Modelling Migration in an OLG Framework: the Case of UK Migration Policy. by Katerina Lisenkova National Institute of Economic and Social Research

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1 Modellin Miraion in an OLG Framework: he Case of UK Miraion Policy by Kaerina Lisenkova Naional Insiue of Economic and Social Research Marcel Méree Universiy of Oawa Miuel Sanchez-Marinez Naional Insiue of Economic and Social Research Ocober 2013 Absrac This paper uses an OLG-CGE model for he UK o illusrae he lon-erm effec of miraion on he economy. We use he curren UK overnmen s miraion are o reduce ne miraion from hundreds of housands o ens of housands as an illusraion. Achievin his are would require reducin recen ne miraion numbers by a facor of abou 2. In presened simulaions, we compare a baseline scenario, ha incorporaes he principal 2010-based ONS populaion projecions, wih a lower miraion scenario, which assumes ha ne miraion is reduced by around 50%. The resuls show ha such a sinifican reducion in ne miraion has sron neaive effecs on he economy. The level of boh GDP and GDP per capia fall durin he simulaion period by 11 and 2 per cen respecively. Moreover, his policy has a sinifican impac on public finances. To keep he overnmen bude balanced, he labour income ax rae has o be increased by 2 percenae poins in he lower miraion scenario. (*) Financial suppor from he Economic and Social Research Council under he ran: A dynamic mulireional OLG-CGE model for he sudy of populaion aein in he UK is raefully acknowleded.

2 1. Inroducion Inernaional miraion is a rowin phenomenon beween 1990 and 2010 he number of inernaional mirans worldwide has increased from 155 o 214 million (Unied Naions, 2012). Miraion has a sinifican economic impac on boh sendin and receivin counries. From he poin of view of developed economies, which usually play he role of hos counries, here are wo disincive views on he possible effecs of immiraion. Firs, immiraion can be rearded as one poenial soluion o he challenes presened by he populaion aein process ha is currenly onoin in mos advanced economies. As an example, over he pas 50 years, he proporion of he UK populaion aed 65 and above has increased from 12 o 17 per cen, and by 2060 i is esimaed o reach 26 per cen 1. Chanes in populaion srucure are deermined by hree demoraphic processes: feriliy, moraliy and miraion. While feriliy and moraliy enerally end o adjus slowly and have a lon-erm impac on demoraphic srucure, miraion can chane rapidly, hereby playin a more imporan role in he shor run. In addiion, miraion flows are more responsive o chanes in policy. Tha is why many developed counries use miraion policies as a ool o address demoraphic challenes. The raionale behind his remedy is ha mirans end o be youner han he naive populaion on averae, and herefore will be able o replace fallin naive workin ae populaion durin he ransiion period. Second, he overall impac of immiraion on he hos economy can be analysed from he viewpoin of compeiion. The main arumen is ha immiran workers compee wih naives for jobs, resulin in hiher unemploymen and lower pay for naive workers. Immirans also apply for welfare benefis and use free (or subsidised) public services. Hence, proponens of his view claim ha he neaive impac of immiraion exends o he public purse oo. Alhouh here is no evidence ha he expansion of immiraion leads o neaive labour marke oucomes for naive-born workers (Dusman e al, 2008; Lemos and Pores, 2008), his view is ofen popular amon he press and he eneral public. In his paper, we aemp o provide a quaniaive assessmen of he lon-erm impac of miraion on he economy ha may cas new lih on his debae. As an experimen, we chose he miraion are se by he curren UK overnmen o reduce he level of ne miraion from hundreds of housands o ens of housands. As Fiure 1 below shows, 1 Accordin o he 2010-based principal ONS projecions

3 posiive ne miraion in he order of hundreds of housands is a relaively recen phenomenon in he UK, since i radiionally experienced neaive ne miraion. The recen lare influx of immirans afer he accession of he Easern European counries o he EU in 2004 (so-called A8 counries 2 ) raised ensions wihin sociey and brouh miraion policy o he forefron of he poliical debae. Tihenin of he miraion rules, inroduced by he curren overnmen, has sared o produce he expeced resuls; accordin o he mos recen esimaes for ne miraion, durin he year endin in Sepember 2012 ne miraion was 153,000 he lowes level since Fiure 1. Ne miraion, UK, , , , , ,000 50, , ,000 Source: ONS The principal ne miraion assumpion in he mos recen 2010-based ONS populaion projecions is ha i will remain a 200,000 per year over he nex 50 years. Thus, if he curren overnmen succeeds in achievin is miraion are, hen ne miraion will be reduced by more han half relaive o he ONS assumpion. The oal of his paper is o model and analyse he overall economic impac of his policy. 2 The lis of A8 counries comprises he Czech Republic, Esonia, Hunary, Lavia, Lihuania, Poland, Slovakia and Slovenia.

