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The fallacy of immigration inflation
Fri 31 Aug 2007 by Matt Nolan.

The Reserve Bank of New Zealand wishes to reduce immigration to ease inflationary pressures.   But blaming immigrants for inflation when we have a tight labour market makes as much sense as thanking the horde of New Zealanders moving to Australia for reducing inflationary pressure.   Although migrants increase demand for goods, they also bring with them a number of types of capital (physical, intellectual, and financial) that can increase the economy’s capacity and thereby ease inflationary pressure.

Beyond inflation, the government has other social and political goals from immigration.   These goals are primarily met through the family reunification and refugee immigration programmes.   Although these groups may impose some economic burden in the short run, the government is willing to accept this in order to achieve its social and political goals.

The target group associated with the government’s strictly economic goals is the skilled labour group.   Over the past year, 13,440 skilled labour applications were approved to enter the country, making up 48% of total primary residential migrant applications.   As any change in government policy to accommodate inflation through immigration would occur by changing the size of this migrant group, it is appropriate to focus on the inflationary effect of these migrants.

  1. By increasing the number of consumers, demand for goods rises, thereby putting upward pressure on prices.
  2. Increasing the number of workers in a labour-short economy will increase the supply of goods and services, thereby putting downward pressure on prices.

Both these arguments make sense.   However, this raises the question, is current government policy conducive to an increase or decrease in inflation through immigration?

The housing market offers a prime example of immigration stoking inflation by creating additional demand for products.   The rate of growth in immigration has undoubtedly contributed to the rate of growth in house prices, as a sudden unexpected leap in immigration in 2003/203 led to an increase in demand for houses.

On the other side, an increase in immigration can drive down inflation by increasing the supply of labour, especially sectors of the economy constrained by skill shortages.   New Zealand has been in a state of constant labour shortage for a number of years.   The most recent Department of Labour survey on labour shortages found that all nine of the major occupation groups were suffering from a shortage of labour.

A shortage of labour drives up wages for those required skills.   To compensate for the increased cost of labour, employers need to put up the price of the goods and services they produce.   By allowing skilled migrants into the country to fill skill gaps, we alleviate the upward pressure on prices.

Furthermore, working migrants increase the set of resources that a country has.   A larger supply of resources allows a country to produce more goods and services, which will have a downward effect on inflation.   In a situation where there is a severe shortage of labour the extra production created from a new worker is substantial, implying that the disinflationary impact of a skilled migrant can be significant.

How can we weigh up the counteracting influences that immigration has on the rate of inflation?

A common argument is that immigration takes time to increase the supply of goods, implying that inflation is driven up in the short-run, but eases back in the medium-term.   But statistics on immigration application approvals suggest that skilled migrants move quickly into work.     Over the last year nearly one third of applications that have been approved under the Skilled Migrant Category had job offers before they entered the country.   Furthermore, many of the remaining two-thirds of approved applications were for applicants that were qualified in occupations in which there is an "absolute shortage" of that skill domestically, implying that they should be able to find work relatively quickly.

As new skilled migrants are able to quickly move into work, their inflationary impact depends on how much they additional product they produce compared to how much they consume.   If the majority of new migrants are moving straight into work in areas of the economy that are short of labour, migration will significantly improve national production and drive down inflationary pressures.   Given the long-term nature of the labour shortages in New Zealand, the migration of skilled labour is more likely to decrease inflationary pressure rather than increase it.

Ultimately the Reserve Bank’s focus should be on the root causes of our inflationary woes: inflated domestic demand, poor productivity growth, and a wasteful government sector.

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