CHAPTER 8

8-1. Suppose a worker with an annual discount rate of 10 percent currently resides in
Pennsylvania and is deciding whether to remain there or to move to Illinois. There are three
work periods left in the life cycle. If the worker remains in Pennsylvania, he will earn
$20,000 per year in each of the three periods. If the worker moves to Illinois, he will earn
$22,000 in each of the three periods. What is the highest cost of migration that a worker is
willing to incur and still make the move?

The worker must compare the present value of staying in Pennsylvania to the present value of
moving to Illinois. A worker will move if the present value of earnings in Illinois minus the costs
of moving there exceed the present value of earnings in Pennsylvania:

20,000 20,000
PV PA  20,000    $54,710.74
1 .1 (1.1) 2
and
22,000 22,000
PV IL  22,000    $60,181.82
1 .1 (1.1) 2

The worker will move, therefore, if

PVIL – C > PVPA,

where C denotes migration costs. Thus, the worker moves if

C < 60,181.82 - 54,710.74 = $5,471.08

8-2. Suppose high-wage workers are more likely than low-wage workers to move to a new
state for a better job.

(a) Explain how this migration pattern can be due solely to differences in the distribution of
wages.

Suppose migration costs are the same for all workers at $3,000. Suppose further that all low-
wage workers are paid either $20,000 or $22,000 depending on productivity and location, and
that all high-wage workers are paid either $40,000 or $45,000 depending on productivity and
location. The immediate result is that no low-wage worker will ever migrate, while all high-wage
workers who are not already earning $45,000 will migrate to a location where they are valued at
$45,000.

(b) Explain how this migration pattern can take place even if the cost to moving is greater
for high-wage workers.

What matters is the difference in wages due to migration and the cost of migration. In the
previous example, for instance, even if the cost to migration was $4,000 for high wage workers
while it remained at $3,000 for low-wage workers, the same pattern of no low-wage workers
migrating and all high-wage workers migrating until they earn $45,000 emerges.

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8-3. Patrick and Rachel live in Seattle. Patrick’s net present value of lifetime earnings in
Seattle is $125,000, while Rachel’s is $500,000. The cost of moving to Atlanta is $25,000 per
person. In Atlanta, Patrick’s net present value of lifetime earnings would be $155,000, while
Rachel’s would be $510,000. If Patrick and Rachel choose where to live based on their joint
well-being, will they move to Atlanta? Is Patrick a tied-mover or a tied-stayer or neither?
Is Rachel a tied-mover or a tied-stayer or neither?

As a couple, the net present value of lifetime earnings of staying in Seattle is $500,000 +
$125,000 = $625,000 and of moving to Atlanta is $510,000 + $155,000 – $50,000 = $615,000.
Thus, as a couple, they would choose to stay in Seattle, and there can be at most one tied-stayer.
(There cannot be a tied-mover because the couple is not moving, and there can never be two-tied-
stayers in a two-person household as if both individuals wish to move then they will opt to
move.)

For Patrick, staying in Seattle is associated with a net present value of $125,000, while moving to
Atlanta would yield a net present value of $155,000 – $25,000 = $130,000. So Patrick would
choose to move to Atlanta. Therefore, Patrick is a tied-stayer.

For Rachel, staying in Seattle is associated with a net present value of $500,000, while moving to
Atlanta would yield a net present value of $510,000 –$25,000 = $485,000. So Rachel would
choose to remain in Seattle. Thus, Rachel is not a tied-stayer.

8-4. Labor demand for low-skilled workers in the United States is w = 24 – 0.1E where E is
the number of workers (in millions) and w is the hourly wage. There are 120 million
domestic U.S. low-skilled workers who supply labor inelastically. If the U.S. opened its
borders to immigration, 20 million low-skill immigrants would enter the U.S. and supply
labor inelastically. What is the market-clearing wage if immigration is not allowed? What
is the market-clearing wage with open borders? How much is the immigration surplus
when the U.S. opens its borders? How much surplus is transferred from domestic workers
to domestic firms?

