Guide Economics in a Changing World: Volume 5 Economic Growth and Capital and Labour Markets

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Team or Enterprise. Premium FT. Pay based on use. Group Subscription. All the benefits of Premium Digital plus: Convenient access for groups of users Integration with third party platforms and CRM systems Usage based pricing and volume discounts for multiple users Subscription management tools and usage reporting SAML-based single sign on SSO Dedicated account and customer success teams. Learn more and compare subscriptions. Or, if you are already a subscriber Sign in. What this means is that the slope of the low-skilled labor demand curve in Figure is likely to be steeper than the slope of the aggregate labor demand curve in Figure Most evidence suggests that these elasticities are positive but not very large.

In other words, there is a relatively low degree of complementarity and comparatively high degree of substitutability between low-skilled labor and both high-skilled labor and capital. This means that the shifts in the demand curves to and to are not likely to be very large, and consequently the initial increase in wages from w s ,1 to w s ,2, and the increase in returns to capital r 1 to r 2 are unlikely to be very large either. The bottom line here is that immigration is predicted to raise native wages in the case where immigrant and native workers are complements, meaning their productivity rises from working together.

Native workers who are substitutes for immigrants, however, will experience negative wage effects. Indeed, as long as the influx of immigrants is confined to one skill category, it is sufficient to know the elasticity of.


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The elasticity of complementarity between factors i and j is. Suppose again that the population is equally divided between high- and low-skilled workers and that the former receive a wage twice as high as the latter. The share of income paid for low-skilled work is now one-third of 0.

Together these values imply that an influx of low-skilled immigrants that increases the overall labor force by 1 percent but raises the size of the low-skilled workforce by 2 percent lowers low-skilled wages by 1. Summarizing, the immigration surplus is larger when immigrant workers are complementary to natives.

Income from the surplus accrues to both owners of capital and high-skilled workers when immigrants are low-skilled. As in the one-labor-category model Section 4. This process raises the wages of both types of workers. Wages of high-skilled workers rise still further as the stock of capital grows, and the wages of low-skilled workers partially recover as well.

Yet with more than one type of labor, neither the process of capital accumulation nor even the free flow of capital from abroad is sufficient to guarantee that wages return to their previous levels for both groups following an unexpected immigration episode, even in the long run, unless it also affects native occupational choice and investment in education.

And even then this adjustment is a very long-run phenomenon. What this means is that. Restating this, once the capital-labor ratio is restored, average wages are also restored, as in the model with just one type of labor. However, in a framework with two types of labor and regardless of any complementarities, relative wages may not return to pre-immigration levels.

If immigrants are low-skilled, the deterioration of the relative wages of low-skilled workers may persist in the long run. There is one more aspect to the dynamic impact of capital accumulation in this context. Empirical work on U. The result is that additional increments of capital raise the productivity and hence the wage of high-skilled workers more than they raise the wage of low-skilled workers. Though wages for both may rise, the additional capital also partly substitutes for low-skilled labor to a degree it does not substitute for high-skilled labor.

Capital-skill complementarity has another implication: The immigration surplus generated by an increase in the number of high-skilled workers is potentially much larger than for a similar-sized influx of low-skilled workers. To see this, consider what happens in the market for high-skilled labor when the population of high-skilled native workers N s is augmented by M s high-skilled immigrant workers. The labor supply curve shifts from to in Figure and wages decrease from w s ,1 to w s ,2.

The immediate impacts of. In Table in Chapter 5 , the panel considers a different configuration of the nested CES production function in which the elasticities of substitution between different types of labor vary but the elasticities of substitution between capital and the different types of labor are identical. Goldin and Katz suggested that capital-skill complementarity emerged during the early 20th century with the transition from artisanal to mass production.

What is different is that because of capital-skill complementarities, the outward shift in the demand curve from to in Figure is assumed to be substantially larger than the shift in Figure This means the rise in the rate of return is larger and the value of the capital-related component of the short-term immigration surplus E K is larger as well. Hence, a percentage increase in the number of high-skilled workers raises the wages of low-skilled workers by more than the same percentage increase in low-skilled workers raises the wages of the high skilled. Assume once again that the initial population is divided equally between high- and low-skilled workers, and that high-skilled workers receive a wage twice that of the low skilled.

