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Wednesday
Dec132006

Immigration's Impact on the Economy ... Evidence from the UK

money.jpgNot too long ago (in Novembe) I reported on the the issues and dilemmas of the Bank of England in pushing up the interest rate to 5%. I am not an ardent watcher of the UK economy so I was pretty much taking the media commentaries at face value speaking about how the perception that the economy was flirting with spare capacity and thus the inflation risk merited a raise. However, more importantly something about immigration and spare capacity or in this case potential output also caught my eye ... this quote from The Economist sums ups excellently;

Just how big an impact higher immigration is having on potential output goes to the heart of the rate-setters' dilemma. On the face of it, there has been a spectacular expansion in the workforce since 2004. Around half a million migrants from eastern Europe have started working in Britain over the past two years. Thanks also to the return of older people to work, the labour force has been growing at its fastest rate for more than 20 years.

This suggests that the bank should be pushing up its estimate of potential output. The migration figures are notoriously poor and difficult to interpret, however. For example, some of the newcomers from eastern Europe have returned home, yet timely estimates of this outflow are not available.

This is indeed interesting is it not? Obviously, the theory here is not particularly difficult since we are simply talking about a de-facto augementation of the labour supply which quite naturally should show a rather direct transmission mechanism with potential output. However, we are leaving out important questions such as for example the nature and properties of the immigration. Apparently, the recent debate about immigration's effect on the economy has gotten some people at the Bank of England's research unit thinking and consequently the just published quarterly bulletin features, among other things, an in-depth article about immigration's effect on the supply in the economy. The article is clearly UK biased but still there are some general points to take away.

An increase in the number of immigrants, other things being equal, would raise the supply potential of the economy. But the extent to which potential supply increases will depend on the economic characteristics of immigrants. This article investigates the characteristics of immigrants, particularly new immigrants — those who have entered the United Kingdom in the past two years. It appears that new immigrants are more educated than both UK-born workers and previous immigrant waves, but are much more likely to be working in low-skilled occupations. The increasing share of new immigrants in low-skill, low-paid jobs seems to have led to the emergence of a gap between the wages of new immigrants and UK-born workers. The implications of these findings for overall productivity and the supply side of
the economy are complex.

(...)

These different possibilities and the difficulty of quantifying the impact of immigration on wages, productivity and the
natural rate of unemployment, demonstrate that the implications for overall productivity and the supply side of the
economy are complex. And, of course, the overall impact on inflation is determined by the extent to which immigration
affects the balance between supply and demand in the economy.

There might not be any decisive theoretical message from this paper but still it is good crack at answering a tough question in a specific economic context and as such it merits some thought I think. 

Wednesday
Dec132006

Productivity Tracking ... New Progress

money.jpgI have been pretty preoccupied lately with thinking about global macroeconomic balances (here and here). Thinking often mean less linking in a blogging context so I thought I would do quick pointer here. Consequently, a lot of interesting things caught my eyes lately but nothing more so than a recent paper from the New York Fed about how to track productivity 'real time.' The paper was also duly noted by Mark Thoma and New Economist (hat tips). So what is the point here? Well how do we track the trend in productivity growth ... yes I know, this is not straightforward as also initially noted by the authors.

The difficulty in assessing the trend in productivity growth stems primarily from the extreme volatility of quarterly growth rates. In any one quarter, annualized growth rates in excess of 5 percent or below zero are common. Moreover, the volatility is not confined to short-term movements in this series; productivity growth also fluctuates with the business cycle, typically declining during a recession and rising sharply at the onset of a recovery.

Apparently, the unravelling of the trend in productivity requires that we look at real consumption and labour compensation as derivative variables of productivity itself.

'(...) specifically, we construct a statistical model that includes, in addition to productivity, two variables that economic theory predicts will move together with productivity over the long term: real (inflation-adjusted) consumption expenditure and real labor compensation. By looking at all three of these economic series at once, the model can more easily uncover the trend that underlies them all.'

The model used (regime-shifting model) is also described in detail ...

The regime-switching model, introduced in Hamilton’s (1988) study of nominal interest rates, has been applied to a number of economic and financial time series. The model is motivated by the observation that many variables go through periods in which their behavior changes dramatically. 

(...)

The regime-switching model is especially useful for our purposes because it will allow the common trend in productivity, real labor compensation, and real consumption expenditure to shift periodically between high-growth and low-growth states.

And the conclusion ...

Volatile short-term growth rates make the tracking of the trend in productivity difficult. But by looking at productivity in conjunction with labor compensation and consumption expenditure, one can discern the trend that is common to all three series. Our regime-switching model proves effective in tracking trend shifts in the postwar period—particularly the jump to trend productivity growth of nearly 3 percent that occurred sometime around 1997. 

Now, this is really interesting from a sort of field study point of view since it seems that this tool will allow us to pin-point the nature of productivity growth more closely. Furthermore, it should also crucially enable us to cut into the bone and track the shifts in productivity which are cyclical (i.e. unsustainable) and those which are structural; this I guess is the whole point of the study. I have, however, one caveat and it has to do with one of the author's variables - real labour compensation. I mean, have we not talked a lot about how the link between labour compensation (wage growth) and productivity has been somewhat broken, at least in a US context? This is also noted in the commentaries on Mark Thoma's post. I had something on it some time ago here on AS. Especially,  the two following studies have been widely noted ... I guess I am just a bit surprised over chart 2 in the New York Fed study, but I am perhaps missing something?

"Where did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income" Ian Dew-Becker and Robert Gordon; December 2005 

"The Evolution of top incomes: A historical and International perspective" Thomas Piketty and Emmanuel Saez; december 2005