Without immigration, the market-clearing wage is $12 as 24 – 0.1(120) = $12, at which all 120
million low-skill U.S. workers are employed. With immigration, the market-clearing wage is $10
as 24 – 0.1(140) = $10, at which all 120 million low-skill U.S. workers and all 20 million
immigrants are employed. The additional surplus received by the U.S. because of the immigration
equals ($12 – $10) (140m – 120m) / 2 = $20 million. The total transfer from U.S. workers to U.S.
firms because of the immigration equals ($12 – $10) (120m) = $240 million.

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8-5. Suppose the United States enacts legislation granting all workers, including newly
arrived immigrants, a minimum income floor of yy dollars. (Assume there is positive
selection of migrants from the home country to the U.S. before the policy change.)

(a) Generalize the Roy model to show how this type of welfare program influences the
incentive to migrate to the United States. Ignore any issues regarding how the welfare
program is funded.

The introduction of a wage floor in the United States (at y) shifts the U.S. earnings-skill
relationship from the straight line (U.S.) to the bold line (kinked) drawn in the figure below. The
welfare program does not affect the incentives of foreigners with high or even moderate skills.
However, it does affect the incentives of those with the least skills as they earn very little in the
home country and now can come to the United States and benefit from the welfare benefit.

U.S. Labor Market

U.S.
Dollars
Home
Country

y
αO

αU Move Don’t Move Move

sL SH Skills

(b) Does this welfare program change the selection of the immigrant flow? In particular, are
immigrants more likely to be negatively selected than in the absence of a welfare program?

As drawn above, before the welfare program was enacted there was only positive selection in
terms of immigration to the United States. With the welfare benefit in place, though, foreigners
with skills below sL now also find it profitable to migrate. Thus, the selection of immigrants
becomes more negative. In fact, it is a bimodal distribution – foreigners with the highest skills
continue to migrate and now those with the lowest skills also choose to migrate.

(c) Which types of workers, the highly skilled or the less skilled, are most likely to be
attracted by the welfare program?

As the returns to skills are higher in the United States, there are two sets of workers who find it
profitable to move: those who have very high skill levels (above sH) as well as those workers who
have very low skill levels (below sL). The welfare program, therefore, acts as a welfare magnet
for workers originating in countries that generate “brain drains”, but not in countries where
unskilled workers have incentives to migrate even in the absence of wage floors.

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8-6. In the absence of any legal barriers on immigration from Neolandia to the United
States, the economic conditions in the two countries generate an immigrant flow that is
negatively selected. In response, the United States enacts an immigration policy that
restricts entry to Neolandians who are in the top 10 percent of Neolandia’s skill
distribution. What type of Neolandian would now migrate to the United States?

No one would migrate from Neolandia. The policy does not change the cost-benefit analysis for
the most skilled Neolandians. They did not want to migrate when they could enter the country
freely, and they still will not want to migrate when they are the only ones who can obtain visas.
The lesson is that changes in immigration policy affect the skill composition of the immigrant
flow only if changes target immigrants who wished to migrate to the United States in the first
place or provide a new incentive to those who did not.

8-7. There are two reasons why the immigration surplus is greater when immigration is
accompanied by human capital externalities compared to when there are no human capital
externalities associated with immigration. Both reasons are evident in Figure 8-12. The first
is represented by triangle BCD. The second is represented by trapezoid ABEF. Explain the
underlying source of each area. Explain why human capital externalities are important to
each region.

Triangle BCD represents the additional benefit domestic firms receive from employing
immigrants. This is compared to the much smaller triangle equal to the change in immigrants
times the change in the wage (times one-half) that would have resulted had the demand for high-
skilled workers (in this case, high-skilled immigrant labor) had not increased due to the human
capital externalities.

Trapezoid ABEF represents the additional benefit domestic firms receive from employing high-
skilled domestic workers which comes about because of human capital externalities. This
trapezoid exists only because demand for high skilled workers increased because of immigration.

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8-8. In addition to it being illegal to enter the U.S. without a visa or to over-stay one’s visa, it
is also illegal for U.S. employers to hire undocumented or “illegal” immigrants. Meanwhile,
federal U.S. enforcement of immigration laws tends to concentrate resources on reducing
illegal immigration rather than on prosecuting U.S. firms for employing undocumented
workers. Using supply and demand analysis, show what would happen to the wage and
employment level of undocumented workers if the government pursued more active
enforcement of employers. According to your model, what would happen to the wage and
employment level of documented workers?

