Global 34320 Public Disclosure Authorized Economic ProspectsProspects Public Disclosure Authorized Public Disclosure Authorized
Public Disclosure Authorized EconomicEconomic Implications Implications ofof RemittancesRemittances andand MigrationMigration 2006
Global Economic Prospects
Economic Implications of Remittances and Migration
2006 © 2006 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: [email protected]
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ISBN: 08213-6344-1 E-ISBN: 0-8213-6345-X 13-digit E-ISBN: 978-0-8213-6345-4 DOI: 10.1596/978-0-8213-6344-7 EAN: 978-0-8213-6344-7
ISSN: 1014-8906
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Cover design: Naylor Design Cover photo: Panos Contents
Foreword vii Acknowledgments ix Overview xi Abbreviations xvii Chapter 1 Prospects for the Global Economy 1 Global growth 3 Long-term prospects and poverty forecast 8 International finance 10 Commodity markets 14 World trade 16 Risks and uncertainties 18 Notes 22 References 23 Chapter 2 The Potential Gains from International Migration 25 International migration trends 26 The demographic challenge 29 Migration and its development impact 31 Returns to households 34 Returns to factors of production 41 Caveats—what the model leaves out 48 Notes 51 References 53 Chapter 3 The Policy Challenges of Migration: The Origin Countries’ Perspective 57 The migration decision and its impact on migrants and their families 59 Low-skilled migration 64 High-skilled emigration 66 Diasporas 70 The return of expatriates can benefit development 70 Temporary migration and international agreements 72 Notes 76 References 78
iii CONTENTS
Chapter 4 Trends, Determinants, and Macroeconomic Effects of Remittances 85 Remittance data and trends 86 Factors affecting remittance flows 92 Macroeconomic effects of remittances 99 Annex 4A.1 World Bank data on remittances 105 Annex 4A.2 A model-based estimation of informal remittance flows 108 Notes 110 References 112
Chapter 5 Remittances, Households, and Poverty 117 Remittances, poverty, and inequality 118 Remittances and household consumption smoothing 122 Remittances and indirect effects on household income 123 Remittances, savings, and investment 125 Annex 5A.1 Poverty simulation model: description and results 127 Notes 129 References 131
Chapter 6 Reducing Remittance Fees 135 Remittance fees and costs 136 Factors underpinning high remittance fees 144 Policies to reduce remittance costs 147 Remittances and financial institutions 149 Annex 6A.1 A stylized remittance transaction—structure, players, instruments 151 Annex 6A.2 Licensing and registration requirements for remittance service providers 152 Annex 6A.3 A brief history of some remittance service providers 153 Notes 154 References 156
Figures 1.1 Industrial production 3 1.2 A sharp slowdown 5 1.3 Regional growth 6 1.4 Dollar-euro interest rate differentials 10 1.5 Financing of the U.S. current account deficit 11 1.6 Emerging market spreads 11 1.7 Real long-term interest rates in G-7 countries 12 1.8 World savings rate 12 1.9 Inflation rates 13 1.10 Cumulative real increase in housing prices, 2005 14 1.11 Commodity prices 14 1.12 Levels of spare oil capacity 15 1.13 World trade volumes 16 1.14 Change in textile exports to the developed world, first half of 2005 17 1.15 Estimated change in textile exports as share of total merchandise exports 18 1.16 Some countries are particularly at risk 20 2.1 International migrants as a share of destination countries’ population 27 iv CONTENTS
2.2 Share of females in international migration 28 2.3 Immigration to selected countries, reasons for admittance, 2001 28 2.4 Labor force and dependency rates 30 2.5 Factor returns and migration 42 2.6 Source of gains for native workers 45 2.7 Factor returns and migration in high-income countries, 2005 46 3.1 Median wage levels for workers in the same occupation, relative to high-income economies, 1988–92 59 3.2 Major developing country diasporas in developed countries 62 3.3 Estimates of stock of irregular migration 62 3.4 Emigration rates for low-skilled workers 64 3.5 Emigration rates for those with a tertiary education, 2000 67 3.6 Number of temporary workers admitted under skill-based programs 72 4.1 Top 20 remittance-recipient countries, 2004 90 4.2 Estimated remittance payment, by country group, 2004 91 4.3 Remittances as percent of private consumption, two years before and two years after natural disasters 100 4.4 Remittances as a share of personal consumption, two years before and two years after conflict 100 4.5 Remittances as a share of personal consumption, two years before and two years after financial crises 101 4.6 Indebtedness classification including and excluding remittances, 2003 101 4.7 Remittance securitization structure 102 4.8 Securitization of remittances, 1994–2004 103 5.1 Sri Lankan migration 122 6.1 Remittance costs are high and regressive 138 6.2 Remittance fees in the United States–Mexico corridor 138 6.3 Fees and foreign exchange spreads for $200 in Western Union transfers from New York City 144 6.4 Exclusive arrangements with post offices skew competition 145 6.5 Barriers perceived by remittance service providers 146
Tables 1.1 The global outlook in summary 4 1.2 Long-term prospects 8 1.3 Regional breakdown of poverty in developing countries 9 1.4 Terms-of-trade impacts of commodity price changes 16 1.5 Impact of a 2 million bpd negative supply shock 19 1.6 Interest rate scenarios 20 2.1 Growth in international migration by destination, 1970–2000 27 2.2 Labor force structure in the base case and after increases in migrants 33 2.3 Change in real income across households in 2025 relative to baseline 34 2.4 Real income impacts across developing regions 38 2.5 Impact of different assumptions on the consumption of public goods and services by selected groups in 2025 39 3.1 Fees charged by recruitment agencies 60 3.2 Emigration rates of skilled workers, 2000 68 4.1 Workers’ remittances to developing countries, 1990–2005 88
v CONTENTS
4.2 Recorded remittances have grown faster than private capital flows and ODA 88 4.3 Choice of remittance channel in selected countries 91 4.4 Estimated increase in formal remittances if transaction costs were reduced to 2 to 5 percent and dual exchange rates were eliminated 92 4.5 Impact of remittances on country credit rating and sovereign spread 102 4A.1.1 Countries with alternative estimates in 2004 106 4A.2.1 Regression results: determinants of worker remittances 109 4A.2.2 Regression results: determinants of transaction costs 109 4A.2.3 Panel regression results: determinants of remittances 110 5.1 Simulated impact of eliminating remittances on poverty rate 120 5A.1 Effect of removing remittances on the poverty headcount rate 128 6.1 Approximate cost of remitting $200 137 6.2 Operating profits of major MTOs 140 6.3 Estimating the cost of a remittance transaction 140 6.4 Remittances are more cost-elastic when costs are higher 143 6.5 Policies to reduce costs, regulate informal providers, and provide remittance-linked financial services 148
Boxes 2.1 The model used in this study 32 2.2 Calculating and interpreting global welfare gains from migration 36 2.3 The impact of immigrants on fiscal balances 40 2.4 Empirical studies of the impact of immigration on wages 43 2.5 Increased migration and its impact on wages 47 3.1 Internal versus international migration 65 3.2 Mode 4 and international migration 75 4.1 International working group on improving data on remittances 87 4.2 The recent surge in remittance flows to India 89 4.3 Collective remittances through hometown associations and matching schemes 95 4.4 Forced remittances 97 4.5 Unlike oil windfalls, remittance inflows do not weaken institutional capacity 105 5.1 Estimating a cross-country poverty change model 119 6.1 Decline in remittance costs in the United States–Mexico corridor 139 6.2 Estimating remittance industry costs 141 6.3 Even charitable donations are sensitive to cost 142 6.4 United States–Mexico FedACH 148 6.5 The World Bank/CPSS task force on general principles for international remittance systems 149 6.6 Smart’s phone-based remittance system in the Philippines 150
vi Foreword
or millennia people have migrated in The World Bank’s research department, in search of economic opportunity. In the partnership with others, has launched a pro- F nineteenth and early twentieth centuries, gram to expand knowledge in an area that de- technological advances and untapped natural serves greater attention. The program ad- resources drove movements of population from dresses the issues surrounding remittances; Europe and Asia to the Americas. International migration of high-skilled workers; the deter- migration generated enormous improvements minants of migration; temporary movements in people’s lives. Immigrants enjoyed higher of persons; social protection and governance; wages, countries of destination profited from and the links among trade, foreign direct in- increased supply of labor, and countries of ori- vestment, and migration. gin saw labor market pressures ease. An integral part of this program, Global Current trends indicate that pressures for Economic Prospects 2006 focuses on policies migration from the south to the north are set to improve the developmental impact of remit- to rise again. This movement is driven largely tances. It documents the high level of transac- by income gaps and the rising number of tions costs facing migrants sending small re- young adults in developing countries seeking mittances to their families, and it outlines the better opportunities abroad. The economic, regulatory issues and market imperfections social, and political implications that come that keep costs high. with the movement of people differ from the Fewer barriers to remittance flows and movement of goods or money. As a result, the greater competition among remittance service topic of international migration has prompted providers could substantially reduce costs and much political debate in the international boost remittance flows to developing coun- community today. tries. Global Economic Prospects 2006 shows The prospects for migration flows are crit- how sound domestic policies and an invest- ical for development. Developing countries ment-friendly climate can significantly increase benefit through the money that migrants send the contribution of remittances and migration home to their families (remittances), through to improved living conditions back home. reduced labor market pressures, and through Migration remains an important force for contacts with international markets and ac- fighting poverty, the key mission of the World cess to technology. Bank, and it is our hope that this report will But migration is not always beneficial. Mi- contribute to this important debate. grants can be subject to exploitation and Paul Wolfowitz abuse, and the loss of highly skilled personnel President through migration has hindered development World Bank in some countries. November 2005
vii
Acknowledgments
HIS REPORT WAS prepared by the Development Prospects Group (DECPG). The lead authors of this report were Dilip Ratha and William Shaw, with direction by Uri Dadush. The Tprincipal authors of the chapters were Andrew Burns (chapter 1), Dominique van der Mensbrugghe (chapter 2), William Shaw (chapter 3), and Dilip Ratha (chapters 4, 5, and 6). The report was prepared under the general guidance of François Bourguignon, chief economist and senior vice president of the World Bank. The main macroeconomic forecasts in chapter 1 were prepared by the Global Trends Team of DECPG led by Hans Timmer and including John Baffes, Andrew Burns, Maurizio Bussolo, Annette de Kleine, Betty Dow, Himmat Kalsi, Fernando Martel Garcia, Donald Mitchell, Gauresh Shailesh Rajadhyaksha, Mick Riordan, Cristina Savescu, Shane Streifel, and Shuo Tan. The out- look for the East Asia and Pacific region was carried out with the cooperation of Milan Brahmb- hatt and Louis Kuijs. The team also benefitted from in-depth consultations and comments from the regional chief economists and their staff, as well as country economists. The long-term growth and poverty forecasts were prepared by Dominique van der Mensbrugghe, Shaohua Chen, and Martin Ravallion. The companion Prospects for the Global Economy web site was prepared by Andrew Burns, Sarah Crow, and Cristina Savescu, in collaboration with Reza Farivari, Saurabh Gupta, David Hobbs, Shahin Outadi, Raja Reddy Komati Reddy, Malarvizhi Veerappan, and Cherin Verghese. Maddalena Honorati and Prabal De provided research assistance. Chapter 2 benefitted from collaboration with Hans Timmer and from comments received from seminar participants, no- tably Lindsay Lowell and Susan Martin. Special thanks are due for the background material provided by Riccardo Faini, Robert Lucas, Julia Nielson, Kathleen Newland, and Irena Omela- niuk for chapter 3; Swaminathan S. Aiyar, Ralph Chami, Neil Fantom, Caroline Freund, Gary McMahon, Irena Omelaniuk, Serdar Sayan, Nikola Spatafora, and K. M. Vijayalakshmi for chapter 4; John McHale for chapter 5; John Gibson, David McKenzie, George Kalan, Dilek Aykut, Nikos Passas, and Jan Riedberg for chapter 6. Ole Andreassen, Jose de Luna Martinez, Raul E. Hernandez-Coss, Massimo Cirasino, and Roger Ballard also contributed background notes for chapter 6. Thanks also to colleagues in the International Organization for Migration who helped collect information on remittance-related government policies (for chapter 4) using their extensive international network, and Bernd Balkenhol of the International Labour Organi- zation for preparing a background paper on forced remittances.
ix ACKNOWLEDGMENTS
Many colleagues provided excellent comments at various stages of the report’s preparation. L. Alan Winters provided comments on the report and guidance throughout its preparation. Luca Barbone, Kevin Barnes, Augusto de la Torre, Shantayanan Devarajan, Mustapha Nabli, John Page, Bryan Roberts, John Whalley, and Dean Yang were peer reviewers at the Bankwide review. Richard Adams, William Easterly, Isaku Endo, Jose Maria Fanelli, Shahrokh Fardoust, Ian Goldin, Daria Goldstein, Yevgeny Kuznetsov, Ali Mansoor, Phil Martin, Maria Soledad Martinez Peria, Fernando Montes-Negret, Nayantara Mukerji, Latifah Osman Merican, Christopher Par- sons, Guillermo Perry, Sonia Plaza, S. Ramachandran, and Terrie Walmsley also provided useful comments. Johan Mistiaen and Romeo Matsas provided excellent help in designing and imple- menting a survey of migrant remitters from Congo, Nigeria, and Senegal residing in Belgium. Maria Amparo Gamboa, Araceli Jimeno, Katherine Rollins, Sarah Crow, and Michael Paul pro- vided invaluable administrative support, including the collection of remittance fee data from all over the world. The report team held consultations in July 2005 in Accra, Brussels, Geneva, London, and Paris. Thanks are due to Haleh Bridi, Barbara Genevaz, Carlos Braga, Sonia Plaza, Michelle Bailly, and other colleagues in these country offices for efficiently and enthusiastically arranging consultations with several international, academic, financial, and non-governmental institutions. Thanks are also due to the International Organization for Migration for assistance with organiz- ing consultations in Geneva and to the International Labour Organization, the Global Commis- sion on International Migration, the European Commission, and the Commonwealth Secretariat for participating in consultations and providing useful feedback. This report also benefitted from the comments of the Bank’s executive directors made at an informal board meeting on October 20, 2005. Marilou Uy, Alan Gelb, Jeff Lewis, Amar Bhattacharya, Shaida Badiee, Robert Keppler, and Misha Belkindas provided guidance and encouragement to the team at various stages. Dorota A. Nowak managed production and dissemination activities by DECPG. Steven Kennedy’s contri- bution as an editor is gratefully acknowledged. Book design, editing, and production were coor- dinated by the World Bank Office of the Publisher.