4 A he empirical level, here exis a number of conribuions ha shed lih ono he several channels in which immiraion can have a bearin on he UK's economy. While many of hem focus on he labour marke aspecs, here is also a rowin lieraure on he ne fiscal impac of miraion. Amon he firs roup of papers, Lemos and Pores (2008) sudy he labour marke impac of A8 immiraion o he UK and do no deec any sinifican effecs on naive's waes or unemploymen. Manacorda, Mannin and Wadsworh (2006) aemp a resolvin ha observed insensiiviy of naives' waes o immiraion by aruin ha UK naive and forein born workers may be imperfec subsiues. Afer esimain he elasiciy of subsiuion beween workers of differen oriin, hey conclude ha immiraion mainly reduces he waes of immirans, wih lile impac on hose of naives. An empirical analysis of he effecs of immiraion on averae waes in he UK is conduced in Nickel and Saleheen (2008). These auhors find ha, even houh small, he immiran-naive raio has a sinifican neaive impac on he averae occupaional wae raes of ha reion, for boh naive and forein workers. They also find ha he bies effec is in he semi/unskilled services secor. On he fiscal implicaions of immiraion ino he UK, Sriskandarajah, Cooley and Reed (2005) provide evidence showin ha he ne conribuion of immirans ino he welfare sae is posiive. Moreover, heir analysis also suess ha he relaive ne fiscal conribuion of foreiners is reaer han ha of UK-born. Similarly, Go and Johnson (2002) also find ha he fiscal impac of he immiran populaion is posiive overall, alhouh hey also warn i is likely ha his resul masks he differen performance of subsecions of his populaion. In a recen sudy, Dusmann e al. (2010) esimaed he fiscal impac of A8 mirans in he UK. They found ha hese immirans have a posiive ne conribuion o public finances. Conrary o hese posiive resuls on he effecs of immiraion, Coleman and Rowhorn (2004) find ha he purely economic consequences of lare-scale immiraion are no equally disribued, ivin rise o winners and losers. However, hey also arue ha he purely economic dimension of immiraion is neliible in comparison wih he demoraphic, social and environmenal issues ha come wih i. The oher major srand of lieraure on he economic impac of immiraion o he UK is based on he use of eneral equilibrium macroeconomic models, which are especially suiable for invesiain he fuure possible consequences of miraion. These approaches

5 enerally employ aen-based macroeconomic models which are calibraed o he UK. There has been paricular ineres in analysin he macroeconomic impacs of Easern European mirans o he UK, afer he EU enlaremen in May Barrell, FizGerald and Riley (2007) use he model NiGEM 3 and predic ha, even houh he overall isolaed impac is likely o be small from an areae perspecive, miraion from hese counries resuled in hiher GDP and lower unemploymen and inflaion. In he same vein, Iakova (2007) employs he IMF's dynamic eneral equilibrium model wih demoraphic feaures and finiely-lived individuals, Mulimod, o explore he effecs of Easern European immiraion o he UK. The resuls from her simulaions poin o posiive effecs of his miraion on economic rowh, capial accumulaion, consumpion and public finances. Based on an assumed pah of miraion flows, Bass and Brucker (2011) employ a CGE model wih imperfec labour markes and draw he conclusion ha he EU enlaremen conribued o he increase in GDP per capia in he UK a he expense of slower ains in wae and unemploymen. Our paper adds o he laer body of research by considerin miraion from all oriins and by employin a richer model srucure. In his sense, our aim is o develop a framework where we can conduc a dynamic assessmen of fuure chanes in immiraion policy. For his purpose, we employ a dynamic overlappin eneraions compuable eneral equilibrium model (OLG-CGE), which is widely acknowleded as he bes ool for he modellin of issues associaed wih demoraphic chane. Amon he advanaes of an OLG- CGE framework is is ae-disareaed naure, which makes i possible o sudy aespecific behaviour and he impac of chanes in he populaion ae srucure on he economy. The model is in he Auerbach and Kolikoff (1987) radiion and inroduces ae-specific moraliy followin Borsch-Supan e al. (2006). This modificaion allows precise replicaion of he populaion srucure from any populaion projecion and dramaically improves he accuracy of demoraphic shocks. There are several approaches o modellin miraion in an OLG-CGE framework. One approach is o assume ha immirans are idenical o naives, i.e. hey come wih he same level of asses, qualificaion and produciviy as naives in he correspondin roup. An 3 NiGEM is a lare esimaed quarerly model of he world economy developed by he Naional Insiue of Economic and Social Research. Bein buil in a New-Keynesian framework, i feaures nominal riidiies in an oherwise sandard model wih forward-lookin aens.

6 alernaive approach is o assume ha immirans differ from naives a leas in some dimensions. One aspec ha seems imporan is he level of immirans asses. Inuiively, if immirans ener he counry wih a posiive (neaive) asse posiion, hey will add o (diminish) he level of he capial sock in he hos counry. Alernaively, if hey come wihou asses, he level of labour produciviy in he economy would decline due o capial diluion caused by a hiher labour supply ha is uncompensaed by a hiher capial sock. Fehr e al. (2004) and Chojnicki e al. (2011) assume ha immirans hold he same level of asses as naives of he same ae and qualificaion, while Soresleen (2000) assumes ha immirans have no asses when hey come. We adop a differen approach. We assume ha he new forein-born mirans have he same level of asses as he forein-born populaion already livin in he UK. Correspondinly, new naive-born mirans own he same level of asses as he naive-born populaion ha says wihin he counry. We also aemp o differeniae he naive-born and forein-born populaion alon oher dimensions as much as possible. The wo roups exhibi differen employmen raes, produciviy levels, qualificaion disribuion as well as differen probabiliy of receivin benefis from he overnmen. Such deailed differeniaion allows us o capure mulidimensional effecs of miraion on he labour marke, areae demand and public finances. The res of he paper is oranised as follows. In secion 2, we ive a descripion of he model. In secion 3, we ouline he calibraion procedure. Secion 4 describes performed simulaions and presens resuls for wo policy alernaives. Finally, secion 5 concludes wih a brief discussion. 2. The Model The model presened in his secion is desined o analyse he lon-erm economic implicaions of demoraphic chane in he UK. The UK is modelled as a small open economy. The res of he world is no explicily modelled, bu, raher, i is presen in he model only o close he UK's curren accoun. Below we describe he demoraphic srucure of he model and ouline he main feaures of he producion, household and overnmen secors. The exoenous demoraphic process is superimposed on he model and provides he exoenous shock or drivin force behind he simulaions resuls.

