print this

Rethinking the gains from immigration: theory and evidence from the US
Open Republic: April/ May/ June 2006

	In this issue
			Shadow Economy – causes, size and dynamic effects Robert Klinglmair and Friedrich Schneider, Department of Economics, Johannes Kepler University Linz, Austria Rethinking the gains from immigration: theory and evidence from the US Gianmarco Ottaviano, Università di Bologna and CEPR, Giovanni Peri, University of California, Davis Demographic alternatives for aging: increased fertility rate, labour force participation, or immigration Robert Holzmann, World Bank and IZA Bonn. The trouble with Chomsky George Jochnowitz Chomsky and the West's new Fifth Column Kevin Myers New strategy needed in developing world Paul MacDonnell, director of the Open Republic Institute (ORI)

An earlier version of this paper was published by the Centre for Economic Policy Research (CEPR), London, Discussion Paper No. 5226 September 2005

1. INTRODUCTION

The United States has experienced a surge of immigration for the last three decades. As Figure 1 illustrates, the percentage of foreign-born residents in the United States has been steadily growing since 1970, and reached a proportion of over 13% of the population by 2005. Economists, demographers and social scientists have used both theoretical models and empirical analysis to gauge the impact of these immigrants on the U.S. economy, and on its native residents. The National Research Council (1997) produced a 430-page volume analyzing the characteristics and effects of immigration on American society. Since then, a number of other studies have re-examined the issue.

Our paper wishes to take a fresh look at the overall issue, emphasize important connections between economic theory and empirical findings, and provide a coherent framework to measure the impact of immigration on the average productivity of U.S. natives.

The question we tackle is: what is the impact of immigration on the productivity and income of workers born in the United States? The question really has two parts. First: does the inflow of foreign-born workers have a positive or negative net effect on the average production and income of U.S.-born residents? This question supposes that we aggregate the wages and incomes of quite heterogeneous U.S. workers. Second: how are the gains and losses from immigration distributed across U.S. born workers with different skills, and between labor and physical capital?

The consensus emerging from the recent literature is that the effects of immigration on the average (aggregate) income accruing to U.S. natives is rather small. Quantifications of this effect (Borjas, 1995) imply that the sum total of foreign-born workers accounts for a mere 0.1% increase in the average income of U.S.-born residents. Therefore, the argument goes, one can neglect this minuscule average effect and concentrate on the second question dealing with the distributional effects of immigration. Moreover, as immigrants are normally endowed with little physical capital most of the literature (Borjas 1995, 2003) represents immigration as an increase in the labor supply with a constant capital stock, and so finds a negative impact of immigration on average wages and a positive impact on the return to capital.

The “macro” aspects of the issue (average income and average wages) have been analyzed more superficially then the “micro” aspects. Most of the recent debate has focused on the effects of immigration on the relative wages of more and less educated U.S.-born workers. Some economists argue in favor of a large relative impact (Borjas, 1994, 1999, 2003; Borjas, Freeman and Katz, 1997) while others favor a smaller, barely significant effect (Butcher and Card, 1991; Card, 2001; Lewis, 2003).

While the size and significance of these relative wage effects from immigration remain controversial, this paper intends to combine this analysis with the analysis of average wage effects, which have rashly and facilely been considered settled (or unapproachable, or irrelevant) in the literature. As such we nest the “macro” (average) and the “micro” (distributional) aspects of the problem within the same framework.

The effects of immigration on the average wage of U.S.-born individuals are extremely difficult to estimate directly with aggregate U.S. data. Time series of aggregate U.S. wage and immigration numbers after World War II contain few observations, and the issues of omitted variable bias and endogeneity make the inference of causality a daunting task. The reported effects of migration on average wages found in the literature have been calculated (rather than estimated) while imposing crucial restrictions on the substitutability of skills and the supply of factors (labor and capital).