x Overview
HE THEMES OF this year’s Global Eco- This publication has two goals. The first is nomic Prospects are international re- to explore the gains and losses from interna- T mittances and migration, their eco- tional migration from the perspective of devel- nomic consequences, and how policies can oping countries, with special attention to the increase their role in reducing poverty. Interna- money that migrants send home. The second tional migration can generate substantial wel- goal is to consider policy initiatives that could fare gains for migrants and their families and improve the developmental impact of migra- for the countries involved (countries of origin tion, again with particular attention to remit- and destination). The money that migrants tances. Our focus (for economic purposes) is send home—remittances—is an important on international migration from developing source of extra income for migrants’ families countries to high-income countries. Despite and for developing countries: in aggregate, re- their importance, internal migration, migra- mittances are more than twice as the size of in- tion among developing countries, and the po- ternational aid flows. However, migration litical and social impacts of migration are should not be viewed as a substitute for eco- beyond the scope of this work. nomic development in the origin country— It is important to keep in mind three basic development ultimately depends on sound principles. First, migration is a diverse phe- domestic economic policies. nomenon, and its economic impact in one Over the past two decades, barriers to location or another depends heavily on the par- cross-border trade and financial transactions ticular circumstances involved. Second, basic have fallen significantly, while barriers to the data on migration and remittances are lacking, cross-border movement of people remain so predicting the impact of policy changes can high. Despite its economic benefits, migration be problematic. This underlines the need for remains controversial and, for some people, better data and more research. Third, migra- threatening. In part, this is because migration, tion has social and political implications that like trade and capital movements, has distrib- may be just as important as the economic utional consequences, whereby net gains for analysis provided here. These are ably and society may mask important losses for some comprehensively discussed in the recent report individuals and groups. But migration also of the United Nations’ Global Commission on sparks resistance because the movement of International Migration. For all of these rea- people has economic, psychological, social, sons, the analysis and policy recommendations and political implications that the movement for migration must remain qualified. This of goods or money do not. report draws conclusions where they can be
xi OVERVIEW
supported by adequate data and points to an The impact of remittances agenda for research where they cannot. and migration The impact on migrants Global economic prospects The bulk of the economic gains from migra- he slowdown among industrial economies tion accrue to migrants and their families, and T that began in the second half of 2004 con- these gains are often large. Wage levels (ad- tinued in 2005, with GDP growth expected to justed for purchasing power) in high-income come in at 2.5 percent, down from 3.1 percent countries are approximately five times those of the year before. The pace of the expansion in low-income countries for similar occupations, the high-income countries is forecast to in- generating an enormous incentive to emigrate. crease slightly over the next two years, with ac- Moreover, to the extent that migrants devote celeration in Europe offsetting a modest slow- a portion of their income to remittances, the ing in Japan and stable growth in the United gains are even greater. Essentially migrants can States. Economic activity also slowed in devel- earn salaries that reflect industrial-country oping economies during 2005. Higher oil prices and spend the money in developing prices, domestic capacity constraints, and countries, where the prices of nontraded goods slower demand for their exports brought GDP are much lower. Migrants, however, incur sub- growth down from a very strong 6.8 percent in stantial costs, including psychological costs, 2004 to an estimated 5.9 percent this year. and immigrants (particularly irregular mi- While GDP growth has remained robust, grants) sometimes run high risks; many suffer higher oil prices have sharply slowed real in- from exploitation and abuse. The decision to come growth among oil importers from 6.4 to migrate is often made with inaccurate infor- 3.7 percent. Looking forward, continued high mation. Given the high costs of migration— oil prices, coupled with inflationary pressures, including the risks of exploitation and the ex- are expected to restrain growth in most devel- orbitant fees paid to traffickers—the net oping countries over the next two years. Nev- benefit in some cases may be low or even neg- ertheless, GDP in these economies should ative. There are costs, too, for family members expand by around 5.5 percent—much more left behind—particularly children—although quickly than during the past two decades. these costs must be balanced against the bene- This relatively positive outlook is subject to fits of the extra income that migrants send important downside risks. The outlook for oil back home to their families. prices is particularly uncertain. Low excess ca- pacity has introduced a risk premium into oil The impact on destination countries prices and will make it more difficult to con- Destination countries can enjoy significant eco- tain the impact of a future supply shock, nomic gains from migration. The increased should one arise. As a result, a significant sup- availability of labor boosts returns to capital ply disruption could slow global growth, with and reduces the cost of production. A model- large negative consequences for global eco- based simulation performed for this study indi- nomic prospects. The future path of interest cates that a rise in migration from developing rates, which despite recent increases are still countries sufficient to raise the labor force of low, is another source of uncertainty. Persis- high-income countries by 3 percent could boost tent global imbalances, signs of rising infla- incomes of natives in high-income countries by tion, and concerns about the sustainability of 0.4 percent. In addition, high-income countries government finances in industrialized coun- may benefit from increased labor-market flexi- tries are all factors that could push rates bility, an increased labor force due to lower higher and possibly provoke a much more se- prices for services such as child care, and per- rious slowdown. haps economies of scale and increased diversity. xii OVERVIEW
Nevertheless, there are losers within destina- remittances at all, even those sent through for- tion countries. Some workers may see an ero- mal channels, or they report remittances under sion of wages or employment, although this ef- other balance of payments entries. fect is found to be small in most empirical Despite the prominence given to remit- studies. In the model-based simulation of the tances from developed countries, South-South impact of increased migration, earlier migrants remittance flows make up between 30 and 45 suffer significant income losses, while the im- percent of total remittances received by devel- pact on natives’ wages is small. (The differential oping countries, reflecting the fact that over impact is reduced if foreign-born workers are half of migrants from developing countries viewed as closer substitutes for natives.) Easing migrate to other developing countries. rules that limit labor-market flexibility, and While the impact of remittances on growth strengthening institutions that provide educa- is unclear, remittances do play an important tion and training, will help workers displaced role in reducing the incidence and severity of by immigration (both natives and resident mi- poverty (with no significant effect on income grants) to find work. Note that the simulation inequality). Remittances directly increase the results are not intended to incorporate all of the income of the recipient and can help smooth economic impacts of migration, nor do they household consumption, especially in response capture important social and political implica- to adverse events, such as crop failure or a tions. The goal is not to forecast the overall im- health crisis. In addition to bringing the direct pact of increased migration, but rather to give benefit of higher wages earned abroad, migra- us insights into the economic gains that might tion helps households diversify their sources of be expected from changes in policy or circum- income (and thus reduce their vulnerability to stances, as well as insights into the channels risks) while providing a much needed source of through which migration affects welfare. savings and capital for investment. Remit- tances appear to be associated with increased The impact on origin countries household investments in education, entrepre- Migration also generates economic benefits for neurship, and health—all of which have a high origin countries, the largest being remittances. social return in most circumstances. International remittances received by develop- Measuring the poverty impact of remit- ing countries—expected to reach $167 billion tances is difficult: data are scarce, and calcu- in 2005—have doubled in the past five years as lating the income gains from remittances re- a result of (a) the increased scrutiny of flows quires assumptions concerning what migrants since the terrorist attacks of September 2001, would have earned if they had stayed at home. (b) changes in the industry that support remit- Careful analyses of the available household tances (lower costs, expanding networks), (c) survey data indicate that remittances have improvements in data recording, (d) the depre- been associated with declines in the poverty ciation of the dollar (which raises the dollar headcount ratio in several low-income value of remittances denominated in other cur- countries—by 11 percentage points in rencies), and (e) growth in the migrant stock Uganda, 6 in Bangladesh, and 5 in Ghana, for and incomes. However, records still underesti- example. In Guatemala, remittances may have mate the full scale of remittances, because pay- reduced the severity of poverty by 20 percent. ments made through informal, unrecorded Cross-country regressions and simulations channels are not captured. Econometric analy- also indicate that increases in remittances help sis and available household surveys suggest that to reduce the incidence of poverty. unrecorded flows through informal channels By generating a steady stream of foreign may conservatively add 50 percent (or more) of exchange earnings, remittances can improve a recorded flows. Several countries with signifi- country's creditworthiness for external bor- cant migrant populations do not report data on rowing and, through innovative financing
xiii OVERVIEW
mechanisms (such as securitization of remit- ties, such as education and health (particularly tance flows), they can expand access to capital for the control of transmissible diseases), may and lower borrowing costs. While large and be impaired; (c) opportunities to achieve sustained remittance inflows can contribute to economies of scale in skill-intensive activities currency appreciation, this outcome may be may be reduced; (d) society loses its return on less severe than it is in the case of natural re- high-skilled workers trained at public ex- source earnings, because remittances are dis- pense; and (e) the price of technical services tributed more widely and may avoid exacer- may rise. Highly educated citizens, if they bating strains on institutional capacity that are stayed in their countries, could help to im- often associated with natural resource booms. prove governance, improve the quality of de- Migration has economic implications for ori- bate on public issues, encourage education of gin countries beyond remittances. The small size children, and strengthen the administrative of migration flows relative to the labor force sug- capacity of the state—contributions that gests that the effects of South–North migration would be lost through high-skilled emigration. on working conditions for low-skilled workers It is impossible to reliably estimate the net in the developing world as a whole must be small benefit, or cost, to origin countries of high- as well. However, in some countries low-skilled skilled emigration because data are limited emigration can raise demand for the remaining and a myriad of individual country circum- low-skilled workers (including poor workers) at stances enter into the calculus of that benefit the margin, leading to some combination of or loss. We can only offer two rough observa- higher wages, lower unemployment, less under- tions, which reflect the wide variation in high- employment, and greater labor force participa- skilled emigration rates among countries: tion. Thus low-skilled emigration can offer a valuable safety valve for insufficient employ- • Very high rates of high-skilled emigra- ment at home. In the long run, however, devel- tion are found in countries that represent oping country policies should aim to generate a small share of the population of the de- adequate employment and rapid growth, rather veloping world. Many of those countries than relying on migration as an alternative to de- have poor investment climates that likely velopment opportunities. limit the productive employment of high- High-skilled emigration has more complex skilled workers. Of course, the loss of implications. Like low-skilled migration, it high-skilled workers may aggravate the can greatly benefit migrants and their families poor investment climate and limit the and help relieve labor market pressures. How- potential benefits of economic reform. ever, a well-educated diaspora can improve ac- • Some countries find it difficult to pro- cess to capital, technology, information, for- vide productive employment for many eign exchange, and business contacts for firms high-skilled workers because of their in the country of origin. The return of expa- small economic scale or because mis- triates and the maintenance of close contacts guided educational policies have resulted with high-skilled emigrants have played an in a large supply of university graduates important role in the transfer of knowledge to for whom no suitable jobs exist. origin countries. At the same time, large out- flows of high-skilled workers can reduce Policies to improve the growth in the origin country for these reasons: developmental impact of (a) the productivity of colleagues, employees, remittances and migration and other workers may suffer because they lose the opportunity for training and mutually Migration policies beneficial exchanges of ideas; (b) the provision Greater emigration of low-skilled emigrants of key public services with positive externali- from developing to industrial countries could xiv OVERVIEW
make a significant contribution to poverty re- igrants to return by identifying job opportuni- duction. The most feasible means of increas- ties for them, cooperating with destination ing such emigration would be to promote countries that have programs to promote re- managed migration programs between origin turn, permitting dual nationality, and helping and destination countries that combine tem- to facilitate the portability of social insurance porary migration of low-skilled workers with benefits. incentives for return. Temporary programs By providing authoritative information on have several advantages, and some disadvan- migration opportunities and risks, govern- tages, relative to permanent migration. From ments could help avoid unfortunate, costly-to- the perspective of the destination country, reverse migration decisions and limit the abuse managed, temporary migration programs ease of vulnerable migrants. Labor recruiters can social tensions by limiting permanent settle- play a valuable role in promoting migration, ment; they limit the potential burden on pub- but emigrants’ lack of information often en- lic expenditures because immigrants are guar- ables recruiters to capture the lion’s share of the anteed a job and are less likely to bring rents generated by constraints on immigration dependents; and they allow for controlled and imperfect information. Origin countries variation of the number of immigrants in re- with effective public sector institutions might sponse to changes in labor-market conditions, consider the regulation of recruitment agents thus limiting adverse effects on low-skilled na- to limit rents and improve transparency. tive workers. However, temporary migration can be less efficient than permanent migration Remittance policies for firms in destination countries because of Governments in destination and origin coun- high training costs. From the origin-country tries can sharpen the developmental impact of perspective, managed, temporary migration remittances through the application of appro- may be the only means of securing deliberate priate policies. Access of poor migrants and increases in low-skilled emigration and may their families to formal financial services for raise remittances and improve the skills of re- sending and receiving remittances could be turning workers. On the other hand, managed improved through public policies that encour- migration programs do not guarantee future age expansion of banking networks, allow access to labor markets (and thus to remit- domestic banks from origin countries to oper- tances), because it is easier for destination ate overseas, provide identification cards to countries to suspend temporary programs migrants, and facilitate the participation of than to expel immigrants. Overall, however, microfinance institutions and credit unions in such programs do represent a feasible ap- providing low-cost remittance services. Remit- proach to capturing the efficiency gains from tances, in turn, can be used to support finan- labor migration. cial products—housing and consumer loans Origin countries that are adversely affected and insurance—for poor people. by high-skilled emigration face challenges in A second set of promising policies could managing it better. Service requirements for improve competition in the remittance trans- access to publicly financed education can be fer market and thereby lower fees. The price evaded and are likely to discourage return; of remittance transactions is often unnecessar- and proposals for the taxation of emigrants to ily high for the small transfers typically made the benefit of the origin country have made lit- by poor migrants. The cost of such transac- tle progress. Origin countries can help to re- tions is often well below the fees paid by cus- tain key workers by improving working con- tomers. Reducing transaction charges in- ditions in public employment and by investing creases the disposable income of poor in research and development. Origin countries migrants and increases their incentives to can also take steps to encourage educated em- remit, because the net receipts of recipients
xv OVERVIEW
increase. The overall result would be stronger ings and improve the allocation of expendi- remittance flows to developing countries. tures should be accomplished through im- Competition among providers of remittance provements in the overall investment climate, services could be increased by lowering capital rather than by targeting remittances. Similarly, requirements on remittance services and open- because remittances are private funds, they ing up postal, banking, and retail networks to should not be viewed as a substitute for offi- nonexclusive partnerships with remittance cial development aid. agencies. Disseminating data on remittance fees in important remittance corridors and es- tablishing a voluntary code of conduct for de- Organization of this study livering fair-value transfers would improve s is customary in this report, chapter 1 transparency and reduce prices for remittance A reviews recent developments in and transactions. Governments could help reduce prospects for the global economy and their costs by supporting the introduction of mod- implications for developing countries. Chapter ern technology in payment systems. Alleviating 2 uses a model-based simulation to evaluate liquidity constraints by providing a credit line the potential global welfare gains and distribu- either to the sender or the recipient, based on tional impact from a hypothetical increase of 3 past remittance activity, would enable senders percent in high-income countries’ labor force to take advantage of the lower fee rates avail- caused by migration from developing coun- able only for larger remittances. Reducing ex- tries. Chapter 3 surveys the economic literature change-rate distortions could also lower the on the benefits and costs of migration for mi- cost of remittance transactions. Finally, regula- grants and their countries of origin, focusing tory regimes need to strike a better balance be- on economically motivated migration from de- tween preventing financial abuse and facilitat- veloping to high-income countries. We then ing the flow of funds through formal channels. turn to remittances, the main theme of the re- Several origin countries have attempted to port. Chapter 4 investigates the size of remit- improve the developmental impact of remit- tance flows to developing countries, the use of tances by introducing incentives to increase formal and informal channels, the role of gov- flows and to channel them to more productive ernment policies in improving the development uses. Such policies are more problematic than impact of remittances, and, for certain coun- efforts to expand access to financial services tries, their macroeconomic impact. Chapter 5 or reduce transaction costs, because they pose addresses the impact of remittances at the clear risks. Tax incentives to attract remittance household level, in particular their role in re- inflows, for example, may also encourage tax ducing poverty, smoothing consumption, pro- evasion, while matching-fund programs to at- viding working capital for small-scale enter- tract remittances from migrant associations prises, and increasing household expenditures may divert funds from other local funding pri- in areas considered to have a high social value. orities. Efforts to channel remittances to in- The last chapter investigates policy measures vestment, meanwhile, have met with little suc- that could lower the cost of remittance trans- cess. Fundamentally, remittances are private actions for poor households and measures to funds that should be treated like other sources strengthen the financial infrastructure support- of household income. Efforts to increase sav- ing remittances.
xvi Abbreviations
ADB Asian Development Bank AML Anti-money laundering AML/CFT Anti-money laundering/countering financing of terrorism ARTEP Asian Regional Team for Employment Protection (ILO) ATC Agreement on Textiles and Clothing BIS Bank for International Settlements BoA Bank of America BOP Balance of payment CECEI Comité des établissements de crédit et des enterprises, d’investissement CEMLA Center for Latin American Monetary Studies (Centro de Estudios Monetarios Latino Americanos) CEPAL Economic Commission for Latin America and the Caribbean (Comisión Económico para América Latina y el Caribe) CES-IFO Center for Economic Studies at the University of Michigan—Institute for Economic Research CGAP Consultative Group to Assist the Poorest CPI Consumer price index CPSS Committee on Payment and Settlement Systems DDP Development data platform DFID Department for International Development DHS Department for Homeland Security DPRs Diversified payment rights DPS Deferred payment scheme ECA Europe and Central Asia ECOSOC UN Economic and Social Council EU European Union EV Equivalent variation FATF Financial Action Task Force against Money Laundering
xvii ABBREVIATIONS
FDC First Data Corporation FDI Foreign direct investment FFMC First Financial Management Corporation FinCEN Financial Crimes Enforcement Network FISDL Social Investment Fund for Local Development (Fondo de Inversión Social para el Desarrollo) GATS General Agreement on Trade in Services GDP Gross domestic product GE General equilibrium GTAP Global Trade Analysis Project HIV/AIDS Human immunodeficiency virus/acquired immune deficiency syndrome HSBC Hong Kong Shanghai Bank Corporation HTAs Hometown associations IADB Inter-American Development Bank IBM International Business Machines ICICI Industrial Credit and Investment Corporation of India ICMC International Catholic Migration Commission IFAD International Fund for Agriculture and Development ILO International Labour Organization IMF International Monetary Fund IOM International Organization for Migration IRCA Immigation Reform and Control Act IRD Institut de recherche pour le développement IRnet International Remittance Network LAC Latin American and the Caribbean LDCs Least-developed countries MCIC Matricula Consular identification card MDG Millennium Development Goal MIDSA Migration for Development in Southern Africa MFIs Microfinance institutions MFN Most-favored nation MICR Magnetic ink character recognition MIDA Migration for Development in Africa MIDWA Migration for Development in Western Africa MPG Migration Policy Group MSB Money service business MTOs Money transfer operators NAFTA North American Free Trade Agreement
xviii ABBREVIATIONS
NBER National Bureau of Economic Research NGOs Non-governmental organization ODA Official development aid OECD Organisation for Economic Co-operation and Development OFAC Office of Foreign Assets Control OPEC Organization of the Petroleum Exporting Countries OLS Ordinary least squares PADF Pan-American Development Foundation PPP Purchasing power parity PRIO International Peace Institute, Oslo PROFECO Procuraduría Federal del Consumidor R&D Research and development SADC Southern African Development Community SPV Special purpose vehicle TDS Telephone and data systems TSG Technical Sub-Group on the Movement of Persons UAE United Arab Emirates UCSD University of California, San Diego UN United Nations UNDP United Nations Development Programme UNESCAP United Nations Economic and Social Commission for Asia and the Pacific UNESCO–ICSU United Nations Educational, Scientific and Cultural Organization–International Council of Scientific Unions USAID United States Agency for International Development USD US dollar WEO World Economic Outlook WOCCU World Council of Credit Unions WTO World Trade Organization
xix
1 Prospects for the Global Economy
Following very strong growth, the world have reduced growth among oil-importing de- economy slowed in late 2004 and into 2005 as veloping countries from 6.9 percent to 6.1 output began to push against capacity con- percent. In terms of real incomes, the slow- straints. High oil prices cut into the incomes of down was much sharper—from 6.4 percent to oil importers, but the expansion remained 3.7 percent. Despite still growing oil revenues, strong, partly because of favorable conditions reduced opportunities to expand production in financial markets, including still low infla- in the petroleum sector meant that output tion, interest rates, and interest-rate spreads. growth in oil-exporting developing countries Tightness in the oil market, the threat of even also eased, from 6.6 percent to 5.6 percent. higher fuel prices, and the possibility that in- During 2006 the expansion among high- terest rates may rise pose major threats to the income countries is projected to be stable, at expansion. about 2.5 percent, before picking up a bit in 2007. This reflects a combination of improved Slower but still strong growth performance in Europe and stable growth in World GDP is estimated to have increased by the United States and Japan. In the United 3.2 percent in 2005, down from 3.8 in 2004. States, higher oil prices and tighter monetary Growth is projected to be stable in 2006, be- policy are expected to offset the positive stim- fore strengthening somewhat in 2007. The ulus to growth from past depreciations. The slowdown that began in the second half of projected pickup in Europe occurs despite a 2004 was experienced throughout the indus- significant drag on growth from high oil prices trialized world, with growth in Europe still whose effects are expected to be more than underperforming its potential. In contrast, the offset by low interest rates, pent up investment economies of the United States and Japan, de- demand, and a dissipation of most of the neg- spite having slowed, are expanding at close to ative consequences following the euro’s real- their maximum sustainable rates. effective appreciation. In Japan, strengthening Among large developing economies, GDP domestic demand and supportive macroeco- in 2005 continued to expand rapidly in China nomic policies should enable growth to re- and India (in excess of 9 percent and about main close to potential, despite high oil prices. 7 percent, respectively), but slowed in Russia Growth in developing economies is pro- as growth in oil production weakened. High jected to slow modestly from an estimated oil prices, in combination with domestic ca- 5.9 percent in 2005 to 5.5 percent by 2007. pacity constraints and slower import demand In East and South Asia, the expansion is from high-income countries, are estimated to projected to moderate somewhat but remain
1 GLOBAL ECONOMIC PROSPECTS 2006
very strong, particularly in China and India. could push prices to more than $90 a barrel In the Middle East and in both North and for more than a year, resulting in a 1.5 percent Sub-Saharan Africa, strong oil revenues reduction in global growth by the second year should buoy internal demand among oil ex- following the shock. The terms-of-trade im- porters and partially offset capacity con- pact for low-income oil-importing economies straints that will slow production growth. The would reduce incomes in these countries by projected easing of growth in Latin America more than 4 percent of their GDP (much more and the Caribbean reflects weaker non-oil than for high-income countries) because their commodity prices as well as a return to trend economies are relatively oil intensive, and be- growth in several countries that rebounded cause a supply shock–induced increase in oil very strongly in 2004. In Europe and Central prices is unlikely to be accompanied by higher Asia, the waning of the growth bonus follow- non-oil commodity prices. ing EU accession and capacity constraints in oil-producing countries are expected to con- Global imbalances remain an issue tribute to a modest slowing of the expansion. Global current account imbalances and the U.S. current account deficit (which is exp- Tight commodity markets ected to exceed $750 billion in 2005) remain Weaker global growth should reduce the important medium-term problems. During strain in non-oil commodity markets. Already late 2004 and early 2005 tensions eased there are signs of stabilization, and even of somewhat. Rising interest rate differentials decline, in the prices of agricultural products, relative to European short- and long-term as- where supply has responded to high prices. sets made private sector purchases of dollar– Metals and shipping prices also show signs of denominated assets more attractive. As a re- easing, although to a lesser extent. sult, the dollar appreciated some 2.5 percent In oil markets, the projected slowdown is in real-effective terms during the first seven not expected to be sufficient to generate a sub- months of 2005, and reserve accumulation by stantial easing of prices. While crude oil supply foreign central banks became less important in is growing marginally faster than demand, the financing of the current account deficit. supply conditions are expected to remain tight. This respite appears to have been short- As a result, crude oil prices, which currently lived. To some extent, the increased private embody a large risk premium, are not expected flows represented a one-off portfolio adjust- to fall rapidly. The baseline assumes that no ment toward U.S. assets by investors. Begin- major supply disruptions occur and that there ning in the second quarter of 2005, the flows will be a gradual decline in oil prices toward diminished, and the dollar faced renewed $40 per barrel by 2010. This implies an aver- downward pressure. As a result, foreign re- age price of $56 for a barrel of oil in 2006 and serve accumulation once again became a criti- $52 in 2007. cal component in the financing of the U.S. cur- Future spikes in oil prices form a potential rent account deficit, restoring the risk that a risk to global prospects. A price hike gener- change in behavior on the part of foreign cen- ated by a sustained negative supply shock tral bankers could prove destabilizing. Recent would be particularly disruptive, because out- decisions by China and Malaysia to widen the put would be constrained directly by the re- range of currencies to which their own cur- duced availability of oil and petroleum-based rencies are pegged could help ease future pres- inputs. This would be in contrast to the recent sures, especially if the scope for appreciation past, when prices rose in the context of rapidly included in the regime is exercised in practice. growing supply. A supply shock that reduced Globally, policy should continue to focus on oil deliveries by 2 million barrels per day increasing public and private savings in deficit
2 PROSPECTS FOR THE GLOBAL ECONOMY
countries and increasing spending (notably on same way that other countries have profited investment goods) in surplus countries. from freer trade in the manufacturing and raw materials sectors. Low interest rates are a source of uncertainty The future path of long-term interest rates and Global growth spreads, which have been at historically low he global economy slowed markedly in levels for an extended period, is an important T2005, but still continued to expand at an uncertainty. A number of factors have helped estimated 3.2 percent pace, compared with maintain interest rates at low levels, including 3.8 percent in 2004 (table 1.1). The slowdown several years of very loose monetary policy was widespread, reaching virtually every eco- throughout the developed world; increased nomic region. It was precipitated by higher oil aging-related savings in Europe; balance-sheet prices, resource-sector capacity constraints, consolidation in the United States and tightening monetary policy in the United Asia; and a low inflationary environment— States, and in some countries, the maturation thanks, in part, to increased competition fol- of the investment cycle following a year of lowing the entry into global markets of China very fast growth. and members of the former Soviet bloc. Most of these factors are temporary and are expected Outturns and prospects in to gradually abate, resulting in a steady rise in high-income countries long-term rates in the baseline. Indeed, yields Growth among industrialized economies in on 10-year U.S. Treasuries have risen 50 basis 2005 is estimated at 2.5 percent, substantially points since September. lower than the 3.1 percent recorded the year However, these temporary factors could before. Industrial production and trade flows continue to hold sway, reversing or bringing among high-income countries were particu- to a halt the recent increase in long-term rates larly weak. Growth rates of the former de- (as they have in the past). This would prompt clined from over 5 percent in mid-2004 to less stronger-than-projected demand, but also ex- than 1.5 percent in the middle of 2005 (figure acerbate capacity constraints. As a result, oil 1.1). High oil prices, rising short-term interest prices could get pushed higher, which would rates, and an unusually disruptive hurricane provoke a more brutal inflationary cycle, and season1 slowed growth in the United States to ultimately, a recession. Alternatively, these forces could dissipate more rapidly, causing long-term interest rates to rise more quickly toward long-term equilib- Figure 1.1 Industrial production rium levels, which would provoke a more pro- % change, monthly, year over year nounced slowdown. While not the most likely 15 scenario, the recent rise in long-term yields Developing countries and inflation suggest that a higher interest- 10 rate scenario is a real possibility. 5 Finally, this environment of slowing growth and global imbalances raises the risk 0 of rising protectionism. In this regard, policy- Developing Ϫ World 5 countries makers need to make a concerted effort to en- (excluding China) sure that the Doha round reaches a successful (excluding China) Ϫ10 conclusion so that developing countries spe- 19971998 1999 2000 2001 2002 2003 2004 2005 cializing in the export of agricultural products Source: World Bank. can benefit from trade liberalization in the
3 GLOBAL ECONOMIC PROSPECTS 2006
Table 1.1 The global outlook in summary Percentage change from previous year, except interest rates and oil price
2003 2004 2005e 2006f 2007f
Global Conditions World trade volume 5.9 10.2 6.2 7.0 7.3 Consumer prices G-7 countriesa,b 1.5 1.7 2.2 2.0 1.7 United States 2.3 2.7 3.4 3.0 2.4 Commodity prices (USD terms) Non-oil commodities 10.2 17.5 11.9 Ϫ5.9 Ϫ6.3 Oil price (US$ per barrel)c 28.9 37.7 53.6 56.0 51.5 Oil price (percent change) 15.9 30.6 42.1 4.5 Ϫ8.0 Manufactures unit export valued 7.5 6.9 2.4 2.4 2.1 Interest rates $, 6-month (percent) 1.2 1.7 3.8 5.0 5.2 €, 6-month (percent) 2.3 2.1 2.2 2.1 2.8
Real GDP growthe World 2.5 3.8 3.2 3.2 3.3 Memo item: world (PPP weights)f 3.9 5.0 4.4 4.3 4.4 High income 1.8 3.1 2.5 2.5 2.7 OECD countries 1.8 3.0 2.4 2.5 2.7 Euro area 0.7 1.7 1.1 1.4 2.0 Japan 1.4 2.6 2.3 1.8 1.7 United States 2.7 4.2 3.5 3.5 3.6 Non-OECD countries 3.7 6.3 4.3 4.2 4.0 Developing countries in 5.5 6.8 5.9 5.7 5.5 East Asia and Pacific 8.1 8.3 7.8 7.6 7.4 Europe and Central Asia 6.1 7.2 5.3 5.2 5.0 Latin America and Caribbean 2.1 5.8 4.5 3.9 3.6 Middle East and N. Africa 5.2 4.9 4.8 5.4 5.2 South Asia 7.9 6.8 6.9 6.4 6.3 Sub-Saharan Africa 3.6 4.5 4.6 4.7 4.5
Memorandum items Developing countries excluding transition countries 5.3 6.8 6.1 5.8 5.6 excluding China and India 4.1 6.0 4.9 4.7 4.6
Note: PPP ϭ purchasing power parity; e ϭ estimate; f ϭ forecast. a. Canada, France, Germany, Italy, Japan, the UK, and the United States. b. In local currency, aggregated using 1995 GDP weights. c. Simple average of Dubai, Brent, and West Texas Intermediate. d. Unit value index of manufactured exports from major economies, expressed in U.S. dollars. e. GDP in 1995 constant dollars;1995 prices and market exchange rates. f. GDP measured at 1995 PPP weights.
