Migration Policy and Welfare State Policy: A New Political Economy Approach

1. Migration Policy and Welfare State Policy:A New Political Economy Approach Assaf Razin June 2008 Based on Razin, Sadka and Swagell (2002), Sand and Razin (2008), Cohen (2008), and Suwankiri (2008)

2. 2 Talk Plan: Presenting basic demographic facts Theory (political-economy models): The effect of immigration over the welfare state policy, given an intra-generational conflicts (rich vs. poor) Welfare state policy and migration policy under inter-generational conflict (old vs. young) Welfare state policy and migration policy under inter-generational and intra-generational conflicts Empirical Aspects: The effect of welfare state policy over immigration without immigration restrictions The effect of welfare state policy over immigration with immigration restrictions

3. From the Financial Times (June 27, 2008) Over the next 10 years Germany faces a demographic disaster � and Kwasi�an immigrant-- could be part of the solution. As the birth rate dwindles and life expectancy goes on rising, the country�s population is both declining and ageing. Unless this double-whammy is confronted head-on, the economy will collapse under the weight of an expensive welfare state that lacks the productive workforce to finance it. 3

4. What is to be Done Something has to be done � and fast � as Germany�s leaders and parts of its economic elite are finally realising. And now they have come up with a last-ditch plan to avert meltdown: a plan designed to harness the untapped resources of its migrant community � people like Kwasi, whose youth, ambition and skills Germany needs to keep its economic engine running. Yet as the teenager�s ambivalence about his new home suggests, their efforts could be too little, too late. 4

5. Germany�s plight is not unique .Although it has one of the world�s lowest fertility rates at 1.4 children per female of childbearing age (2.1 children is the minimum for a generation to renew itself), Poland�s and Spain�s have dropped even further. Countries such as South Korea and Japan have suffered steep falls, too. What makes the German case so critical is that it was the first industrial nation to experience a sharp drop in births, almost 40 years ago. 5

6. Fertility Even if birth rates were to shoot up now, Germany has too few potential parents for such a rebound in fertility to make a difference. Although birth rates are now higher than in many east European countries, Germany still has the lowest number of children per inhabitant in the world. This makes it a laboratory of demographic change, the place whose near future could reveal the shape of things to come for the rest of the industrial world. 6

7. Labor Market Germany�s labour market is already facing skill shortages, which will intensify from 2010 when the postwar baby boomers enter retirement. When that happens, virtually all measures of economic dynamism, from gross domestic product per head to labour productivity, will plummet. As the working population shrinks and the number of pensioners rises, its welfare state, which dishes out �700bn a year in benefits to the elderly, the sick and the unemployed, will come under huge strain. 7

8. Migration Policy Faced with a population at such an advanced stage of ageing, the German government has executed a dramatic policy U-turn. The message now � officially at least � is �migrants welcome here�. Chancellor Angela Merkel�s cabinet drew up the country�s first integration strategy: a set of grassroots measures aimed at improving its ethnic minorities� access to education � starting with intensive language courses � and to the labour market. 8

9. Nearly half these immigrants have no professional training whatsoever. Only 4 per cent of the students at the elite Gymnasium schools are from a migrant background. Excluding exchange students, foreigners make up fewer than 3 per cent of university students. More than half of juveniles convicted of violent crimes are foreigners. Research from the Bertelsmann Foundation, a charity and think-tank, puts the annual cost of such human wastage in foregone taxes and wider social benefits at �11.8bn to �15.6bn. 9

10. 10 An increase in the total net-immigration into OECD countries

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13. 13 Immigrants-Emigrants ratio, by education attainment (stock data, 2000)

14. 14 TFR of immigrants in the U.S. compared to the TFR in their home countries

15. 15 Working age rate is higher among immigrants than natives

16. 16

17. 17 The Effect of Immigration over the Welfare-State Policy Assume that immigration is set exogenously to the welfare-state policy within the host country On one hand, higher immigration increases the political power of the pro-generous welfare state coalition With intra-generational conflict between the rich and poor, the poor-immigrant coalition become stronger, since both these groups benefit from redistribution This effect assumes immigrants have some political power, and that they are low skilled, as well as the poor natives group Of course, often immigrants has no political power

