The Economics of Immigration: A Story of Substitutes and Complements

America is a nation of immigrants. Currently, immigrants make up about 13 percent of the overall population, which means about 40 million people living in the United States are foreign born.¹ Indeed, nearly all Americans have an immigration story in their family history. Yet, despite their history and a culture of immigration, Americans have mixed feelings about whether the country should keep its welcome mat out on the doorstep. A 2014 Gallup poll reports 72 percent of Americans believe immigration is a good thing, but 36 percent would like to see the level of immigration decrease.² Economists, who focus on economic costs and benefits, are generally more supportive of immigration than the general public.

The Economics of Immigration

In many ways, the arguments about the economics of immigration are similar to those about the economics of international trade. Economists typically reason that voluntary trade is mutually beneficial—if it were not, the trade partners would not pursue trade. Economists therefore generally support free and open trade of goods and services across national borders. In a similar way, economists think of immigration as mutually beneficial “trade” between immigrants and their employers. And as with trade, both the immigrant workers and their employers generally benefit. Not surprisingly, economists generally support free and open immigration.

Immigration increases labor resources, which increase the productive capacity of the economy. Currently, foreign-born workers make up 16.3 percent of the labor force (see the chart). Stated differently, the increase in labor resources increases the economy's ability to produce goods and services. But how does immigration affect the average American? Once the costs and benefits are weighed, economists estimate the annual economic gains to the native-born population to be between 0.1 and 0.3 percent of gross domestic product³, which might not seem like a sizable gain but is significant when extended over a lifetime. Some of these benefits take the form of lower labor costs for employers, lower prices for consumers, and increased employment opportunities for some workers. However, while the economy in general might be better off, there are negative externalities, or cases in which third parties are negatively affected. In the case of immigration, the concerns about negative effects are usually expressed by native-born workers and taxpayers. These concerns are explained below.

Immigrant Workers: Substitutes or Complements?

One of the most important distinctions between workers is their skill level: Some workers are more skilled than others. This is true of both native-born and immigrant workers. But in addition to having skills that differentiate immigrant workers from each other, the skills of immigrant workers also differ from those of the native-born labor force. Immigrant workers are overrepresented at the extremes of the skills spectrum—there are many at the low-skilled end of the spectrum and many at the high-skilled end. On the low-skilled end, 27 percent of foreign-born workers in 2013 had less than a high school diploma compared with 7 percent of the native-born population.⁴ At the high-skilled end, about 40 percent of U.S. PhDs and engineers are foreign born.⁵

Immigrant workers can either be substitutes for native-born workers or complements to them. When immigrant workers are substitutes for native-born workers, they compete for similar jobs. Using a simple supply and demand model, an influx of substitutable workers constitutes an increase in the supply of labor, causing wages to fall for workers with similar skills. Because many immigrants are low-skilled workers, economic studies have found that an influx of immigrants depresses wages for low-skilled native-born workers in the short run.6 And, because many immigrants are also high-skilled, a similar substitution effect occurs for some high-skilled workers.

However, when workers are complementary, an increase in immigrant labor can increase job opportunities and wages for native-born workers. So, the low-skilled immigrant labor reduces the cost of production and increases the output of those goods; this greater output increases the demand for other, higher-skilled workers. For example, consider that immigrant workers account for 22 percent of the construction workforce. They tend to pursue jobs in the construction industry that require less training and education but are areas where the industry has its largest labor shortages—such as painters, drywall installers, and construction laborers.⁷ This supply of immigrant labor has decreased the cost and presumably increased the number of homes produced and sold over time. The increase in housing construction has increased the demand for higher-skilled construction workers such as contractors, electricians, and plumbers and increased the demand for manufactured goods such as air conditioners and appliances. In some cases, immigrant labor has complemented native-born laborers by allowing them to move into the labor force. For example, immigration has provided families with access to low-cost child care. This has allowed more native-born women to enter the workforce.⁸

In the modern economy, high-skilled immigrants complement high-skilled native-born workers by filling positions in the fast-growing science, technology, engineering, and math (STEM) fields; they make up about 45 percent of medical scientists and 37 percent of computer programmers.⁹ These workers fill positions in areas where native-born labor is relatively scarce and positions that are often complementary to other STEM jobs. For example, Bill Gates has stated in congressional testimony that Microsoft hires four additional employees to support each high-skilled worker hired on a temporary work (H-1B) visa.¹⁰ In addition, high-skilled immigrants appear to be more innovative than their native-born counterparts, which can boost productivity and economic growth over time. Highly educated immigrants receive patents at twice the rate of highly educated native-born workers. Immigrants also tend to be more entrepreneurial; research indicates they are about 30 percent more likely to start a business than non-immigrants.¹¹ In fact, immigrants founded 25 percent of the U.S. high-tech startups between 1995 and 2005.¹²

The Effects of Immigrant Workers on the U.S. Federal Budget

Low-skilled and high-skilled immigrants also differ in how they influence the U.S. federal budget. The United States has a progressive income tax, which means that those with higher incomes pay a greater percentage of their incomes in taxes. Low-skilled workers typically earn low wages and as such do not pay much in taxes, but they benefit from taxpayer-supported education services, medical services, income subsidies, and other means-tested (asset- or income-dependent) benefit programs. This results in low-skilled (low-income) immigrant workers creating a net fiscal drain. Such programs function as a taxpayer subsidy to firms that hire low-skilled workers and their customers. The firms, their customers (through lower prices), and the immigrants are better off, while taxpayers bear the cost of providing the benefit programs. High-skilled immigrant workers are likely to earn higher incomes—and therefore pay higher income taxes—and qualify for fewer means-tested benefits. As a result, high-skilled immigrants are more likely to generate a fiscal surplus. Their situation is not unlike that of their native-born counterparts with comparable skills.

What About Illegal Immigration?

In 2010, slightly more than 1 million immigrants were admitted to the United States legally, and the net inflow of illegal immigrants was at least 500,000.¹³ Economists who study immigration often do not differentiate between legal and illegal immigrants. However, noneconomists draw a sharp distinction between these two groups: Most are supportive of legal immigrants but very critical of illegal immigrants. The 2014 Gallup poll mentioned earlier also reported 88 percent of Americans worry at least a little about illegal immigration, and 93 percent report that controlling the U.S. borders to halt the flow of illegal immigrants into the country is at least moderately important.¹⁴ Despite these perceptions, recent research suggests that policies that reduce immigration (legal and illegal) will also reduce job creation and the benefits that would have accrued to native-born workers. This research argues that a policy of deportation would have a negative effect on the employment opportunities of native-born workers, whereas a policy of legalization would increase job opportunities.¹⁵

Conclusion

Immigration creates economic winners and losers. Winners include (i) employers who benefit from lower labor costs, (ii) consumers who benefit from lower prices for goods and services, and (iii) complementary workers who benefit from increased job opportunities and higher wages. The losers are (i) substitutable workers who compete for the same jobs as immigrant workers (in both low-skilled and high-skilled professions) and earn depressed wages as a result and (ii) taxpayers who pay higher taxes to support means-tested benefit programs. There are many noneconomic factors involved in the issue of immigration; but, in terms of simply weighing the economic costs and benefits of admitting additional workers, immigration is a net benefit.