an estimated 3.5 percent, compared with 1.2 percent (1.1 percent in the euro zone), was 4.2 percent the year before. The slowdown much weaker. The relatively low oil-intensity was not as marked as it could have been, of European economies and relaxed macro- because low long-term interest rates boosted economic policy stance help explain why the domestic demand, and the cumulative effect slowdown in Europe was not more pro- of past dollar depreciations improved net nounced. In Japan, GDP is estimated to have exports. increased 2.3 percent. Rising domestic de- In Europe, the growth slowdown was less mand and household incomes, as a result of pronounced, but the expansion, at an estimated tighter labor market conditions and reduced
4 PROSPECTS FOR THE GLOBAL ECONOMY
industrial restructuring, compensated for much slower Chinese import demand. Figure 1.2 A sharp slowdown % change, GDP Looking forward, the increase in oil prices Projection observed in 2005 is expected to slow global 7 Developing countries growth by about one quarter of a percentage 6
point in 2006, compared with what it would 5 have been had prices remained stable. In the United States, the pace of the expansion is 4 3 projected to remain broadly stable, because World the negative effects of further expected in- 2 creases in interest rates and high oil prices will 1 be partly offset by a deficit-financed pickup in post-hurricane investment and additional in- 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 creases in the contribution of the external sec- Source: World Bank. tor to growth. In Europe, economic activity is projected to accelerate despite a significant drag on growth from high oil prices, because of low interest rates, pent up investment again outperform high-income economies by a demand, and a dissipation of most of the wide margin through 2007. negative consequences following the euro’s real-effective appreciation. Meanwhile, in Regional outlooks Japan, the negative consequences of higher oil prices are expected to be substantially offset Detailed descriptions of economic develop- by strengthening domestic demand and con- ments in developing regions can be found tinued supportive macroeconomic policies. in the Regional Outlooks section of http://www. worldbank.org/globaloutlook. Developing economy outturns and prospects The economies of the East Asia and Despite a slowdown of almost a full percent- Pacific region continued to expand rapidly age point, growth in developing economies re- in 2005. Regional GDP is estimated to have mained very robust, at an estimated 5.9 per- increased by 7.8 percent, down from 8.3 per- cent in 2005 (figure 1.2). In part this reflects cent in 2004. Growth in China remained the strong performance of China and India, very strong—despite a substantial slowing in where output continued to expand at rapid both private consumption and investment rates (in excess of 9 percent and about 7 per- demand—because exports continued to cent, respectively). The slowdown among the grow rapidly, and import growth declined by oil-importing countries (excluding China and half. China appears to have been a major India) was sharper, from 5.6 percent to beneficiary of the expiration of quotas on 4.3 percent.2 At the same time, dwindling textiles (see the global trade discussion spare capacity in the petroleum sector caused below), which contributed to rapid export growth in oil-exporting developing countries growth in the first half of the year. Since to ease from 6.6 percent to 5.7 percent, even then, the re-imposition of quotas by the though oil revenues continued to rise. United States and the European Union (EU) High oil prices, rising interest rates, and have attenuated this positive force. For other building inflationary pressures are expected to countries in the region, the slowdown in restrain growth in most developing regions in Chinese imports, weak global high-tech de- 2006 and 2007 (figure 1.3). As a group, how- mand, and elevated oil prices have translated ever, low- and middle-income countries should into reduced export growth, rapidly rising
5 GLOBAL ECONOMIC PROSPECTS 2006
Figure 1.3 Regional growth
% change, GDP 9 2006 8 2005 7 2004 2007 2003 6
5
4
3
2
1 East Asia and Europe and Latin America Middle East South Asia Sub-Saharan Oil importers Oil importers, the Pacific Central Asia and the and North Africa except China Caribbean Africa
Source: World Bank.
producer prices, and a deterioration of cur- revenues in oil-exporting countries helped off- rent account balances. set much slower growth in the oil sector itself. Even higher oil prices on average in 2006,3 Reflecting these capacity constraints and the the longer-term implications of reduced in- very strong growth recorded last year, infla- vestment levels of China, and a tightening of tionary pressures have built up in many coun- monetary policy are expected to slow regional tries in the region, notably Russia. Turkey, growth to 7.6 and 7.4 percent in 2006 and where improved macroeconomic policy has 2007, respectively. The changes in the cur- pushed inflation below 10 percent, represents rency regimes of China and Malaysia are not an important exception. The expected acceler- expected to have a major impact on growth. ation of demand in Europe, continued high oil Nevertheless, as discussed below, these prices—which for many countries in the re- regimes should improve financial stability gion are a positive factor—and additional both domestically and internationally. gains in European market share, suggest that Economic activity in the Europe and Cen- growth for the region as a whole should re- tral Asia region decelerated sharply in 2005, main relatively stable—at about 5 percent in with GDP growing by an estimated 5.3 per- 2006 and 2007, which is close to the region’s cent, down from 7.2 percent in 2004. Slower potential growth rate. increases in oil production, a peaking of the Economic activity in Latin America and the investment cycle (especially among economies Caribbean is estimated to have increased by that recently joined the EU), and less robust some 4.5 percent during 2005, substantially world demand for the region’s exports con- slower than the 5.8 percent recorded in 2004 tributed to the slowdown, which was particu- but much faster than the region’s 0.4 percent larly intense in a number of the larger average growth rate during the preceding economies of the region. Russia decelerated three years. Supply constraints and tight mon- from 7.2 percent to 6.0 percent; Ukraine from etary policy are estimated to have slowed GDP 12.1 percent to 4.4 percent; Poland growth in Brazil to some 3.8 percent (down from 5.4 percent to 3.5 percent; and Turkey from 4.9 percent in 2004), while in Mexico from 8.9 percent to 4.8 percent. five fewer working days in 2005 than in 2004 Higher oil prices constrained domestic are expected to contribute to a significant demand in oil-importing countries, but oil slowing.4 Excluding these countries, regional
6 PROSPECTS FOR THE GLOBAL ECONOMY
growth in 2005 is estimated at a robust the ATC. The region’s strong performance re- 5.9 percent, boosted by both strong world flects, in part, past reforms, such as steps to demand for the region’s exports (particularly improve transparency in the oil sector in oil, coffee, and copper, which account for 65 Algeria, as well as banking-sector reform, re- percent of the regions’ commodity exports) ductions in customs duties, privatization, and and low interest rates. Domestic factors that regulatory reform in other Maghreb countries. contributed to the strong performance include These efforts, and in particular, the substantial past efforts to open the region up to interna- reforms underway in Egypt, help to raise the tional trade, more responsible budget policy, region’s growth potential by improving both the introduction of more flexible exchange infrastructure and the overall investment cli- rate regimes, and lower inflation. mate. While heartening, the pace of reform Slower global growth is already easing ten- outside of Egypt appears to have waned, per- sions in the non-oil commodity markets that haps because high oil prices have reduced have driven the recovery in the Latin America the sense of urgency attached to reform in oil- and Caribbean region, and this trend is ex- exporting countries. pected to continue. Moreover, while many In contrast to the slowdown elsewhere in countries in the region benefit from high oil the world economy, growth in South Asia is prices, many others, particularly those in the estimated to have picked up a bit in 2005, Caribbean, are heavily oil dependent and face coming in at 6.9 percent, compared with substantial income losses.5 As a result, re- 6.8 percent in 2004. This mainly reflects im- gional GDP growth is projected to decline to proved performance in Pakistan, where GDP 3.6 percent by 2007. is estimated to have increased 8.4 percent (up High oil prices and strong oil demand con- from 6.6 percent in 2004), thanks to a broad- tinue to be key drivers for the economies of based acceleration in the manufacturing and the Middle East and North Africa, where GDP agricultural sectors. Like Pakistan, other is estimated to have increased by 4.8 percent countries in the region have enjoyed very in 2005. Very high oil revenues generated strong export performance, in part because of double-digit advances in public spending, the recent removal of ATC quotas. However, which have helped to increase GDP in oil- the sharp rise in oil prices and solid regional producing economies by an estimated 5.4 per- growth over the past several years have cent. Strong demand from these economies contributed to an acceleration of inflation. spilled over to the labor-abundant economies Addressing this issue will require a further of the region through higher remittances and tightening of monetary policy, which, in com- increased intraregional tourism flows. How- bination with rising oil bills, is expected to ever, weak growth in Europe, high oil bills, result in a modest deceleration of economic and a one-off negative effect from the removal activity to about 6.3 percent by 2007. of quotas under the Agreement on Textiles GDP in Sub-Saharan Africa is estimated to and Clothing (ATC) reduced growth of re- have increased 4.6 percent in 2005, bolstered gional oil-importing countries from 4.6 per- by very strong growth among resource-rich cent in 2004 to about 4.0 percent in 2005. countries. Output in South Africa, the region’s Looking forward, high oil prices are ex- largest economy, is estimated to have acceler- pected to continue feeding demand in oil- ated to 4.2 percent, lifted by high metal prices, producing countries, whose economies should strong confidence, low nominal interest expand by 5.4 percent in 2006 and 5.1 percent rates and the rand’s recent depreciation. in 2007. In the oil-importing economies, The economies of oil-exporting countries, growth is expected to accelerate to about the including Nigeria (the region’s second largest same level, supported by stronger European economy), grew an estimated 5.5 percent in growth and a weaker negative effect from 2005, reflecting rapid increases in petroleum
7 GLOBAL ECONOMIC PROSPECTS 2006
production and investment inflows. Growth single digits as a result of lower food prices in some oil-exporting countries may exceed and prudent monetary policies. Recent eco- 25 percent in 2006 and 2007, as new oil fields nomic reforms, and increased donor sup- come on stream. However, the pace of the port—as more countries reach the Heavily In- expansion will taper off in other countries as debted Poor Country (HIPC) completion they reach capacity constraints. point—will also help support growth, which is In West Africa, strong commodity prices in projected to be at or above 4.5 percent over 2005, improved rainfall, and more vigorous the medium term. use of insecticides are expected to lift regional growth. In East and Southern Africa the ex- pansion is projected to slow somewhat, partly Long-term prospects and poverty because the removal of quotas under the ATC forecast will continue to put textile exports under pres- he recent strong economic performance of sure. Political strife and insecurity in Côte Tdeveloping economies and the relatively d’Ivoire and the Great Lakes region are likely rapid growth projected for these economies to impact growth there. Countries are increas- over the medium term owe much to the eco- ingly passing higher crude-oil prices through nomic reforms undertaken over the past sev- to consumers with the aim of containing bud- eral years. Improved macroeconomic policies, get deficits but will cut into consumer demand reflected in lower inflation, trade liberalization and add to inflationary pressures. (average tariffs have fallen from 30 percent to The balance of payments and economic less than 10 percent since the 1980s), more consequences of higher oil prices are expected flexible exchange rate regimes, and lower fiscal to intensify over the next year as other com- deficits have reduced uncertainty and im- modity prices, which have attenuated the proved the overall investment environment. terms-of-trade impact of high oil prices, ease. More microeconomic structural reforms, such Despite higher oil prices and increased pass- as privatization and regulatory reform initia- through, inflation is expected to remain in the tives, have also played a key role.
Table 1.2 Long-term prospects Real GDP per capita, annual average percentage change
Forecast
Medium-term Long-term 1980s 1990s 2001–06 2006–15
World Total 1.3 1.2 1.5 2.1
High-income countries 2.5 1.8 1.6 2.4 OECD 2.5 1.8 1.6 2.4 United States 2.3 2.0 1.8 2.5 Japan 3.4 1.1 1.1 1.9 European Union 2.1 1.8 1.4 2.3 Non-OECD 3.5 4.0 2.0 3.5
Developing economies 0.7 1.5 3.7 3.5 East Asia & Pacific 5.8 6.3 6.4 5.3 Europe & Central Asia 0.9 Ϫ1.8 5.0 3.5 Latin America & Caribbean Ϫ0.9 1.6 1.2 2.3 Middle East & North Africa Ϫ1.1 1.0 2.5 2.6 South Asia 3.3 3.2 4.5 4.2 Sub-Saharan Africa Ϫ1.1 Ϫ0.5 1.8 1.6 Source: World Bank.
8 PROSPECTS FOR THE GLOBAL ECONOMY
These factors are expected to contribute population living in extreme poverty is ex- to better long-term growth performance pected to decline in all developing regions.6 as compared with past decades (table 1.2). With the exception of Sub-Saharan Africa, Consistent with recent improvements in eco- all regions are expected to achieve their nomic performance, per capita incomes in de- Millennium Development Goal of reducing veloping countries are projected to grow poverty by 50 percent from its 1990 level. In some 3.5 percent a year, more than twice as East Asia, the target has already been fast as the 1.5 percent growth rates recorded achieved. Moreover, based on the current during the 1990s. Projected future growth long-term forecast, extreme poverty would be rates are higher than during the 1980s and almost eliminated by 2015 in both the East 1990s in every developing region except East Asia and Pacific and the Europe and Central Asia, where they are expected to decline Asia regions. Overall, the number of people somewhat due to an aging population. living on $1 a day or less will fall to around Table 1.3 reports poverty projections 620 million, from 1.2 billion in 1990 and an based on these real per capita income growth estimated 1.0 billion in 2002. rates and the (re)distribution of income Despite these heartening prospects, there is within the population. The table indicates no room for complacency. The percent of the that over the next 15 years the share of the population in developing economies living at
Table 1.3 Regional breakdown of poverty in developing countries
Millions of people living on
less than $1 per day less than $2 per day
Region 1990 2002 2015 1990 2002 2015
East Asia and the Pacific 472 214 14 1,116 748 260 China 375 180 11 825 533 181 Rest of East Asia and the Pacific 97 34 2 292 215 78 Europe and Central Asia 2 10 4 23 76 39 Latin America and the Caribbean 49 42 29 125 119 106 Middle East and North Africa 6 5 3 51 61 40 South Asia 462 437 232 958 1,091 955 Sub-Saharan Africa 227 303 336 382 516 592 Total 1,218 1,011 617 2,654 2,611 1,993 Excluding China 844 831 606 1,829 2,078 1,811
Percent of population living on
less than $1 per day less than $2 per day
Region 1990 2002 2015 1990 2002 2015
East Asia and the Pacific 29.6 14.9 0.9 69.9 40.7 12.7 China 33.0 16.6 1.2 72.6 41.6 13.1 Rest of East Asia and the Pacific 21.1 10.8 0.4 63.2 38.6 11.9 Europe and Central Asia 0.5 3.6 0.4 4.9 16.1 8.2 Latin America and the Caribbean 11.3 9.5 6.9 28.4 22.6 17.2 Middle East and North Africa 2.3 2.4 0.9 21.4 19.8 10.4 South Asia 41.3 31.3 12.8 85.5 77.8 56.7 Sub-Saharan Africa 44.6 46.4 38.4 75.0 74.9 67.1 Total 27.9 21.1 10.2 60.8 49.9 32.8 Excluding China 26.1 22.5 12.9 56.6 52.6 38.6 Source: World Bank.