This problem is best answered by considering two labor markets concurrently – the market for
undocumented workers and the market for documented workers. Focusing enforcement on the
employers (i.e., fining employers caught employing undocumented workers) would decrease the
demand for undocumented workers. Essentially, if the cost of hiring undocumented workers
increases because of potential fines, then in order to hire the same number of such workers, the
wage will need to fall.

What would happen in the market for documented workers is a little unclear. Certainly
employment wouldn’t fall, nor would wages. One could make the argument that nothing would
happen in this market. (For example, maybe an employer will replace all undocumented workers
with machines.) However, more likely is that the demand for undocumented workers will
increase, not because such workers are all of a sudden more productive, but rather because the
legal cost of hiring such workers has fallen, at least relatively.

In the analysis below, it is assumed that the enforcement mechanism lowers the demand for
undocumented workers and increases the demand for documented workers. The result is that the
employment and wage of undocumented workers both fall while the employment and wage of
documented workers both increase.

Market of Undocumented Workers Market for Documented Workers

Wage

ED0 ES ED1 ES

WU0 WD,1

WU1 WD0

ED1 ED0

EU1 EU0 Undoc. Wkrs ED0 ED1 Doc. Wkrs

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8-9. Under 2001 tax legislation enacted in the United States, all income tax filers became
eligible to deduct from their total income half of their expenses incurred when moving more
than 50 miles to accept a new job. Prior to the change, only tax filers who itemized their
deductions were allowed to deduct their moving expenses. (Typically, homeowners itemize
their deductions and renters do not itemize.) How would this change in tax policy likely
affect the mobility of homeowners and renters?

The policy change has no effect on homeowners, whereas the policy change reduces the cost of
moving for renters. Therefore, the policy is predicted to increase the mobility of renters.

8-10. Suppose the immigrant flow from Lowland to Highland is positively selected. In order
to mitigate the “brain drain” Lowland experiences as a result of this migration, public
officials of Lowland successfully convince all Lowlanders who migrate to Highland to remit
10 percent of their wages to family members.

(a) What effect will this policy have on the immigrant flow?

The policy, in essence, increases the cost of migration. In particular, the policy convinces
everyone who is thinking about immigrating to act as if their wage in Highland will be 90% of
what it actually is because immigrants “must” remit 10% of their earnings.

(b) Provide a graph that details the extent to which this policy will limit the brain drain.

The implication is that fewer people will immigrate from Lowland to Highland, with the action
taking place on the margin (section A in the graph below). Thus, the policy limits the brain drain
partially as some high skill people who otherwise would have immigrated no longer do.
However, the policy will not prevent the most skilled people from still immigrating. Thus,
Lowland still experiences brain drain of its best people.

Return to Skill in
Highland Pre-Policy Return to Skill in
Earnings Highland Post-Policy

Return to Skill in
Lowland

A B
Skills

In the graph above, Lowlanders with skills in A or B immigrate to Highland before the policy.
After the policy, those in B still immigrate, but those in A no longer opt to do so.

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8-11.

(a) According to standard migration theory, how will skill selection (positive vs. negative)
change on average as the distance between the source country and the destination country
increases?

The further two countries are apart from each other, the greater are the monetary costs of
migrating just in terms of traveling to the destination country, but also in terms of returning home
for visits, possibly in terms of culture, etc. Thus, skill selection should be more and more
positively selected the further the home country is from the destination country.

(b) Does Table 8-2 lend empirical support for the idea that skill selection is a monotonic
function of the distance between countries?

There is some evidence supporting the standard migration theory, but there is certainly no
evidence that the relationship is monotonic. Case in point: the average wage differential for
Canadians who migrate to the U.S. is +24.5 while it is -39.5 for Mexicans. (If the theory held
perfectly, the number for Canadians would also be large and negative.) Similarly, the average
wage differential for Indians who migrate to the U.S. is +17.6 while it is -18.9 for Vietnamese.
(If the theory held perfectly, the number for Vietnamese would also be large and positive.)

8-12.

(a) Explain how a universal healthcare system would likely cause a greater amount of
efficient turnover.

