The welfare state and migration: Coalition-formation dynamics

Assaf Razin, Efraim Sadka, Benjarong Suwankiri

Allowing greater immigration may raise tax revenue and help pay for the welfare state, but it also affects the future composition of the voting population. This column discusses a political-economy model in which the largest group in a winning coalition chooses tax and immigration policies, and explains how the composition of the voting population changes over time.

Most advanced economies face a generational distribution problem that migration might help with, but migration affects young and old, rich and poor, differently. The welfare state of these advanced economies is also a magnet for migrants, especially the low-skill. On the one hand, the native-born older population need young immigrants to support the welfare state; on the other hand these immigrants may increase the fiscal burden on the native-born young. How these tensions are to be resolved in the political economy context? Two of our recent publications (Razin and Sadka 2014 and Razin et al. 2014) help us think about the various sharp and seemingly inconsistent reactions of different income and age groups to migration.

This column highlights the dynamics of coalition formation in the context of a welfare state and in the presence of migration. There are three distinct voting groups: skilled workers, unskilled workers, and old retirees. The essence of inter- and intra-generational redistribution of a typical welfare system is captured with a proportional tax on labour income to finance a transfer in a balanced-budget manner. Our recent research analyses the political-economic equilibrium policy rules consisting of the tax rate, the skill composition of migrants, and the total number of migrants. When none of these groups enjoy a majority (50% of the voters or more), political coalitions will form. With overlapping generations and policy-determined influx of immigrants, the formation of the political coalitions changes over time. With forward-looking voters, the future changes are strategically taken into account when policies are shaped.

A political-economy model of the welfare state and migration policies

In Razin et al. (2014), we developed a general equilibrium dynamic setup with a pay-as-you-go welfare system and migration policies, which provides a resolution to political tensions across generations and income groups.

A common feature among models with Markov-perfect equilibrium is the idea that today’s voters have the power to influence the identity of future policymakers. We built a dynamic political-economic model featuring three distinct voting groups: skilled workers, unskilled workers, and retirees, with both inter- and intra-generational redistribution, resembling a typical welfare state. The skilled workers are net contributors to the welfare state whereas the unskilled workers and old retirees are net beneficiaries. They provide an analytical characterisation for the policymaking coalitions, which design the tax rate, immigrants’ skill composition, and the total number of immigrants.

The electoral system is that of Besley and Coate (1997), known as the citizen-candidates model with strategic voting behaviours (also similar to Osborne and Slivinski 1996, albeit under sincere-voting behaviours). Each of the three distinct voting groups presents a candidate who will implement the most preferred policy of his group, if elected. When one of these groups enjoys a majority (that is, it constitutes more than 50% of the voters), then its candidate automatically wins the election and implements his most preferred policy. Noteworthy is that the current preferred policy (especially with respect to immigration) takes in to account how immigration may change the composition of the voters in each group and, consequently, the policy that will be implemented in the future. When no group enjoys the majority, there is effectively a ‘second round’ run-off between two candidates representing the two largest groups of voters. Despite having its representative candidate, the third group, the smallest, will vote for the candidate of that one of the two largest groups whose most preferred policy is better for the third group, even though this policy is not the preferred policy of the third group.

The model is designed to make a three-dimensional policy choice in such a way that there are a clear ‘left’ group, a ‘centre’ group, and a ‘right’ group. The left group consists of the old native-born and the old first-generation immigrants (both skilled and unskilled) who earn no income and wish to extend as much as possible the generosity of the welfare state. They prefer to admit as many skilled immigrants as possible to help finance the generosity of the welfare state. The right group consists of the native-born skilled workers who bear the lion’s share of financing the welfare state and wish therefore to downscale its generosity as much as possible. The attitude of this group toward skilled immigrants is subject to two conflicting considerations. On the one hand, they benefit from the contribution of the skilled immigrants to the financing of the welfare state, which alleviates the burden on them. On the other hand, they are aware that the offspring of the skilled immigrants will vote to downscale the generosity of the welfare state in the next period, when the members of this right group turn older and benefit from the generosity of the welfare state. The fact that the fertility rate of immigrants is larger than the native-born amplifies this consideration.

The centre group consists of the native-born unskilled young. They do like the generous welfare state, but not as much as the old do because they also pay for it. They like it more than the native-born skilled young do, because they pay less for it –making them net beneficiaries. With respect to immigration, they (like the native-born skilled young) face two conflicting effects. On the one hand, they would like to admit skilled immigrants who contribute positively towards the finances of the welfare state in the current period. But, on the other hand, they are concerned that the skilled offspring of these skilled migrants will tilt the political balance of power in favour of the skilled in the next period; and, consequently, against the generosity of the welfare state. The centre group is more pro-skilled immigrant than the left group, but similar in attitude to the right group.