7 2.1 Demoraphic Srucure The populaion is divided ino 21 eneraions or ae roups (i.e., 0-4, 5-9, 10-14, 15-19,, ). Demoraphic variables, feriliy, moraliy and ne-miraion raes are assumed o be exoenous. 4 This is a simplifyin assumpion iven ha such variables are likely endoenous and affeced by, for example, chanes in economic rowh. Every cohor is described by wo indices. The firs is, which denoes ime. The second is, which denoes a specific eneraion or ae roup. The size of he cohor belonin o eneraion +k in any period is iven by he followin wo laws of moion: (1) Pop, + k Pop = Pop 1, + k+ 5 1, + k 1 fr 1 for k = 0 ( sr + mr ) for k [ 1,20] 1, + k 1 1, + k 1 The firs equaion simply implies ha he number of children born a ime (ae roup +k =, i.e. ae roup 0-4) is equal o he size of he firs adul ae roup (+k+5=+5, i.e. ae roup 20-24) a ime -1 muliplied by he feriliy rae, fr, in ha period. If every couple has wo children on averae, he feriliy rae is approximaely equal o 1 and he size of he younes eneraion a ime is approximaely equal o he size of he firs adul eneraion +5 one year before. A period in he model corresponds o five years and a uni incremen in he index k represens boh he nex period, +k, and, for an individual, a shif o he nex ae roup, +k. The second law of moion ives he size a ime of any ae roup, +k, beyond he firs eneraion, as he size of his eneraion a year ao imes he sum of he ae specific condiional survival rae, sr, and he ne miraion rae, mr, a ime -1. In his model he feriliy raes vary across ime, while he survival and ne miraion raes vary across ime and ae. For he final eneraion (i.e., he ae roup (k=20)), he condiional survival rae is zero. This means ha everyone belonin o he oldes ae roup in any period dies wih cerainy a he end of he period. 4 In fac we assume ha here is a ne excess demand for posiive ne miraion in UK from foreiners. Hence he number of forein immirans in UK is somewha under he conrol of he Briish overnmen.

8 To accoun for he fac ha boh forein- and naive-born populaion can mirae, we disareae ae-specific ne miraion raes by oriin, i.e. here are separae ne miraion flows for naives (mosly neaive) and foreiners (mosly posiive). Areae ne miraion raes, mr, are a sum of naive ne miraion raes, nmr, and forein ne miraion raes, fmr. This is done o properly rack naive- and forein-born populaion size. As will be discussed below, hese wo roups have many differen characerisics in he model. Time variable feriliy and ime/ae-variable ne miraion and condiional survival raes are calibraed based on exoenous populaion projecions. This permis a precise modellin of he demoraphic scenario of any confiuraion wihin he model. This feaure of he model makes i ideal for sudyin he overall impac of demoraphic chane on he economy. 2.2 Producion A any ime, a represenaive firm hires labour and rens physical capial o produce a sinle ood usin a Cobb-Doulas echnoloy. The producion funcion hus reads: (2) Y = AK α 1 α L where Y denoes oupu, K is physical capial L denoes effecive unis of labour, A is a scalin facor and α represens he share of physical capial in oupu. The marke in which he represenaive firm operaes is assumed o be perfecly compeiive. Facor demands hus follow from he soluion o he recursive profi maximizaion problem: (3) re K = αa L α 1 (4) K w = α (1 )A L α where re and w denoe, respecively, he renal rae of capial and he wae rae. We assume ha here are hree ypes of labour ha can be employed by he firm, which are indexed as qual = 1, 2 and 3. These ypes are defined in erms of skill-level/qualificaion: hih-skilled workers (qual=1), medium-skilled workers (qual=2) and low-skilled workers (qual=3). Naive and forein-born workers of he same skill-level are perfec

