Is Immigration the Answer to a Labor Shortage?

Joseph L. Daleiden

Executive Director, MCRI

As a nation reaches the peak of a business cycle, labor shortages inevitably appear and pressure on wage rates increases, especially in the fastest growing industries. Businessmen frequently seek to increase immigration to obtain additional labor. Central banks may be inclined to raise interest rates to curb the possibility of inflation. Both short term fixes interfere with the natural workings of a market economy and can only create severe problems in the long term, including slower productivity growth, greater income inequality, and - ultimately - overpopulation and all of its related problems.

Key Words: GDP, immigration, labor, overpopulation, inflation

Much of current talk about a labor shortage in the U.S. is reminiscent of the concern expressed by slaveowners who argued that if the U.S. abolished slavery there would be no one to pick the cotton. Today we hear that without more immigrants there will be no one to pick lettuce, cut lawns, work in restaurants or perform a million and one other low-skilled tasks. In the high tech industry we hear a variation of the same theme: the software industry argues that there is a shortage of programmers and information technology specialists. Some warn that the specter of labor shortages will result in lower national growth and a decline in real income.

To understand whether there is any truth in the latter argument, we have to review some basic economic and demographics tenets. Too few commentators realize that the only way a nation's per capita wealth can increase is through increased productivity (more output using less input). In the absence of productivity growth, individuals can only increase their wealth through reallocation, i.e., the transfer of income from one individual or group to another individual or group.

A nation's total wealth or annual output (Gross Domestic Product) can also increase through simple population growth, since there are more hands to produce things, but total wealth is largely irrelevant as a measure of changes in human well-being. China's total output (GDP) is 8 times larger than that of Switzerland, but on a per capita basis the GDP of the Swiss is 20 times that of the Chinese.

In the normal business cycle, increases in productivity are shared by the providers of labor and the providers of capital (investors). Their respective shares are determined by the relative scarcity or abundance of each. During the 1950s and early '60s, the shortage of labor in the U.S. resulted in U.S. labor being able to improve its bargaining position and wages rose rapidly. During the 1970s and 1980s, the labor force swelled due to the baby boom and the growing labor force participation rates for women. The increased supply of labor relative to demand weakened the competitive position of labor. The growth of international markets and, hence, competition from low wage countries resulted in further downward pressure on wages. The net result was that inflation adjusted hourly wage rates declined steadily from 1973 until 1993. Productivity grew 1.2% annually over this 20 year period; the total increase in productivity amounted to 24%. Therefore, if labor had maintained its bargaining power, real wages might have increased about 24%. Instead, average weekly earnings dropped by 19%, a net difference of 43%. Some of this decline was offset by increased benefits, but total compensation adjusted for inflation remained unchanged over this period.

After the baby boom was absorbed into the labor force, the slowing in the growth of the labor force would normally have resulted in real wages rising again, but probably not as much as in the 1950s because the U.S. now faces far more competition from international markets. Nevertheless, since international exports account for only about 12% of total U.S. output, wage rates would still be primarily affected by the supply and demand for labor in the U.S.

Corporations understand that the supply and demand for labor determines wage rates and that is why they successfully lobbied Congress to increase immigration in 1990. Unions do not appear to understand the law of supply and demand, or else care more for attracting additional dues-paying members than increasing their members' wages. Hence, they did not oppose the increased immigration; in fact, they supported it.

Of course, given the huge increase in the labor force due to the post-war baby boom, the increase in immigration will not be sufficient to entirely offset the decline in the labor force as the post-war baby boomers retire. However, the shortage is temporary since we will soon have the children of the baby boomers entering the labor force. Remember, the baby boom lasted from 1945 until 1957. Since many of the baby boomers started family formation much later than their parents, the bulk of children of the baby boomers range in age from 10 to 25. Therefore, most have not yet entered the labor force.

Can immigration fill this temporary job market shortfall? Certainly, but then there will once again be a labor surplus when the bulk of the baby boom children enter the labor market. Moreover, wage earners will be unable to increase their share of the productivity pie. A far better solution is to allow the free market to work. In this case, the labor shortage will result in increased wage rates making up some of the lost ground since 1973.

