the prices of the inputs are set at levels such that all available capital or labour is in fact employed and does not remain idle. So this “flourishing modern economy” with high immigration celebrated by the Guardian is based on persistent large wage inequalities.

A powerful force in the global economy is driving the increase in inequality that has been seen in western economies over the past few decades. In essence, there has been a massive increase in the effective supply of labour. Over the past three decades or so, China and India have gradually been absorbed into the network of international trade.

This puts pressure on European labour markets. Many call centres, for example, have been relocated to India. But much of the impact of this is indirect, operating via trade flows, and is only really felt by certain sectors of western economies.

Closer to home, the opening up of eastern Europe in the early 1990s has had a strong effect, especially on countries that are their immediate neighbours, such as Germany. Employers soon realised that economies such as Poland and the Czech Republic possessed educated labour forces, whose productivity potential had been suppressed by the gross inefficiencies inherent in planned economies. German companies opened up new production plants in the old Soviet bloc countries in Europe, rather than at home.

The impact on wage rates of this increase in competition was dramatic. Christian Dustmann at University College London has provided clear evidence on the evolution of wage rates in the former West Germany. The 15th percentile of the wage distribution is the level at which only 15% of wages are lower. In West Germany, at the 15th percentile, real wages have fallen almost continuously since the mid-1990s. At the 50th percentile, where half get more and half get less, the reduction has been less sharp.

But the fall had set in by the early 2000s. At the 85th percentile, the mirror image of the 15th, real wages grew strongly, reaping the benefits of the recovery of the economy created by the increase in competitiveness.

It is against this background that New Labour opened up Britain’s borders in the late 1990s. It was a major betrayal of the very people the party purported to represent.

In addition to the global competition from countries such as China, in addition to competition closer to home from the economies of eastern Europe, New Labour allowed direct competition to enter the UK labour market on a scale unprecedented in our history.

Not surprisingly, the distribution of wage rates has evolved in very similar ways to those of West Germany. It is the relatively unskilled in the bottom half of the distribution who have lost out. The liberal elite do not suffer.

Indeed, they benefit because many of the services they consume are provided at lower prices than would have been the case without mass immigration. It is sometimes argued that immigrants do jobs that native British workers are unwilling to take.

Very well then, without mass immigration, employers would be obliged to raise the real wage rate to induce these people to take the jobs.

The effects of this extend to benefit levels. With at least half the population facing at best stagnant and often falling real wages, basic political economy requires benefits to be squeezed as well. Hostility to benefits is strongest precisely in the bottom part of the wage distribution. It is political suicide to increase real benefits in this context, regardless of who is in power.

In the so-called neoclassical growth theory of economics, whether of the pre- or post-endogenous variety, by far the most important source of sustained growth is innovation. The age structure of immigration means that it does make a change to per capita economic growth, but one that is barely perceptible. Moreover, immigrants themselves age eventually, so eventually even this tiny benefit disappears.

A truly modern economy does not rely on more and more capital and labour being fuelled into the machinery of production. That was the old Soviet model.

A modern economy relies instead on innovation. This should be the focus of policy. The potential gains are huge, not marginal and ephemeral.

Image: Budget by Simon Cunningham under license CC BY 2.0

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