Preferred policies

A common feature among models with Markov-perfect equilibrium is the idea that today’s voters have the power to influence the identity of future policymakers.1

The migration policy of either young group reflects the fact that they may want to make themselves the largest group in the next period. Thus, instead of letting in too many migrants (who will give birth to a large new generation of skilled workers) they will want to limit immigration. The skilled are net contributors to the welfare state, while the other two groups are net beneficiaries. The preferences of the old retirees are simple. If the old cohort is the largest, it wants maximal welfare social benefits; that is, taxing up to the Laffer point. They also allow the maximum number of skilled migrants into the economy in order to benefit from their tax contributions.

The unskilled young are net beneficiaries of the welfare state. Clearly, the unskilled workers also prefer a migration policy that lets in skilled immigrants (due to their contribution to the welfare state). Nevertheless, the unskilled also pay taxes. Hence, the preferred tax rate of the unskilled voters must be smaller than the Laffer point. How many they will let in depends on a simple tradeoff. They weigh the future social security benefits against the tax burden in the present. If the unskilled workers are not sufficiently forward-looking, it is in their best interest to let into the economy as many skilled migrants as the economy is capable of absorbing. If, however, they are not so myopic, such a large wave of migrants – who are more fertile then their native-born counterparts – will lead to too little income redistribution in the next period, because the skilled workers will be the largest voting group.

The skilled native-born young prefer more skilled migrants for a different reason than the other two groups. Thanks to the higher fertility rate of migrants, this will create higher number of skilled native workers in the next period when they retire, compared to the native-born. By being forward-looking, the skilled native-born will also prefer to let in more skilled workers in their retirement period. However, they prefer not to let in too many of them, because migrants’ high birth rate may render the skilled young in the next period the largest group, who will then vote to weaken the generosity of the welfare state.

Note that the current political debate in the US about the path to citizenship of the existing illegal immigrants is significantly influenced by current expectations about how these new citizens may affect the future composition of the voting population.

Coalition-formation: Dynamics

The evolution of coalition formation and the fiscal and immigration policies over time depends naturally on the state in which the economy starts. In Razin et al. (2014), we model the problem at hand so that the state variable of this stylised economy depends exclusively on the share of the native-born skilled young in the total native-born young population. We find that there are several decisive ranges for this share that determine which one of the three groups’ preferred policies prevails. The ranges are arranged from the lowest values of the state variable (starting from 0), up to the largest value of the state variable (ending at 1). These ranges depend on the fertility rates of the native-born and the first-generation immigrants. That is, the cut-off levels of the state variable, which are the borderlines of the ranges, depend on the ageing of the population. When the share of the native-born skilled young (in the total native-born young population) falls into the lowest range, the policy that will be implemented is the preferred policy of the centre group (the native-born unskilled young). In this case, this group forms a majority and its candidate is able to implement his most preferred policy – moderate welfare-state generosity with large, but not extreme, influx of skilled immigrants only. Therefore, the share of the native-born skilled grows over time. Eventually the share enters the next range.

When the share enters the next range, the centre group is still the largest group, but does not constitute a majority. The native-born skilled is the smallest group in this case. This latter group, being on the right, always prefers the most preferred policy of the centre group to the most preferred policy of the left group (the old). Therefore, the most preferred policy of the centre will win, though by a coalition (with the right) in this case, rather than by a sheer majority of the centre group. Note that this policy increases over time the share of the native-born skilled, and eventually the share of the native-born skilled young in the total native-born young population enters the next range.

When the share of the native-born skilled young in the total native-born young population moves into the next range, then the left group (the old) is the largest group, but does not constitute a majority. The right group (the native-born skilled) is the smallest group. In this case, the centre group (the native-born unskilled) will join a coalition led by the left, provided that the preferred tax rate of the left group is not excessive. The left group candidate wins and the most preferred policy of the left will be implemented – an extreme generosity of the welfare state and an extreme influx of skilled immigrants.

Consequently, the share of the native-born skilled young in the total native-born young population continues to rise, and so on. Eventually, when the share of the native-born skilled young in the total native-born young population becomes too large, the right group (the native-born skilled) becomes the largest group and its candidate will get to implement the group’s most preferred policy – the generosity of the welfare state will be severely downscaled. All will be concerned about admitting more skilled immigrants; it would render the skilled in the next period an unbeatable majority, who would severely cut their benefits in the next period, when they grow old. This future threat to the welfare state helps balance the dynamic forces to further changes in the share of the native-born skilled young in the total native-born young population, and it stops rising. Only limited skilled immigrants are to be allowed in. The share of skilled native born will then converge to its steady state.

The effect of ageing

Naturally, a lower rate of population growth (that is, an ageing population) increases the political influence of the old (the left group). However, as Razin et al. (2000) demonstrate, this is by no means the end of the analysis, because the increased share of old-age dependents in the population also raises the fiscal burden on the young (particularly, the skilled). Thus, the effect of ageing of the native-born on the coalitions is subject to two conflicting effects: the change in the political balance and the change in the fiscal burden on the working-age population.

References

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Footnote

This feature is also prominent in the analysis in Dolmas and Huffman (2004), Ortega (2005), and Sand and Razin (2007).