Wednesday, 6 March 2013

Migration, Development, and Investing in Eastern Poland

Matt Yglesias has a pretty good answer prepared for the inevitable day when his psychotherapist asks why he didn’t invest in Eastern Poland – namely that conditional convergence (‘catch-up growth’) doesn’t happen within countries.
The theory he's appealing to here is "conditional convergence" and unfortunately it's dead wrong. Look around the world and you'll see that region-to-region convergence almost never happens. Mississippi is poorer than Massachusetts and has been for a long time. The same goes for Northern Italy and Southern Italy, or Scotland and England. East Germany hasn't caught up to West Germany since reunification despite massive public sector expenditure aimed at closing the gap. And the reason it doesn't happen, roughly speaking, is that people move. The economic opportunities are better in the richer part of the country and the most ambitious people from the poor part of the country move toward opportunity. They leave behind a population that's disproportionately composed of retired people, the less-ambitious segments of the native born population, and folks who've chosen to prioritize something in life other than big time professional success (bucolic country living, a strong sense of community, cheap land, whatever).
This is a good point. Northern England is a lot poorer than the South – and the problem has only been getting worse, not better, for the past 50 years. Matt provides a bunch of other similar examples, and suggests that this is because of economic migration. Cities have enormous agglomeration effects – prosperous regions are prosperous because lots of smart, hardworking people live there, which causes more people to move there in search of work, increasing the relative prosperity of those regions.

As someone who is sympathetic to the idea of open borders, I wonder about the extent to which this argument applies to immigration generally. Matt suggests that the reason why China hasn’t caught up with the UK is that ‘people can’t just pick up and move to London or New York or Tokyo.’ The flipside of this would be that, under open borders, there would be massive movement of people to very productive developed-world cities – and the convergence of China and India and Africa would suddenly stop.

I’m not sure this is true. It’s worth considering that the reasons for international income differences are different to the reasons for differences at the subnational level. One reason Eastern Poland is poor is because it’s further away from Germany, Poland’s main export market. Coastal China is the richest part of China largely because it’s, well, coastal. Lagos is poor, but Abuja is much poorer because it’s further inland in a region where road transport is unreliable and expensive.

One of the main drivers of international income differences are institutions. One of the reasons India is poorer than Poland is that India is very badly governed. Regulations enrich incumbents at the expense of everyone else. Contracts cannot be enforced because of the horribly bureaucratic legal system. Power and transportation infrastructure is bad. A lot of the government funds allocated to alleviating poverty are appropriated by corrupt officials. The rule of law is weak.

One of the main reasons India and China are getting much richer is that their institutions are improving, allowing the improvements in human capital and in technology deployment that lead to development. This is one of the reasons why China has grown faster than India has grown faster than Sub-Saharan Africa. But of course Eastern Poland is governed about as well as Western Poland. There isn’t room for Eastern Poland to develop relative to Western Poland by improving its government, because by and large they have the same government.*

The other point of course is that the income gap between China and the EU is a lot bigger than the difference between Eastern and Western Poland. And we wouldn’t be surprised if Chinese convergence to slow dramatically, or ground to a halt entirely, as Chinese per capita income gets to 70 or 80% of the level it is in the developed world.

One of the reasons for explosive Chinese growth has been in utilising technologies that it wasn’t using before. Companies eager to take advantage of cheap Chinese labour relative to the developing world have poured investment into building factories and deploying these technologies. As China develops, it no longer has the cheapest labour – but it has leapt up to the next rung on the development ladder, becoming the best in the world at producing goods like electronics. And already we are seeing China take the next step, along the path worn by South Korea and Japan before it – moving from producing to innovating. This post is brought to you by my laptop, courtesy of Lenovo. The worry is that if manufacturing moves to high productivity areas which now have quite cheap labour, then who is going to invest in bringing modern technology to developing? If there are no foreign manufacturers to attract, what incentive do local elites have to support good policies? And if this rung of the development ladder is missing then how can developing countries ever hope to reach the next one?

So would open borders halt development? Maybe. If lots of workers flocked to high-productivity areas, then wages would go down in those areas. In today’s world, companies sometimes pick the country with cheap labour and mediocre institutions over the one with expensive labour and good institutions – but in a world with open borders, they wouldn’t have to choose. And so there might not be that investment that pulls developing countries rapidly to the forefront of the 21st Century.

But on the other hand, one consequence of massive immigration is that land is going to become very expensive. We can think of this by comparing New York and Florida. Lots of companies find it beneficial to locate in New York, because there are lots of skilled workers there. Lots of skilled workers move to New York because that’s where the jobs are. This of course makes housing obscenely expensive in New York. So companies that don’t rely so much on agglomeration effects are going to move to areas where land is cheaper. And old people, who don’t benefit from being where the jobs are and don’t benefit from the trendy gastropubs, are also going to sell up and move to Florida. Another example of this happening is the exodus of British pensioners to Southern Spain, the land of sun, sea and a relatively low cost of living.

Similarly, in a scenario where there are open borders, workers are going to move to places where people are very productive. And that’s going to reduce (average) productivity in the areas they leave. But cheap land in the areas they leave is going to attract people who don’t really care about living in a very productive place. If the border between the USA and Mexico was open, lots of Mexicans would move to work in the States – but lots of American pensioners would buy beach condos in Mexico. Mexicans with low productivity, who cannot afford to live in big American cities, would be able to get jobs working for American pensioners.

This would obviously have a huge effect on politics, not least the detrimental fiscal impact – Florida would not be in great shape if the federal US government wasn’t picking up the tab for Medicare. But large capital inflows from retirees moving, as well as remittances from productive workers in big cities, will lead to higher standards of living in developing countries. And competition among developing countries for tourists and retirees, as well as the larger community of skilled expats, is likely to ensure that developing-world institutions continue to improve.

Open borders have really interesting implications for development. People think a lot about the impact of poor people moving to rich countries, but perhaps not as much as they should about rich people moving to poor countries. Under open borders, GDP per head in the developed world is likely to be much higher, while it might be somewhat lower in the developing world because productive workers will move and over time the equilibrium will entrench itself. But that doesn’t mean everyone won’t be better off as a result.

But one thing is clear. If you do invest in Eastern Poland, you probably want to build golf courses, and not factories.

*It’s a bit different under a federal system – and indeed well-governed Indian states like Gujarat are catching up faster than the poorly-governed ones. But these differences are also less likely to drive convergence in the long term.

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