9 subsiues. A firm ransforms is demand for oal labour, L, ino a skill-specific labour demand, L qual, based on he followin consan-elasiciy-of-subsiuion (CES) funcion: w (5) Lqual ς, = qual L w qual, σ L where w qual denoes he wae rae for a specific qualificaion, ς qual is he share of each L qualificaion in oal labour inpu and σ represens he elasiciy of subsiuion beween qualificaions. The relaionship beween he composie wae rae of he firm s areae labour inpu, w, and he skill-specific marke waes, w qual, is iven by: L 1 σ (6) w = ς qual qual w L 1 σ qual, 2.3 Household secor The household secor in he model is disareaed by ae (21 eneraions), qualificaion (3 qualificaions) and oriin (naive- or forein-born). Household behaviour in every qualificaion/oriin roup is capured by 21 represenaive households ha inerac in an Allais-Samuelson overlappin eneraions srucure represenin each of he ae roups. Individuals ener he labour marke a he ae of 20, reire a ae 65, and die a he laes by ae 104. Youner eneraions (i.e. 0-4, 5-9, and 15-19) are fully dependen on heir parens and play no acive role in he model. However, hey do influence he public expendiure. An exoenous ae/ime-variable survival rae deermines life expecancy. Adul eneraions (i.e. ae roups 20-24, 25-29,, ) opimise heir consumpionsavin paerns over ime. The household s opimizaion problem consiss of choosin a profile of consumpion over he life cycle ha maximizes a CES ype iner-emporal uiliy funcion, subjec o he lifeime bude consrain. In paricular, he iner-emporal preferences of an individual born a ime are iven by: k qual, na = 4 = 0 +, +,, +, + ) k m m m qual na k k k 1 θ (7) U = Π sr ( C ) 1 θ 1+ ρ 0 < θ< 1

10 where C denoes consumpion, ρ is he pure rae of ime preference and θ represens he inverse of he consan iner-emporal elasiciy of subsiuion. Fuure consumpion is also discouned a he uncondiional survival rae, Π sr k + k, + k, which is he probabiliy of survival up o he ae +k and period +k. I is he produc of he ae/ime-variable condiional survival rae, sr +k,+k, beween periods +k and +k+1 and aes +k and +k+1. The household is no alruisic, i.e. i does no leave inenional bequess o children. However, i leaves uninenional bequess due o unknown life duraion. The uninenional bequess are disribued hrouh a perfec annuiy marke, as described heoreically by Yaari (1965) and implemened in an OLG conex by Boersch-Supan e al (2006). Given he assumpion of a perfec annuiy marke, he household s dynamic bude consrain akes he followin form: (8) HA qual, na, + 1, + 1 L L [ Y ( 1 τ Cr ) + Pens + TRF + ( 1+ Ri ) HA C ] qual, na,, 1 = sr., na,, qual, na,, qual, na,, where HA is he level of household asses, Ri is he rae of reurn on physical asses, τ K is he effecive ax rae on capial, τ L he effecive ax rae on labour, Cr is he conribuion rae o he public pension sysem, Y L is he labour income, Pens is he level of pension benefis and TRF is public ransfers oher han pensions. The inuiion behind he erm 1/sr is ha he asses of hose who die durin period are disribued equally beween heir survivin peers. Therefore, if he survival rae a ime in ae roup is less han one, hen a ime +1 everyone in heir roup has more asses. Tha is, hey all receive an uninenional beques hrouh he perfec annuiy marke. Labour income is defined as: L (9) Y qual, na,, = wqual, EPqual, na, LS qual, na, where LS is he exoenously iven supply of labour differeniaed by qualificaion and oriin. I is assumed ha labour income depends on he individual s ae-specific produciviy. In urn, i is assumed ha hese ae-specific produciviy differences are capured in aeearnins profiles ha are also disareaed by qualificaion and oriin. These produciviy profiles are quadraic funcions of ae:

11 (10) EP 2 qual, na, = γ qual, na + ( λqual, na ) ( ψ qual, na ), γ, λ, ψ 0 wih parameric values esimaed from micro-daa (as discussed in he calibraion secion). Differeniain he household uiliy funcion, subjec o is lifeime bude consrain, wih respec o consumpion yields he followin firs-order condiion for consumpion, commonly known as Euler equaion: K [ + ( 1 τ + 1) Ri 1] (11) 1 1 θ + C qual, + 1, + 1 = Cqual,, (1 + ρ qual ) I is imporan o noe ha, since survival probabiliies are presen in boh he uiliy funcion and he bude consrain, hey cancel each oher ou and are no presen in he Euler equaion. 2.4 Modellin miraion As was described in he previous secion, household secor is disareaed by qualificaion (hree caeories) and oriin (naive-/forein-born). Differen caeories of households have differen opimisaion problems, i.e. he naive-born populaion and forein-born populaions have differen opimal level of asses a every ae and qualificaion level (usually naives have hiher asses han foreiners). We assume ha new forein-born mirans have he same level of asses as he represenaive forein-born households in he same ae/qualificaion roups already livin in he UK. Correspondinly, new naive-born mirans own he same level of asses as he naive-born populaion ha says wihin he counry. We also aemp o differeniae he naive-born and forein-born populaion alon oher dimensions. The wo roups have differen ae-specific employmen raes, ae-produciviy profiles and qualificaion disribuions. They also have differen probabiliies of receivin ransfers from he overnmen. All of hese parameers are esimaed from he LFS which is discussed in more deail in he calibraion secion. Such deailed differeniaion allows us o capure mulidimensional influences of miraion on he labour marke, areae demand and public finances.

