The theory of capital adjustment

Up to now, the analysis has been largely static, with capital and wealth regarded as fixed. It is necessary now to look at the dynamic effects on capital and wealth.

This is contained within the theory of capital adjustment following an influx of immigrants, since this is the core argument of pro-immigration economists that immigration benefits natives – or at any rate does not harm them. Though John Meadowcroft of the Institute of Economic Affairs has stated that immigration will make a country richer on account of making available ‘freed capital to be put to more productive use elsewhere’, it is important to note that this is not a claim made by the American immigration experts.[26]

Any arguments that migration benefits native workers centre on the increased returns to capital, which create a fresh demand for workers and a new equilibrium, with higher levels of capital and employment (but not higher amounts of capital per head).

It should be noted that the leading American academics, such as the NRC and Professor Borjas, do not claim that the increased returns to capital will do any more than restore native wages to the pre-immigration level. In its second major study, entitled The Immigration Debate, the NRC stated: ‘We are not, of course, suggesting that immigration caused an improvement in real wages.’[27] This fits in logically with the NRC analysis quoted earlier, demonstrating that, once immigrants acquire skills and capital similar to those of the natives, the economy will simply enlarge pro rata. So the American academics (and, incidentally, the Dutch Economic Institute) believe that increased returns to capital are only effective up to the point at which immigrants have the same skills and capital as natives.

This must be the logical conclusion.

Furthermore, the NRC states:

As already mentioned, in the short run the influx of new labor is likely to depress the capital–labor ratio before it is restored through new investment. If the capital stock is disproportionately owned by native-born residents…then native-born owners of capital will benefit temporarily from higher returns to capital. Indeed, it is this higher return to capital that (in part) is thought to induce an increased volume of investment that ultimately restores the capital–labor ratio to its pre-immigration level.[28]

The theory of capital adjustment makes it clear that money taken away from native workers is used to fund the capital required by immigrants. Capitalists are an intermediary in this process.

The argument (and, once again, it must be emphasized that this is not suggested by the NRC or by Professor Borjas) that immigration benefits natives through the mechanism of capital adjustment has formidable hurdles to surmount. To start with, nearly all economic theorists – as the Dutch Economic Institute states and the NRC concludes – believe migration in the short run, with capital fixed, reduces the earnings of natives and increases the return to capital.

In its study, the NRC outlines the mechanism by which migration restores the capital–labour ratio: by initially depressing natives’ wages, increasing returns to capital, drawing in more capital, and thus establishing a new equilibrium. In other words, for native labour earnings to stabilize, they must first fall. This seems a wayward path. Nor is there much academic support for it. As the NRC reports: ‘The second key point – the impact of immigration on capital formation – has been left largely to assumption and speculation.’[29]

In any event, the capital adjustment process centres on restoring the amount of tools of production, not on total wealth.

To say that immigration benefits natives in Britain today, the following logical hurdles must be cleared:

1) The immigrant must accumulate the same amount as the average wealth held by native workers. This figure, in 2004 in Britain, was estimated to be £141,000 per worker. Because we assume one dependant per worker, which is the present state of the British labour force, a family of four would require £282,000 of capital.

2) The immigrant must then pay interest on the wealth appropriated from natives (or elsewhere) to support him for as long as it takes him to accumulate the requisite £141,000.

3) He must then also match the further capital additions generated by native workers during the period when the immigrant is generating his stake capital of £141,000 (plus interest). (The native worker adds £2,235 per annum.)

4) Only then does the immigrant reach a point of equality of contribution with natives. For him actually to benefit natives, he must generate a further increase in capital, beyond the native’s yearly increase in capital that he must match.

There are two sources (excluding non-measurable costs and benefits) of an immigrant’s contribution to wealth accumulation:

· savings by the worker out of his own wages directly or in the form of profits to the enterprise in which he is employed; and
· savings by capitalists out of the extra returns to capital, due to a fall in the wages paid to native labour.

In actual fact, depending on what activities the government is engaged in, some of the process of capital addition is in the hands of government. Some government activities are core areas, such as roads, order and justice; other areas, such as health, education, railways, may fall partly or generally within the government area. The government appropriates part of workers’ wages and enterprise profits to carry out its activities, some of which entail capital additions to wealth.

