House of Lords - Economic Affairs

Select Committee on Economic Affairs Minutes of Evidence

Memorandum by Professor David Blanchflower

Question 4: What impact has immigration had on the labour market, including wages, unemployment and other employment conditions of the UK workforce, and has it differed for skilled and unskilled employees? How does the minimum wage affect the impact of immigration?

1. The particular focus of my recent research has been on the impact on the UK economy of the influx of workers from the A8 countries of the Czech Republic; Estonia; Hungary; Latvia; Lithuania; Poland; Slovakia; and Slovenia who have come to the UK since accession in May 2004 and more recently the flow from Romania and Bulgaria (the A2). I refer to the ten countries collectively as the A10. The propensity to come to the UK to work from these countries is higher the lower is GDP per capita in each of the East European countries. The decision is also strongly negatively correlated with life satisfaction scores and positively correlated with unemployment rates, but is uncorrelated with employment rates or rates of inflation.

2. There is reason to believe that the majority of those who have arrived in the UK from Eastern Europe have not come permanently. They have come to work, are highly productive, educated, mobile and are prepared to work for relatively low wages. When surveyed only 9% said they expected to stay for more than two years. Hence, in my view it is inappropriate to call them migrants, whereas in fact they should more appropriately be considered temporary or guest workers.

3. The flow of workers from the A8 and the A2 appear to have increased the "fear" of unemployment, which tends to have a downward impact on pay especially in the non-union sector (Blanchflower, 1991). The "fear" of unemployment refers to the probability of a worker losing their job, and may increase if the competition for jobs rises, for instance, through immigration or the threat of greater outsourcing to lower-cost economies. Both these channels can be used to explain an increase in the `fear' of unemployment in the UK since the accession of the A8 nations in May 2004.

4. The Directorate General for Economic and Financial Affairs of the European Commission conducts regular harmonised surveys for different sectors of European Union and applicant country economies. They are addressed to representatives of industry (manufacturing), the services, retail trade and construction sectors, as well as to consumers. Consumers in each monthly survey are asked (Q7): "How do you expect the number of people unemployed in this country to change over the next twelve months? The number will (a) increase sharply (b) increase slightly (c) remain the same (d) fall slightly (e) fall sharply (f) don't know." The answers obtained from the survey are aggregated into a survey "balance". Balances are constructed as the difference between the proportion giving positive and negative replies.

5. Charts 1-3 plot three-month averages of the survey balances (advanced 12 months) against actual unemployment rates for the UK, EU-15 and Ireland respectively. Chart 1 shows that the "fear" of unemployment and actual unemployment have risen over the past few years in the UK, consistent with the accession of the A8 nations to the EU and the UK opening it's borders to workers from these countries. In contrast, Chart 2 shows that the "fear" of unemployment has declined in the EU-15 since 2003-04.[10] This is consistent with most of the other EU15 countries placing restrictions on the ability of A8 workers to enter local labour markets.

6. Chart 3 plots the survey balance for Ireland, which along with Sweden and the UK, was one of the only countries to grant full access to its labour market for A8 workers following accession. The "fear" of unemployment has risen there as it has done in the UK as the number of Eastern Europeans in the country has increased.[11] Ireland's population increased by 313,000, or 8.1%, between 2002 and 2006. Of this increase 213,000 was from migration. The largest increases were from Poland (+60k); Lithuania (+22k) and +40k from the rest of the EU-25 excluding Britain and Northern Ireland.[12]

7. Consistent with a rise in the "fear" of unemployment, wage growth has been depressed in both the UK and Ireland since A8 accession. According to the UK Average Earnings Index (excluding bonuses), wage growth has fallen from 4.2% in 2004 to 3.9% in 2005, 3.8% in 2006 and 3.5% in 2007 Q2. Average weekly earnings growth in Ireland has fallen from 5.0% in 2004 to 3.1% in 2006.[13] Given the strong growth rates of both economies, many economists have struggled to find an explanation for this apparent weakness. I believe a rise in the "fear" of unemployment is the only realistic candidate explanation.

8. The fact that wage growth has been benign in both countries should not be viewed as a negative point, however. An easing in wage growth has helped to offset inflationary pressures emanating in other areas of the economy, such as increases in the prices of energy and food. Immigration has therefore helped the Monetary Policy Committee to hit its inflation target.

Question 7: What has been the impact of immigration on key macroeconomic indicators: GDP and GDP per head, unemployment, productivity, investment, inflation and asset prices especially housing? Do the economic effects of immigration vary over time?

and

Question 10: How does the impact of immigration vary across different regions of the UK?