18. 18 On the other hand, the entrance of low-skilled immigrants increases the burden upon the host country�s welfare system The marginal benefit of taxation for natives becomes lower, as larger portion of their tax proceeds is granted to immigrants, who are net-beneficiaries of the tax-welfare programs (the �fiscal leakage� effect) Thus the natives would respond by lowering taxes, reducing thereby the scope of the welfare state This effect exists whether the median voter is a domestic low-skilled or high-skilled This can explain the surprising negative correlation between immigration rates and the welfare state, within developed countries The Effect of Immigration over the Welfare-State Policy

19. 19 What happens if immigration is not exogenous to the host country? This question arises especially in light of the known argument, that immigrants, who are usually in working age, have a positive contribution to the social security system: Simon (1995). On the other hand, other researches have concluded that this positive contribution to the social security system is negligible: Lee and Miller (2000); Storesletten (2000) Welfare State Policy and Migration Policy in an Inter-generational Model

20. 20 Target: Examining the influence of immigration over the pension system (PAYG), specifically in light of population aging Namely, how do immigrants effect the conflict of interests between old and young regarding inter-generational transfers Sand and Razin (2008) use a dynamic model to explore how do two policy decisions are adopted, under median voter mechanism: the tax rate which funds the PAYG pension system and immigration quotas The work relies on political-economy models of pension systems: Cooley and Soares (1999), Boldrin and Rusthicini (2000), Froni (2007) Welfare State Policy and Migration Policy in an Inter-generational Model

21. 21 The assumption is that immigrants do not effect the fiscal-system only economically, as a working force; They also effect by their ability to vote and influence future policy Voters are rational thus take this element into account, and choose the policy strategically Another assumption � immigrants fertility rate is higher than for the aging native population Welfare State Policy and Migration Policy in an Inter-generational Model

22. 22 Equilibrium: Immigration policy with restriction is opted for by a young median voter This strategy replaces the identity of the median voter in the following period, from young to old Thus, when the current median young voter becomes old and in need of pension benefits he will be the median voter Welfare State Policy and Migration Policy in an Inter-generational Model

23. 23 Main results: In comparison to �no migration� model, in periods with young majority, immigration can pose a threat to the stability of the pension system. This despite the fact that immigration increases the total pension payments per worker Explanation: the young majority is interested in an old median voter to support the continuation of the pension system in the future, when he becomes pension receiver. Young immigrants might support cutting down their due pension payments Welfare State Policy and Migration Policy in an Inter-generational Model

24. 24 As expected, population aging increases openness to immigrants and reduces the total pension payments per worker, since immigration increases the total pension payments per worker Unexpectedly, despite that the wage of the young median voter is adversely affected by the increased labor force due to immigration, he is not cutting down migration to zero. The voter is forward looking to the period when will need pension benefits, in which he could use the larger labor force he approves today Welfare State Policy and Migration Policy in an Inter-generational Model

25. 25 Skilled and unskilled labor

26. 26 Immigration

27. 27 Tax

28. 28 Majority voting: Young skilled are majority Young unskilled are majority Old are majority

29. 29 Sincere voting equilibrium, namely, when people vote according to their true preferences, without strategic considerations

30. 30 Strategies profile in a sub-perfect equilibrium:

31. 31 Tax rate chosen by unskilled:

32. 32 Fiscal leakage effect: More skilled immigrants enable higher inter-generational redistribution When wages are fixed, more skilled immigrants increases inequality, thus the demand for income redistribution is higher More unskilled immigrants increases the fiscal burden, thus the majority of unskilled voters reduces current welfare state policy below the Lauffer point

33. 33 Wage complementarity between skilled and unskilled

34. 34 Incentives driving preferences are from two channels�wage and transfer. Transfer channel similar to fixed wage model. Wage channel: unskilled benefit from complementarity with skilled: unskilled young prefer even more skilled immigrants. Due to the wage channel, Skilled young prefer unskilled immigrants due to complementarity and shun skilled due to substitution.

