Immigration as a growth strategy

What forms of supply-side reform would do most to boost UK growth over the medium to long term? Bizarrely, much of the recent debate has concentrated on reducing various forms of labour market regulation (procedures for unfair dismissal, health and safety, etc). The evidence base supporting such proposals is remarkably thin. The UK labour market, as many have observed, is doing  surprisingly well. Hiring – given economic conditions – is pretty healthy, and employment is rising, despite weak or no growth. Labour market economists, and international organisations like the OECD, agree that three decades of successful reform have given the UK a flexible and generally well-functioning labour market, by international standards. There is no reason to believe labour market regulation is currently a significant barrier to job creation. This suggests that – while doubtless there are improvements that could be made around the edges – there is little to gain from further wholesale deregulation. Spain and Italy need radical labour market reform; we don’t.

But, looked at in a broader perspective, there is one aspect of labour market regulation where sensible deregulation is urgently needed, and could genuinely boost UK growth over the medium term. This is immigration for people with high skills. Now immigration rules are not generally what either economists or policymakers think of when they talk about labour market regulation. But of course restrictions on those who want to come here, or stay here, to take up employment or to look for a job are exactly that: they are government regulations that change the way the labour market functions.

So the changes to skilled migration introduced by the government – a set of new burdensome and bureaucratic rules and regulations, including a quota on skilled migrants – are new labour market regulations. Indeed, in contrast to almost all other such regulations, which are at least designed with an eye to ensuring that the benefits to employers and employees outweigh the costs, these changes were designed expressly to make it more difficult for businesses to employ the workers they want.

As a consequence, they will reduce growth and make us poorer. And these impacts, even according to the government’s own estimates, are potentially very large. As I said in my testimony to the Treasury select committee after the 2011 budget: “The extra employment regulation that the government has imposed on employers wishing to employ migrant workers — the cap on skilled migration — will, using the government’s own methodology, reduce UK output by between £2 and 4bn by the end of the parliament.”

This is not just a result of the reduced size of the population; since the regulations are designed to exclude skilled migrants, who tend to be more productive, they also reduce average productivity and hence GDP per capita. None of this is news to economists; most of us, wherever we are on the political spectrum, think that well-functioning markets usually do a pretty good job of allocating resources. That goes for the labour market too, so it is no surprise that liberal (in the true sense of the word) immigration policies are good for the economy, and restrictive ones are not. So simply reversing the new regulations introduced by this government, let alone further deregulation, could yield large gains. Moreover, in contrast to some other policy changes that might promote growth, the fiscal impact would be positive, not negative.

But this is not the end of the story by any means. The estimates above of the economic impacts, while significant, are still not that large relative to the size of the UK economy. And on one level, this is not surprising; in standard ‘static’ economic models, the impact of immigration is positive – to the extent that immigrants are complements to natives – but relatively small. And to the extent that immigrants are substitutes for natives then the impact is essentially zero.

So it is often argued that the economic impacts of migration – positive or negative – are likely to be small, with the main impact being to increase both population and GDP, but with little impact (over the medium to long run at least) on GDP per capita or unemployment and employment rates.

However, this is a freeze-frame view of the world; it does not reflect how economies actually work, or where growth really comes from. To see this, we merely need to observe that the same modest benefits are predicted for freer trade. This is not surprising, since the underlying mathematical structure of the basic models economists use to model trade and immigration is identical. So, for example, estimates of the benefits to the UK of completing the Doha round of multilateral trade liberalisation are typically no more than 0.1 per cent of GDP.

But of course most economists believe that the economic benefits of trade are quite considerable, and that these static estimates are not the whole story or even the main point; the benefits are dynamic and arise from competition and specialisation rather than simple static comparative advantage. We do not gain from free trade in, say, cars with the EU because either we or the French or Germans have a fixed and static comparative advantage in different types of car, so we can produce one type of car better and they can produce another. Rather we gain because trade increases competition between different producers, diversification of the supply chain across the EU, the incentives for technological innovation, and all sort of other difficult to measure but important effects that increase productivity in the medium to long term.

The same is, in principle, likely to be true of skilled immigration. Immigration is likely to have impacts on productivity and growth over the medium to long term in a number of ways.