Presently, many Americans receive employer-based health insurance. That is, employers pay a
portion (or all of) the insurance premiums. The benefit of health insurance, therefore, would be
lost if the employee separates from the job. In particular, many people would refuse to leave one
job with health insurance benefits for another (even higher paying) job without health insurance
benefits simply because of the risk. Under a universal healthcare system, everyone receives
health benefits regardless of employment. Thus, workers would not feel tied to a particular job
simply because they were currently receiving benefits. Consequently, a universal healthcare
system would likely cause a greater amount of efficient labor turnover as workers seek out better
employer matches without worry about losing healthcare benefits.

(b) Defined-benefit retirement plans promise a fixed amount of retirement income to

workers, but in order to receive benefits workers must be vested in the plan which usually
requires working at the firm for 10 or 15 years. In contrast, a defined-contribution
retirement plan specifies a fixed amount of money the firm contributes each pay period to a
worker’s retirement fund which the worker then largely controls and can access even if she
changes jobs. Do defined-benefit or defined-contribution retirement plans allow for more
efficient turnover? How is the social security system in the United States like a defined-
benefit plan? How is it like a defined-contribution plan?

Defined-contribution retirement plans allow for more efficient labor turnover, because the money
(i.e., value of the benefit/asset) is in the employee’s control and belongs to the employee even
after separating from the job. So, just like in part (a), a defined-contribution plan follows the
worker from job to job just like a universal healthcare system would, while a defined-benefit plan

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that requires the employee to become vested with the plan ties the employee to the firm just like
employer provided health insurance.

Social security is like a defined-benefit plan in that one’s benefits are tied, in part, to work history
and one’s contributions to the system. Social security is like a defined-contribution plan,
however, in that the benefits and contributions are linked specifically to the individual employee
and moves with the employee from job to job.

(c) When federal workers in Washington D.C. move jobs from one federal agency to
another, the worker keeps her same health insurance and retirement benefits. In order to
quantify the degree to which ease of transfer of benefits affects turnover, two groups of new
economists Ph.Ds. who accept a job in Washington D.C. are observed. The first group
contains US citizens. The second group contains non-US residents who eventually received
permanent resident status after 3 years of work experience. By law, several government
agencies cannot hire non-residents. Among the group of US citizens, 42 percent changed
jobs within the first 3 years of work while 33 percent changed jobs during their fourth to
sixth years of work. Among the group of non-US residents, 17 percent changed jobs in the 3
years before becoming a resident while 29 percent changed jobs in the 3 years after
becoming a US resident. Provide a difference-in-differences estimator of the effect of being
a US resident/citizen in Washington D.C. for Ph.D. economists.

The data generate the following table (on the next page).

Group Turnover Turnover

Years 0 – 3 Years 4 – 6 Difference Diff-inDiff
U.S. Citizens 0.42 0.33 -0.09
Non-Citizens 0.17 0.29 +0.12 +0.21

Receiving a green card, which opens up job possibilities, therefore, is associated with a turnover
rate that is 21 percentage points higher.

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8-13. The Immigration Reform Act of 2006 provided fewer work visas than were available
in previous years for college graduates to remain in the United States. The exception is that
work visas remained plentiful for college graduates who majored in technical areas such as
math, computer programming, and physics.

(a) How will this policy likely affect the skill distribution of immigrants to the United States
and the age-earnings profile of immigrants in the United States?

The policy favors high-tech college majors, not so much in terms of attracting them to the United
States but rather in terms of allowing them to stay once they were educated in the United States.
Thus, the policy will likely allow more high-tech (high-skill) immigrants to stay in the U.S. while
requiring others to leave the U.S. after college. Measured in terms of wages, therefore, the policy
will likely result in a greater positive skill-selection and result in a higher age-earnings profile of
new immigrants. The profile for the year 2000 cohort may be steeper as well, but that is not so
clear.

(b) In the future a demographer uses the 2010 U.S. census to study immigrant wages and
concludes that the U.S. policy actually had the unintended consequence of attracting
immigrants with lower levels of productivity as shown by a flatter age-earnings profile.
Using a graph similar to Figure 8-5, show why the demographer’s conclusions are sensitive
to cohort effects.

Dollars 2000 Wave

1990 Wave

Cohort Implied Age-

Earnings Profile

Age
22-28 32-38

In 2010 when using cohort analysis, the age-earnings profile will appear to be flatter than during
similar previous studies. This is because the average wage of 20-something immigrants presently
will be higher than it would have been without the policy and therefore the profile between 20-
somethings and 30-somethings will appear to be less steep. Put differently, because of the higher
earnings of the younger cohort, the age-earnings profile implied by the 1990 and 2000 cohorts
appears to be very flat.