Furthermore, because the rise in the rate of return is higher when high-skilled rather than low-skilled immigrants are added to the economy, the inflow or accumulation of capital will be larger as well. This means that the further increase in low-skilled wages from w u ,2 to w u ,3 will be somewhat higher and that, in particular, a more significant portion of the loss in high-skilled wages will be corrected in the long term as the demand curve in Figure shifts from to. This means that even after the long-run accumulation of capital is accounted for, here the immigration surplus does not completely disappear.

Simulations by Ben-Gad found that even if university-educated workers are only 2. Immigration generates a surplus that accrues to both immigrants and natives, but the latter capture a larger share of the surplus when immigrants are skilled. Capital is likely more complementary to high-skilled than low-skilled labor, which has implications for the immigration surplus.

It might seem odd that the influx of the same number of immigrants who are exclusively either high-skilled or low-skilled can each generate a surplus larger than the influx generated by immigrants in the model with undifferentiated labor.


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  • The reason for this result is that by altering the skill distribution in the economy, immigrant labor creates shifts in wages that represent opportunities for native-born workers. In other words, the arrival of new workers from abroad disrupts the relative supply of different factors of production, and it is this disruption that generates the immigration surplus. The more disruptive the influx—here not only the number of workers but the mix of different skill types is altered—the greater the magnitude of the surplus.

    This last point is emphasized by Borjas a , who examined the immigration surplus for varying proportions of high- and low-skilled immigration. Applying this criterion to data from the Decennial Census, Given that immigrants comprise approximately 15 percent of the U. Immigrants fail to generate a substantial surplus because they are too similar to the population absorbing them. By contrast, if all the immigrants were low skilled, the short-run surplus would be between 0. If all the immigrants were high skilled, the corresponding numbers are 0. In the short run, natives benefit most from the arrival of high-skilled immigrants because of capital-skill complementarities, but in the long run, low-skilled immigrants generate the larger surplus because they are more dissimilar to natives.

    In all cases, once capital adjusts, capital-skill complementarity is less important to the immigration surplus. The extent to which the immigrant skill set differs from that of natives has, in theory, comparatively more effect on the magnitude of the immigration surplus in the long run. So far, this discussion has assumed that people in this model economy produce and consume some aggregate good or, similarly, that there are many goods but they are produced using the same production technology.

    It is instructive to consider the impact of immigration under a set of alternative assumptions about the nature of markets, including in the context of a model designed to analyze the impact of international trade. Assume once again that the economy being modeled produces the goods it consumes by combining two factors, capital and labor, but instead of one type of good it now produces two distinct goods, designated A and B in the Lerner diagram in Figure More specifically, to produce each unit of good A requires relatively large amounts of capital and less labor, while the production of good B employs relatively more workers and uses less capital.

    Assume further that all goods are freely traded internationally. This assumption simplifies the analysis because it implies that the prices of each good are set in global markets. The rays from the origin labeled A and B each represent the combination of capital and labor that is required to produce one of the final goods.

    The shaded area between the two rays is referred to as the cone of diversification. The alternatives are that the economy exclusively produces good A if the initial endowment is to the left of the shaded area or exclusively produces good B if the initial endowment is to the right of the shaded area. In the case assumed in Figure , initially—before the arrival of new immigrants—the production of good A employs most of the labor N A,1 and capital K A,1 , leaving only a comparatively small amounts N B,1 and K B,1 employed in the production of good B.

    All this changes when the initial work force N is supplemented by the arrival of M new immigrants, causing the initial endowment to shift horizontally to the right. Still, as long as the shift is not large enough to carry the new endowment point outside the cone of diversification, the economy continues to produce both types of goods.

    Since both goods are traded on world markets, and at fixed world prices, the amount of each good consumed does not change. Suppose that before the arrival of the immigrants, the economy exported A and imported B. After the arrival of the immigrants, the volume of trade would decline and, if the effect is sufficiently large, one expects a switch toward importing A and exporting B.

    Alternatively, if initially this economy imported A and exported B, the volume of this trade would increase. To provide a concrete example, suppose the garment industry in this economy is relatively labor intensive. Its domestic garment industry produces less than the total amount of garments consumed and the remainder is imported.

    The arrival of more labor will reduce the volume of these imports and increase the amount produced domestically. Of course none of these rather extreme assumptions is particularly representative of the condition of the U. Neither the prices of different goods nor the wages or returns to capital are fixed in global markets, and this simple example abstracts from the way trade can shift production within sectors between different firms.

