The Labor Market Challenge. Does International Migration Challenge Labor Markets in Host Countries? A Critical Review of the Recent and Traditional Literature

This paper addresses a classical question: Does immigration reduce wages and increases unemployment in receiving countries? Fears that immigrants take jobs away from natives have been fuelled by the current financial and economic crisis in host countries on both sides of the Atlantic and resulted in tighter immigration policies. From a theoretical perspective, an increasing labor supply through immigration does not necessarily reduce wages, or, if labor markets are not perfect, increase unemployment. In contrast, economic theory predicts that capital stocks adjust to labor supply changes such that aggregate wage levels and the real interest rate remain constant. Similarly, trade and the adjustment of production can absorb changes in labor supply such that immigration leaves wages and employment opportunities unaffected. It remains thus an empirical question, whether and to which extent immigration does actually affect labor markets in host countries. There exists a comprehensive empirical literature addressing these issues. The overwhelming share of this traditional literature uses the variance of the foreigner share across local labor markets for the identification of the immigration effects. Meta-studies of this literature indicate that an immigration of 1 percent of the labor force reduces wages by no more than 1 percent and increased the unemployment rate by less than 1 percentage point. Even these small effects need not to be significant. This literature has been challenged by an increasing criticism which states that the area approach systematically underestimates the wage and employment effects if other factors such as native migration, regional trade and capital mobility equilibrate the effects of immigration across local labor markets. A recent literature uses therefore the variance of the foreigner share across education and work experience groups at the national level for identification. Although some of these studies find effects which are substantially larger than those of the traditional literature, there exist meanwhile a number of studies which find similar aggregate effects as the traditional area approach. These studies consider that capital stocks adjust to labor supply shocks and that natives and immigrants are imperfect substitutes in the labor market, i.e. do not perfectly compete even if they possess the same education and work experience level. A shortcoming of most of the recent literature is that it does not address the impact of immigration systematically in a setting with imperfect labor markets and persistent unemployment. Novel approaches which consider wage-bargaining and other imperfections, find that immigration can do both, reduce wages and increase unemployment. Although the effects disappear in the long-term when capital stocks adjust, they may affect labor markets significantly in the short term. The most important challenge for immigration and integration policies is however the finding that different groups in the labor markets are affected by immigration in very different ways: While natives tend to benefit across all education groups from immigration, immigrants lose substantially from further immigration in terms of lower wages and higher unemployment. Addressing these inequalities forms the main challenge for immigration, integration and related labor market policies.