Migrant outflows to Australia, wages, and productivity: What is going on?
Posted February 5, 2008
on:A rising outflow of New Zealander’s to Australia is causing concern amongst a bunch of people. People move away for a number of reasons, as the Department of Labour nicely points out. However, as economists we like to think at the margin. We are not interested in the general reasons that people are leaving New Zealand, in so much as we are interested in the ‘marginal’ factors that are driving people overseas. The non-policy factors mentioned by DOL are constant, the weather will stay warmer, the country will remain as close, and the culture will remain similar. However, the policy factors (e.g wages, taxes) can be changed, and as a result will have an impact on the ‘change’ in migration levels (beyond some sort of trend).
The Standard provides one piece of the puzzle we require in order to control migrant outflows – we need higher wages. However, the solutions they provide may not necessarily be the correct ones. A important marginal factor in the decision on whether to stay and work in NZ, or do so in Australia is the difference in ‘real disposable income’. Ignoring non-wage income for now leaves us with ‘real disposable salary’. Increasing nominal wages may not lead to an increase in real disposable salary if all it does is increase inflation. If we pay everyone more $$$ but don’t increase the number of goods avaliable to buy, then the price of goods will increase and peoples true living standard will not change.
There are two ways people are talking about increasing real disposable salary:
- Tax cuts that increase the demand for labour more than they increase the supply of labour, or that cause a smaller reduction in the real wage than the quantity of the tax cut, or transfer funds into more productive sectors,
- An increase in labour productivity.
Fundamentally, both these solutions require policy that increases the amount of product produced by labour. Now this begs the question, how do we increase labour productivity relative to Australia.
By cutting taxes we stimulate the economy, although if we are running a balanced budget there must be reduction in government spending, if people value government spending sufficiently this may lead to more people moving overseas! For simplicity lets assume that the stimulus is canceled out by a reduction in government spending.
First let us thing about an individual firm. If some of the incidence of tax falls on the firm then this will increase their cash flows, allowing them to invest more. As an increase in capital increases the marginal product of labour, this will increase wages. However, lower taxes make labour relatively cheaper than capital, increasing the incentive for firms to hire labour instead of capital. As the marginal product of labour falls as the quantity of labour rises, and as capital expenditure has eased, this will put downward pressure on wages. As a result, we care ultimately care about which of these effects dominates, when deciding whether tax cuts will actually increase real wages.
However, one thing we do know about tax cuts is that it decreases the cost of production for the firm – implying that production must increase. As a result, the question we have to ask is whether this surplus is passed on to employees or whether it accrues to the owners of capital – this is an empirical question.
Other arguments have been made stating that we should increase taxes on labour or improve the power of unions in order to increase the relative price of labour, thereby leading to an increase in capital and an increase in the marginal product of labour. There are a few important things to note about this point of view:
- It will lead to a reduction in production in the short-run, as it increases firms costs,
- It may not lead to an increase in capital, as labour increases the marginal product of capital,
- This point of view requires a cut in employment, and so supports people losing their jobs (something I did not expect the left wing blogs to be supporting).
As this policy will reduce national output, its impact on peoples real wage will depend on how it redistributes production between the owners of capital and workers. If increased union power was sufficient enough relative to the change in output, then it may in fact increase the real wage of employees (this would involve a significant of amount of employer power in the labour market currently).
Further discussion has focused on ‘strategic complementarity’ between firms (eg if one firm increases its capital input, it may lead to other firms increasing their capital input). In this case we need to define the spillovers (R&D spillovers?) and figure out how important they are to the problem. The existence of ‘multiple equilibria’ in the economy depends on these spillovers or strategic interactions – so if you hear anyone say that higher taxes may move us too a new, pareto superior equilibrium, ask them what the source of the strategic complementarity is, if they can’t answer you they are talking trash 😉
Ultimately, the impact of government policy on productivity and thereby on migration is an inherently empirical matter, as theory can point use either way. As data on New Zealand labour productivity is relatively recent, subject to constant revisions, and filled with structural breaks, any killer blow to the ideas coming from the left or right of the spectrum is unlikely to appear.
Anyone that can improve my logic, or explain to me where I might be mixed up is welcome to do so in the comments 😉
37 Responses to "Migrant outflows to Australia, wages, and productivity: What is going on?"
Matt, can I start with the obvious (and I think most salient) criticism that if we throw human capital into your growth model, and interpret income taxes as a tax on investing in human capital, then it is fairly straightforward to produce the result of: a reduction in labour taxes -> more human capital -> higher growth/wages.