We will argue that these assumptions, which produce estimates implying that immigration has negligible effects on the total income of U.S. born residents and negative effects on the average wages of U.S. born workers, may not be the most appropriate. Treating the issues of skill complementarities and physical capital accumulation more carefully, we uncover positive effects of immigration on the average wages and incomes of natives. We analyze this crucial point by employing estimation and simulation exercises on both aggregate data and data from metropolitan areas.

The modern analysis of the effects of immigrant inflows on the wages of natives began with studies (Grossman 1982; Altonji and Card 1991) that treated the foreign-born simply as a single homogeneous group of workers, imperfectly substitutable with U.S.-born workers. A number of studies on the relative supply of skills and relative wages of U.S.-born workers (Katz and Murphy 1992; Card and Lemieux 2001) make clear, however, that workers with different levels of schooling and experience are better considered as imperfectly substitutable factors. As a consequence, more recent analysis of the impact of immigration on the wages of U.S.-born workers has been carried out partitioning workers among imperfectly substitutable groups by education and experience, while assuming perfect substitution within each group (e.g. Card 2001 and Borjas 2003).

Our paper combines the first and second approaches – both cases can be seen as special examples nested in our general framework. We assume the existence of an aggregate production function that combines workers and physical capital, while using education, experience and place of origin (U.S. versus elsewhere) to categorize imperfectly substitutable groups. Following Borjas (2003) we nest two groups (U.S. born and foreign born workers) within eight experience groups, and these in turn into four educational attainment groups. This allows for the imperfect substitutability of workers both of different country origins and of different education-experience levels.

This imperfect substitutability may arise from different training, occupational choices and various unobserved characteristics of workers. While intuition suggests that a Chinese-born cook is not a perfect substitute for an American cook, and that an Italian tailor and a French architect differ from their U.S. counterparts, the degree of substitutability between the foreign and U.S. born must ultimately be determined empirically.

Finally, we include physical capital in production, and treat its accumulation as driven by market forces that equalize real returns to capital in the long run. This is also a departure from the literature, which mostly assumes a fixed capital stock when evaluating the distributional effects of immigration.

In summary then, our production function can be used to calculate the relative, absolute and average wage effects from the recent inflow of immigrants, as well as simulate the effects of counter-factual scenarios.

In the first part of the paper we estimate the elasticity of substitution between foreign and U.S.-born workers within education-experience cells using data from U.S. censuses from 1970 to 2000. Adopting an empirical methodology similar to Borjas (2003) we find that the data support imperfect substitutability between the two groups. In particular, among the college educated the elasticity of substitution between U.S. and foreign born is around four, while among high-school dropouts it is around seven. This elasticity grows larger (around 10) for intermediately educated groups.

Using both these estimates, and previous estimates of the elasticity of substitution between experience groups (Card and Lemieux 2001) and educational groups (Katz and Murphy 1992) we can calculate the effects of immigration during the 1990s on relative wages, or on absolute wages by education group, or on the average wages of U.S.-born workers. We calculate that the average wage of U.S. born workers experienced an increase between 2% and 2.5% in response to the inflow of foreign-born workers in the 1990-2000 period. At the same time, the inflow lowered the real wage of native workers without a high school degree by 1%, but increased the real wage of native workers with at least a high-school degree as much as 3-4%.

The remainder of the paper is organized as follows. In section 2 we use aggregate CES production function in order to estimate the elasticities of substitution between U.S. and foreign-born workers within each education group. We calculate the impact of immigration in the 1990s on the relative, absolute and average wages of U.S.-born workers. This section also presents direct estimates of the impact of the relative skills of immigrants on relative U.S. wages using national data, and compares them with the values obtained from the production function. Section 3 concentrates on the effect immigrants have on average U.S. wages, using the variation of immigrant inflows and wage changes across US cities from 1970 to 2000. All estimates find positive and significant effects of immigration on the average wages and value of houses for the U.S.-born. These effects are entirely consistent with the positive aggregate effects of immigration on the wages of U.S.-born workers calculated in Section 2.