The problem that I identified for the Eurozone in my previous posts is already well-documented on a smaller scale within countries - migration from rural areas to cities. And as various people have pointed out, we are also seeing it in the US and UK, which are currency unions. It's also a particularly worrying feature of the Baltic states and other Eastern European members of the European Union. In short, it's not just a problem peculiar to the Eurozone.
The theory behind free movement of labour runs as follows. Consider countries within an economic union where there are no legal barriers to the movement of people. When a country undergoes internal devaluation which causes wages to fall and increases unemployment, the result is migration of the young, able and skilled to other countries where there is more work and higher wages. We can regard this as export of labour, and the countries receiving the migrants can be said to be importing labour.
We assume that importing countries are attracting labour that they need, and exporting countries are shedding labour that they don't need. Migration of labour from low-wage to high-wage areas is an essential part of the internal devaluation process. For any given job, a worker will wish to receive a high wage, while an employer will wish to pay a low wage. The market-clearing price is somewhere between the two depending on their relative power: where there is a shortage of labour the price will be nearer to the worker's demand, while a glut of labour will enable employers to control the price. (Yes, I know this is a bit simplistic!) Clearly, therefore, the low-wage country has more labour than it needs, and the high-wage country does't have enough. If workers can move from low-wage to high-wage countries, therefore, the supply of labour increases in the high-wage country, putting downwards pressure on labour costs, and decreases in the low-wage country, putting upwards pressure on labour costs. And concurrently, when the cost of moving is lower than the benefit to be gained by relocating in a low-wage country, firms will move into that country. As the demand for labour falls in the high-wage country due to firms relocating, wages fall, and conversely as more firms relocate in low-wage country, wages rise. Eventually the two countries reach equilibrium, wages stabilise, labour stops migrating and firms stop relocating.
That's the theory. Like all theories, it assumes a lot of things. Firstly, it assumes that for both workers and firms, price is the only consideration. That isn't the case: for example, for firms, availability of natural resources may be a key consideration in deciding whether or not to relocate. And workers may be put off migrating by language barriers or family ties. Also, local regulations may discourage firms from relocating and/or workers from migrating: free movement of both capital and labour may exist in theory but not necessarily in practice.
More importantly, it assumes that the labour supply is homogenous and that there are no GENERAL shortages of skills. But this is not the case. There are general shortages of some skills - and it is always the people with scarce skills who leave first. Migration of people with skills that are generally in short supply can continue until the supply in the exporting country is completely exhausted, regardless of whether local firms need those skills: local firms are simply not going to be able to pay the wages available in the receiving country. This is because high wages usually mean a richer economy: people spend more, which generates income and profits for firms. Firms that are located in a depressed economy simply cannot match the wages paid by firms in more prosperous areas. Eventually this either forces them out of business or encourages them to move TO higher-wage areas in search of skills - exactly the opposite of the effect that forcing down wages is supposed to have on firms's behaviour.
The usual political response to the "brain drain" of people with scarce skills away from less prosperous countries is to demand that the education system delivers workers with skills that are in short supply. But this is impossible. If industry cannot recruit people with the skills it needs because of competition from richer countries, how on earth is the education system supposed to recruit teachers with those skills? In fact the drain of skilled workers away from low-wage areas affects the education system as much as industry. Teachers can migrate too.
Along with skills shortages, there may be skills gluts which can make it almost impossible for redundant workers to find jobs that use their skills. For example, when the reason for a particular area suffering a serious fall in employment is that a major industry has collapsed, there are likely to be a large number of people with skills that are no longer needed in that area. Their chances of getting equivalent work elsewhere are vanishingly small: often the only work they can hope for is unskilled, poorly-paid and highly insecure. If the costs of migrating are high, these workers may not be able to afford to move. This is what happened in the UK in the 1980s and 1990s: despite the advice from a Government minister at the time to "get on your bike", the reality was that there were few jobs anywhere within cycling distance. Skills gluts perversely increase demand for unskilled jobs, as those who are unable to find work appropriate to their skills take unskilled jobs: this forces out the genuinely unskilled, who can find it almost impossible to find ANY work. Skills gluts are largely responsible for the prevalence of unskilled people among the long-term unemployed in many countries.
The third assumption is that the labour supply remains constant - in other words, that as fast as people migrate, other people replace them. Now, in countries with a birth rate at or above replacement level, this is true. But if the country that is losing its young and skilled ALSO has a falling birth rate, it is in serious trouble. As the young and skilled leave and are not replaced, the age profile of the population increases, the proportion of sick and disabled increases and the proportion of unskilled to skilled increases. This amounts to a form of hysteresis. The attractiveness of the remaining labour force to firms declines as both skills and productivity fall: consequently firms are less likely to relocate to the country, which removes the brake on migration that relocation of firms would be expected to create (assuming of course that if jobs are available and wages equivalent, people will prefer to stay put). Migration would therefore continue until the only people left are those who either can't or won't leave. This problem is more immediate in those countries like Portugal that have had a falling birth rate for some years: but even if a country doesn't have a falling birth rate at the time that the young start to leave, by the time the migration has continued for a few years it will have.
Someone suggested that the loss of the young & skilled would be offset by immigration, so the population profile wouldn't change that much and firms would still relocate. I find this bizarre. Why would skilled immigrants come to a country from which people with the same skills were leaving? Surely they, too, would go to the higher-wage countries?