9 GLOBAL ECONOMIC PROSPECTS 2006
or below $2 per day is projected to remain dis- turbingly high. Moreover, notwithstanding Figure 1.4 Dollar-euro interest rate differentials that inroads have been made recently, the inci- dence of extreme poverty in Sub-Saharan Percentage points Africa in 2002 was actually higher than in 2.0 1990. While current projections suggest 8 per- 1.5 Long-term difference cent of the subcontinent’s population will be 1.0 lifted above the extreme poverty line by 2015, 0.5
some 38 percent of Africans will still be living 0 in extreme poverty. Worse, the absolute num- Ϫ0.5 ber of Africans living at or below the $1-a-day Short-term Ϫ1.0 level is projected to increase. And, because per difference Ϫ capita incomes elsewhere are projected to 1.5 grow faster, the continent will continue to fall Ϫ2.0
farther behind the rest of the world—unless 2005 steps are taken to greatly improve economic Jan. 2003Apr. 2003July 2003Oct. 2003Jan. 2004Apr. 2004July 2004Oct. 2004Jan. 2005Apr. July 2005
growth in Africa. Source: World Bank.
International finance he significant adjustments of international inflows in the first quarter of 2005 as in- Texchange rates over the past several years vestors adjusted their portfolios. Not only did paused in 2005. In particular, notwithstanding these inflows help strengthen the dollar, they the persistence of the U.S. current account also financed a large share of the U.S. current deficit (expected to exceed $750 billion this account deficit (figure 1.5). As a result, the year), the dollar’s trend decline with respect to dollar was much less reliant on the accumula- major currencies came to an end. Initially, the tion of reserves by foreign central banks (for- currency appreciated against its trading part- eign official asset purchases) than in 2004. ners by some 3.5 percent in real-effective terms In the second quarter of 2005, however, as of July 2005. It then lost value in August private inflows eased, and foreign central and September, before showing signs of banks once again assumed a large role in the strengthening in October. financing of the dollar. Moreover, toward the The strengthening of the dollar during the end of July the dollar came under renewed first seven months of 2005 is partly explained downward pressure and depreciated some by rising U.S. short-term interest rates (as the 1.7 percent in real-effective terms during Federal Reserve Bank continued its policy of August and September. The dollar began to gradual tightening) and falling long-term rates appreciate again only after the long-term in Europe (possibly in response to the conti- interest rate started to rise again. By October nent’s relatively weaker economic perfor- 2005, the long-term interest rate differential mance). By July, these developments had had widened to about 120 basis points. generated a 300 basis-point swing in the dif- The apparent sensitivity of the dollar and ference between U.S. and European short the financing of the U.S. current account rates, along with a 75 basis-point gap in favor deficit to interest-rate differentials highlight of long-term U.S. bonds (figure 1.4). the problems posed by the large financing These growing interest rate differentials in- requirements of the U.S. current account creased the financial incentive to hold dollar- deficit. versus euro-denominated assets, temporarily Until global imbalances are resolved, the producing stronger net private sector capital dollar is likely to continue to come under
10 PROSPECTS FOR THE GLOBAL ECONOMY
Figure 1.5 Financing of the U.S. current Figure 1.6 Emerging market spreads
account deficit Basis points $ billions, annualized 1,000 900 800 600 EMBI global bond spreads 600 300 400 0 200 Ϫ300 2004 2005 2005 Q1 Q2 July 2002 Jan. 2003 July 2003 Jan. 2004 July 2004 Jan. 2005 July 2005
Other private flows Private sector Source: World Bank; Datastream. treasury bills Official assets Net equity and FDI (reserves)
Source: U.S. Department of Commerce; BEA; U.S. Treasury Bulletin. managed. While technically the announced rules could allow the renminbi to depreciate as much as 9 percent per month, similar possibil- ities for flexibility existed under the former downward pressure, unless foreign central regime but were not exercised. banks accumulate substantial quantities of dollars or interest-rate differentials widen fur- ther. In the baseline, interest rate differentials Interest rates and spreads remain low are projected to widen further, and the dollar The recent period of very low real interest is projected to decline gradually, falling by rates has been particularly beneficial to devel- about 5 percent per year. Should central banks oping economies. Together with narrower cease to be willing to accumulate reserves at risk premia (figure 1.6), low rates have al- current rates, there could be a disruptive hike lowed developing countries to reduce their in interest rates or a more precipitous fall in financing costs, restructure their debt, and the dollar (World Bank 2005). pursue strong investment growth. Early re- The recent decision of the Chinese and payment of Paris Club debt has already Malaysian authorities to move from an ex- reached $22 billion in 2005, and among change rate regime linked to the dollar alone emerging-market economies, virtually all to one focusing on a basket of currencies rep- financing requirements for this year had been resents a major and welcome move toward a met by August.8 more flexible currency regime. While it will Short-term rates have been rising, and not resolve current account imbalances, it they can be expected to continue to rise as should increase the stability of the renminbi monetary policy tightens, initially in the and ringitt with respect to the currencies of United States, but eventually in Europe as their trading partners (other than the United well. In contrast and notwithstanding re- States) and reduce the amount by which the cent increases, longer-term interest rates dollar would have to depreciate relative to have remained low longer than expected other currencies to achieve a given level of ad- (figure 1.7), while spreads on more risky justment.7 How effective the new regimes will emerging market and corporate assets have be, depends importantly on how they are fallen even further.
11 GLOBAL ECONOMIC PROSPECTS 2006
Figure 1.7 Real long-term interest rates in Figure 1.8 World savings rate G-7 countries % of nominal GDPa Percent 25 8 Period Global average 24 savings rate 6
4 23
2 22 0 Average Ϫ 21 2 GDP-weighted average savings rate of the 10-yeara government Ϫ4 bond yields 20 Ϫ6 1981 1986 1991 1996 2001 2005 1970 1975 1980 1985 1990 1995 2000 2005 Source: World Bank. Source: World Bank. a. Sum of national savings divided by the sum of national Note: For data prior to 1972, exclude Italy, a 10-year or GDP expressed in U.S. dollars at market exchange rates. nearest government bond yields.
Many reasons for these low interest rates activity, principally in the developed world, has have been proposed (see IMF 2005 for a re- failed to keep pace with savings as they have cent overview), including the following: returned to historical levels (see IMF 2005). Most of these explanations for lower long- • Excess liquidity stemming from an ex- term rates involve temporary factors, imply- tended period of very low short-term ing that long-term rates will eventually rise interest rates in almost all developed toward their long-run equilibrium level9 (fre- economies. quently defined as the long-run potential • A low inflation environment, thanks to growth rate of the economy). In this context, improved credibility of monetary policy, the question is not so much why long-term and the disinflationary impact of in- rates are low, but how much longer they will creased competition following the entry remain so. In the baseline, increased invest- into global markets of China and mem- ment in Europe and tighter monetary policy bers of the former Soviet bloc. result in a gradual rise in interest rates, which • An increase in global savings, due to will nevertheless remain below recent esti- – increased savings in Europe following mates of the long-term growth potential of the heightened recognition of the need to U.S. economy. The final section of this chapter prepare for the impending retirement explores some of the economic implications of the baby-boom generation; and should interest rates stay low for an extended – increased corporate savings in dy- period of time or, alternatively, should they namic East Asia (caused by corporate rise more quickly than anticipated. restructuring following the currency crisis) and in the United States (follow- Signs of rising inflation ing the stock market decline in 2000). Low interest rates have contributed directly to However, while global savings have in- the strong economic performance of recent creased recently, this follows a period where years. Growth has, in turn, provoked a pickup they declined substantially, making it difficult in inflation in many developing countries. The to argue that the world savings rate is currently largest hikes have been in commodity prices too high (figure 1.8). Rather, investment (see below). However, producer price inflation
12 PROSPECTS FOR THE GLOBAL ECONOMY
has jumped by more than 4 percentage points productivity growth suggest that core infla- in some regions and exceeds 5 percent in tion, which has been more stable, may begin every developing region except Sub-Saharan to rise soon. In Europe, high oil prices have Africa.10 limited disinflation despite significant slack Consumer price inflation has also been and the appreciation of the euro. rising (if less spectacularly). Weighted by These same factors should continue to limit GDP, aggregate inflation among developing price inflation in Europe. However, in the economies increased from 4.0 percent in the United States, high oil prices plus the pro- fourth quarter of 2003 to 5.4 percent by July jected further depreciation of the dollar are of 2005. It has since eased somewhat. Region- expected to generate additional upward price ally, inflation has picked up strongly in South pressure. Asia, Sub-Saharan Africa, and East Asia (fig- Low interest rates have resulted in higher ure 1.9). Inflation in developing countries prices of interest-sensitive assets in markets is projected to continue rising in 2005, as with strong financial intermediation—notably growth remains at or above trend rates, and in the United States and some European the pass-through from high oil prices contin- countries—contributing to strong consumer ues to exert upward pressure on prices. demand (World Bank 2005, IMF 2005). As in- In high-income countries, there are only terest rates rise, housing prices are expected to limited signs of rising inflation. In the United plateau and even decline, which has already States, where output is close to potential, in- begun in the United Kingdom. As they do so, flation has been rising steadily. It jumped to the rate at which household wealth increases 4.7 percent in September 2005, but the in- will moderate and its contribution to con- crease is not expected to be permanent, be- sumer demand should abate.11 cause it reflects very high gasoline prices that Data indicate that house prices have also month, which have since declined. Neverthe- been rising rapidly in a number of middle- less, data pointing to rising wages and lower income countries, such as Bulgaria, India,
Figure 1.9 Inflation rates
Annual % change 9 2003 8 2002 7 2004 6 Most recent available dataa
5
4
3
2
1
0 East Asia Europe and Latin America Middle East and South Asia Sub-Saharan OECD and Pacific Central Asia and the Caribbean North Africa Africa
Source: World Bank. a. Data concern August 2005, except for East Asia (September), the Middle East and North Africa (June), and Sub-Saharan Africa (March).
13 GLOBAL ECONOMIC PROSPECTS 2006
Figure 1.10 Cumulative real increase in Figure 1.11 Commodity prices housing prices, 2005 Index, 1990 ϭ 100 Percent 300
100 Metals and 250 minerals Energy Agricultural 80 200 products
150 60
100 40 50 2000 2001 2002 2003 2004 2005 2006 20 Source: World Bank.
0 a a India Bulgaria Russia China Thailand Shanghai (Mumbai)South Africa (Bangkok)United States Although metals and minerals prices rose Source: World Bank; BIS. during the first months of the year, they have a. Data for Russia and China reflect increases between 2000 since stabilized, and in October 2005, they and 2004; data for other countries reflect increases between 2000 and 2005. were at the same level as in March 2005. Conditions in some metals and minerals mar- kets remain tight, due to low inventories. In Indonesia, Malaysia, and South Africa (fig- the case of copper and aluminum, prices re- ure 1.10). While fast economic growth and main elevated (partly reflecting higher energy changes in the regulatory environment have content in the production of these goods). certainly played a role in these countries, so Demand has weakened markedly for lead, tin, have low interest rates. Unfortunately, data and zinc. limitations prevent a thorough analysis of the Analysis of past non-oil commodity cycles causes and consequences of rising housing suggests that this one may have run its course. prices in low- and middle-income economies.12 Already it distinguishes itself from previous episodes by having lasted longer, in part, because energy prices have also been high, Commodity markets which was not always the case during previ- fter several years of rising commodity ous episodes. In so far as high fuel prices in- Aprices, there are indications of a stabiliza- crease production costs in both agriculture tion and even reversal of gains in the markets and metals and minerals, they may have re- for agricultural products and for metals and duced the supply response, keeping prices minerals (figure 1.11). higher longer. Agricultural prices have been declining In line with the projected slowdown in most of this year and are down 5 percent since global growth and increased supply, prices of March 2005. However, prices of agricultural agricultural products and metals and minerals raw materials are rising, partly because of are projected to decline somewhat in 2006. higher prices for commodities that are close substitutes for crude oil-based products (for Limited spare capacity to keep example, natural rubber prices are up 41 per- oil prices high cent because of increases in synthetic rubber In contrast with other commodity prices, costs). oil prices continued to strengthen during the
14 PROSPECTS FOR THE GLOBAL ECONOMY
first nine months of 2005. During this period, refining capacity, particularly of lower-quality they averaged some $52 per barrel, a 38 per- crude oil. cent increase compared with the average for Spare production capacity is now about 2004. These increases occurred despite an eas- 2 million barrels per day (mbpd), compared ing of conditions in the oil market. Demand with almost 6 mbpd three years ago, and ca- growth slowed from more than 3.5 percent in pacity will remain tight over the near term. 2004 (the highest growth since the late 1970s) This reflects long lags in bringing significant to a 1.4 percent annualized rate during the new quantities of oil into production15 and first three quarters of 2005. As a result, supply shorter lags before demand substitution can is actually increasing faster than demand,13 have an effect.16 Moreover, approximately and inventories have begun to accumulate, half of the expected new capacity is being pro- although they remain low.14 duced by OPEC, suggesting that the organiza- Rising prices over the first eight months of tion will continue to exercise significant mar- the year reflected the market’s concern that ket power over the near term. existing spare capacity was insufficient to deal In this environment, prices are likely to re- with a major disruption to supply or an in- main volatile, as small events or even minor crease in demand (figure 1.12). In some sense, changes in expectations may provoke signifi- hurricane Katrina was the kind of serious cant price swings. As a result, the World Bank shock the market feared. Although oil prices has adopted a technical assumption for the spiked briefly to more than $70 a barrel, they future path of oil prices based on a slow de- are back below $60, following the release of cline toward $40 per barrel by 2010. This some 29 million barrels of crude oil from the implies an average price of $56 in 2006 and stockpiles of the International Energy Agency $52 in 2007, which is somewhat higher than and the U.S. government. Moreover, gasoline the current consensus forecast. The economic prices in the United States have returned to the consequences of alternative scenarios, notably levels observed before hurricane Katrina, and a sharp negative supply shock, are discussed in market concerns have switched from a focus the final section of this chapter. on inadequate oil supply to insufficient The impact of oil prices on developing economies The world economy in general and developing Figure 1.12 Levels of spare oil capacity countries in particular have shown consider- able resilience to higher oil prices. This reflects Million barrels per day increases in non-oil commodity prices and a 8 very robust global economy, which have, until 7 recently, muted the impact of higher oil prices. 6 The first round of oil price hikes (1999–
5 2000) adversely affected low- and middle- income countries. The price increase was very 4 large in percentage terms (rising from just 3 under $12 to almost $30 per barrel between the 2 first quarter of 1999 and the end of 2000) but smaller than the most recent increases in dollar 1 terms (table 1.4). Current account deficits 0 among low-income oil-importing African Jan. July Jan. July Jan. July Jan. July 2002 2002 2003 2003 2004 2004 2005 2005 countries increased by 0.5 percent of GDP on 17 Source: World Bank. average. Moreover, government deficits in those countries that did not pass on the price
15 GLOBAL ECONOMIC PROSPECTS 2006
Table 1.4 Terms-of-trade impacts non-oil commodity prices. Indeed, the esti- of commodity price changes mated terms-of-trade shock from price move- ments since January 2004 is more than three 1999–00 2001–03 2004–05 times as large for various groups of Cumulative price change low-income countries than the cumulative Oil 120.3 18.9 88.0 shock over the preceding three years. As a re- Agricultural products 0.3 15.7 8.9 sult, non-oil imports from poor, current Metals and minerals 25.0 10.2 47.9 Manufactures Ϫ5.0 3.0 10.4 account–constrained countries are expected to come under pressure in the coming months. Total terms-of-trade effect (% of GDP) Oil Importers Moreover, the impact on oil-importing poor Low and Middle income Ϫ1.8 Ϫ0.1 Ϫ0.9 countries could be significantly aggravated if Ϫ Ϫ Ϫ Low income 3.8 0.9 2.9 oil prices remain at or close to current levels Sub-Saharan Africa Ϫ2.5 1.4 Ϫ1.2 South Asia Ϫ3.9 Ϫ1.5 Ϫ2.7 and if non-energy commodity prices return to Highly indebted Ϫ4.3 1.5 Ϫ3.3 pre-shock levels. poor countries
Source: World Bank. Note: Periods Jan. 1999–Dec. 2000, Dec. 2000–Dec. 2003, World trade Dec. 2003–July 2005. he expansion of world trade slowed sig- Tnificantly during 2005 (figure 1.13). While merchandise exports were growing at a hikes rose by about the same amount.18 Among 16 percent or more annualized pace in the those countries with limited access to interna- middle of 2004, they subsequently slowed and tional finance, non-oil imports fell by 3.8 per- were expanding at an 8.5 percent pace during cent in 2000, partly because insufficient foreign the third quarter of 2005. exchange was available to finance imports at previous levels. During the second bout of (more gradual) price increases (2001–3) the same countries performed much better. Current account posi- Figure 1.13 World trade volumes tions actually improved as a percent of GDP, Annual growth rates, 6-month moving average and there were no discernible slowdown in 40 China non-oil imports. Part of this improved perfor- 36 mance is explained by real exchange rate 32 movements (which diminished the domestic currency cost of the oil-price hike) and by a 28 number of non-oil commodity prices that also 24 World Other developing increased rapidly during that time, thus pro- 20 viding the necessary foreign currency to meet countries the additional oil burden without cutting into 16 non-oil imports. On average, high non-oil 12 commodity prices reduced the negative terms- 8 of-trade shock from higher energy costs by High-income 4 more than half. countries Drawing from this experience, the impact 0 Jan. July Jan. July Jan. July of the latest hike in oil prices on poor oil im- 2003 2003 2004 2004 2005 2005
porters is a concern, principally because it has Source: World Bank. not been accompanied by as much strength in
16 PROSPECTS FOR THE GLOBAL ECONOMY
