Feldstein: Immigration Won't Solve Europe's Fiscal Problems

Marty Feldstein says European countries are making a mistake if they think they can rely on immigration to fund social programs for their aging populations:

Immigration is no way to fund an ageing population, by Martin Feldstein, Commentary, Financial Times (free): Increasing life expectancy and declining birth rates are leading to big fiscal problems throughout Europe. Without fundamental changes, the rise in the relative number of older people and the slower growth of the labour force will substantially raise government outlays for pensions and healthcare.

A common reaction to this problem is a call for increased immigration. The taxes paid by these new workers would help to finance the benefits of the aged. Although there is general discomfort with some of the social consequences..., many have concluded that increased immigration is the only way to avoid a big increase in tax rates or a cut in benefits.

However, a little analysis shows that even a very large increase in immigration would have only a very small impact on ... revenue... Much of the tax paid by the new workers would be needed to finance the government benefits that they and their families consume – especially for healthcare and education. It is necessary, therefore, to ask how much net revenue is created by immigration...

Here are some simple calculations for Spain. The analysis would be much the same for other leading European countries. ... Consider the potential impact of a one-time inflow to Spain of an additional 2m new workers, equivalent to a 10 per cent increase in Spain’s labour force. ... Since immigrants generally earn less than native Spanish workers, a rise in ... foreign-born workers equal to 10 per cent of the labour force would raise total labour compensation by about 8 per cent or less. Since wages are only about 75 per cent of total GDP, a rise of 8 per cent in gross wages would be equivalent to a 6 per cent rise in GDP.

At least half of the additional 6 per cent of GDP would be consumed by the immigrants and their families. An additional fraction of the extra GDP would be used by the government to finance benefits for them. So the net additional revenue available to pay benefits ... would be only about 2 per cent of GDP or less.

This 2 per cent of GDP is very small relative to the future fiscal problem. Government spending on pensions and healthcare is ... projected to rise by 2050 to 24 per cent. The 2 per cent of GDP in net revenue ... would therefore finance less than 10 per cent of the projected pension and health benefits.

The increased immigration would, moreover, provide only temporary relief to a permanent fiscal problem. ... The extra immigrants ... would provide net revenue temporarily but would eventually receive retirement pensions and healthcare that absorb the extra taxes that they pay. It would take a continuing increase in the number of immigrants to achieve even the relatively small additional revenue that I have described. ...

There may be many reasons to favour increased immigration. ... But it would be wrong to advocate increased immigration as necessary to deal with the fiscal consequences of an ageing population...

The only way to avoid either significantly higher tax rates or substantially lower retirement incomes is to shift from a pure tax-financed system to one that supplements the tax-financed benefits with increased saving and investment. It is not too late to begin a transition from a pure pay-as-you-go system to a mixed system, but it will be progressively more difficult to do so as the population ages.