12 2.5 Invesmen and Asse Reurns Takin ino accoun he discussion of miran s asses in he previous secion, he law of moion for he capial sock, Ksock, akes ino accoun boh depreciaion and he ne asses of newly arrived (lef) mirans: (12) Ksock 1 = Inv + ( 1 δ ) Ksock + HAqual, na, + 1, + 1NM qual, na, + 1, qual where Inv represens invesmen, δ is he depreciaion rae of capial, and NM is he level of ne-miraion. Capial markes are assumed o be fully ineraed. This implies ha financial capial is undiffereniaed from physical capial, so ha he ineres rae pariy holds: (13) 1 Ri = re + (1 δ ) + where Ri and re denoe he ne and ross raes of reurn o physical capial, respecively. 2.6 Governmen Secor The Governmen s bude consrain reads: (14) Pop L ( τ + Cr )( wqual, EPqual, na,, LS qual, na,, ) C, τ qual, na qual, na = Gov + GovH, + GovE, + na, Pop na,, + C qual, na,, ( TRFna,, + Pens, ) + Ri Deb + Def C where τ is he effecive ax rae on consumpion, Def is fiscal defici, Deb is level of public deb, Gov is ae-unrelaed public consumpion, GovH denoes overnmen expendiure on healh and GovE denoes overnmen expendiure on educaion. The lef-hand side of he consrain conains he overnmen revenues, roupin oeher all ax revenues from differen sources and overnmen borrowin. The rih-hand side of he equaion represens differen caeories of overnmen expendiure includin oriin-dependen ransfers o households, pension benefis and servicin of he public deb. Noe ha he pension proram is a par of he overall overnmen bude. Public deb accumulaes over ime accordin o he followin rule:

13 (15) Deb +1 = Deb + Def Public expendiures on healh and educaion are ae-dependen. They are fixed per person of a specific ae. More specifically, ASHEPC is ae-specific healh expendiure per-person and ASEEPC is ae-specific educaion expendiure per-person. Therefore, oal public expendiure in hese caeories depends no only on he size of he populaion bu also on is ae srucure: (16), (17), Oher ypes of public expendiures per person, GEPC, are assumed o be ae-invarian. They are fixed per-person and hence oal expendiure, Gov, depends only on he size of he oal populaion, TPop. (18) In he simulaions presened in his paper we use he wae ax rae, L τ, as he only endoenous policy variable ha adjuss in every period o achieve a balanced overnmen bude. The choice o focus on he wae ax rae as he main fiscal insrumen is jusified, amon oher reasons, by he fac ha i does no enerae efficiency disorions, iven he absence of an endoenous labour-leisure decision. 2.7 Marke and Areaion Equilibrium Condiions Perfec compeiion is assumed in all markes. The equilibrium condiion in he oods marke requires ha he UK's oupu be equal o areae absorpion, which is he sum of areae consumpion, invesmen and overnmen spendin: =, (19) Y Pop, C + Inv + Gov + GovH + GovE

14 Labour marke clearin requires ha he demand for labour of a specific qualificaion level be equal o he supply of his qualificaion: (20) qual, = Pop L, LSqual, EPqual, Similarly, he unis of capial accumulaed up o period mus equal he unis of capial demanded by he represenaive firm in ha period: (21) Ksock = K In he same vein, equilibrium in he financial marke requires oal sock of privae wealh accumulaed a he end of period o be equal o he value of he oal sock of capial and overnmen deb accumulaed a he end of period :, (22) Pop, HA = Ksock + Deb Finally, he curren accoun balance can be obained as he difference beween naional savins and domesic invesmen: (23) CA Pop+ 1, + 1HA + 1, + 1 Pop, + 1HA, + 1 Ksock 1 Ksock = + Privae Naional Savins Domesic Invesmen 3. Calibraion The demoraphic, producion and overnmen sides of he model are calibraed usin 2010 daa for he UK. The daa for he demoraphic baseline shock is aken from he 2010-based principal populaion projecions produced by he Office of Naional Saisics (ONS). Populaion projecions are used for calibraion of he feriliy, survival and ne miraion raes used in he model. They are calculaed accordin o he formulae used in he model o replicae he demoraphic process (secion 2.1). As menioned above, ne miraion is disareaed ino naive ne miraion and forein ne miraion. For ha we use he mos recen daa available from ONS on he lon-erm miraion by oriin. We assume ha oal fuure naive ne miraion will be -75,000 a year. This is boh he mos recen level for he

15 year finishin in Sepember 2012 and averae level over he las 6 years. The level of he oal forein ne miraion is calculaed as he difference beween he ONS oal ne miraion assumpion and he naive ne miraion assumpion, i.e. in he case of he principal scenario i is 275,000 per year. Ae decomposiion follows he daa on broad ae roups srucure of ne miraion by ciizenship from he Inernaional Passener Survey. We also assume ha forein ne miraion above ae 64 is equal o zero, i.e. here is only naive miraion in his ae roup. The daa on public finances and GDP componens are aken from he ONS and HM Treasury. Effecive wae income and consumpion ax raes are calculaed from he correspondin overnmen revenue caeories and calibraed ax bases, namely oal labour income and areae consumpion. Daa on oal amoun of pensions are aken from he Governmen Acuarial Deparmen (GAD); oher ransfers are from he Deparmen for Work and Pensions. Based on his informaion, he effecive pension conribuion rae and he averae size of pension benefis can be obained. The averae amoun of pension benefis per person is obained by dividin he oal amoun of pension benefis by he oal number of people of pension ae. For simpliciy, i is assumed ha boh males and females sar receivin pension benefis a he ae of 65. The source of he labour marke daa is he Labour Force Survey (LFS). Three labour marke characerisics are derived from he daa: ae-specific employmen raes by qualificaion, he disribuion of he labour force by qualificaion and ae-specific produciviy profiles by qualificaion. The laer are esimaed via he use of ae-earnin reressions of he Mincerian ype (Mincer, 1958). The firs wo parameers were calculaed from he four mos recen waves of he LFS (Q Q1 2013). Because many of he observaions in he LFS lack earnins daa, we had o increase he number of included waves o 10 for esimaion of he produciviy profiles (Q ). The level of qualificaion is defined in erms of he number of years of educaion, as i is common in he relaed micro-economeric lieraure on immiraion. In paricular, hihskilled individuals are assumed o be hose who lef formal educaion a he ae of 21 or laer, medium-skilled people are hose who lef educaion in beween he aes of 17 and 20 (inclusive) and, finally, low-skilled individuals are hose who lef educaion youner han 17 years old or who repor o have no qualificaions. For he reamen of hose observaions who are sill in educaion, we make use of heir repored level of qualificaion. Firs, hose