Most of the deceleration concerned the ex- ports of high-income economies, volumes of Figure 1.14 Change in textile exports to the developed world, first half of 2005 which grew by less than 4 percent (annualized) in the first quarter of 2005, before strengthen- Tajikistan ing more recently. Merchandise export volumes Myanmar Nepal of developing countries (excluding China) were Kenyaa relatively robust, increasing at an estimated Philippines 12 percent pace toward the middle of 2005. Mexico Mongolia Chinese exports, boosted by the removal of Mauritius ATC quotas, grew at a 24 percent pace. South Africa Commodity markets have significantly Vietnam Tunisia shaped developments in world trade. The mer- Lesothoa chandise exports of oil-exporting countries, Madagascar which had been rising at some 5.8 percent in Moldova Albania 2004, increased by an estimated 5.2 percent Macedonia, FYR in 2005. The deceleration among developing Pakistan oil importers (excluding China) was steeper in Morocco Thailand percentage terms (from 15 percent to 11 per- Swazilandb cent), but growth rates remained much higher. Indonesia Growth in the production of non-oil com- Romania Bulgaria modities in general is moderating, both be- Lao PDR cause demand is easing and because of supply Egypt constraints. Bangladesh Cambodia As a reflection of the slowdown already ob- Perua served, international trade is forecast to slow Jordan down relative to 2004 as a whole. Merchan- Turkey Sri Lanka dise trade volumes are expected to increase India by around 7.7 percent. The goods and service Chinab trade is expected to increase 6.2 percent in Ϫ60 Ϫ40 Ϫ20 0 20 40 60 2005 before strengthening somewhat in % change, year over year, $ values 2006–7. Source: World Bank, IMF, U.S. Department of Commerce, Exports of developing economies continue and EuroStat. a. Data refer to the first five months of each year only. to be heavily influenced by developments in the b. Data for China include Hong Kong and Macao. volatile high-tech market. After falling sharply in the third quarter of 2004, global sales of semiconductors and other high-tech products picked up before weakening once again in the January 2005 (figure 1.14). While the removal second quarter of 2005. This volatility is ap- of quotas was done in phases, and ten years of parent in East Asian export volumes (high-tech adjustment time provided, backloading of the products represent as much as two-thirds of the removal of quotas meant that they were still exports of some economies in this region).19 binding when they were finally removed. As a High-frequency data suggest a strengthening of result, there were significant changes in pat- demand for these products, implying a pick up terns of trade among affected goods in 2005, in export flows from the region. most notably in the form of increased exports Trade growth for some countries was from China (and other countries, whose mar- heavily influenced by the removal of quotas ket share had been artificially held back under under the ATC of the Multifiber agreement in the old quota scheme) to the detriment of
17 GLOBAL ECONOMIC PROSPECTS 2006
income imports over the same period. The tex- Figure 1.15 Estimated change in textile tile sectors in Kenya, Myanmar, Nepal, the exports as share of total merchandise Philippines, and Tajikistan, on the other hand, exports saw the dollar value of their exports decline by Bangladesh 4 or more percent. Cambodia However, many of these countries are not Sri Lanka Turkey large exporters of textiles. As a result, these Jordan figures may exaggerate the overall economic India impact of the relaxation of textile quotas. Lao PDR Expressed as a percent of these countries’ Pakistan Romania total merchandise exports, the biggest gains Chinaa were experienced by Bangladesh, Cambodia, Bulgaria Jordan, India, Pakistan, Sri Lanka, and Morocco Turkey, while the largest losses were those of Egypt, Arab Rep. Macedonia, FYR Kenya, Nepal, Myanmar, Mongolia, and Madagascar Tajikistan (figure 1.15). Perub Tunisia Albania Risks and uncertainties Moldova Indonesia ow interest rates, moderate inflation, and Vietnam Lthe robust growth projected in the baseline Thailand constitute a relatively benign scenario. However, South Africa the outlook is dominated by downside risks. Mexico Mauritius Philippines An oil-market supply shock could cause b Kenya serious disruption Mongolia Myanmar The most important potential risk comes Nepal from the oil market. As global demand and Tajikistan supply are projected to increase broadly in Ϫ15 Ϫ10 Ϫ5051015 step, excess capacity (currently estimated at Percent 1.9 million barrels per day) will remain very Source: World Bank, IMF, U.S. Department of Commerce, constrained. In this context, the market can be and EuroStat. expected to continue reacting to events in a Note: Data reflect the change in textile and clothing exports between 2004 and 2005 as a percent of total merchandise relatively volatile manner. Rather than gradu- exports. ally declining, as in the baseline scenario, a. Data for China include Hong Kong and Macao. b. Data refer to the first five months of each year only. prices could remain at current levels, rise fur- ther, or even fall. More fundamentally, with spare produc- tion capacity so low, the market is particularly those exporters that had benefited most from vulnerable to a supply shock. Because no the old quota system. country can easily ramp up production, if out- Using U.S. and European imports of tex- put in another producing country were to fall tiles as a proxy for developments in the world significantly, world supply would fall, provok- as a whole, China,20 India, Jordan, Peru, ing a decline in economic activity to the extent Sri Lanka, and Turkey saw the dollar value of that the global economy could not quickly their exports increase between the first half of adopt an alternative energy source.21 2004 and the same period in 2005 by more Table 1.5 presents results from a simulation than the 20 percent average increase in high- of the impact of a 2-million-barrels-per-day
18 PROSPECTS FOR THE GLOBAL ECONOMY
Table 1.5 Impact of a 2 million bpd income and middle-income countries, both be- negative supply shock cause of higher energy intensities and a greater inflationary impact, which requires a larger 2006 2007 2008 2009 contraction to eliminate. Price of oil 90 70 44 40 While the impact in terms of GDP for cur- (Change from base line) 34 28 3 0 rent account–constrained low-income coun- Change in GDP % of baseline tries is smaller, it is more severe in terms of World Ϫ1.0 Ϫ1.5 Ϫ1.1 0.2 domestic consumption and investment. Such Ϫ Ϫ Ϫ Ϫ High income 0.7 1.3 1.3 0.3 countries have limited access to international Middle income Ϫ1.6 Ϫ1.6 Ϫ0.1 1.4 Large low income Ϫ1.7 Ϫ2.8 Ϫ1.8 0.7 capital markets, and their capacity to pay higher oil prices is limited by their export rev- Impact on inflation rate World 2.6 0.6 Ϫ0.9 Ϫ0.2 enues. If these revenues are stable, they are High income 1.4 0.0 Ϫ1.0 Ϫ0.4 forced to reduce domestic demand and non- Ϫ Middle income 5.8 2.0 0.9 0.5 oil imports in order to pay their higher oil Large low income 2.8 0.9 Ϫ0.7 Ϫ0.2 bill. As a consequence, when oil prices rise, Impact on real interest rates (levels) oil consumption remains relatively constant World 1.0 0.2 Ϫ0.1 0.1 High income 1.0 0.1 Ϫ0.2 0.0 in volume terms (being generally inelastic in Middle income 1.1 0.7 0.2 0.2 the short run), but the oil bill rises. To com- Large low income 0.5 0.1 0.1 0.4 pensate, non-oil imports and domestic de- Impact on current account balance (% of GDP) mand tend to decline in unison—leaving GDP World Ϫ1.1 Ϫ0.5 Ϫ0.1 Ϫ0.1 relatively unchanged. For these countries, the High income Ϫ1.1 Ϫ0.7 Ϫ0.2 Ϫ0.2 Middle income Ϫ0.9 Ϫ0.2 Ϫ0.5 Ϫ0.3 terms-of-trade shock of the initial increase in Large low income Ϫ1.9 Ϫ0.2 1.7 1.0 oil prices is estimated at 4.1 percent of their Impacts on low-income current account– GDP, which would translate into a 2.7 per- constrained countries (1) cent decline in domestic demand, with poten- Terms of trade Ϫ4.1 .. .. tially serious impacts on poverty. GDP Ϫ0.3 0.1 0.0 Domestic demand Ϫ2.7 Ϫ1.1 0.0 Current account balance Ϫ1.2 0.9 0 The future path of interest rates represents Source: World Bank. an additional source of uncertainty Note: Impacts on low-income, current account–constrained Persistent global imbalances continue to be a economies were estimates based on the terms-of-trade impact serious source of uncertainty. The current ac- using a purpose-built VAR model. Other estimates were simulated using the World Bank’s macroeconomic simulation count deficit of the United States and its fi- model. nancing requirements are very large, and the willingness of investors to finance it is sensi- negative supply shock.22 The disruption is tive to both interest-rate differentials and assumed to last throughout the projection exchange-rate expectations. As net foreign lia- period, causing prices to rise to $120 for an bilities accumulate, markets will become in- initial period of three months before easing creasingly sensitive to adverse shocks or to $80 for three quarters. Thereafter, supply changes in sentiment, and the dollar is likely and demand adjustments result in a gradual to come under downward pressure once decline in oil prices toward $40. again, which would put upward pressure on Global output responds to the initial shock interest rates. by contracting, as compared with the baseline, Table 1.6 explores the possible implications by 1.5 percent of GDP after two years, while of higher interest rates. In this scenario, faced inflation picks up rapidly. On average, the with sustained downward pressure on the dol- current account position of oil-importing lar, investors demand higher returns on U.S.- countries deteriorates by about 1.1 percent of denominated assets to offset further expected GDP. The impact is more severe in large low- depreciations. This, combined with concerns
19 GLOBAL ECONOMIC PROSPECTS 2006
Table 1.6 Interest rate scenarios prices and consumer wealth. Slower growth eases inflationary pressure and global ten- 2005 2006 2007 2008 2009 sions, including in the oil market. As mone- A. A 200 basis-point increase in interest rates and in spreads tary policy loosens in response to increasing output gaps, growth starts to pick up again, Interest rates (change of Q4 level from baseline) World 1.8 1.4 Ϫ0.6 0.2 1.3 bringing output back to the levels in the base- High income 1.7 1.1 Ϫ1.1 Ϫ0.3 0.9 line by the end of the simulation period. Low and middle Higher interest rates would also affect fi- income 2.0 2.7 1.9 2.6 3.1 nancing conditions for developing countries GDP (% change from baseline) by increasing future borrowing costs. For World Ϫ0.1 Ϫ1.7 Ϫ2.9 Ϫ1.9 Ϫ0.6 High income 0.0 Ϫ1.5 Ϫ2.7 Ϫ2.5 Ϫ1.0 many countries this will not pose a serious Low and middle short-term risk, because they have taken ad- Ϫ Ϫ Ϫ Ϫ Ϫ income 0.2 2.4 3.5 3.0 1.5 vantage of low rates to reduce the share of Inflation (change in inflation rate) short-term debt relative to their overall debt Ϫ Ϫ Ϫ Ϫ World 0.0 0.3 1.1 1.1 0.3 and to prefinance some of their future bor- High income 0.0 Ϫ0.3 Ϫ1.5 Ϫ1.6 Ϫ0.5 Low and middle rowing needs. For others, particularly those income 0.0 Ϫ0.3 0.7 1.2 0.9 with large debt-to-GDP ratios or those that B. Persistently low interest rates have accumulated large short-term debt posi- tions (figure 1.16), a rapid rise in interest rates Interest rates (change of Q4 level from baseline) World Ϫ0.7 Ϫ0.5 0.6 0.1 Ϫ0.6 High income Ϫ0.7 Ϫ0.5 0.8 0.1 Ϫ0.6 Low and middle income Ϫ0.8 Ϫ0.8 Ϫ0.1 Ϫ0.1 Ϫ0.7 Figure 1.16 Some countries are particularly at risk GDP (% change from baseline) World 0.0 0.8 1.4 0.3 Ϫ0.5 Debt/GNI ratio High income 0.0 0.8 1.4 0.4 Ϫ0.5 0 50 100 150 200 Low and middle income 0.0 1.0 1.4 Ϫ0.1 Ϫ0.7 Argentina Belize Inflation (change in inflation rate) World 0.0 0.2 0.6 0.6 0.1 Lebanon High income 0.0 0.2 0.8 0.8 0.2 Papua New Guinea Low and middle income 0.0 0.1 Ϫ0.2 Ϫ0.5 Ϫ0.3 Uruguay Indonesia Source: World Bank. Ecuador about rising debt and pension liabilities in Turkey industrialized countries, and a more rapid dis- Philippines sipation of the temporary factors depressing Jamaica long-term interest rates, causes them to in- Bolivia crease by some 200 basis points in high- Paraguay income countries. Risk premia in developing Brazil economies increase by an additional 200 basis Pakistan points as investors’ appetites for risk decline. R.B. de Venezuela The world economy reacts to the substan- Ukraine tial tightening of monetary conditions by re- Dominican Rep. ducing global growth by half for a period Guatemala
of two years, as higher interest rates cut into 0 5 10 15 20 25 30 35 investment and consumption demand, both Short-term debt/Total debt through classic transmission mechanisms and Source: World Bank. via the impact of interest rates on housing
20 PROSPECTS FOR THE GLOBAL ECONOMY
could pose a real threat—particularly if the stitution toward alternative energy sources— rise in base interest rates also provokes a re- to the ultimate detriment of oil-producing turn of spreads to more usual levels. countries. Alternatively, if excess liquidity and global In the developed world, efforts to increase savings prevent long-term interest rates from energy efficiency by developing more fuel- rising as quickly as in the baseline scenario, efficient technologies, such as hybrid cars, the resulting higher levels of demand could in- could well pay important dividends. These crease tensions in commodity markets, includ- technologies are already economic in some ing the oil market. In addition, lower interest countries, where gasoline is heavily taxed, and rates could cause a number of economies, in- could generate substantial savings in overall cluding the United States, to overheat, gener- fuel demand.23 In addition to the ecological ating additional inflation that forces a further benefits, making such technology available in tightening of monetary policy. As a result, developing economies, where the increase in while growth would be initially higher, the transportation-related energy demand is high- subsequent tightening of policy could provoke est, would be particularly effective in limiting a stronger-than-projected slowdown. overall demand. The depth of the cycle would depend im- Finally, efforts to improve cooperation be- portantly on the extent of the wealth effect tween users and suppliers concerning the qual- generated by low interest rates on housing ity and transparency of oil market data could prices. The more pronounced, the deeper the help reduce unwarranted volatility and per- cycle. Moreover, because asset prices become haps contribute to lower prices by reducing even more out of step with their long-run the oil-price risk premia. levels, an even longer period of slow growth To further dissipate the risk from global could be required to re-establish equilibrium. imbalances, policies need to promote both public and private savings in countries with Policy challenges large current account deficits. Recent mea- Policy can help reduce both the economic sures to tighten fiscal policy in the United severity of such unfavorable outturns and the States are headed in this direction, but more likelihood that they will materialize. tightening is required. Tighter monetary pol- High oil prices will naturally induce substi- icy is helping. Higher interest rates in the tution toward alternative energy sources and United States promote private sector financing conservation. In the current context, where of the deficit but also promote private sector the increase in oil prices is expected to endure, saving. In Europe, policymakers should seek countries that have not passed on recent price to maintain low interest rates in an effort to hikes to consumers (and industry) may wish stimulate demand. As output picks up, fiscal to revise their policies. Not only are the bud- policy (rather than monetary policy) should be getary costs of such subsidies likely to be dif- used to restrict demand, if necessary. Indeed, ficult to support, but these policies also im- given unfunded public pension liabilities in pede adjustment. these countries, such a fiscal tightening is nec- Moreover, countries with restrictive rules essary in its own right. concerning the exploitation of oil reserves Developing economies should react flexibly, might wish to re-examine them. Such policies seeking to maintain real effective exchange may deny these countries access to technical rates in line with their fundamentals, rather expertise and financial capital, thereby pre- than a particular alignment with any one cur- venting them from investing in new produc- rency. In this regard, recent steps by some tion to the extent that they might otherwise. countries to adopt an exchange rate regime This may slow the aggregate supply response that reflects their overall trade patterns are and encourage greater conservation and sub- positive and could be emulated by other
21 GLOBAL ECONOMIC PROSPECTS 2006
countries. Petro-dollars could help reduce the weekends. Occasionally, these fluctuations can have an likelihood of a disruptive resolution of global important impact on annual GDP growth. While five imbalances if they are recycled into the global fewer days corresponds to roughly a 2.5 percent re- duction in working time, in general, the actual reduc- economy in a way that reduces tensions. In tion in production is less pronounced. particular, the financing of investment expen- 5. These losses are estimated at more than 5 per- ditures both domestically and in other devel- cent of GDP for Antigua and Barbuda, Belize, Guyana, oping countries would help stimulate demand Honduras, Nicaragua, and Jamaica. outside of the United States, reducing that 6. This year’s projections differ somewhat from country’s current account deficit. To the extent 2004’s partly because of a shift in the base year for cal- that these funds are invested in U.S. financial culations from 2001 to 2002, which reduces the poverty level of the starting year in all regions that securities, they could also help finance the U.S. have experienced positive per capita growth. In addi- current account deficit. tion, new survey data was employed for a large num- Finally, global weakness could trigger in- ber of countries (more than half in the Europe and creased protectionism or a slowing of trade Central Asia region), including important new house- liberalization (which has been the basis for hold surveys in a number of Latin American countries much of developing countries’ recent success). in the place of labor force survey data used in the past. The supply disruptions in Europe provoked by Finally, revisions to national income estimates of GDP, inflation, and consumption play a role. For more the re-imposition of quotas on Chinese im- information concerning the changes to the poverty ports of textiles, following their liberalization forecast, please visit the Long-term Prospects and at the beginning of this year, is a good illus- Poverty Forecasts section of http://www.worldbank. tration of how trade restrictions work to the org/globaloutlook. detriment of both exporting and importing 7. The extent to which the new regime will con- countries. Not only should countries resist the tribute to increased stability in world markets will also temptation to intervene in already liberalized depend on the extent to which other Asian currencies follow suit, and how much flexibility is permitted in domains, concerted efforts need to be made to practice. achieve meaningful liberalization in the agri- 8. As of August 2005, overall financing for emerg- cultural and service sectors in the Doha ing market sovereign debt was already 74 percent process. To date, liberalization has largely funded; this share reached 93 percent for emerging omitted the politically sensitive agricultural Europe and Turkey, and 100 percent for Latin America. sector, depriving many developing countries 9. Long-term interest rates tend to be determined of the benefits from trade liberalization that by the long-term growth potential of the economy and expected inflation. Historically, temporary factors have more manufacturing-oriented economies have caused them to deviate from this measure, sometimes enjoyed. for extended periods of time. However, they have al- ways tended to return to this level. 10. In the first half of 2005, producer price infla- Notes tion exceeded 15 percent in the Europe and Central 1. The Congressional Budget Office (2005) esti- Asia region, was more than 9 percent in Latin America mates that hurricane Katrina reduced growth in the and the Caribbean, about 7 percent in the Middle United States by 0.4 and 0.9 percent (annual rates) in East and North Africa, and around 6 percent in both the third and fourth quarters. East and South Asia. 2. The importance of China to aggregate statistics 11. The stock of housing in the United States is es- is also visible in the industrial production data. Growth timated by the Federal Reserve Bank to be equal to rates for all developing countries showed little slowing, $15.2 trillion, or about 138 percent of GDP. A 10 per- but excluding China, annualized growth rates declined cent change in the value of that stock would represent from about 7.5 percent in mid 2004 to less than 5 per- 13.8 percent of GDP, or 19 percent of consumption. cent a year later. Econometric estimates suggest that the long-term mar- 3. Although oil prices are projected to decline dur- ginal propensity to consume from housing wealth is ing 2006, they will be higher, on average, than in 2005. 0.05 (see, for example Catte and others 2004 and 4. The number of working days each year varies, Benjamin, Chinloy, and Jud 2004), implying a reduc- generally because certain holidays do or do not fall on tion in consumption of 1.35 percent.
