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The effect of immigration on labour markets

January 18, 2012

This is a contentious subject and the analysis I am giving here is far from comprehensive, I’m just using one of the general arguments to show how simple factor market analysis is used in this context.

One of the theories surrounding the effect of immigration on labour markets is that you can divide labour into ‘skilled’ and ‘unskilled’ labour, and the immigration of one of the two forms of labour in the absence of sufficient immigration of the other, will lead to negative effects for domestic workers in the type of labour that is receiving immigration, and positive effects for the other type.

This rests on the idea that the two factors are complementary, in the way that capital is complementary to labour – so an increase in unskilled labour will ‘augment’ the labour of skilled labour by making it more productive (presumably skilled labour will be able to achieve more output if it has a wider pool of unskilled labour to work with) and an increase in skilled labour will ‘augment’ the labour of unskilled labour (possibly by designing products and processes that will improve the productivity of unskilled labour – capital could be involved here as well if the skilled labour improves the amount and quality of capital available through its skilled design).

So lets consider the case where there is immigration only of unskilled labour.

First lets see the effects on the labour market for unskilled labour:

At first where there are only home workers, L1 workers are employed and are paid wage w1. The arrival of the immigrants increases the supply of unskilled labour so the total amount of labour hired rises to L2 but the market wage is driven down to w2. Returning to the original supply curve of home workers, you can see that some of the workers that were willing to work at wage w1 are now unwilling to work at wage w2 and so they become voluntarily unemployed.

Now lets see the effects on the labour market for skilled labour:

Remember here that there is no migration of skilled labour, all the migrants are unskilled. So the supply of skilled labour does not change. But as unskilled labour is a complementary factor (ie it augments the productivity of skilled labour) it increases the marginal productivity of skilled labour, so it shifts out the marginal revenue product of skilled labour curve. This results in an increase in the amount of skilled labour being hired, and an increase in the wage of skilled labour.

You could have the same type of graph if you were looking at the effects on the owners of capital. If there is an increase in a complementary factor, and unskilled labour was complementary to capital, then you would have the same graph as above – the marginal revenue product of capital would increase, and so the amount of capital demanded and the return to capital would increase.

So the conclusion from this type of model is that migration of unskilled labour benefits skilled labour and owners of capital and harms domestic unskilled labour.

You can think of this in terms of an “immigration surplus” by looking at the labour market for unskilled labour:

First think of the perspective of “firms”, as these are the consumers in a labour market, they are the buyers of unskilled labour. The “consumer surplus” ie the surplus to firms, is a in the first case where there are only home workers in the market. After the immigrant workers join, then the surplus rises to a + b + c + d so there has been a gain of b + c + d. This is the immigration surplus. This surplus will go to the owners of the complementary factors, ie the owners of capital and skilled workers.

Now think of the perspective of home unskilled workers. At first their “producer surplus” as the producers of labour in this market is area b + e. But after the immigrant labour joins the workforce, the surplus is reduced to e, so home workers have lost b to firms.

The overall “producer surplus” for total workers after the immigrants join is e + f + g + h, however all the areas other than e are below the supply curve for home workers, so areas f + g + h are gained by migrant workers.

So the predictions of this model are that migration of unskilled labour will cause lower wages and more unemployment for home unskilled workers while increasing the returns for owners of capital and increasing the wages of skilled workers. However the empirical literature on this field is mixed, so the model may not be an entirely accurate reflection of reality – as with most economic models it makes a lot of assumptions. But it is a good idea to understand the model at least.

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