Tighter labor markets will also result in increased productivity as businesses seek to avoid higher labor cost by becoming more efficient or developing new methods of mechanization. The lemon growers of California are a good example. From W.W.II until 1964, lemon growers depended upon temporary workers under the Bracero program. When the Bracero program ended, fear of increased labor costs caused the growers to invest in mechanization and higher-producing dwarf trees. But when immigration increased again in the 1970s, the growers stopped innovating and increased their dependence on cheap labor.

Won't higher wages result in inflation? Not if the Central Banks keep their heads and avoid pumping up the money supply as the Federal Reserve Board did beginning in 1965. It works like this: the tight labor market results in increased wages. If wages rise faster than productivity, businesses will seek to maintain profits by increasing productivity (often by replacing labor with mechanization) or raising prices. But either reducing employment or increasing prices will cut aggregate demand for business products. The drop in demand means that inventories will increase and businesses will reduce production; this leads to decreased prices or layoffs. Layoffs will result in still less demand and further downward pressure on prices. Hence, inflation is curbed without the need for active government intervention.

One of the benefits of a market economy is that, for the most part, it is self-regulating. In fact, government intervention often does more harm than good by interfering with the normal adjustment processes. Importing millions of additional workers is one of those ill-advised interventions.

Initially, a high level of immigration will be viewed as an economic benefit as it results in increased economic growth. The reason for the higher growth rates will be in part simply due to the increase in population. However, as mentioned, only per capita GDP, not total GDP, is a relevant measure of social welfare. When the National Research Council reported in 1997 that immigration increased U.S. economic output by $1 to $10 billion annually, they were being disingenuous not to note that adding in the population of immigrants actually reduced GDP per capita. When the additional cost, (both capital and maintenance) of the immigrants are included, such as the cost of constructing and maintaining more schools, highways, power, water and sanitation systems, police and fire protection, etc., not only is the per capita cost far greater, but the total economic loss was estimated at $10 to $14 billion annually.

Nevertheless, it is entirely possible that in the short run increased immigration will have a net positive per capita benefit. The downward pressure on wage rates, and the resulting increase in return on investment, will attract additional capital from abroad. Furthermore, providing investors with a larger share of total national income will increase the average propensity to save and invest. As a consequence, productivity and, hence, average per capita GDP might increase. However, since the providers of capital will not share this output equally with the providers of labor, it is problematic whether labor will be better off. The NRC study found that even in the short term, immigration decreased the per capita income of the poorest 10% of society by 5% while increasing the income of the rest of society by a mere 0.2%.

In the long run, to be competitive other nations will have to either increase their productivity or, if they are unable to sufficiently increase productivity to offset the lower wages of the U.S., they will have to reduce their wage rates as well. The net result will be increasing worldwide inequality of income between the providers of capital and providers of labor.

There is yet another problem to be considered: the fate of those immigrants who fail to compete for jobs in the U.S. During the last great wave of immigration (1900-1914), 40% of the immigrants went back home when they couldn't find jobs in the U.S. Now they, or the Americans they displace, will end up on welfare or struggling to survive on low paying jobs. At a time when we are also seeking to push millions of welfare recipients into the workforce will make the problem that much worse.

The post-W.W.II baby boom created temporary problems in the U.S. when the baby-boomers entered school and the labor force, and will create some problems at the other end of their lives when they leave the labor force and retire. It is like the bulge in a python that swallowed a goat. It has to work its way through the digestive system. In the case of the baby boom, swallowing this huge increase in the labor force has caused some economic heartburn, but you don't treat indigestion by eating more food.

Finally, some policy makers have suggested that we increase the supply of labor to generate additional tax dollars to pay for the benefits of the baby boomers as they retire. But of course this would require adding still more immigrants, to cover the benefits of the first wave of immigrants when they retire. Like any pyramid scheme requiring ever larger numbers, it must ultimately collapse. The answer to providing increased benefits is to increase productivity and, hence, per capita wealth. The primary way of increasing productivity is to increase investment per worker, not to simply increase the total number of workers.

Joseph Daleiden is an business economist, demographer and author who has worked in both the private and public sectors. Most recently he served as the Director of Long Term Planning for Ameritech. His latest book, The American Dream: Can it Survive the 21st Century? is to be published by Prometheus Books in February 1999.

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