    Yet even if the assumptions are mostly unrealistic, the analysis is useful because it captures in a relatively extreme fashion an additional dimension through which immigration alters the U. Adjustment through changes in the mix of goods produced, along with the subsequent changes in both the volume and pattern of international trade, implies less adjustment through factor prices and so will dampen, to some degree, the downward pressure immigration might otherwise exert on wages in the short run.

    Of course final goods are not the only things traded—factor inputs including capital are imported and exported. Indeed the very process of international migration represents a flow of the factor input labor between countries and can serve as a substitute for trade in final goods. Workers can produce a good in a foreign country and export it to the United States, driving down both the price of the good paid by U. Alternatively they can migrate to the United States and expand domestic production. Qualitatively the effect would be similar. Hence, there is some degree of substitution between international migration and international trade.

    Summarizing, firms that use relatively labor-intensive technology benefit more from immigration and respond by increasing production and, hence, their demand for labor. Thus far, the models discussed in this chapter have assumed that the technology for any given firm or industry is fixed and exogenously determined. In reality, technology progresses. Recognition that firms may have a choice of technologies, that the evolution of technology is likely to be influenced by changes in the composition of labor, and that immigrants themselves may hasten the process of technological change leads to an appreciation of additional links between immigration and wages.

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    Consider the possibility that a good may be produced with either of two technologies. Instead of assuming two different goods as above, Figure now models an economy such that A and B represent different technologies. An influx of new immigrants now causes the amount produced using technology B to increase and the amount produced using technology A to decline.

    The aggregate amount of capital remains constant as long as its rate of return is determined on global markets, but the amount used by type A firms declines from K A,1 to K A,2 , and the amount used by type B firms increases from K B,1 to K B,2. The shift in the allocation of capital reinforces the shifts in the allocation of labor, so that even though the total amount of labor in the economy grows, the amount employed by type A firms always declines from N A,1 to N A,2. Since this case assumes that the labor supplied by natives and by immigrants is identical, one can assume furthermore that all M new immigrants join type B firms.

    Even so, the number of native workers employed at type B firms increases as well, from N B,1 to N B,2. Hence, if one assumes the economy is completely open and all the relevant prices, including wages and rates of return are determined on global markets, the economy can still absorb large numbers of immigrant workers by reallocating both capital and labor between the different types of technologies available. As with the introduction of multiple goods, the introduction of different modes of production for the same good provides an additional channel through which immigration may alter the economy and absorb some of the impact that might otherwise force down wages.

    In the case analyzed by Lewis , this result extends beyond the two-factor example with only one type of labor to models with multiple types of labor. Namely, an influx of immigrants who supply a particular type of labor once again causes a portion of output to shift toward those firms that employ that labor most intensively. Adding more types of technology increases the range of possible responses of industry to an influx of new immigrants. Of course, it is unlikely that the transition between different modes of production is instantaneous. Beaudry and Green modeled an economy that is gradually transitioning between older and newer, more advanced technologies that rely more heavily on both capital and high-skilled workers.

    They found that the pace at which the older technology is replaced is determined by the pace at which both physical and human capital accumulate.

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    Chapter 6 examines the role of human capital in more detail. An influx of new immigrants alters not only the supply of overall labor relative to capital but also the relative supply of different types of labor, potentially changing the pace of the transition. Another implication of the Beaudry and Green model is that an increase in the number of high-skilled workers may not only lower the wages these workers can command in the market but, in contrast to the analysis in Section 4.

    It is useful to go a step further, and ask how these different technologies arise. The shifting availability of workers with different levels or types of skill alters the incentives for the development of different types of technology. Hence, an influx of high-skilled workers would spur the development of new technologies that complement the type of labor they supply. Indeed under certain conditions, particularly if there is a high degree of substitutability between the different workers in the economy, the long-run labor demand curve will slope upward.

    In the initial phase, the wage drops from w s ,1 to w s ,2 along the short-run labor demand curve. Over time, as new technologies are developed to take advantage of the now more plentiful supply of high-skilled labor, the demand curve shifts out to and wages increase from w s ,2 to w s ,3.

    The long-run demand curve for high-skilled labor is upward sloping. It is further possible that immigration could speed technological progress for any given skill group if skilled immigrants are themselves innovative or provide entrepreneurial skills complementary to native innovators. This would reinforce the endogenous technological change just described. The theoretical link between immigrants and innovation is considered further in the context of immigration and economic growth in Chapter 6.

