Econ 101: Why Immigration Happens
Despite political issues, immigration is really just economic forces at work.

By Gary Wolfram, Ph.D.
Business & Media Institute Adviser
June 14, 2006

     One of the hottest topics in today’s news is immigration, both legal and illegal. The discussion is focused on “solutions,” but perhaps we should begin with an examination of why immigration occurs.

     The kind of immigration that is making headlines – movement of Hispanic immigrants across our Southern border – is primarily economic immigration. That means we should be able to use basic economic theory to tell us why it is occurring and what ought to be done about it, if anything.

     Basic economic theory tells us that labor tends to move from low-wage areas to high-wage areas. For example, suppose the average wage for an unskilled worker in Ohio is $5 per hour, and the average wage for an unskilled worker in Michigan is $50 per hour. We would expect that workers would begin moving from Ohio to Michigan. We should not be any more surprised to see that people are eager to move from low-wage Mexico (GDP per capita of $10,000) to the high-wage United States (GDP per capita of $42,000).

     We also know that capital – the economist’s term for buildings, factories, machinery, computers, etc. – moves from high-wage areas to low-wage areas. Using the same example as above, we would not be surprised if Dell set up a computer factory in Ohio rather than Michigan. This part of the story is related to another hot topic: outsourcing. Outsourcing is not the movement of jobs from one place to another; it is the movement of capital from one place to another. We could say Dell has “outsourced” to Ohio when it sets up a factory there rather than expanding a factory in Michigan. The same thing is going on in regard to the United States and Mexico.

     Now what happens to wages as these movements occur? Holding everything else constant, wages will decline in the area where more labor accumulates, and wages will increase in the area targeted by capital growth. The increase in the supply of labor in Michigan in our example will decrease the price of labor there. Meanwhile, the additional capital in Ohio will add to the productivity of Ohio workers and bid up wages there.

     The degree of wage change depends on the size of the labor flow relative to the existing capital. For example, if 15 workers move from Ohio to Michigan, with a labor force of 4.5 million, then the wage effect will be small. If the Dell factory moving to Ohio adds significantly to the capital in Ohio, then the wage effect will be large.

     In the case of Mexico and the United States, academic studies show varying effects of immigration on wages. A recent National Bureau of Economic Research study by Gordon Hanson found the reduction in trade barriers from the implementation of the North American Free Trade Agreement raised wages in Mexico. That was particularly true for the most well-educated workers, who were best able to make effective use of capital. George Borjas of Harvard’s Kennedy School of Government found that wages for U.S. workers who competed with immigrant labor did not rise as fast as for other workers.

     What policy implications arise from this basic knowledge? It will be very difficult to overcome the strong incentive for labor to move to the high-wage area. That is, of course, why we have nine to 10 million illegal immigrants in the United States. If one is concerned about the flow of those immigrants, one should alter the incentives, rather than use up resources trying to fight the incentives.

     This could be done in two ways. First, deny government-provided benefits such as free education, medical care and welfare assistance to illegal immigrants. This would ensure that the only immigrants who enter would be ones who could produce goods and services that are more highly valued than the goods and services they consume. Second, reduce U.S. and Mexican government-imposed barriers to capital flows. The more capital moves to Mexico, the higher the productivity of Mexican workers, and the higher the wages of Mexican workers. This would reduce wage disparities and the flow of illegal immigrants.

     When I was a young child, Japan was noted for its low wages and something “made in Japan” meant it was cheap and probably a little shoddy. By 1995, according to a recent study by Koji Nomura and Jon Samuels, also of the Kennedy School of Government, Japanese wages exceeded those in the United States. Today Japanese vehicles are known for their quality. As a consequence of the wage disparity, we find Japanese companies opening up factories in the United States.

     By fully integrating the Mexican and U.S. economies in a similar way, we may one day find capital moving from Mexico to the U.S. and labor moving from the U.S. to Mexico. The alternative is to waste billions of dollars of resources in a futile attempt to fight market forces so strong that people are willing to risk their lives in response to them.