16 who repor bein sill in educaion and a he same ime have a level of qualificaion equivalen o NVQ Level 4 and above are rouped ino he hih qualificaion caeory. Second, hose who also repor currenly bein in educaion bu have aained a level of educaion of eiher NVQ Level 3 or NVQ Level 2, or hey have compleed a rade appreniceship, are considered o be medium-qualified. Finally, hose individuals sill in educaion who repor havin no qualificaions or a qualificaion level below NVQ Level 2 are considered o be low qualified 5. All he labour marke measures are disareaed by he oriin of he individuals, namely naive- or forein-born. As an illusraion of he heeroeneiy in he qualificaion disribuion and labour marke oucomes across foreiners and naives, Table 1 summarises he percenae share of individuals in each qualificaion caeory and heir respecive employmen raes. Table 1. Descripive saisics by oriin. Naive-born Forein-born Employmen rae 1 75% 70% Hih qualificaion 22% 46% Medium qualificaion 33% 36% Low-qualificaion 45% 18% Source: LFS, Q1:2012-Q1: Here defined as he number of people employed in each roup divided by he oal number of people in he same roup. As apparen from hese daa, he skill composiion of foreiners is in sharp conras wih ha of naives; he majoriy of foreiners belon o he wo hihes qualificaion roups, whereas he disribuion for naives is skewed owards low-skilled individuals. The employmen rae is, however, hiher amon naives han amon foreiners. 5 Those who are sill in educaion bu repor o have "oher qualificaions" are he ones who are lef ou from his skill classificaion, since wihou furher informaion, any assinmen o some of he hree qualificaion roups would be arbirary. For a deailed discussion of hese qualificaion levels, see he ONS's websie: hp://

17 We also observe ha immirans end o have lower ae-earnins profiles for all qualificaion levels. This confirms he well-known discrepancy in waes beween naives and foreiners a he same skill level. Finally, he daa from he LFS are also employed in he esimaion of he difference in he likelihood of claimin sae benefis beween foreiners and naives. We find ha he foreiners in our sample have a 4.6% lower probabiliy of claimin benefis compared o naives. The exac empirical reression model used o calculae his can be found in Dusmann e al (2010). Fiure 2. Ae Disribuion of Healh and Educaion Expendiure per Person, UK % 30% 25% 20% Public educaion Public healh 15% 10% 5% 0% The esimaes of he ae srucure of overnmen spendin on healh and educaion are aken from he UK Naional Transfer Accouns for 2007 consruced by McCarhy and Sefon (2010). Fiure 2 shows he ae profiles of public spendin on healh and educaion in he UK in The majoriy of educaion spendin occurs beween he aes 5-9 and Healh

18 spendin rows slowly unil he ae of when i sars increasin much faser and acceleraes afer ae As i is sandard in he lieraure, he capial income share of oupu (α) is se o 0.3. The (5- year) iner-emporal elasiciy of subsiuion (1/θ) is se o 1.25 and (5-year) ineres rae o 10.4% (2% a year). The calibraion procedure is a sequence of four seps. In he firs sep, available labour marke daa on he disribuion of workers skills is used o calibrae he composiion of he populaion accordinly, such ha labour demand equals labour supply for each skill or qualificaion level. The second sep consiss of usin he informaion on oupu, capial and labour demands and he firs-order condiions of he firms' problem, he areae resource consrain and he marke clearin condiion for capial o calibrae he scalin parameer in he producion funcion, he wae rae and he capial renal rae. The hird sep is he mos challenin one since i involves equaions perainin o he household s opimisaion problem, he equilibrium condiions in he asses and oods markes and he overnmen expendiure on secors oher han healh and educaion (Gov). In paricular, he (5-year) rae of ime preference is solved endoenously durin he calibraion procedure in order o enerae plausible consumpion and capial ownership profiles for each ae roup, for which no daa are easily available. Capial ownership profiles mus also saisfy he equilibrium condiion on he asse marke. Finally, public expendiure on oher secors is endoenously deermined o close he bude consrain of he overnmen and o ensure he equilibrium on he oods marke. Noe ha he rae of ime preference and he iner-emporal elasiciy of subsiuion oeher deermine he slope of he consumpion profiles across ae roups in he calibraion sae of he model (when he populaion is assumed o be consan). This slope coincides wih he one for he lifeime consumpion profile of an individual in he simulaion wih neiher demoraphic shocks nor economic rowh. The fourh and final sep uses he calibraion resuls of he firs hree seps o verify ha he model is able o replicae he observed daa correspondin o he iniial equilibrium. Only