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8-14. KAPC, a pharmaceutical company located in rural Kansas, is finding it difficult to
retain its employees who frequently leave after just six months of working at KAPC for jobs
at pharmaceutical companies paying higher wages in Chicago. To address its problem with
labor turnover, human resource officers at KAPC decide to run an experiment. Of their
next 100 newly hired employees, 25 will randomly be selected to receive a housing voucher
worth up to $4,000 per year to offset property taxes. To take advantage of this program,
the employee must not only be randomly selected into the program but she must also
purchase a home. Of the 25 employees selected into the housing voucher program, 7 leave
KAPC within 12 months of starting. Of the 75 employees not selected into the program, 37
leave KAPC within 12 months of starting.

(a) Provide an estimate of the effect the housing voucher program has on retention at
KAPC.

The problem doesn’t give quite enough information to perform a pure diff-in-diff estimation, but
we can make one simple assumption and then generate the results. The assumption is that 49.3%
(37 out of 75) of all new employees leave KAPC within 1 year of being hired if they are not
given a housing subsidy, and this rate applies pre- and post- subsidy. The data are now:

Leave in 1 Year Leave in 1 Year

Group Pre-Experiement Post-Experiment Difference Diff-in-Diff
Control Group 0.493 0.493 0.00
Rec. Subsidy 0.493 0.280 -0.213 -0.213

Notice that although the table above makes the estimate look like a difference-in-differences
estimate, it really is just a difference estimate. That said, the policy seems to have a striking
effect, reducing the probability someone leaves KAPC in the first year by 21.3 percentage points.

(b) Suppose KAPC spends $10,000 in hiring costs each time a position is vacated. Would
you endorse expanding the housing voucher program to all new employees? Justify your
decision.

Consider 100 hires. Without the housing subsidy, KAPC expects to pay $10,000 on each hire
and, after one year, to have 51 (50.7%) of these workers remain. Thus, it costs $1 million to hire
51 workers.

With the housing subsidy, as 72% of those hired remain, KAPC needs to hire 51 ÷ 0.72 = 71
workers in order to have 51 remain employed after one year. Thus, KAPC spends $710,000 on
hiring costs. However, it also gives each worker a subsidy of $4,000, which totals $284,000. The
total cost, therefore, is $994,000.

By the slimmest of margins, therefore, the policy is economically justifiable. If the housing
voucher is renewable, however, then the policy is not efficient as KAPC would end up paying the
remaining 51 workers each an additional $4,000 per year.

Lastly, the problem never specifies what percent of people who are offered the voucher actually
use it (i.e., actually buy a house). Thus, $784,000 is highest possible cost to the program.

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8-15. Consider the Roy model of potential immigrant flows as discussed in the chapter.

(a) Why is it that a source country can experience both an outflow of low-skill workers and
an outflow of high-skill workers at the same time?

In reality a source country will experience an outflow of low-skill and high-skill workers at the
same time because of individual preferences – some people will want to immigrate regardless of
the skills issue.

In theory and in practice, however, a source country can experience an outflow of low-skill and
high-skill workers at the same time because the returns to skills in the two countries are not linear
as the model in the text suggests. In the United States, for example, the returns to low-skills may
be much greater than in Mexico. At the same time, the returns to high-skills may also be much
greater in the United States than in Mexico. In the middle, though, the returns may be relatively
higher in Mexico. If so, then Mexico will experience an outflow of low-skill and high-skill
workers.

(b) Provide a graph of the returns to skills in the destination and source countries that
would suggest both behaviors occur simultaneously.

Returns in Destination Country

Returns in Source Country

Move Don’t Move Move Skills

(c) How do the social and economic (i.e., tax) policies of the United States encourage both
types of flows?

The policies of the United States may encourage both types of flows in that the social safety net,
working conditions, etc. are better for low-income, low-skill workers in the United States than in
Mexico. At the same time, the highest tax rate is only 35% and wealth and liberty are well-
protected for everyone (including the wealthy) in the United States. In combination, these
policies likely attract the lowest-skilled and highest-skilled Mexicans.

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