By definition, the first of the sources of contribution (for the average worker) can only be item (3) above, less overseas remittances. So the whole burden of generating the remainder of the wealth required in items (1), (2) and (4) falls on the added return to the extra savings of capitalists, which, of course, are also reduced by the lesser savings now being made by native workers out of their reduced wages. (Workers are also capitalists in relation to their own savings, pension funds, etc.)

Professor Borjas also notes:

as the capital stock inevitably adjusts to the changed economic environment, the immigration surplus will tend to become smaller and smaller and, in the end natives may be neither better off nor worse off because of immigration.[30]

So, for natives, the whole process of immigration means initial losses, immense dislocation, reduced production per head, a reduction in the standard of living due to wealth dilution, with the ultimate result that the capital–labour ratio is restored to its pre-immigration level – or, put another way, ‘as you were’. This is not a good deal for natives, since we show below that the calculations of capital adjustment do not return wealth to its pre-immigration level.

There is simply no respectable argument that immigration will ever generate added returns for natives, unless immigrants have skills and capital that are superior to those of natives. At best, as the NRC shows very logically in its analysis, once the immigrants acquire skills and capital similar to those possessed by natives, GDP will simply enlarge pro rata.

Calculations of capital adjustment – are they realistic?

Professor Borjas calculates that the 10 per cent of the US workforce that is immigrant would, in his central projection, generate an increase of 3 per cent in the total income of capitalists in the USA at the expense of labour. Conveniently for calculation, this is approximately 1 per cent of US GDP (capital takes about one third of US GDP).

If one transposes this extremely rough calculation to the UK, which also has an immigration labour force that totals 10 per cent of the whole and a similar split in returns between capital and labour, 1 per cent of the UK GDP in 2004 would be £9 billion. This is the amount workers lose to capital. Approximately 50 per cent of capital’s returns are used for capital formation, so, following Borjas, one could generally estimate the increased capital formation due to the immigrant-induced fall in native labour wages to be about £5 billion.

The target required for immigrant wealth to match native wealth is 10 per cent of the total national wealth (remember, immigrants are taking care of the £2,235 annual increase required out of their wages and enterprise profits, unless they are making foreign remittances), which is £424 billion; at £5 billion per annum, this would take 85 years to reach – 85 years to achieve equality with natives.

However, there are three further problems.

The first is a simple interest effect. Someone has to be paid for supplying immigrants with wealth while they have not got any. For example, if it is imported, there will be a drain of interest. The other alternative is for wealth to be appropriated from natives. It is clear that the interest effects on £424 billion alone would swamp the £5 billion capital formation.

The second problem is that, as Borjas points out, the immigrant surplus, which causes distribution from native wages to capital, shrinks as immigrants and their children take up native skills – in his example, the skills of US workers.

Third, as the immigrants become better equipped with capital (at £5 billion per annum) this also shrinks the immigration surplus and the extra returns to capital caused by immigration. As Borjas says, ‘the immigration surplus will tend to become smaller and smaller’.

Borjas himself does not do the calculations, but he appears to suggest that the difference in skills shrinks by 50 per cent in one generation, and a further 25 per cent in the second generation. This would mean the benefits to capital formation would shrink to £2.5 billion per annum after 30 years and to £1.25 billion per annum after 60 years. After 85 years, the capital generated would be not £424 billion, but somewhere in the region of £250 billion.

He makes no calculation for the shrinkage in returns to capital as the capital stock grows. This would reduce the £250 billion further and, if we assume the same shrinkage rate as applied to the shrinkage in the skills’ differential, this would imply the extra capital would reduce to about £150 billion, assuming there were no foreign remittances – a long way below the £424 billion required to avoid dilution of the wealth of natives.

A great deal more analysis needs to be done on the statistics of capital adjustment on all three problems mentioned above.

These figures are very rough and may be regarded as speculative. It should be remembered that, throughout the process, wages of native workers are reduced so as to produce higher returns to capital, which, in turn, supplies the capital formation required by immigrants.

Simultaneously, there will be a fall in savings by native workers, and this should be deducted from the amounts available to generate capital adjustment. This has not been calculated.