19 when he iniial equilibrium is perfecly replicaed by he calibraion soluion can he model be used o evaluae he consequences exoenous shocks. 4. Simulaions and Resuls To consruc he baseline scenario, we use he 2010-based principal populaion projecions produced by he ONS for he UK. Fiure 3 shows hese projecions for differen ae roups over he nex 50 years. The fases prediced rowh is for he ae roup 65+; by he end of he projecion horizon, i is expeced o increase by over 100% when compared o 2010 fiures. The number of children (0-19) and workin ae aduls (20-64) are also expeced o rise, bu a a much slower pace here will be 19% and 16% more people in hese ae roups respecively compared o Toal populaion is prediced o increase by 31 %. Fiure 3. Projeced Chane in UK Populaion by Ae Groups, % 100% Toal 80% 60% 40% 20% 0% Source: 2010-based principal ONS populaion projecion To illusrae he effecs of immiraion on he economy, we make use of a houh experimen ha reflecs he curren overnmen s miraion policy are: o reduce ne

20 miraion from hundreds of housands o ens of housands. As noed before, he principal scenario of he ONS populaion projecions assumes a lon-erm ne miraion inflow of 200,000 per year on averae. This means ha ne miraion has o decrease by a facor reaer han 2 o achieve he saed are. We also assume ha his policy does no affec he naive ne miraion level and only influences forein ne miraion. For simpliciy, we model his lower miraion scenario by reducin forein ne miraion raes in all ae bands, hus assumin ha forein ne miraion in every ae roup decreases in he same proporion. This simplifyin assumpion allows a quick illusraion of he overall effecs of his miraion policy. To achieve he desired lower level of ne miraion forein ne miraion raes have o be reduced by a facor of Fiure 4. Oupu and facors of producion 0% % -4% oupu -6% oupu per capia labour -8% capial -10% -12% Source: simulaion resuls The resuls presened in he followin fiures show he percenae difference beween he lower miraion scenario and he baseline scenario unless oherwise specified. Fiure 4 depics he difference in facors of producion and in oupu beween he wo scenarios. In he scenario wih he lower level of miraion by 2060, he produciviy adjused level of 6 Because naive ne miraion is no affeced and reducin raes is no equivalen o reducin numbers

21 labour supply (i.e., akin ino accoun ae-produciviy profiles and qualificaions) is abou 11% lower han in he baseline scenario. The same is rue reardin he level of oupu and he capial sock. Oupu per person falls o a much lower exen as lower ne miraion leads o a eneral decrease in populaion. Neverheless, oupu per person is 2.3% lower in he lower miraion scenario. Given our assumpion ha differen caeories of overnmen expendiures depend on he size of he relevan populaion roups, overnmen spendin is lower in he lower miraion scenario relaive o he baseline scenario because here are less people. However, if expressed as a share of GDP, overnmen expendiures are increasin. Fiure 5 shows rajecories of chane for differen caeories of overnmen spendin as a percenae poins difference beween he wo scenarios. The caeories ha are mos affeced are pensions and healh expendiures. This is due o he fac ha boh of hese caeories of spendin are concenraed in he older ae roups and immirans bein enerally much youner han naive populaion help o alleviae his burden. The oal level of overnmen spendin is abou 1.3 percenae poins of GDP hiher in low miraion scenario by Fiure 5. Governmen spendin as a share of GDP, percenae poins 1.6% 1.4% 1.2% 1.0% 0.8% ae-unrelaed expendiure healh educaion pensions ransfers oal 0.6% 0.4% 0.2% 0.0% -0.2% Source: simulaion resuls

22 Because of he addiional srain ha faser aein populaion pus on overnmen finances in lower miraion scenario, he labour income ax rae required o keep he overnmen s bude balanced is hiher in his scenario (see Fiure 6). Given he assumpion of fixed oal deb, fixed consumpion ax rae and fixed pension conribuion raes hrouhou he simulaions, he only fiscal insrumen ha can adjus o achieve a balanced bude in every period is he labour income ax rae. The reason for ha is he relaive size of oal overnmen expendiure and revenue. On he revenue side, he labour income ax base suffers sinifican erosion afer he chane in miraion policy. Areae consumpion is also reduced in he low miraion scenario, which resuls in relaively weaker consumpion ax revenues. A he same ime, overnmen expendiures on, for example, healh and pensions, decrease sinificanly less han revenues. Thus, he labour income ax rae needs o be hiher wih lower miraion in order o compensae for he increase in he old-ae dependency raio. Fiure 6. Effecive labour income ax rae 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% % Source: simulaion resuls

