Immigration's Impact on the Economy ... Evidence from the UK

Not too long ago (in Novembe) I reported on the the issues and dilemmas of the Bank of England in pushing up the interest rate to 5%. I am not an ardent watcher of the UK economy so I was pretty much taking the media commentaries at face value speaking about how the perception that the economy was flirting with spare capacity and thus the inflation risk merited a raise. However, more importantly something about immigration and spare capacity or in this case potential output also caught my eye ... this quote from The Economist sums ups excellently;

Just how big an impact higher immigration is having on potential output goes to the heart of the rate-setters' dilemma. On the face of it, there has been a spectacular expansion in the workforce since 2004. Around half a million migrants from eastern Europe have started working in Britain over the past two years. Thanks also to the return of older people to work, the labour force has been growing at its fastest rate for more than 20 years.

This suggests that the bank should be pushing up its estimate of potential output. The migration figures are notoriously poor and difficult to interpret, however. For example, some of the newcomers from eastern Europe have returned home, yet timely estimates of this outflow are not available.

This is indeed interesting is it not? Obviously, the theory here is not particularly difficult since we are simply talking about a de-facto augementation of the labour supply which quite naturally should show a rather direct transmission mechanism with potential output. However, we are leaving out important questions such as for example the nature and properties of the immigration. Apparently, the recent debate about immigration's effect on the economy has gotten some people at the Bank of England's research unit thinking and consequently the just published quarterly bulletin features, among other things, an in-depth article about immigration's effect on the supply in the economy. The article is clearly UK biased but still there are some general points to take away.

An increase in the number of immigrants, other things being equal, would raise the supply potential of the economy. But the extent to which potential supply increases will depend on the economic characteristics of immigrants. This article investigates the characteristics of immigrants, particularly new immigrants — those who have entered the United Kingdom in the past two years. It appears that new immigrants are more educated than both UK-born workers and previous immigrant waves, but are much more likely to be working in low-skilled occupations. The increasing share of new immigrants in low-skill, low-paid jobs seems to have led to the emergence of a gap between the wages of new immigrants and UK-born workers. The implications of these findings for overall productivity and the supply side of
the economy are complex.

(...)

These different possibilities and the difficulty of quantifying the impact of immigration on wages, productivity and the
natural rate of unemployment, demonstrate that the implications for overall productivity and the supply side of the
economy are complex. And, of course, the overall impact on inflation is determined by the extent to which immigration
affects the balance between supply and demand in the economy.

There might not be any decisive theoretical message from this paper but still it is good crack at answering a tough question in a specific economic context and as such it merits some thought I think.