    Once again, even for relatively small countries most of the assumptions made in the models discussed in this chapter are unrealistic. Even in small. Furthermore, not all goods are tradeable across different countries or even different regions. Everything seems to show that the very process of globalization fuels a downwards pressure on the levels of income taxation while pressing on low wages and boosting some high wages more closely associated to the dynamics of profits. Kuznets, Nobel Prize winner in economics in , predicted that trade liberalization would lead first to an increase in income inequalities which would reverse after a while.

    Though the long trend in the contemporary rise in income inequality does not seem to curb down. How can one explain such rigidity? How can such unequal situation be endured by the populations? How is this politically sustainable in countries which have and are still praising equality and democracy?

    The reason has to be looked for in the political history of the specific relations between wage earners and capitalists in all the populations under view. We shall restrict our investigation to the history of politics in the western economies which have for long been proud of their democratic systems which seemed to go all along with some normative views regarding the spread of incomes and more especially the spread of wages. Such views are social conventions which play a great role in the fabric of societies but which clearly can evolve along time depending on the social and economic contexts.

    Though such changes in conventions by nature are long processes and one may find difficult to see if a convention is slowly definitively petering out or just transitorily affected. Lessons can be drawn from history in that respect. And regarding the past of the democracies of the western world, a major reference remains the conventions on which, in the aftermath of World War II, the reconstruction of the capitalist regimes took place.

    Section 2 will thus review rapidly the conventions that took place in the aftermath of World War II. On this basis, Section 3 will revisit the present situations in order to assess whether a new convention could emerge and of which kind.

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    The economic crisis, altogether with the ensuing disasters of World War II, led large part of the western populations to think that capitalism could not go on as it stood in the pre-war period. All the more so, communism could represent a desirable alternative for growing shares of the population if only to get rid of the spectrum of unemployment. Such stand was made clear in a famous paper of a polish follower of Keynes, Michael Kalecki, in , [ 3 ] stating that capitalism will have to ensure full employment, or it would have to be scrapped.

    Such strong positions can be found in the various programs of reforms that were discussed, more or less in every western country, at the end of World War II. A view of the universal nature of this call at the time can be given by the spirit of a conference which took place in Philadelphia in cf Supiot [ 5 ] , organized by the UN to give a fresh post-war restarting to the International Labor Office ILO.

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    The articles included in the Philadelphia declaration presented in Insert 1 show how committing was the calls to reform capitalism. This diversity will be a lasting figure of this modern capitalism as it will be stressed at the turn of the twenty-first century by Hall and Soskice [ 6 ] and Amable and Petit [ 7 ]. The imperative of the reconstruction of the huge war destructions in Europe did give a boost to the rapid economic growth experience in most western countries in guiding the aftermath of World War II.

    A set of international institutions, negotiated at Bretton Wood USA in , 5 also served as a framework, guiding the development of the western countries, slowly opening up to trade, facilitated by a fixed exchange rates system based on a dollar, freely convertible into gold. Significantly helping has also been at the time the Marshall plan launched by the USA to ensure a quick resuming of the European economies.

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    Still one should not be misled and think that these times were those of harmonic peaceful relations between labour and capital. The development of these welfare states has been marked by continuous struggles mainly strikes to increase rights, transfers and wages. All these improvements were parts of the current political debates.

    The issues were more on the timing of these measures, considering their actual feasibility, than on their principles which had been somehow acted with the big employment conventions of the World War II aftermath. It took also some times to the workers themselves to realize that major changes had occurred in the working of capitalism. Only around the s did they realize to what extent their ways of life, social protection and aspirations had changed, with access to the American way of life, with their equipment goods, of which owning a car stood as the more symbolic, becoming the new normal.

    Somehow the widespread protest of the youth, at the end of the s, was linked with the consciousness that the emergence of relatively affluent, more consumerist societies 6 was bound to change the old patterns of social relations. Strangely enough, another face of the coin showed up rather rapidly at the turn of the s: the impact on the environment of this development, using intensively natural resources.

    A report stressing the limits of growth was widely diffused cf. In effect, in this more consumer-oriented world, fuelled by increasing trade flows, the trust in a gold exchange standard, based on the dollar, suddenly collapsed, largely due to the costs of the Vietnam war for the USA.