9. The overall impact of immigration on native labour market outcomes, inflation and growth on its own is not clear-cut—there is no automatic rule-of-thumb that we can look to in order to determine the impact on the economy. Dustman et al (2005) examined the way immigration impacted native outcomes in the UK using data from the 1983-2000 Labour Force Surveys. They used pooled data for 18 years across 17 regions, but, because of data availability, just the period 1992-2000 for wages. They estimated a series of regressions with the immigrant-native ratio as a control. Their main findings were that there was little evidence of any adverse outcomes for natives on wages, employment or unemployment, consistent with findings for the US and elsewhere.

10. Hatton and Tani (2005) have investigated the hypothesis that net immigration is a determinant of inter-regional migration flows for Britain. The evidence indicates consistently negative correlations between immigration to one region from abroad and in-migration from other regions. But they are only significant for the southern regions where immigration of foreign citizens is most concentrated. Nevertheless they suggest that inter-regional migration may be an important mechanism through which the British labour market adjusts to immigration. Frijters et al (2005) find that immigrant job search is less successful than that of natives; immigrants are as likely to gain employment through informal methods as via verifiable routes; the probability of success increases with years since migration. The finding that immigrants do not effectively compete for jobs may thus help explain why immigration has little impact on native employment. Manacorda et al (2006) find evidence that natives and immigrants in the UK are imperfect substitutes, like Ottaviano and Peri (2005, 2006) for the US. They find that a 10% rise in the share of immigrants increases native-migrant male wage differentials by 2%. This acts to attenuate any effect of increased labour supply on the native wage distribution and then only has a sizeable effect on wages of migrants who were already in the UK. It also helps to explain the findings of Dustman et al (2005) and others that the wage impact of immigration on natives is small.

11. Longhi et al (2005) calculate that, across 165 estimates from nine recent studies for various OECD countries, the average estimated impact on natives' employment of a 1% increase in the number of immigrants is stronger for low-skilled than for high-skilled workers (-0.04% for low-skilled only), but on average it amounts to a negligible -0.02%. The impact is larger on existing immigrants, but still small at only -0.05%.

12. In an interesting new study for the OECD Jean and Jiménez (2007) also examined the unemployment effect of immigration in OECD countries, with a focus on the time profile of these effects and on their interaction with product and labour market policies. They did not find any permanent effect of immigration, measured as the share of immigrants in the labour force, upon natives' unemployment. They did, however, find significant evidence of a transitory and delayed impact on unemployment of changes in the share of immigrants. The impact was weak when measured at the skill level: natives with skills most similar to those of immigrants were not found to suffer from a strong rise in their unemployment rate relative to other categories of natives. Jean and Jiménez (2007) found further that the extent and duration of the unemployment impact of immigration partly is shown to depend on policies. In particular, they found that anticompetitive product market regulation increased both the magnitude and persistence of the impact of a change in the share of immigrants in the labour force on native male unemployment. They show that employment protection legislation increases the persistence of the unemployment impact of immigration, while the generosity of unemployment benefits increases its magnitude. These are particularly low in the UK compared with most other OECD countries. The authors conclude as follows.

per se

(Jean and Jiménez, 2007, p 22)

13. In thinking about the supply potential of an economy, most people would probably agree that extra (immigrant) workers in an economy would raise the supply potential of the economy. But the extent to which aggregate supply increases will depend on the economic characteristics of immigrants relative to native workers. A recent survey of contacts of the Bank of England's regional Agents suggested that the new A8 workers were highly productive. This is consistent with the findings of a Home Office Study on the use of migrant labour that concluded as follows.

"Employers cited advantages of migrant workers in terms of their general attitude and work ethic. They tended to be more motivated, reliable and committed than domestic workers. For example, migrants were said to be more likely to: demonstrate lower turnover and absenteeism; be prepared to work longer and flexible hours; be satisfied with their duties and hours of work; and work harder in terms of productivity and speed. In the view of some employers, the more favourable work ethic of migrant workers encouraged domestic workers to work harder." (Dench, 2006)

14. In Saleheen and Shadforth (2006) it was argued that immigration of higher skilled (or more productive) workers could temporarily raise the domestic rate of productivity growth; and that immigrant labour could lower the natural rate of unemployment, either by filling skill gaps (assuming that foreign-born workers are complementary to the domestic workforce) or by tempering wage demands, as wage bargainers become aware that they can be replaced more easily than in the past. In support of the latter argument, the OECD Economic Outlook notes that "international as well as UK evidence suggests [that] immigration can serve to make the labour market as a whole more fluid and wages less sensitive to demand fluctuations (2006, p 68)".