• immigrants could bring different skills and aptitudes, and transmit those to non-immigrant colleagues (and vice versa);

• immigration could be complementary to trade in goods and services (because of immigrant networks or for other reasons);

• immigrants could increase competition in particular labour markets, increasing the incentive for natives to acquire certain skills;

• similarly, immigrant entrepreneurs could increase competition in product markets;

• workplace diversity (across a number of dimensions) could increase (or decrease) productivity and innovation

Not all of these impacts are necessarily positive: for example, it is well known that immigrants are substantially more likely to be entrepreneurs or self-employed. This could be because of self-selection, so enterprising people are more likely to migrate; but exclusion or discrimination might also force some migrants into low-productivity self-employment. So what does the evidence say? Well, in contrast to the well-established economic literature on the impact of migration on labour markets, we have much less quantitative analysis on these topics. What there is does, however, support the arguments above. There is a considerable body of evidence in the US that suggests that immigration is associated with increased innovation (for example, that that immigrants are more likely to register patents, and that this in turn leads to an increase in patent activity on the part of natives); and with international trade and knowledge transfer, particularly in high-tech industries. Here in the UK, Max Nathan has written a number of papers for the National Institute of Economic and Social Research (NIESR) on similar topics, particularly focusing on the impact of diversity on innovation, patent behaviour, and other measures of firm performance. This, and work in other European countries, suggests that similar effects are at work.

It is often hypothesised that immigration reduces the incentive for employees to train native workers. However, in the US, Jennifer Hunt shows that immigration increases the educational attainment of natives; she hypothesises this is because of increased competition in the labour market.  Meanwhile, NIESR research for the Migration Advisory Committee found that “rather than migrants substituting for home-grown talent, there is evidence of complementarities between skilled migrants and skilled resident workers”. Looking at the macro-level impacts on growth, and explicitly putting the impact of immigration in the same analytical framework as that of trade, a recent paper by Francesc Ortega and Giovanni Peri found that, looking across countries, the positive impact of immigration on growth has been very large. Indeed, they find that it is considerably larger than trade. Crucially, the channel through which immigration increases growth is through its impact on productivity, which would not be expected from standard models.

This research agenda is still in its infancy; we still do not know precisely the channels through which immigration impacts on growth. Nor will we ever be able to put precise numbers on it, any more than we can identify the contribution ofBritain’s history as a trading nation to our current prosperity. But we do know enough to set a clear direction for policy.

So what should we do?  It is simply not credible for the prime minister to claim that the UK is ‘open for business’ and for the chancellor to say that he is prepared to take the ‘difficult decisions’ to boost growth, while at the same time making the primary objective of immigration policy the reduction of net migration; and putting the implementation of that policy entirely in the hands of a department – the Home Office – which has no interest whatsoever in growth or productivity. The fact that the immigration minister regards a fall in the number of student visas issued – that is, a fall in British exports – as a policy success, is a damning indictment of the administration of current policy.

So the first priority should be simply to make clear that immigration, like trade, is indeed central to making the UK open for business, and hence to our growth strategy. The next step would be then to examine each aspect of immigration policy – but in particular those relating to students, skilled workers, and settlement – with a view towards reorienting them towards growth.

We should start by reversing the most obvious policy errors made by this government. The most egregious of this was the abolition of the ‘post-study work route’, which allowed foreign students to stay on after graduation to look for a job. This initiative was introduced by the previous government, based on two observations: the success of Silicon Valley, in particular, and high-tech US companies in general, who relied heavily on individuals who came to the US to study but stayed on to work (and in some cases, set up their own businesses); that, for the brightest and most motivated foreign students, the possibility of being able to remain in the country for a period after graduation to work was a significant draw.

The abolition of the PSWR was a major own goal; it means that foreign students who want to stay on here and try to build a career or a business find it much more difficult, if not impossible. Since such people are, almost by definition, likely to be relatively well educated and motivated, English speaking, at least partly integrated intoUKsociety already, and so on, they are precisely the sort of people we want on both economic and social grounds. Of course some will fail; they will end up unemployed or doing low-skilledjobs. That is the nature of immigration; not all immigrants succeed, just as not all native-born entrepreneurs do either.

There are many other sensible changes, major and minor, that are required. But more important than specific policy changes is a change of attitude and mindset on the part of government and policymakers. If we want to be serious about growth, we will need to be positive about migration.