22 PROSPECTS FOR THE GLOBAL ECONOMY
12. Very few low- and middle-income countries 22. Beccue and Huntington (2005) estimate that have housing data similar to the data available in high- the probability of such a disruption occurring during income countries; and what does exist tends to be the next 10 years is high (70 percent for one lasting limited to wealthy neighborhoods in single cities. 6 months and 35 percent for one of 18 months). Moreover, there is little information on home owner- 23. In the United States, for example, hybrid cars ship ratios, and mortgage-market completeness—all currently offer approximately an 80 percent improve- critical components in determining housing-market ment in fuel efficiency. Were these vehicles to gain a wealth effects. 10 percent share of new car sales, new energy demand 13. The U.S. Department of Energy estimates that would be reduced by about 12 percent (c. 0.3 percent- both oil and gasoline consumption fell by 2.5 or more age points) per year for about seven years. percent in September 2005. 14. In the second quarter, stocks equaled 54 days worth of consumption versus an average of more than 58 days during the first half of the 1990s. References 15. Some oil fields can be brought into production Beccue, Phillip C., and Hillard G. Huntington. 2005. within 1 year, but others would take as long as 10 years. “An Assessment of Oil Market Disruption Three to five years would be needed to bring in two mil- Risks.” In Final Report EMF SR 8. Energy Mod- lion barrels per day over and above expected increases eling Forum. October. in demand. Benjamin, J.D., P. Chinloy, and G.D. Jud. 2004. “Real 16. Opportunities for demand substitution may be Estate versus Financial Wealth in Consumption.” less plentiful than in the 1970s because of the substan- Journal of Real Estate Finance and Economics tial conservation steps undertaken then. Nevertheless, 29(3): 341–54. use of fuel-efficient cars and less intensive use of Catte, P., N. Girouard, R. Price, and C. André. 2004. existing cars can have substantial impacts on overall “Housing Markets, Wealth and the Business demand. Cycle.” Economics Department Working Paper 17. Simple average of 32 oil-importing Sub- 394. OECD, Paris. Saharan economies. Congressional Budget Office. 2005. “Macroeconomic 18. Among countries that did not pass prices and Budgetary Effects of Hurricane Katrina.” through fully, fuel subsidy spending rose substantially, Report. September 6. Washington, DC. for instance in the Central African Republic, Guinea Huntington, Hillard G. 2005. “The Economic Conse- Bissau, Malawi, and the Seychelles. quences of Higher Crude Oil Prices.” In Final 19. In 2003, high-tech products represented 13 per- Report EMF SR 9. Energy Modeling Forum, cent of Thailand’s exports, but more than 50 percent of October. Taiwanese, Malaysian, and Philippine exports. International Energy Agency. 2004. World Energy 20. China here is taken as the sum of Hong Kong, Outlook. Paris. Macao, and China, based on the assumption that prior IMF (International Monetary Fund). 2005. World to liberalization some of the exports from Hong Kong Economic Outlook. Washington, DC. and Macao had actually originated in China, and OECD (Organisation for Economic Co-operation and therefore, the changes in their market share reported in Development). 2004. Economic Outlook, no. 74. official statistics are exaggerated. Paris. 21. During the 1980s (and before), OPEC acted as World Bank. 2005. Global Development Finance a swing producer, stepping up production in response 2005. Washington, DC. to shortfalls elsewhere. With its spare capacity now measured at less than 2 million barrels per day, its capacity to act as a swing producer is limited.
23
2 The Potential Gains from International Migration
International migration can generate substan- migrants and for their origin countries. Here tial welfare gains for migrants, their countries we can refer to a broader range of economic of origin, and the countries to which they mi- issues than are captured by the model, al- grate. The main focus of this report is on gains though without the ability to quantify that the from the remittances that migrants send home model-based simulation provides. (discussed in chapters 4–6); chapters 2 and 3 Starting from the base-case forecast of eco- address the economic costs and benefits of nomic activity described in chapter 1, we in- migration and the impact of migration on troduce an additional increase in migration poverty. In this chapter, we use an economic from developing to high-income countries suf- model to estimate the size of the welfare gains ficient to raise the labor force of high-income resulting from migration from developing to countries by 3 percent over the period high-income countries.1 It must be recognized 2001–25. The assumed increase, roughly one- at the outset that the model fails to capture eighth of a percentage point a year, is close to some known costs and benefits of migration; that observed over the 1970–2000 period. We that the results are dependent on the specifica- imply no judgment concerning whether such tion of the model and its key parameters; an increase is likely or politically feasible, but and that the model cannot incorporate social rather view the rise in migration as an exoge- or political considerations.2 The results of this nous shock. As discussed in chapter 3, pres- simulation do not provide a precise forecast of sures to migrate are likely to rise over the next the likely impact of migration; instead, they few decades, but the actual size of the migrant provide a consistent framework that offers in- flows will depend heavily on political deci- sights into (a) the economic gains that can be sions in destination countries. This exercise expected from changes in policy or circum- presents us with the following key findings. stances, and (b) the channels through which migration affects welfare—and both are diffi- The expected decline in the labor force in cult to measure in reality. The conclusions high-income countries will increase depen- drawn from the model are supported by sev- dency ratios, which could add to the benefits eral empirical studies, and they hold up well from migration. However, such increases in under various alternative assumptions for migration are unlikely to be large enough to model specification and parameters. have a significant impact on dependency ra- In chapter 3, we complement this model- tios in high-income countries. based approach to measuring the gains from migration with a review of the economic liter- Under the assumptions adopted in this model- ature, which covers the implications for ing exercise, the rise in migration—small
25 GLOBAL ECONOMIC PROSPECTS 2006
relative to the labor force of high-income coun- The costs of adjusting to increased migration tries, but large relative to the existing stock of and the gains from migration depend, in part, migrants—would generate large increases in on the investment climate. Adjustment costs global welfare. Migrants, natives in destination as a result of migration will be lower if more countries, and households in origin countries flexible labor markets and more efficient cap- would experience gains in income, although mi- ital markets in high-income economies reduce grants already living in high-income countries transitional unemployment and the cost of re- would see a decline in wages relative to the base placing capital as economies adjust to the rise case. Estimates of these gains and losses are par- in immigration. Similarly, developing coun- ticularly sensitive to assumptions about the de- tries with strong investment climates will be gree of differentiation among workers (between able to use increased remittances more effi- natives and migrants and between old and new ciently, and enable workers who do not mi- migrants), the impact of migrants on fiscal bal- grate to respond to improved labor market ances, and the extent of remittances. conditions. The cost of adjustment may also be lower if migration is spread over time Empirical studies of the impact of migration rather than concentrated in spurts. on natives’ wages have had mixed results. In this simulation exercise, the rise in migration A principal conclusion from this exercise is leads to a small decline in average wages in that migration can generate significant eco- high-income countries relative to the baseline, nomic gains for migrants, origin countries, which one would anticipate from a labor sup- and destination countries—but migration also ply shock. But the decline has a barely per- can have important political and social conse- ceptible impact on the long-term growth rate quences. For example, natives in destination for wages. countries may become concerned about main- Native households in high-income countries taining cultural identity in the middle of a enjoy a rise in income, on average, as returns growing diversity, which also has implications to capital increase, offsetting the mild decline relative to minority languages and other issues in wages. The impact on developing countries surrounding the integration of migrants. To is nearly the reverse, with wage income rising some extent, opposition to migration is driven as labor-market conditions for workers im- by these concerns, and not by an economic prove, while returns on capital decline with calculation of the gains and losses. the smaller supply of workers. In developing We begin with a discussion of recent trends countries the gain from increased remittances and discuss how migration to high-income greatly exceeds that from changes in factor countries has grown over the past 30 years. returns. We then turn to the prospects for migration, including the intense pressures generated by The economic benefits for high-income demographic changes. We describe the base- economies could be even larger than those pre- case scenario for migration and the model- dicted by the model, due to several factors: the based analysis of the welfare gains from in- model excludes the increased productivity of creased migration. We conclude with issues migrants (and the benefits to their offspring) that the model does not consider. over time; investment levels could increase substantially in response to higher returns to International migration trends capital; labor-force participation could rise among natives with the greater availability of Migration to high-income countries migrant labor (for household help, for exam- has accelerated ple); the labor market would become more The United Nations (UN) estimates that mi- flexibile, and diversity would increase. grants account for some 3 percent of the
26 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
Table 2.1 Growth in international migration by destination, 1970–2000 Percent change per year in stock of migrants
1970–80 1982–90 1990–2000
World 2.0 4.4 1.3 High-income countries 2.4 2.9 3.1 Developing countries 1.8 5.5 –0.1 Excluding former USSR 1.9 2.1 0.0 Former USSR 0.5 25.0 –0.3
Source: United Nations.
world’s population, or about 175 million tion growth, the share of migrants in develop- persons.3 The stock of immigrants to high- ing countries’ population (excluding the for- income countries increased at about 3 percent mer Soviet Union) fell (figure 2.1).4 per year from 1980 to 2000, up from the Most high-income countries saw immigra- 2.4 percent pace in the 1970s (table 2.1). At tion rise by at least 2 percent per year from that rate of growth, the share of migrants in 1980 to 2000.5 This increase reflected, in high-income countries’ population almost part, increased demand for services accom- doubled over the 30-year period, and popula- panying rising incomes, global competition tion growth (excluding migration) fell from for highly educated workers as technological 0.7 percent per year in the 1970s to 0.5 per- advances boosted the premium for skills, the cent in the 1990s. Immigration has had a par- growth of networks of immigrants in high- ticular impact on population growth in several income countries that facilitated new immi- high-income countries. For example, without gration, and increased refugee movements. immigration Germany, Italy, and Sweden Almost 70 percent of the increase in immi- would have experienced a decline in popula- gration is accounted for by the United States tion in the past few decades (OECD 2005; and Germany, which together make up less IOM 2005). By contrast, migration to devel- than 40 percent of the population of the oping countries rose by only 1.3 percent per high-income countries. In the United States, year from 1970 to 2000. With rapid popula- the Immigration Reform and Control Act (IRCA) of 1986, which provided permanent status to 2.7 million migrants, facilitated fur- Figure 2.1 International migrants as a ther immigration through rules governing share of destination countries’ population family reunification and may have encour-
Percentage aged further irregular immigration (Passel 9 2005) by encouraging expectations of future 6 8 amnesties. Germany saw a large inflow of 7 ethnic Germans following the breakup of the 6 Soviet Union (Dustmann and Glitz 2005), as 5 well as an increase in temporary migration 4 1970 under bilateral agreements. 3 2000 2 Though the stock of migrants has acceler- 1 ated sharply relative to the population in the 0 industrial countries, in some respects the com- World Developed Developing Developing countries countries countriesa position and patterns of international migra- tion have exhibited continuity over the past Source: United Nations. Note: a. Excluding countries of the former USSR. few decades. The share of female migrants has remained almost unchanged (47 percent
27 GLOBAL ECONOMIC PROSPECTS 2006
Figure 2.2 Share of females in Figure 2.3 Immigration to selected international migration countries, reasons for admittance, 2001
Percentage Percent 51 80 United 50 70 Kingdom Australia 49 60 2000 United 48 1970 50 States 47 40 France 46 30 45 20 44 10 43 0 World Developed Developing Workers Reuniting Refugee/ countries countries families asylum
Source: United Nations. Source: United Nations. Note: Stock data, reported by countries of destination. Note: Stock data, reported by destination countries.
of global migrant populations in 1970, com- It should be emphasized that the migration pared with 49 percent in 2000—figure 2.2), data on which these judgments are based although women are the great majority of tend to be unreliable and incomplete. Many migrants from some countries. More women countries and international agencies do not today are migrating as independent wage distinguish between regular and irregular earners, rather than to accompany their hus- migration or among types of temporary migra- bands (IOM 2005). Migration continues to be tion. Some record migrants’ country of birth; heavily determined by geographic proximity others their nationality (OECD 2005). (from Mexico to the United States, from National estimates of the number of migrants North Africa to Southern Europe, and from can be vastly different depending on whether Eastern to Western Europe), as well as by “migrant” is defined as foreign born or of for- colonial ties (from Latin America to Spain and eign nationality. from a number of Sub-Saharan African coun- tries to Belgium, France, Portugal, and the Migration is set to increase United Kingdom—OECD 2005). The major It is likely that the number of people who wish countries of destination continue to admit the to migrate from developing to high-income largest share of permanent immigrants for countries will rise over the next two decades. family reunification (or, in the case of the EU About 31 percent of developing countries’ countries, for humanitarian or refugee resettle- population is below the age of 14, compared ment), although some countries are refocusing with 18 percent in high-income countries. We their migration policy toward economic can thus anticipate a large influx in the age (largely skilled) immigration (figure 2.3).7 But categories most suitable for emigration, as international migration is also changing, par- lifetime earnings from migration tend to be ticularly in the direction of flows. For exam- largest for those emigrating early in their ple, more Asians are today seeking work in working life. The surge in immigration since other Asian countries rather than in the Mid- the 1980s has established large diasporas in dle East (Wickramasekera 2002; OECD 2005; high-income countries, which help to reduce IOM 2005), while more Latin Americans are the costs and risks of migration (see chap- turning to Europe for work opportunities, in ter 3). The demand for immigrant services in addition to North America. high-income countries will also rise as the
28 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
aging of the population shrinks the workforce suming no change in labor-force participation and increases demand for services that rates, the high-income countries may lose immigrants can supply (such as nursing care). about 20 million workers by 2025, relative to As income standards rise, the demand for peak employment.8 other services that employ migrants (such as The expected decline in the labor force is household and restaurant help) should grow accompanied by a rise in the overall depen- rapidly. The intensifying competition for dency ratio, defined as the ratio of nonworkers skilled workers may also draw migrants, espe- to workers. For the high-income countries as a cially from countries with strong systems of group, this ratio is forecast to remain at just higher education. under one through 2009. However, by 2025, 100 workers will be supporting 111 depen- Policies in destination countries dents, largely reflecting the increased number can affect migration of the elderly (also, in most countries the num- Forecasts of migration flows remain problem- ber of children under 15 will fall). The largest atic. But with the underlying demand for and rise in the dependency ratio will be in Europe. supply of migrants likely to increase in com- If we focus more narrowly on the number of ing decades, the number of migrants will de- elderly per worker, every 100 European work- pend on policy decisions governing admit- ers now support 36 elderly people; by 2025 tance and the effectiveness of efforts to police they will have to support 52. In Japan 100 borders and enforce workplace rules. Opposi- workers will support 60 elderly in 2025. tion to immigration may grow as the number of migrants increases, as it did in major In the developing countries the labor countries of destination before World War I. force will expand But it is likely that the main policy issue will Developing countries show considerable di- be how best to manage and live with in- versity in demographic trends, but overall the creased migration. In the simulations that fol- bulge of youths born over the last two decades low, we explore the impact of an increase in is now entering the labor force, the number of migration to 2025 in line with recent histori- elderly is as yet still rising slowly, and the cal experience. number of births is falling rapidly. Thus developing countries are forecast to add nearly one billion workers to the world’s labor The demographic challenge force by 2025, again assuming no change in the labor-force participation rate, and depen- The labor force in the high-income dency ratios are expected to fall. countries is set to decline The expected expansion of the labor force A key driver in the demand for international in developing countries, coupled with large migrants over the next 20 years will be slow- wage premiums in high-income countries, ing growth, and then decline, of the labor means that migration could help reduce de- force in high-income countries. The age group pendency ratios in high-income countries. that supplies the bulk of the labor force However, increases in immigration sufficient (15–65 years old) is expected to peak near to have a noticeable impact on dependency ra- 500 million in 2010, and then fall to around tios would have to be very large. The scenario 475 million by 2025 (figure 2.4). In Japan this discussed below envisions an increase in the age group has already begun to shrink, while labor force in high-income countries of 3 per- in Europe the peak will be reached in cent through migration, or a hike of nearly 2007–08. In the other high-income countries, 50 percent in working migrants in high-income the peak will occur later—around 2020 for countries. Even if migrants come with no the United States and 2015 for the rest. As- elderly, the dependency ratio in the host coun-
29 GLOBAL ECONOMIC PROSPECTS 2006
Figure 2.4 Labor force and dependency rates
Europe Japan
Labor force, millions Dependency rateLabor force, millions Dependency rate 200 1.3 70 1.3
195 65 1.2 1.2
190 60 1.1 1.1 185 55 1.0 1.0 180 50
0.9 0.9 175 45
170 0.8 40 0.8
2001 2004 2007 2010 2013 2016 2019 2022 2025 2001 2004 2007 2010 2013 2016 2019 2022 2025
United States Other high-income countries
Labor force, millions Dependency rateLabor force, millions Dependency rate 170 1.3 80 1.3
165 75 1.2 1.2
160 70 1.1 1.1 155 65 1.0 1.0 150 60
0.9 0.9 145 55
140 0.8 50 0.8
2001 2004 2007 2010 2013 2016 2019 2022 2025 2001 2004 2007 2010 2013 2016 2019 2022 2025
Total, High-income countries Total, Developing countries
Labor force, millions Dependency rate Labor force, millions Dependency rate 500 1.3 3,600 1.3
495 3,400 1.2 1.2
490 3,200 1.1 1.1 485 3,000 1.0 1.0 480 2,800
0.9 0.9 475 2,600
470 0.8 2,400 0.8
2001 2004 2007 2010 2013 2016 2019 2022 2025 2001 2004 2007 2010 2013 2016 2019 2022 2025
Labor force Dependency rate
Source: World Bank databanks (DDP). Note: The dependency rate is measured as the ratio of the nonworking population to working population.