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    A system of flexible exchange rates soon replaced the gold standard fixed exchange rate system. The transition rapidly fuelled waves of interrelated inflations of domestic prices, mainly launched by a high rise in oil prices, set up by the OPEC, a coalition of oil producers, eager to protect their incomes in times highly uncertain. This oil price shock in turn led to a sharp slowdown in the economic growth rates of the western countries and to unprecedented rises in unemployment, thought in the first place to be transitory. Policy makers at the time focused on the reduction of inflation as the main way to adjust to the change to a flexible exchange rate regime.

    In this fight against price inflation, the liberalization of the economies became the main motto and wage rigidities the main factor in accusation. The flexibilization of labour markets surged as a major policy issue. At this point the contradiction with the big labour-capital compromise became obvious. Full employment had lost its priority, and the sharing of productivity gains was not any more the major determinant of wage increases. Though of the full employment convention had not entirely disappeared.

    Policies against inflation were still presented as a transitory mean to adjust to the competitiveness among countries introduced by a flexible exchange rate system. At the turn of the s, as the situation was not improving a decade after the collapse of the Bretton Woods fixed exchange rate system, another kind of argument was advanced. Free market economics would bring to the workers a consumer surplus, the reduction in prices of consumer goods helping to rise their purchasing power.

    The argument was weak as what the workers could win in such bargain was largely overtaken by the losses induced by increasing unemployment and a stagnation of wages following the flexibilization of labour markets adjusting to the rising competition of low-wage countries. Within a decade or so, this turn to free market economics made it clear: a vast majority of wage earners were the losers, and the theme of the consumer surplus was not heard of anymore, if only in the handbooks of the apologists of this free market economics, attached to the formal beauty of the highly unrealistic neoclassical model of general equilibrium.

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    Meanwhile the consumerist movements that emerged in the s and early s petered out in the s as shown by the rise and fall of Ralf Nader in the political scene of the USA 7 ; no alternative convention emerged from the political debates. The main benefiter of this liberalization of the economies has finally been the financial sector.

    It took advantage of the liberalization of trade and capital movements to develop its operations at a global level. The rising role of finance, which much contributed to the hollowing out of the full employment convention, is still far to have been unanimously accepted. For some it is a key factor for the adaptation of the economy; for others it fuels all kinds of speculations, leading to detrimental financial crises, tax evasion and wealth concentration. Strangely enough finance even succeeded to find ways to develop financial services for an impoverished working class, diffusing new specific loans for housing or acquiring equipment goods see [ 10 , 11 ].

    The sub-prime loans were one of these tools and will remain in history as the uncontrolled financial instrument at the origin of the global financial crisis. The securitization of uncertain loans e. No wonder that so many politicians have issued bashing statements on finance and all the more surprising that so few actions have been taken to domesticate it. It does not follow that all citizens had a dual view of finance. The need to domesticate finance has become in the process a clear dividing lines between pros and antis, between those who would like to go back to a boaring finance 9 to quote Bidhe [ 12 ] and those who see In a liberalized innovative finance an efficient tool of development.

    Still those in favor of a domestication of finance remained in all developed countries a minority. On the other side, an apathy, if not a sympathy, towards the role of finance has been developing a long time with what can be considered as a passive corruption of large parts of the elites. The financial sector, widely speaking, for example, insurance and business services, has strongly contributed to an incredible widening of the wage scales in most activities.

    Pretending to reward individual productivities where in most cases they cannot be distinguished from collective ones 10 , they paved the way for a general expansion of the wage scales. No wonder then that, with such devastation of the full employment conventions of the post-war era, researchers like Piketty could observe a steady rise in income inequalities see Section 1. Even more alarming this trend, legitimizing wide scales of wages, was not a transitory phenomenon, linked with a generation that had the opportunity to experience the turn towards a new free market economics; it also tended to become a new normal for the new elites entering the flexibilized labour markets.

    The financial sector did attract in the s a fair share of the elite of the major schools of the western world see Colander [ 14 ] for the USA. Such largely extended wage hierarchies, at a time when conversely the wage labour status was itself divided into many kinds of petty jobs, had thus became more or less a common trait in the developed economies. Does that mean that the erosion of the full employment conventions, a silent revolution indeed, considering the lack or weakness of protests on the political scenes, had been accomplished by the time of the GFC?

    Indeed a good share of the new social elites seemed both largely internationalized and considering as a new sustainable growth regime this world, where most of the norms regarding distribution with wide ranging wage scales and production with international games of mergers and acquisitions have been set by the financial sector. Indeed authors coined the term financialization to characterize such new regime.

    To answer such question, one needs to pay more attention to the factors of change and to the various challenges met by our societies. Insert 1.