Economists and immigration – No wonder people vote for Brexit

Finally immigration becomes an issue which is openly acknowledged by at least the Labour party in the current Brexit discussions.

Economists have missed most of the underlying issues here. Their analysis has been less than helpful. The commentary by Reenen et al, Portes, Wright-Lewis, or here from the Institute of Fiscal Studies and others has been all along the lines of:

a) immigrants pay their way and pay into the tax system more than they take out therefore they are good for the economy
b) lack of housing, school places, NHS services has nothing to do with immigration, that is all due to lack of government investment
c) smaller wages through immigration, no evidence, maximum 1 penny less per hour each year through increase in immigration

This breathtakingly simple analysis is really astounding and is, of course further indication that economics is the science of mixing up stocks (in this case national wealth) with flows (let us call it GDP for these purposes). The cost/benefit analysis of immigration deserves more analysis.

Each immigrant, for a start, needs housing, a very scarce and expensive resource currently in the UK. This housing is becoming more scarce and more expensive with each new immigrant. Each newcomer needs to take up, say, £100,000 of housing stock, which will mean that less is available for everyone else. Even working full time, someone will have to work many years to accumulate enough to be able to pay for the construction of a new property. Many on the minimum wage will never be able to do so.

We also know that no immigrant will first build or pay £100,000 for his new accommodation. However, before he or she starts his/her first shift either a house, flat or shared room has to be available. So the wealth (stock) per person, here the amount of housing per person, goes down with each new immigrant. We all have to squeeze up or pay a significantly higher amount for rents or property, driven higher by more demand. Each immigrant makes us poorer – when measured in available housing per person.

So that is, of course, what everybody is complaining about, justifiably. Wealth per person (housing/schools/NHS) is ignored. GDP is all what counts for our myopic economists. Average stock of national wealth per person is brushed over, only the flow into the economy by additional GDP counts.

Now, social housing, schools, and additional NHS services can, of course, be provided, but at a cost of taxes from all of us, which includes to a very small part also the immigrants. But just last year a government was voted in keen on reducing taxes. So nothing adds up.

So justifiably, Brexiteers are intent on voting against immigration.

Further, there is the second problem. The Paradox of Immigration, just like the Paradox of Thrift, could well mean that the economy is better off with immigration, while the individual loses out significantly. Immigrants allow us to generate more GDP, no question. But to insist, as Jonathan Portes does, that it reduces wages by only a penny per hour cost is a highly dubious claim.

This relies on the Bank of England analysis by two economists, who could tell us, allegedly, exactly what effect the additional supply of labour through immigration had on wages.

Now, although that is an interesting stab in the dark, it relies on the model being correct. What the Bank of England economists are essentially doing here is forecasting prices in a freely traded commodity. Their analysis went trough boom and bust cycles of the economy, but whatever the cycle, apparently immigration costs the economy not more than 1 penny an hour off their normal wages.

If economists were that brilliant with their pricing models, they could, of course, predict the price of copper, oil or other commodities. However, as we all know, prediction of market prices is more complicated. But for immigration we are all supposed to believe that two economists at the Bank of England know what the effect of immigration on wages are. That is just ludicrous. The model tells you an penny an hour, but it could of course be much more. The model could be completely wrong.

Further, economists are working with averages. So the average immigrant works for up to 13.5% less wages than the average UK worker in some industries. (see Table 6 of the Bank of England study) However, in some circumstances immigrants will be happy to do the work for less than 50% of the previous going rate.

For the individual employer it is the marginal costs which counts. Immigration allows employers to take advantage of a marginal cost reduction in the price of labour which would not be there if there was no immigration and leads to smaller pay-increases.

This graph comes out of the  LSE study (Reenen at al.).

wages

It shows a very huge association between increased EU immigration and lower wages. How come that before 2004 wages were rising, only flattening out when immigration from EU countries started? And as immigration continued to climb after the 2008/09 recession, wages were actually falling? This correlation is difficult to explain, other than immigration has a significantly detrimental effect on wages. Higher supply meant that the price of Labour fell. (The LSE does not provide a satisfactory answer and brushes over the issue.)

Brexiteers are right to feel that the impact on wages on immigration is far higher than estimated. The graph seems to confim that, showing a significant decline in wages going hand and hand with increased immigration after 2008.

Summary and way forward

Economists only assess the effect on increasing GDP (flow) and not on decreasing average wealth (stock) when assessing impact on immigration. For the individual in the job market it is the marginal impact of immigration is the effect they see. Economists ignore that marginal impact on immigration and look at the average. They have a model which suggests the cost of immigration on wages is minimal, but as any model, it is unlikely to accurately predict prices in a market economy.

The cost of immigration is externalised. A fund, as Labour and Jeremy Corbyn suggested, to deal with the cost of immigration makes that very explicit. The fact that no analysis has been performed on how high the cost is. That is more than surprising, given that immigration has been a concern for voters for a long time. At least some economists have acknowledged that there is a cost. If my estimate is correct, and each immigrant needs at least £100,000 of housing, the cost of providing that housing is approximately £30bn before they start to work. The addition to GDP from these immigrants would perhaps be £6bn a year.

Paul Mason makes some good suggestions here how this issue of immigration should be dealt with. He suggests, among other things, increasing minimum wages and a levy on employers who employ immigrants. Yvette Cooper makes other points in the Guardian today, again explaining what an impact fund would look like. Maybe this thinking should go further. If employers (who are the main beneficiaries from immigration) were forced to provide housing (or pay into a housing levy) for immigrants, the relative attractiveness of immigration labour would of course fall.

We might be stumbling into a Brexit. The inability of the political classes to address immigration will have been the main driver for Brexit.

Economists are guilty, as their perfunctory analysis which addresses only some of the issues with immigration (the benefit to GDP), should have been much more thorough. Clearly the country must be able to address these issues thoroughly, aided by detailed analysis, even though an analysis which also addresses the costs of immigration could be seen to help bigots and racists. To avoid that analysis will back-fire.

The costs of immigration (loss of average wealth) should have been made much more explicit, and remedies to deal with these costs should have been advocated earlier than one week before the referendum. Concessions by a Labour party, which is not even in government to implement them, will not change the mind of Brexiteers, I fear.

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