Leaving that aside, the question you’re asking is whether tax cuts increase capital stocks. I think it is fairly unambiguous (assuming for the moment the standard model type responses) that cuts to corporate taxes or taxes on savings (ie on capital) should deliver greater amounts of capital.
It is not clear cut that cheaper labour leads to less capital investment (as you imply). There’s an income effect as well as a substitution effect. But empirically labour supply is pretty inelastic so I would expect that most of a labour tax cut just results in higher post-tax wages for labour, with very little change in employment or in firm labour costs.
Taking a different approach, if tax-cuts are revenue neutral (that is spending is cut), then unless people have a marginal propensity to consume of 1 then savings must increase.
Congrats on pointing out how stupid the idea that artificially increasing the cost of labour will benefit us is. As before, the income effect doesn’t guarantee more capital, the only unambiguous result is less employment and less output. Furthermore, people are confusing an ongoing incentive to invest (such as a lower tax on capital) with the one-off adjustment increase in the capital stock that higher labour costs might produce. (p.s. I realise that a lower capital tax still results in a steady state level of capital in the simple models, I am hopeful that this is not how the world works in reality).
Finally, I think there is some value in modeling the Australian immigration issue as a game. They choose low tax/low social services/low income redistribution, we choose high tax/high social services/high income redistribution. The simple result of such a game is high income people are better off in Australia, low income people better off in New Zealand, which in turn suggests that our strategy becomes unsustainable. I’m not claiming this story is all or even much of a full explanation, but it is worth bearing in mind.
[…] there is a big debate raging in the New Zealand blogosphere about the exodus of labor to Australia. Matt joined in on the debate and made the very valid point that it’s real wages we need to care […]
robinsod,
1. Any business can decide to make less profits in order to invest more in either capital or labour (assuming they are making profits to being with). But businesses that consistently earn much lower returns on their capital as a result of doing so are unlikely to be around for long. There is substantial evidence that capital is fairly mobile, and post-tax rates of return tend to equalize across countries. I don’t get how you can say “It’s also absurdly naive to claim firms would take advantage of a strategic advantage if higher wages would provide them with one.” after you raised the Henry Ford example. Pointing out the real world is more complicated than a simple model doesn’t in any way suggest how the simple model is likely to be wrong. How do we know that imperfect information doesn’t mean that workers are already getting paid too much?
3. The last seven or so years could be characterized as having strong increases in labour demand, partly mitigated by increasing labour supply (immigration and higher participation rates), with an entirely standard result: lower unemployment and real wages that have risen faster than labour productivity. Where’s the beef?
4. Models remain an excellent starting point for discussion. Why not be specific about your objection, rather than hand-waving? It seems to me that the specific claim you’re hinting at is that firms’ labour demand curves are essential vertical. Do you have any evidence for this?
Just on that profits point, I put earnings per share for the NZSX50 at 7.2% for 2007. That hardly seems like excessive profits with a risk-free 10-year government bond paying 6.3%. (And we’re probably nearer the top than the bottom of the earnings cycle).
gsveoidi
gsveoidi
[…] migrate, such as the weather. Now although this discussion by DOL has been roundly criticised (even by myself), it is appropriate to look at it this way if we are going to focus on […]
I think other web-site proprietors should take this website as an model, very clean and great user genial style and design, let alone the content. You are an expert in this topic!
All I see in Canada, Is constant immigration and we now have waaayyyyy less purchasing power. THE END
1 | robinsod
February 5, 2008 at 11:17 am
1. It will lead to a reduction in production in the short-run, as it increases firms costs,
2. It may not lead to an increase in capital, as labour increases the marginal product of capital,
3. This point of view requires a cut in employment, and so supports people losing their jobs (something I did not expect the left wing blogs to be supporting).
I find it difficult to match these assertions with reality.
1. While fail to see how an increase in costs will lead to loss of production, I’m going to guess that you mean that more money on wages means less money for reinvestment in capital. In practice quite the reverse is true as employers tend to recognise they need to make better productivity gains to offset labour costs. A low wage economy offers no incentive to do so. There are also sound arguments that the extra costs of higher wages are partially or totally compensated for by increased retention and reduced HR costs. The decision by Henry Ford to double factory wages and thus save money over all is perhaps the most famous example of this.
2. I don’t even understand what you are talking about. Could you clarify please?
3. This is a simplistic demand and supply interpretation that simply does not bear out in the real world. Having watched the minimum wage increase considerably over the last few years while unemployment falls I can only suggest that your model is too simplistic.