30 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
tries would fall by only about 3 percent under numbers hold up well as an approximation of such a scenario. In the case of Japan, it would the gains to global output, regardless of vari- lower the number of elderly dependents in ous assumptions made about taxes, non-wage 2025 from 60 per 100 workers to 59 per 100 income distribution, key model parameters, workers—barely a dent. Nevertheless, as and other factors. discussed in more detail below, selective Our modeling exercise uses a global gen- migration—for example, of experienced and eral equilibrium model to measure the impact skilled workers—can help mitigate the transi- of migration (box 2.1).10 One of the purposes tional costs of financing pension benefits for of the global model is to verify the basic intu- rapidly aging populations in high-income ition described above—that migration pro- countries. duces a sizeable global gain. But it also is a powerful tool to evaluate distributional impacts—between skilled and unskilled work- Migration and its development ers, between native- and foreign-born workers, impact between capital and labor, and across o illustrate the potential gains from regions—and to show how these distribu- Tincreased migration, we compare the base- tional impacts vary with policy choices and case forecast for output and consumption parameters (for example, the role of fiscal in chapter 1 with an alternative scenario, in policies or the propensity to remit). which the stock of migrant workers is allowed to increase in the high-income countries so The assumption is that migrants as a as to raise the overall stock of workers by 3 per- share of population remain constant cent (a movement of 14.2 million workers in the baseline scenario from developing countries to high-income We begin with a base case for global eco- countries by the year 2025). A first nomic activity (outlined in chapter 1), demo- approximation of the global gains from such a graphic trends (described at the outset of this scenario is simply to calculate the income gains chapter), and for migration. For the base case, accruing to the new migrant workers—this the proportion of migrants in each region re- will reflect the gains to the global economy, mains the same over time—somewhat con- because it approximates the increase in global trary to the trends of the last two decades. productivity derived from equipping the mi- This does not imply that gross migration is grants with more and improved capital and stagnant, or even declining. The stock of mi- technology. This back-of-the-envelope calcula- grants in any year will equal the previous tion yields an increase in gross wage income of stock of migrants, plus new migrants, less the $772 billion in 2025.9 As we will see later, attrition through death and return migration. when corrected for differences in prices that We chose a relatively neutral assumption be- migrants face in high-income versus develop- cause of the difficulty in forecasting these ing countries, and taking into account other complex processes. For some countries—for impacts of migration (on prices, for example) example Japan and those in Europe—the as- as calculated by the model, global gains fall to sumption results in an absolute decline in the $356 billion—an 0.6 percent increase in global stock of migrant workers. This decline paral- income. The scenario is particularly beneficial lels the overall decline in the European and to developing countries relative to high-income Japanese labor forces.11 For the high-income countries. The aggregate percentage gain to countries as a group, the stock of migrant developing countries (including the new mi- workers would increase by some 760,000 grants) is 1.8 percent, whereas the gains to between 2001 and 2025, just a small increment natives in high-income countries amount to from the estimated 27.8 million in 2001. The 0.4 percent relative to baseline income. These main issue, however, is not the base case,
31 GLOBAL ECONOMIC PROSPECTS 2006
Box 2.1 The model used in this study
he underlying analytical framework used in this including estimates of population and the stock of Tchapter is the World Bank’s standard global workers, both skilled and unskilled (Walmsley, general equilibrium model—LINKAGE—which has Ahmed, and Parsons 2005).a World Bank data (de- been used in previous reports for trade policy analy- scribed in more detail in chapter 4 of this report) sis. It has been modified to differentiate between mi- was used to provide the total level of remittances, grant and native workers and to incorporate remit- and the bilateral stock of migrants was used to esti- tances. The model is based on release 6.0 of the mate the bilateral remittance flows subject to the GTAP database (base year 2001), developed by the overall total flows. Global Trade Analysis Project (www.gtap.org), a The standard horizon for the LINKAGE model has global network of researchers and policymakers en- been 2015. For the work described here, the model gaged in the quantitative analysis of international horizon has been extended to 2025, in part because policy issues. It is supplemented for use in our demographic dynamics play a more important role model with a new database developed jointly by over the longer-term horizon, and in part to allow GTAP and the University of Sussex (Parsons and for more time to phase in the increase in migration. others 2005). That database contains a comprehen- sive estimate of bilateral stocks of migrants for 226 countries and territories. While the new migration database is undergoing aThe 87 regions of GTAP have been aggregated into 21 re- constant improvements as new data become avail- gions for the purposes of this study. Six of these are high-in- able and obvious errors are corrected, its developers come regions using World Bank definitions—the European Union and the European Free Trade Area, Canada, the United have done a remarkable amount of detective work, States, Japan, Australia/New Zealand, and the newly-industrial- largely in national data sources. The GTAP center izing economies. The fifteen developing countries/regions in- has used this underlying migration database to build clude China, the Philippines, India, Russia, Turkey, South a bilateral migration database for the 87-region level Africa, and Mexico as individual countries, plus 6 regions that of aggregation of the main GTAP database— represent the remaining countries in each geographical area.
but rather the impact of deviations from of high-income countries by 3 percent, phased it—although significantly different base as- in from 2010 through 2020.12 As migrants sumptions could affect the deviations aswell. make up about 6 percent of high-income According to the base-case scenario, mi- countries’ labor force, a 3 percent rise in the grant workers would make up about 6 percent labor force (through migration) implies a of the labor force of high-income countries in 50 percent increase in the number of migrant 2025, though with sharp differences across workers. This may seem like a large change, regions and skills (table 2.2). The vast major- but the resulting stock of migrants in Europe, ity of migrant workers are unskilled—some Japan, and the United States would remain a 25.3 million migrant workers out of a pro- far smaller share of population than current jected total of 28.5 million, or 7.8 percent of levels in some high-migration countries. (In high-income countries’ labor force. Skilled mi- Australia, for example, about a quarter of the grants, on the other hand, represent just 2.2 per- population are migrants, in Canada 19 per- cent of the total skilled workforce on average. cent, in Kuwait 50 percent). The percentage increase in migrants is large in Japan (as the There are welfare implications if baseline share of migrants is relatively low), migration rises significantly and lower in the United States. The increase The alternative scenario involves a rise in corresponds to an annual growth rate of migration sufficient to increase the labor force about 1.9 percent, somewhat slower than the
32 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
Table 2.2 Labor force structure in the base case and after increases in migrants In millions except where noted
Baseline Migration shock
2001 2025 Change in millions 2001–25 Change in percent 2001–25
High-income countries Total labor force 480.8 474.0 14.2 3.0 Developing-country migrant workers 27.8 28.5 14.2 49.9 Unskilled 24.6 25.3 9.8 38.6 Skilled 3.1 3.2 4.5 137.9 Developing-country migrant workers as share of total labor force, percenta 5.8 6.0 8.8 Unskilled, percent 7.4 7.8 10.5 Skilled, percent 2.1 2.2 5.0 Developing countries Total labor force 2,596.2 3,561.0 –14.2 –0.4 Unskilled 2,395.9 3,294.3 –9.8 –0.3 Skilled 200.4 266.7 –4.5 –1.7
Source: Initial 2001 data from migration database under development by GTAP/University of Sussex (Parsons and others 2005 and Walmsley, Ahmed, and Parsons 2005). Scenarios based on World Bank assumptions. Note: a. The percentage of migrant workers as a share of the total labor force is assumed to be the same for each individual region of the model throughout 2001–25, but the share averaged across all developed regions will change through aggregation effects.
average increase over the period 1980–2000. reflect the likely migration pressures implied Moreover, the growth rate is unbalanced, with by large differences in demographic trends in an annual increase of only 1.5 percent in un- sending regions (for example, Sub-Saharan skilled workers, but 3.8 percent in skilled Africa versus Latin America). workers. A number of additional assumptions Third, foreign workers are assumed to are critical to the results. bring family members in proportion to the First, the high-income countries’ labor dependency ratio in their home country. As a force of both skilled and unskilled workers result, the total number of migrants in high- increases by 3 percent.13 As the share of skilled income countries increases from 65 million workers among migrants is much smaller than (6.5 percent of high-income countries’ popula- the share of skilled workers among high- tion) in the baseline for 2025, to 93 million income country natives, the shock results in a (9 percent of population) after the shock. This much larger percentage increase for skilled assumption can change the average depen- migrants. The number of unskilled migrant dency ratio of the host country. It can workers increases by 39 percent, while the also have other implications not modeled number of skilled migrant workers rises by explicitly—including fiscal impacts, because 138 percent.14 the families of new migrants may require ad- Second, the share of migrants by region of ditional public services (such as schooling), origin remains constant; in other words, the not fully compensated by the taxes paid by the new migrants reflect the same allocation by new migrants. region of origin as existing ones. Thus if Fourth, remittances are assumed to be a Mexicans constitute 30 percent of foreign mi- fixed proportion of migrants’ labor income, grants in the United States in the base case, equal to the level in the base year. The average they maintain the same share after the increase for developing countries is 17 percent, although in migration. This assumption is made to sim- the level varies with the migrant’s origin and plify the analysis, although it does fail to destination countries. New migrants are
33 GLOBAL ECONOMIC PROSPECTS 2006
assumed to send remittances to their home nearly 0.9 percent from baseline levels.18 A country at the same rate (relative to income) significant portion of the increase is due to the as existing migrants.15 remittances from the new migrants, with some improvement in labor-market conditions for Returns to households remaining workers. Those who are likely to lose—in the absence of any compensatory The gains from increased migration mechanism—are the existing migrants in are large high-income countries, who are relatively With the labor force moving, it is best to close substitutes for the new migrants. Their assess the effects on real income in terms of private consumption would decline by over households as opposed to the national level 9 percent and overall consumption (including (as is typically done in analyses of trade re- public services) by 6 percent compared to form). Households are broken down into four baseline levels. groups. First are the native households in high-income countries.16 Second are previous New migrants and their countries migrants from developing countries now liv- of origin reap benefits ing in high-income countries, that is, those (through remittances) who were in place in the baseline scenario. The main gains come from the higher incomes Third are native households in developing the new migrant workers can earn in the des- countries—households that do not migrate.17 tination country relative to what they would And finally, we have the households of the have earned in their country of origin. New new migrants. Each household’s welfare is migrants earn $481 billion in real (after-tax) broken down between the change in private income in 2025 over the base case. However, consumption and the change in the consump- the dollar increase in income overestimates the tion of public services. welfare gains for migrants. Essentially, an Natives in high-income countries gain additional $1 spent in the high-income coun- $139 billion in real income, or 0.4 percent of tries does not provide the same amount of the baseline, as a result of the rise in migration welfare as an additional $1 spent in the home (table 2.3). Nonmigrating households in de- country, because prices are higher in high- veloping countries see a rise in real income of income countries. Whereas the prices of
Table 2.3 Change in real income across households in 2025 relative to baseline
Real income adjusted for Real income cost of living
Private Public Total Private Public Total
Change, $ billions Change, $ billions Natives in high-income countries 139 –1 139 139 –1 139 Old migrants in high-income countries –88 0 –88 –88 0 –88 Natives in developing countries 131 12 143 131 12 143 New migrants 372 109 481 126 36 162 World total 554 120 674 308 48 356 Change, % Change, % Natives in high-income countries 0.44 –0.01 0.36 0.44 –0.01 0.36 Old migrants in high-income countries –9.41 –0.02 –6.02 –9.41 –0.02 –6.02 Natives in developing countries 0.94 0.44 0.86 0.94 0.44 0.86 New migrants 584 607 589 198 203 199 World total 1.20 1.15 1.19 0.67 0.45 0.63 Source: World Bank model simulations.
34 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
traded goods (for example, cars and electron- using purchasing power parity (PPP) exchange ics) are the same worldwide, at least in princi- rates from the World Bank’s database.20 Thus ple, the prices of nontraded goods and services instead of an increase of $481 billion, the rise (for example, housing and haircuts) are much in welfare for new migrants is $162 billion.21 higher in high-income countries. Table 2.3 shows the change in these com- A simple example may clarify the idea. ponents for the four household groups and the Take a household of two persons living in world. Measured in national accounting their home country. One works and earns terms, that is, with no adjustments for the dif- $200. The other does not work. Each spends ference in the cost of living for the new mi- $100, half on tradable goods (each priced at grants, global real income rises under the $1) and half on nontradable goods (likewise model by 1.2 percent relative to the baseline, priced at $1). Now the worker moves to a or 0.6 percent with the cost-of-living adjust- high-income country and earns $700. Assume ment. Global private consumption increases in that spending patterns do not change. The real terms by $308 billion in 2025 (with the worker remits $200 back to the home country, cost-of-living adjustment), with real govern- so the income (and welfare, in money terms) ment expenditures increasing by an additional of the other doubles. The new migrant buys $48 billion. The total real gain—with equal the same goods—50 units of tradable goods weight for high-income—and developing- and 50 units of nontradable,19 but the price of country gains—is $356 billion, with just the latter is now $9 and not $1. The migrant under half accruing to the new migrants, thus spends $500, but welfare is unchanged, though natives in both high-income and devel- because the basket of purchased goods is oping countries also are better off. In percent- identical. age terms—where relative weights between Welfare evaluations are of course more high-income and developing countries are complex than this simple example illustrates. irrelevant—the scenario clearly indicates that For one thing, new migrants will have to adjust the relative gains are much higher for their spending patterns to deal with their new developing-country households than high- environment. Heating oil and warm clothes income country households, rivaling gains are necessities that will not boost a migrant’s from global reform of merchandise trade. welfare above what it was in the home coun- Obviously, global income and global gains try. For another, the decision to migrate is not would also be larger if expressed in PPP terms. taken for simply static reasons; there are sig- As the percentage increase in welfare for mi- nificant dynamic reasons for migrating—for grants living (originally) in developing coun- example, better opportunities for one’s chil- tries is larger than the percentage increase for dren that are not captured in this simple frame- those living in high-income countries, a switch work. Nonetheless, the difference in purchas- to PPP measures would also increase the ing power illustrated in the example is a strong global gains as a percentage of global income. motivation for migrating, even on a temporary If in the migration scenario presented here the basis. The more wage income earned in high- gains are PPP-adjusted, the global gains would income countries that can be spent in lower- amount to 0.9 percent of global income in the income countries, the greater will be the wel- baseline, instead of 0.6 percent using the EV fare benefits. Box 2.2 provides additional aggregation. This scenario illustrates that mi- detail on the computation and interpretation grants living (originally) in developing coun- of global welfare gains from migration. tries gain the most from migration in percent- To account for the change in prices faced age terms. by the new migrants, their “new” consump- The impact of higher migration on prices is tion in the destination country is adjusted to mild in aggregate in high-income countries, account for differences in the cost of living, with a small decline in the average price of
35 GLOBAL ECONOMIC PROSPECTS 2006
Box 2.2 Calculating and interpreting global welfare gains from migration
wo sets of issues arise with respect to the so- national accounting standards. However, the stan- Tcalled global gains from a policy shock. First, dard real income measure is still a good approxima- how should the gains of specific groups be evaluated tion of the welfare gains for the other households in and how do the gains compare with traditional mea- the model. sures, such as GDP or national accounting stan- To the extent that new migrants remit part of dards? Second, how should the gains be aggregated their income to their country of origin and that over groups and countries, and how should the income is spent in that country of origin, the increase aggregated gains be interpreted? in the cost of living that new migrants face is not Evaluation of the welfare gains of specific relevant. Therefore, the EV measure of remittances is groups. In standard applications of general equilib- larger than the same nominal income spent by the rium (GE) models, the welfare impacts of specific new migrant in the host country. This difference groups are evaluated using a concept from welfare illustrates the incentive for new migrants to remit theory called equivalent variation (EV). The con- income home. cept is relatively straightforward. Welfare changes Aggregation. The second issue relates to the inter- as a result of changes in nominal income and pretation of the “global” gains. Typically, to derive changes in prices. EV calculations summarize this aggregate or global gains, EV (expressed in a com- welfare change in terms of an equivalent change mon currency, typically the U.S. dollar) is summed in income alone, showing by how much income across all households. For individual persons or ho- at original prices would have to change to mogeneous groups this EV aggregation, expressed as achieve the same change in welfare as observed in a percentage of original income, is a good approxi- a a simulation. mation of the change in welfare (or more precisely, it For most households, the standard notion of the is a good indication of the change in welfare).e change in real income, that is, the difference in nomi- However, no clear link exists between global wel- nal income adjusted by the change in the CPI, is a fare and the aggregation of EV across heterogeneous b good approximation of EV. groups, because we do not know how to weigh indi- This is not the case for new migrants, however. vidual welfare across heterogeneous groups (a partic- There is no standard price index that can be used as ularly difficult issue in aggregating across countries a deflator for the change in the nominal gains for the at very different stages of development, as is done new migrants, since the prices they face in their new here). For example, while most groups gain from mi- host country have no linkages to the prices they paid gration in the scenario discussed in the text, some in their home countries. GE and macro models typi- lose. The fact that the change in global welfare (ex- cally calibrate base-year prices in each region to one pressed as the aggregation of EV across groups) is (or unit value) by choosing corresponding volume positive does not mean that the welfare gains of the c units. winners are considered more important than the wel- This approach does not allow one to take into ac- fare losses of the losers. Thus, global gains as ex- count the price increases that new migrants face as pressed in aggregate EV should not be interpreted as a result of their migration. In the simulations, the a value judgment on how to weigh individual or macro PPP exchange rate (as an approximation of local welfare gains. the rise in prices faced by migrants from developing The aggregation of EV across groups does, to high-income countries) has been used to adjust the however, have a useful interpretation, which is gains to the migrants—although this is just an ap- linked to the notion of compensation and Pareto d proximation of the true welfare gains. optimality. As long as the global gains are positive— Because of the cost-of-living adjustment to the using the standard practice of adding up EVs across welfare gain of new migrants, the real gain reported households—then it is possible through redistribu- is no longer equal to real income gains of tion to compensate households that lose (so that no countries—and real output gains—measured using one is worse off relative to the baseline scenario),
36 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
Box 2.2 (continued)
when some households are better off. In that sense developing countries in global aggregates would in- the global gain can be compared with an equal rise crease in the measurement of both global income in global output plus redistribution. levels and global welfare gains. However, the per- In this report we maintain this standard practice centage increase in income for developing countries of reporting EV aggregates, making the gains compa- would not be affected. rable to global gains in many other studies. An alternative approach to calculating global aOne of the advantages of the EV measure is that it trans- gains would be to add up changes in income mea- forms the ordinal concept of welfare into a cardinal concept of sured in PPP terms. The rationale for that alterna- income. While it is impossible to measure how much one welfare tive is that because prices of nontraded goods are level differs from another (one can only conclude that one level is preferred to another), the corresponding increase in income can lower in developing countries, the addition of a dol- be measured, and the size of the increase has a clear meaning. lar to a developing country would enable the pur- bFor example, in trade-reform scenarios, the change in the chase of a larger amount of goods and services than price index is a relatively good approximation of the welfare in an high-income country. In that case, both base impact, since the new price is approximately the old price less income and gains for new migrants and for those the tariff. c who remain in developing countries would be There are exceptions. For example, in the case of climate- change models, it is necessary to know the relative prices of the roughly three times as large as reported here. This different fuels to accurately determine the carbon tax. is true for all gains, whether they come from migra- dSee Timmer and van der Mensbrugghe (2005) for more tion itself, from remittances, or from changes in details. wages and prices in developing countries. As a re- eThe size of the change in individual welfare is undeter- sult, the share of those who live (originally) in mined, since welfare is an ordinal concept.
absorption (private consumption, private in- For the new migrants, the real income vestment, and government spending) of 0.1 gains—cost-of-living adjusted—increase by percent. However, prices of some key nontrad- nearly 200 percent. There are large differences ables decline by larger amounts—0.8 percent across regions, with the highest gains (in per- on average for public services (including centage terms) accruing to migrants from Sub- health-related services) and 0.2 percent for con- Saharan Africa (619 percent) and the lowest struction and recreational services. These price to migrants from the Middle East and North declines will be even sharper for specific sub- Africa and Europe and Central Asia. The main sectors where migrant workers are concen- reason for the disparity is the relative differen- trated (for example, household help), for which tial between wages in origin and destination we currently have no comprehensive data. countries. Variations in wages paid to mi- The allocation of the gains across develop- grants from different regions in destination ing countries depends on various factors, in- countries are minor, whereas there are very cluding the skill loss and the resulting impact wide variations in wages in countries of ori- on production, the locations to which mi- gin. For example, the average wage for a mi- grants move and the relative wage differential, grant in Europe in the base year is about and the propensity to remit. By developing re- $16,500—with only minor variation across gion, the gains to households under the model migrants. However, the average wage in Sub- vary from 0.6 percent for Europe and Central Saharan Africa is only $470, whereas in the Asia to 1.1 percent for South Asia and Latin Middle East and North Africa it is $2,700. America and the Caribbean (table 2.4). Thus, the migrant from Sub-Saharan Africa
37 GLOBAL ECONOMIC PROSPECTS 2006
Table 2.4 Real income impacts across developing regions Change in 2025 relative to the baseline, adjusted for differences in cost of living
Natives in region New migrants from region
$ billions Percent $ billions Percent
Total developing 143 0.9 162 199 East Asia and Pacific 37 0.7 32 215 South Asia 21 1.1 2 175 Europe and Central Asia 14 0.6 25 138 Middle East and North Africa 18 0.9 11 134 Sub-Saharan Africa 7 0.9 7 619 Latin America and the Caribbean 47 1.1 85 224
Source: World Bank model simulations.