The problem of internal devaluation where there are skills shortages, skills gluts, labour market rigidities and a falling birth rate looks insoluble. But I don't think it is. I'd turn this round and look at it another way. I recently wrote an article comparing free workers with slaves, in which I noted that slaves are capital assets - firms have to pay for them upfront - whereas cheap, unskilled and insecure labour incurs no capital cost so can be a much cheaper alternative to a slave, and this is not necessarily beneficial to the free worker......in Roman times, people used to sell themselves into slavery, if the alternative was starvation. The migration problem within economic unions is actually a variation of the same thing, but it is perhaps more immediately comprehensible to view it as a balance of trade problem.
I noted above that the country from which people are migrating can be regarded as exporting labour, while the country receiving the migrants is importing labour. And the receiving country unquestionably benefits. Immigrants plug skills gaps, benefiting its industries: immigrants spend their wages, benefiting economic activity: immigrants pay tax, benefiting public finances. Now, if the migrants were unemployed in their country of origin, then in the short term their departure is also beneficial to the fiscal finances in the exporting country. But skilled migrants leaving in search of higher wages may not be unemployed in their country of origin, and the gaps they leave may be hard to fill: and over time, migration of the young - even unemployed ones - creates a demographic problem for the exporting country. On balance, I would say that the importing country generally does better out of the people trade than the exporting one does. Considerably better. In fact, if the export of people means that the exporting country goes into terminal decline due to loss of the young & skilled and hysteresis in the remaining population, then I would regard the trade in people as zero-sum. The importing country benefits at the expense of the exporting one.
Which invites the question - why is this export free? After all, imports usually have to be paid for. Exporting countries receive inflows of money in payment for the goods and services they provide - unless the export is people. Well, not quite though - if we export footballers, we get paid for them. And in days gone by, the trade in people could be extremely lucrative (though it's fair to say it probably benefited the intermediaries most). But we've abolished slavery now.....
And I'm certainly not advocating bringing back slavery! But there is a strong argument to my mind that countries that export labour as part of an internal devaluation programme within an economic union should receive payment from the importing countries. The labour they export for nothing contributes to the GDP and the tax revenue of the importing countries. It seems only right and proper that they should share in that benefit.
Now, before anyone suggests this is not a "real" trade imbalance, let me remind you that the cost of supporting an ageing and poorly skilled population when GDP is falling means increasing levels of public debt....just as would be the case if this were a real trade imbalance. The loss of productive labour is disastrous for the fiscal finances.
To my mind the normal riposte to this - that migrant workers will of course send money back to their families - is inadequate. Migrants make those payments out of taxed income: the exporting country does not share in that tax payment. And as I've noted previously, if migrants believe that the state will support the old and frail, they may not send much back at all. Voluntary remittance is no substitute for a system of payments to compensate exporting countries for the loss of productive labour. Or, if you like, to reverse the implicit fiscal transfers from low-wage countries to high-wage ones that are the inevitable consequence of economic migration.
Of course, our rich young migrants might send money back to their countries of origin - to buy themselves retirement homes for their old age. I suppose this would stimulate the construction industry and increase house prices. I'm not entirely clear in what way raising house prices for an impoverished population is supposed to stimulate the economy. It is more likely, surely. to make it even harder for these people to afford basic necessities such as a roof over their heads. Nor is it reasonable to assume, as some have, that the inexorable march of technology will somehow make an ageing and increasingly unproductive workforce more affordable for states that are already highly indebted and whose GDP is falling. On the contrary, it seems more likely that technological improvements - which require capital investment that these countries are unlikely to be able to afford - will simply pass them by.
So where does this leave us? Most currency unions have some kind of system of fiscal transfers, though these are usually flawed and inadequate, not least because the importing countries/states/cities resent sending money back to exporters. But the European Union is not a currency union. Yet it still needs somehow to staunch the flow of people from countries such as the Baltic states if they are to avoid going into a death spiral.
There are, of course, real issues here concerning the rights of the individual. It would be very easy to suggest that where there is no fiscal union, states should be free to prevent people leaving if they so wish. But this could result in a Kafkaesque nightmare, where people that aren't needed in the workforce can leave but others can't.....Though I find myself asking why states should be free to prevent certain people coming IN if they so please, but not free to prevent certain people LEAVING? To its credit, the European Union - in theory at least - does not allow member states to prevent people coming in, either. But this doesn't help the states that are slowly bleeding to death.
I am forced to the conclusion that free movement of people within any economic union requires a commitment from all members of that union to ensure economic prosperity for all the people within the union, even if that means giving up cherished ideas of fiscal independence. Fiscal transfers to countries that are suffering the consequences of large-scale emigration are not "aid" or "bailouts". They are simply a recognition by more prosperous states that their prosperity is not entirely due to their own efforts. It is simply not acceptable for some states within a union to obtain competitive advantage by bleeding other states of productive capital and labour. For what kind of "economic union" is it if the prosperity of some is bought at the expense of the impoverishment of others?
The creeping desert - Coppola Comment
The movement of people (and its consequences) - Coppola Comment
Increasing returns and economic geography - Paul Krugman
Memo to Paul Krugman on the Eurozone: read your own research! - Nathan Tankus (Naked Capitalism)
Ubi solitudinem faciunt, pacem appellant - Jonathan Portes (NIESR)
The shortage of Bulgarians inside Bulgaria - Edward Hugh (Economonitor)
The financialisation of labour - Frances Coppola (Pieria)
From huddled masses to property investors - From Arse to Elbow