35. 35 Skilled young prefer unskilled immigrants because of the wage effect, but prefer skilled immigrants whose children (inheriting their skill) help support the welfare state. In addition, young cohort try strategically to place its older self as the majority next period.

36. 36 Revised fiscal leakage Take immigration quota and immigration composition as given.

37. 37 Fixed Transfer Level T: Exogenous wages Increasing the skilled/unskilled ratio of immigration lower the tax pressure on native workers. If immigrants net contribution is higher thenper capita benefits, then immigrants lower tax burden; otherwise they raise fiscal burden. a fall in native birth rate, put strains on financing of T. this raises the tax on working young.

38. 38 Empirical Support in the Absence of Immigration Restrictions Immigration policy (other than quotas) can be hard to measure Nevertheless, in some environments, neglecting migration policy as a determinant of migration in equilibrium, is reasonable For instance, within the EU-155 old member states. Since the Paris treaty (1951), gradually, including Norway and others by the European Economic Area agreement and Switzerland by its bilateral treaties with the EU. Among all those countries, it is agreed that people are free to relocate, immigrate and work, with specific equal treatment clause, prohibiting discrimination between natives and immigrants in the labor market In which case, immigration equilibrium is supply determined

39. 39 What is the effect of the welfare-state over immigration? We need to separate unskilled immigrants from skilled immigrants Unskilled immigrants are drawn to countries with generous welfare benefits (the welfare magnet effect). The reason is obvious: welfare state policy reflects redistribution of income, benefiting the low income individuals Empirical Support in the Absence of Immigration Restrictions

40. 40 There are evidences for welfare migration: Gramlich and Laren (1984) Blank (1988) Enchautegui (1997) Borjas (1997) Meyer (1998) And there are evidence to the contrary: Levine and Zimmerman (1995) Walker (1994) Empirical Support in the Absence of Immigration Restrictions

41. 41 High-skilled immigrants, on the other hand, who usually enjoy high wages, are deterred by generous welfare states, since they are the ones who finance it Thus welfare state policy induces negative self selection among immigrants There are no conclusive evidence for that, however, in the literature Empirical Support in the Absence of Immigration Restrictions

42. 42 The model: The sample includes bilateral immigration among the U.K, Austria, Belgium, Denmark, France, Germany, Italy, Netherlands, Norway, Sweden, Switzerland, Finland, Greece, Ireland, Portugal and Spain The dependent variable: the skill-differences of the immigrants stock rate in 2000 We control for per worker GDP in the source and host countries, distance, common language and the dependent variable in 1990. We use lagged average values of 1974-1990 to capture aggregate social benefits per capita This skill differences model neutralizes the effect of omitted variables whose impact on migration is skill invariant, as well as time invariant variables Empirical Support in the Absence of Immigration Restrictions

43. 43 Welfare benefits per capita has a negative effect over the skill composition of immigrants This result is robust to different measure of welfare Empirical Support in the Absence of Immigration Restrictions

44. 44 This result reoccur also using IV (coverage rate of collective bargaining) Although, the effect here is more substantial, which may suggest a possible upward bias in the former regression due to the fiscal leakage effect Empirical Support in the Absence of Immigration Restrictions

45. 45 This result is also based upon a different estimation approach, using the micro-economic decision to emigrate We estimate it using a conditional logit model, which enables the individuals to decide whether to emigrate and if so, where to, based on the possible utilities in each country Empirical Support in the Absence of Immigration Restrictions

46. 46 The challenge: estimating policy rules of migration and welfare, as a function of macro-economic and demographic variables, according to the above theory of political economy This estimation assumes that immigration reflects a demand side determined equilibrium, as set by quotas, and not according to the choice of the immigrants This requires simultaneous estimation of both policy rules as endogenous