will gain much more in both absolute and per- several channels, some of which increase, and centage terms than one from the Middle East others that decrease, trade flows: and North Africa. • First, the rise in incomes due to migra- The impact of migration on trade tion produces a small rise in global trade would be mild flows, with regional differentiation (be- Whether migration and trade are substitutes cause income gains differ considerably for each other is an old debate. For exam- among regions). In addition to higher in- ple, in the discussions leading up to the sign- comes, the rise in migration changes the ing of NAFTA—the free trade agreement size of regional economies, with implica- among the United States, Canada, and tions for their demand for imports and Mexico—one of the key arguments was that ability to export. trade would replace migration and reduce • Second, the nature of the shock assumed the pressure for Mexicans to migrate to the in our model differs from the standard North. Likewise, allowing for increased debate over trade and migration. The migration—for example of unskilled share of skilled workers in total migrants workers—could reduce trade, because it is larger in the shock than in actual mi- would enable the high-income countries to gration over the recent past. A large continue producing low-skill-intensive prod- proportion of skilled workers will find ucts at competitive cost. employment in nontraded sectors—for Evidence of the link between trade and example, as doctors and nurses—rather changing the comparative advantage emerges than in producing traded goods. This in the migration scenario described here. For will have general equilibrium effects to example, the largest gains in export revenue the extent that the price of nontraded for high-income countries come in agriculture, goods will decline by more than the price clothing, other manufacturing, recreational of traded goods. Thus there will be a rel- services, and public services—all labor- ative shift to nontraded goods and a intensive sectors, the first four being relatively potential reduction in demand for im- intensive in unskilled workers and the last in ports of traded goods. Overall, the larger skilled workers. share of skilled versus unskilled workers Change in comparative advantage has only does tend to reduce trade flows. a mild impact on trade flows in this scenario, • Third, the increase in remittances pro- however, as migration affects trade through vides an opportunity for developing
38 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
countries to import more and export less, Migrants’ impact on government fiscal as their current-account balance will in- accounts is broadly neutral crease by the size of the remittances ($98 The assumption concerning the level of billion in net terms). The model results consumption of public goods and services by show that total imports into developing new migrants has important implications for countries would increase by $58 billion individual gains, and global gains, under the in 2025 (1.1 percent relative to the base- modeled scenario. We assume that the new line), as aggregate exports decline by migrants’ level of consumption of public $40 billion (0.7 percent).22 The change goods and services equals the amount they pay in remittances leads to an appreciation of in taxes, that is, their impact on the public the real exchange rate and therefore a budget is revenue-neutral. This is broadly con- loss in relative export competitiveness.23 sistent with the available evidence (box 2.3). For instance, the output price index in To provide some sense of how different ap- developing countries rises by 0.6 percent proaches would affect the scenario results, we on average, whereas it declines by 0.1 per- present two alternative assumptions regarding cent for high-income countries. the distribution of public goods and services to the new migrants (table 2.5). The default In summary, the scenario provides evidence assumption had a largely neutral impact for that changes in comparative advantage due to existing residents in the host country. Under migration do influence trade flows. However, another assumption—new migrants pay taxes overall migration and trade are not substitutes but receive no benefits from public goods and for each other, because migration has many services—existing residents, native and mi- other economic effects that have more power grant, enjoy a rise in real incomes of $126 bil- to stimulate or reduce trade. One implication lion ($117 billion for natives and $9 billion of this finding is that migration policies should for existing migrant households). Note that not be pursued because of their specific impact the global welfare gains increase as well, since on trade flows. Likewise, in trade policies the the income accruing to natives (and existing impact on migration should not be a main migrants) is not adjusted for the differences in focus.24 Trade and migration policies should the cost of living between developing and be evaluated on their own merits. high-income countries.25 A second extreme
Table 2.5 Impact of different assumptions on the consumption of public goods and services by selected groups in 2025 Change in cost-of-living-adjusted real income in 2025; billions of dollars
Default assumption— “New” migrants “New” migrants receive benefits receive no public “New” migrants equal to their benefits but pay receive per capita taxes taxes average benefit
Private Public Total Public Total Public Total
Natives in high-income countries 139 1 139 117 256 85 54 Old migrants in high-income countries 88 0 88 9 79 6 94 Natives in developing countries 131 12 143 12 143 12 143 New migrants 126 36 162 18 108 75 201 World total 308 48 356 120 428 4 304
Source: World Bank model simulations.
39 GLOBAL ECONOMIC PROSPECTS 2006
Box 2.3 The impact of immigrants on fiscal balances
mmigrants’ net contribution to fiscal revenues is 60s generally imposed a long-term burden. Studies Iusually considered to be small. The net fiscal im- that follow immigrants over time generally conclude pact of immigration on the United States has been that in net-present-value terms, immigrants and their minimal (Coppel, Dumont, and Visco 2001; descendants tend to contribute more in terms of tax Auerbach and Oreopoulos 1999). The U.S. revenues than they absorb in expenditures, but the or- Binational Study on Migration (1997) found that ir- ders of magnitude are typically small (OECD 1997). regular migrants did impose a significant fiscal bur- Intergenerational models are sensitive to the discount den on state and local government. However, school rate used and assumptions concerning the allocation expenses accounted for the bulk of these costs, and of the fiscal burden over future generations. (as the authors note) education is an investment Third, the computation will depend on the level that may readily be recovered in greater future pro- of skills, experience, education, and fertility of immi- ductivity. Moreover, Lee and Miller (2000) found grants. Rowthorn (2004) calculates that skilled mi- that the overall fiscal consequences of altering the grants to the United States typically make a large volume of immigration to the United States would positive contribution to the fiscal balance, whereas be quite small. Gott and Johnston (2002) and unskilled immigrants cost more on average than the Sriskandarajah, Cooley, and Reed (2005) estimated that immigrants made a positive contribution to taxes they pay. Storesletten (2000) calculates that the public finances in the United Kingdom. Gustafsson net-present-value contribution of the average high- and Osterberg (2001) found that new immigrants to skilled immigrant to the U.S. budget is $96,000; the Sweden generated a net fiscal cost, but this turned medium-skilled immigrant’s contribution is $2,000; into a positive contribution after a few years. Nana and low-skilled immigrant’s contribution is and Williams (1999) found that immigrants to New $36,000. Zealand had a positive fiscal impact. Bonin, The results may change over time, as migrant Raffelhuschen, and Walliser (2000) found that the characteristics and government policies change. The net fiscal contribution of immigrants to Germany probability that an immigrant to the United States could be significant if the government selects for will receive public benefits has risen since the 1970s, skills. probably due to an increasing share of immigrants Calculations of the net fiscal cost of immigration from poorer countries (Gustmann and Steinmeier are fraught with difficulties, for several reasons. 1998). First, the computation at any point in time An issue of particular concern has been the im- depends heavily on the methodology used, what pact of migration on government-financed pensions. expenditures and revenues are included, which public Likely increases in immigration can make only a services should be regarded as pure public goods (and small net contribution to strengthening the financing the extent of economies of scale in expenditures), and of pensions in the United States (Fehr, Jokisch, and whether households or individuals are considered. Kotlikoff 2004), although selecting immigrants for Second, static calculations of the current net fiscal working age and high skill levels could improve the impact fail to take into account the age structure of picture (Storesletten 2000). By contrast, increases in the immigrant population. Smith and Edmonston immigration could make a significant contribution (1997) found that immigrants arriving between the to financing pensions in Germany (Bonin, Raffel- ages of 10 and 25 years produced fiscal benefits under huschen, and Walliser 2000) and Spain (Collado, most scenarios, while immigrants arriving in their late Iturbe-Ormaetxe, and Valera 2004).
assumption is that new migrants receive the taxes.26 In this case natives in high-income same amount in public benefits as the average countries would lose $85 billion in aggregate household in the destination country. This public goods and services, although this would imply a net positive transfer to the new amount would not translate one-for-one into a migrant households, since they would receive benefit for new migrants due to the cost-of- more in public benefits than they paid in living adjustment. These simulations underline
40 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
the effect of public policy on the distribution those from an increase in migration, and those of gains from migration. from global trade reform—are scaled to the same reference year, 2001, the gains from trade reforms are $155 billion versus $175 bil- Additional gains from migration lion from the migration scenario.29 This can be substantial leaves little doubt that easing restrictions on The gains for migrants from this scenario the movement of labor could provide a sig- essentially provide the same message as ear- nificant boost to the global economy. More- lier estimates. In their seminal paper, Walmsley over, in comparison with the most recent and Winters (2003) estimate that a relax- work on global merchandise trade reform, ation on the movement of temporary work- the gains from an increase in migration are ers on the same order as that modeled more balanced toward income increases for here—that is, 3 percent of the labor force of developing countries relative to developed the high-income countries—would yield countries. In a study by Anderson, Martin, global income gains of $150 billion (using a and van der Mensbrugghe (2005), the gains 1997-based comparative static model). The to high-income and developing countries are result from our scenario that is roughly 0.6 and 0.8 percent, respectively, relative to comparable to their figures (that is, global baseline income. In the scenario modeled gains before adjustment for cost of living here, the income increases are 0.4 percent and measured relative to 2001, rather than for native households in high-income coun- 2025) are more than double their results.27 tries and 1.8 percent for developing coun- However, our figures are comparable with tries (including the new migrants). the more recent work done by Walmsley and her colleagues.28 One of the key reasons for the increase in the global welfare impact Returns to factors of production is a reevaluation of the assumed wage dif- our critical factors determine the distribu- ferential between the home and host coun- Ftion of gains from migration among skilled try. In their initial work, Walmsley and workers, unskilled workers, and owners of Winters had assumed that new migrants capital: (a) the size of the increase in migra- made up 50 percent of the difference be- tion; (b) the distribution of nonwage income tween the home and host country’s wages. (profits); (c) the degree of substitution between Their new assumption (used in our model as workers by region of origin; and (d) the degree well) is 75 percent, based in part on the fact of substitution or complementarity between that the migrants are permanent rather than workers and capital. We have already posited temporary. Hamilton and Whalley (1984) that the increase in migration is large, with an and Moses and Letnes (2004) have shown average increase in the migrant labor force of that removing all restrictions on labor around 50 percent over a 20-year period, and movement, admittedly not a realistic sce- comparable (if somewhat less) to the rise in the nario, would yield a huge increase in world share of migrants in high-income country pop- output. Overall, these papers suggest that ulation over 1970–2000. In the absence of any labor-market restrictions are imposing a specific data on the source of migrant income, much larger burden on the global economy we assume that migrants—both existing and than are trade restrictions. The World Bank’s new—receive no nonwage income. In essence, trade model suggests that removing all re- their real income will be driven by changes in maining merchandise trade barriers would wages. The effects of this simple assumption yield $287 billion in global real income gains on the distribution of gains are significant, and in 2015. For the purpose of comparison, when the implications of relaxing it are discussed the gains from the two different scenarios— below.
41 GLOBAL ECONOMIC PROSPECTS 2006
Substituting between migrant and native empirical evidence of the extent to which mi- workers determines who gains grants are substitutes for natives or for exist- The key issue of who reaps the benefits in- ing migrants is sparse. Thus in addition to volves the degree of substitution among dif- exploring the implications of the assumptions ferent workers. The allocation of demand for made, we also devote attention to alternative workers assumes differentiation among work- assumptions. ers from different regions. This is done in two Finally, in a departure from previous steps. First, “similar” workers are bundled to- work but in line with a developing consen- gether into “native” workers and “foreign- sus, we assume that skilled workers are near born” workers.30 In the second step, these complements with capital (meaning that they two bundles are decomposed into labor de- are more productive, and thus earn higher mand by region of origin. We assume that returns, when used together with capital), there is more differentiation between a native whereas unskilled workers are substitutes and a foreign-born worker (that is, a lower for capital and skilled labor.32 This specifi- substitution elasticity) than between two cation has important consequences for the workers from different countries of origin distributional impacts of increased migra- within each of the two aggregate bundles. For tion. Whereas investment rises with in- example, in the case of the United States, em- creased income, the overall increase in the ployers see a greater difference between a U.S. stock of capital is modest, so that the rise in worker and a generic immigrant from a devel- the supply of skilled workers is not matched oping country than between a Mexican and a by an equivalent increase in capital. Thus the Salvadoran worker. The implication is that a marginal productivity of additional skilled rise in the supply of migrants has a greater im- workers declines, provoking a decline in the pact on old migrants than on native workers, wage of skilled workers (by more than the which plays a key role in the distributional fall in the wages of unskilled workers). outcomes of the increase in migration. The assumption of labor demand differentiation Increased migration can generate operates for both skilled and unskilled labor substantial changes in income distribution in the model. among workers and owners of capital In the default case, we assume that wages The change in factor returns is depicted in are flexible, with a substitution elasticity be- figure 2.5. In the high-income countries only tween unskilled migrants and natives that is roughly comparable to that implied in the Figure 2.5 Factor returns and migration conclusions of the meta analysis in Longhi, % change in factor returns, 2025, relative to baseline Nijkamp, and Poot (2004); they conclude 10 that a “one percentage point increase in the Developing countries 5 proportion of immigrants in the labor force lowers wages across the investigated studies 0 by only 0.119 percent.” (See box 2.4 for a re- 5 view of empirical studies of the impact of mi- 10 gration on wages.) In the scenario described 15 High-income here, the 50 percent increase in the stock of 20 countries migrants raises their proportion of the labor 25 force by about 3 percentage points, produc- Capital Unskilled Unskilled Skilled Skilled native foreign- native foreign- ing a 0.5 percent decline in the wages of na- workers born workers born tives.31 We also assume perfect substitution workers workers
between new and old migrants (the large ma- Source: World Bank simulations. jority of both categories being unskilled). The
42 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
Box 2.4 Empirical studies of the impact of immigration on wages
ost cross-sectional studies find that immigrants increased the unemployment rate by 0.2 percentage Mhave no impact, or a very limited impact, on points. This shows more adjustment through em- the wages or employment of natives (LaLonde and ployment than through earnings compared to U.S. Topel 1997 and Borjas, Freeman, and Katz 1997 for studies, which may be due to French rules governing the United States; Pischke and Velling 1994 for wages (Dustmann and Glitz 2005). The comparison Germany). However, cross-sectional approaches re- underlines the importance of the investment climate, late wage differences across local labor markets to and in particular, labor-market flexibility, in the effi- the share of immigrants in each market. If immi- cient absorption of migrants. Some studies show that grants are attracted to high-wage areas, which is immigration reduces native unemployment in the likely, it is difficult to identify the exogenous impact long term (Poot and Cochrane 2004), presumably of immigrants on wages.a Studies of sudden, politi- because increased consumption demand from immi- cally driven inflows of immigrants likewise fail to de- grants raises the demand for labor.d tect a significant impact on natives’ wages or employ- ment in affected areas.b However, native workers Thus some articles support the view that unskilled may adjust to large, sudden inflows of immigrants by immigrants are relatively close substitutes for native moving to other areas (or through reduced inflows workers (without attempting to distinguish between from other areas), again obscuring the relationship the effects on native workers and old migrants). How- between immigration and labor-market outcomes.c ever, the share of low-skilled native workers in desti- This problem has encouraged the use of panel nation countries is falling. The share of U.S. adults techniques that can discern the combined effects of with less than a high-school education declined from time and cross-sectional effects. Some panel studies 47 percent in 1970 to 22 percent in 1998 (Massey have found a significant impact on the wages of un- 2000). About 90 percent of new native entrants to the skilled natives, who in addition have suffered de- U.S. labor force in 2004 had completed high school clines in wages due to skill-biased technical change (U.S. Labor Survey 2005). By contrast, the average and increased trade. Borjas (2003a), analyzed the im- migrant from rural Mexico has six years of education pact of immigration in the United States across dif- and does not speak English (Mora and Taylor 2005). ferent levels of skills and experience and estimates Many low-skill immigrants may have such limited ed- that immigration reduced the wages of native high- ucation and language skills that they do not compete school dropouts in the United States by 8.9 percent with native low-skilled workers at all, but instead from 1980 to 2000. Jaeger (1996) finds that immi- take jobs that natives are unwilling to do. In this view, gration lowered the real wage of U.S. high-school the rise in immigration in high-income economies dropouts by as much as 3.6 percent in the 1980s. since 1980 has been accompanied by increases in na- DeNew and Zimmermann (1994) find that a one tive educational levels; essentially natives moved out percentage point rise in the share of migrants in the of certain kinds of jobs, creating a demand for immi- labor force reduces the wages of blue-collar workers grant labor. by almost 6 percent. By contrast, Dustmann and oth- ers (2003) find that immigration has little impact on native wages (or employment) in the United aThe researchers do attempt to correct for endogeneity by Kingdom, including for the low-skilled. using instrumental variables. Where wages are relatively inflexible, an inflow of bExamples include the Mariel boatlift from Cuba (Card migrants may affect employment levels rather than 1989), the repatriation of Algerians of European origin to France wages. Angrist and Kugler (2002) find that increased (Hunt 1992), the inflow of workers to Austria after the break- immigration in Europe is associated with a signifi- down of the communist regimes (Winter-Ebmer and Zweimuller 1999), and the return of Portuguese from Africa in the 1970s cant decline in native employment, particularly for (Carrington and de Lima 1996). the low-skilled. Hunt (1992) finds that a one per- cStill, Card (2001) finds no evidence that immigration into centage point rise in the share of immigrants in the an area leads to offsetting net outflows of workers. French labor force (following Algerian independence) dSee Gross (1999) for this result for France.
43 GLOBAL ECONOMIC PROSPECTS 2006
capital enjoys an increase in returns under the larger than skilled migration, so that the wage model—with wages declining for all labor impact of unskilled migration is easier to de- categories, skilled and unskilled, native and tect in empirical work. Second, the shock foreign-born. With essentially only a labor modeled here represents a one-time increase in shock, the scarcity value of capital increases. skilled migration that is larger than the exist- The negative impact on unskilled native wages ing stock, which has built up over time. And is small, at around 0.3 percent, depending on third, the model assumes little change in the the assumed elasticity of substitution between capital stock, while increased investment in re- migrant and native workers.33 The greater sponse to migration would dampen the fall in impact is felt by existing, unskilled migrants, skilled wages, a point to which we return in whose wages decline by more than 10 per- the conclusion to this chapter. cent.34 At least two factors mitigate that The impact in developing countries is decline. First, labor markets are not com- nearly the reverse. Capital returns suffer and pletely segmented, so that part of the adjust- labor returns improve, with larger improve- ment falls on native workers. Second, other ments for skilled workers than for unskilled general equilibrium effects are at work, such workers. The magnitudes differ because the as a relative shift in the demand for unskilled relative size of the shock differs. For example, workers as the price of capital (combined with the decline in unskilled workers in developing skilled labor) rises and a relative shift in de- countries is only 0.3 percent, versus 1.7 per- mand toward goods that use unskilled labor cent for skilled workers. intensively, raising the relative demand for un- Assuming that all capital income accrues skilled workers. to native households, native households in The impact of the shock on the wages of high-income countries are on aggregate better skilled workers is greater than for unskilled. off after the shock, with real incomes increas- Wages decline by 1.1 percent on average for ing by 0.4 percent. That is, the increase in skilled natives, significantly more than for capital income more than offsets the loss in unskilled natives. Old skilled migrants suffer a wage income. Part of the old migrants’ 6 per- wage decline of 20 percent, which is double cent decline in real income is due to the as- that of old unskilled migrants. The impact on sumption that they own no capital, so enjoy skilled workers is larger than for unskilled no nonwage income.35 An alternative, ex- because skilled workers are assumed to be near treme assumption is that on a per capita basis, complements with capital; with capital in- old migrants receive the same amount of non- creasing only slightly, this would tend to drive wage income as natives. This alternative down skilled wages. And the impact is largest would reduce old migrants’ loss to 3.4 percent on old skilled migrants because the rise in of base real income. migration of skilled workers is large relative to To summarize, the new migrants are the stock of old skilled migrants, and the new clearly the large winners, particularly in per- migrants are assumed to be closer substitutes centage terms. Under the assumptions of the for skilled migrants than are native workers. model, existing migrants are likely to be The greater impact of migration on skilled losers—though the extent of their loss will than unskilled wages is not at first sight con- depend on their degree of substitutabil- sistent with the limited evidence available. In ity with native workers and their share of those studies that find any significant impact nonwage income. Native households in both of migration on native wages, the largest im- high-income and developing countries are pact tends to be on unskilled wages (see better off. The sources of their gains, though, above). Our seemingly contrary result arises are very different (figure 2.6). In the high- for three reasons. First, unskilled immigration income countries the gains are generated by to high-income countries has been much higher returns to capital—somewhat offset by
44 THE POTENTIAL GAINS FROM INTERNATIONAL MIGRATION
Figure 2.6 Source of gains for native workers
Native workers in high-income regions Native workers in developing regions
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