23 Fiure 7 depics he pah followed by he averae wae index as well as he ne averae wae. The equilibrium ross wae composie becomes slihly hiher afer he lower miraion shock, due o he reducion in overall labour supply. On he oher hand, he evoluion of ne wae capures he difference over ime beween ross wae and oal labour income ax paymens. As is apparen, he increase in he labour income ax rae offses he iniial increase in he ross wae once he miraion shock akes place, hereby causin a reducion in he ne wae and hence a reducion in he households' disposable income. Fiure 7. Wae and ne wae 1.00% 0.00% % -2.00% averae wae ne averae wae -3.00% -4.00% Source: simulaion resuls 4.1 Decomposiion of he effecs The resuls presened above show he effecs of reduced miraion, akin ino accoun all of he differences beween he naive- and forein-born populaion ha we have idenified from he daa. However, differen labour marke characerisics have differen imporance. In his secion we provide a decomposiion of he areae effecs presened in he previous secion. Table 2 summarises differences in oupu per person and effecive labour

24 income ax rae ha arise if we vary only one labour marke parameer a a ime. I also includes he case if foreiners are idenical o he naive-born populaion in heir labour marke characerisics (bu no in ae srucure). As before, in each case we are comparin wo scenarios one wih a baseline level of ne miraion, and one wih a lower ne miraion. In he case of oupu per person, he resuls are a percenae difference beween he wo scenarios. In he case of he effecive labour income ax rae, i is percenae poins difference. Table 2. Effecs for differen labour marke characerisics in Oupu per person Effecive labour income ax rae Foreiners are like naives -2.8% 2.3% Differen produciviy -2.1% 2.0% Differen employmen raes -1.8% 1.8% Differen qualificaion disribuion -4.0% 2.8% All characerisics are differen -2.4% 2.0% Source: simulaion resuls Because forein-born individuals have lower earnins, which as we assume reflec heir lower produciviy, and lower employmen raes han naive-born populaion, chanin only hese wo characerisics diminishes he neaive effec from lower miraion compared wih he scenario in which foreiners and naives share he same labour marke characerisics. However, foreiners are more educaed and hus chanin only heir qualificaion disribuion sinificanly increases he neaive effec of reduced miraion. Combinin all hree labour marke characerisics resuls in he overall effec which is lower han in he case if forein-born possess he same labour marke characerisics as naiveborn, bu no by very much. 4.2 Sensiiviy o qualiy of mirans As he previous secion showed, overall resuls depend no only on a reducion in he number of forein-born mirans bu also on heir qualiy, as described by heir labour marke characerisics. Here we would like o invesiae his furher by concenrain on one roup of recen mirans wih very disincive characerisics. These are mirans from

25 he so called A8 counries. Table 3 summarises how differen his roup is from an averae miran. Table 3. Labour marke characerisics of all immirans and of A8 immirans 7 All forein-born A8-born Employmen rae 70% 85% Hih qualificaion 46% 32% Medium qualificaion 36% 55% Low qualificaion 18% 13% Source: LFS, Q1:2012-Q1:2013 This roup of mirans has subsanially hiher employmen raes in all ae roups, and a hiher proporion of medium and hihly qualified workers han all forein-born populaion on averae. In addiion o his, hey are 17% less likely o claim overnmen benefis compared wih he naive-born populaion, while for he forein-born populaion as a whole his probabiliy is only 4% lower. Table 4 compares resuls from he main simulaion wih he hypoheical scenario of all fuure forein-born mirans havin he same characerisics as recen A8 mirans. The resuls are percenae poins difference beween he wo ses of scenarios. Table 4. Difference beween scenarios wih A8 immirans and averae immirans, percenae poins Oupu per person Effecive labour income ax rae -0.51% 0.28% Source: simulaion resuls In he case of all fuure forein-born mirans havin he same characerisics as A8 mirans ha came ino he UK recenly, he neaive effec of reduced miraion is sroner by abou 15-20%. 7 We could no calculae ae-specific earnins profiles by qualificaion for his roup of mirans because of insufficien number of observaions conainin earnins daa. We use for hem he same ae-earnins profiles are for all mirans.

26 5. Conclusions In his paper we employed an OLG-CGE model for he UK o illusrae he lon-erm effecs of miraion on he economy. As an illusraion, we used he recen UK overnmen s miraion are o reduce ne miraion from hundreds of housands o ens of housands. Achievin his are would ranslae ino a reducion in recen ne miraion numbers by a facor of 2. In our analysis, we compare he impac of such a miraion policy wih a baseline scenario which is buil in line wih he principal ONS populaion projecion. A number of resuls arise when conducin his policy experimen. Firs, we find ha he sinifican reducion in ne miraion has sron neaive effecs on he economy. By 2060 in low miraion scenario areae GDP decreases by 10.8% and GDP per capia by 2.5% compared o he baseline scenario. Second, his policy has a sinifican neaive impac on he public finances, owin o he shif in he demoraphic srucure afer he shock. The oal level of overnmen spendin expressed as a share of GDP increases by 1.3 percenae poins by This effec requires an increase in he effecive labour income ax rae for he overnmen o balance is bude in every period. By 2060 he required increase is 2.0 percenae poins. Third, he effec of he hiher labour income ax rae is fel a he household level, wih averae households' ne income worsenin wih lower miraion because of he hiher income ax despie he iniial increase in ross waes due o lower labour supply. By 2060 ne wae is 3% lower in lower miraion scenario. In lih of he resuls obained, we conclude ha his policy has weak jusificaion on purely economic rounds. Given he socioeconomic profile of he immirans o he UK, i is likely ha he naive populaion would be made worse off in a simple cos-benefi assessmen, due o he many advanaes ha he counry and is ciizens would be missin ou on.

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