15. Katz and Krueger (1999) argue that recruitment agencies for temporary workers have also contributed to declines in the natural rate of unemployment. Shimer (1998) argues that time series changes in the natural rate of unemployment in the US are driven by demographic changes; the declining natural rate of unemployment over the past decade or so has resulted from declines in the proportion of individuals in the population that had high propensities for unemployment. The analogy for the UK is that the workforce has increased in size as a result of adding a group—the A8—with a relatively low propensity to be unemployed and to claim benefits. The workforce appears more flexible and mobile than it was before the entry of workers from the A8.[14] They had no entitlement to benefits so the replacement rate in the economy has fallen, once again lowering the natural rate of unemployment. These A10 migrants have likely reduced the natural rate through their impact on the wage bargaining process, lowering the bargaining power of native workers.

16. In thinking about aggregate demand, most people would agree that immigrants are extra consumers and that they raise aggregate consumption demand. It is likely that immigrants spend a lower fraction of their income when compared to domestic workers, perhaps because they send remittances back home or spend less on durable goods while temporarily resident in the UK—this would, on its own, suggest that immigrants raise demand by less than they raise supply. However, the funds that migrants send home might be recycled back to the UK through greater export demand, and UK consumers might also benefit from lower prices as a result of the extra productivity of migrants. Aggregate demand might also rise because of increased investment. The theoretical argument here is that firms require both labour and capital to produce their output. Immigration gives them more labour, and firms may wish to supplement this with more capital. But the extent to which investment rises, and how quickly, will depend on the skills of immigrants and the technologies of firms. If firms are able to substitute between labour and capital, then there may be a smaller impact on investment than might otherwise be the case.

17. On balance I would suggest that at present it appears that the recent inflow of workers from the A10 has acted to reduce the natural rate of unemployment in the UK. But it also seems that it is likely to have raised potential supply by more than it has raised demand, and thereby has acted to reduce inflationary pressures. This argument holds for three reasons. First, the consumption behaviour of native workers may have been affected by the increased "fear" of unemployment resulting from a more flexible labour market. Second, the recycling of remitted funds back to the UK is unlikely to be perfect. Third, firms may be able to substitute between capital and labour, offsetting some of the potential for investment spending to rise.

18. Consistent with the results from previous studies, such as Manacorda et al (2007), Chart 4 shows that regions with the biggest increases from Eastern Europe have tended to see the smallest rises in their unemployment rates. This is consistent with the possibility that foreign workers are attracted to those regions where the unemployment rate is lowest and opportunities are greatest, for which there appears to be some evidence. There is tentative evidence, however, in contrast to some other studies, to suggest that A8 workers have lowered wage inflation among the least skilled. Chart 5 shows a negative relationship between the change in the annual rate of wage inflation of those in elementary occupations (defined in the LFS as SOC 9) between 2005 and 2006 and the change in the share of A8 workers one year earlier, as recorded in the WRS in 2004 and 2005, across regions. The downward sloping line is consistent with a reduction in wage pressures brought about by immigration, or an increase in the fear of unemployment, or both.

19. However, we know that most immigrants are young (43% of workers on the Worker Registration Scheme are aged 18-24), and that the most recent rise in the aggregate unemployment rate has been driven by an increase in youth unemployment. In fact, the proportion of total unemployment accounted for by 18-24 year olds has been rising steadily, from 24.3% of the total in 2000, to 30.7% in 2006 Q3.[15] So what about the possibility that the influx of migrants has increased the youth unemployment rate? Chart 6 shows that there is only a weakly positive, but statistically insignificant, relationship between those regions that have witnessed the largest increases in youth unemployment and those that have seen the biggest influxes of new immigrants. Consistent evidence across OECD countries is presented in Jean and Jiménez (2007).

20. So it seems that the increase in unemployment in the UK has had relatively little to do with the influx of temporary workers from Eastern Europe. Metcalf (2007) summarizes a large body of evidence that suggests that the introduction of, and subsequent raises in, the National Minimum Wage has also had little or no impact on employment or unemployment. There is also no empirical evidence whatsoever to support the claim that unemployment in the UK has increased because wages or non-labour costs have not been sufficiently flexible downwards. The UK has a flexible labour market and has policies in place (Jean and Jiménez, 2007), which are likely to have minimized the impact on employment and unemployment of the recent inflow of workers from the A10. Replacement rates, for example, are low and job protection measures are also well below OECD averages (OECD, 2004).[16] Rising labour market slack, which has occurred in the UK since mid 2005 has likely reduced worker's bargaining power as has a rising fear of unemployment. The presence of highly productive workers from the A10 who are prepared to work for relatively low wages along with associated increases in actual unemployment are what has helped to keep wages down. There is little or no evidence of any displacement effects.