SUPPLY, DEMAND AND LABOUR MARKET EQUILIBRIUM

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Supply, Demand and Labour Market Equilibrium

The labour market has always been prone to uncertainty through different shocks. Immigration is one of these shocks that has affected the labour supply and demand, resulting in a shift of the labour market equilibrium. Borjas (2013) has explained how wages are affected by the flow of migration. Immigration leads to an increase in the labour force, which is referred to as the labour supply shock; this shifts the labour supply curve further to the right. According to Borjas (2013), if the foreign labour force is assumed as a substitute for natives, this means that they possess equivalent skills, hence, more competition for the same job, leading to a reduction of wages. In order to integrate into the labour market, foreign labour force will settle for lower wages. From a firm’s perspective, employers will prefer to substitute native workers with immigrants, hence, maximising their profits. This scenario would hold in the short-run; however, in the long-run, the labour market equilibrium will be reached through efficient allocation of labour supply and market demand for them. This is an example of Adam Smith’s Invisible hand’s theory only if the competition is allowed in the labour market.
Borjas (2013) talks about the case where the foreign-born are complements to natives, meaning that immigrants can possess lower education in comparison to a share of native workers. Therefore, foreign-born will fill the gap of labour-intensive jobs, leaving the native workers to occupy jobs requiring higher levels of education and skills. By assuming that foreign individuals and natives are complements, they will not compete for the same job. In this case, an increase in immigration will shift the demand for labour to the right, resulting in an increase in wages for natives due to higher productivity and efficient allocation in the labour market.

Minimum wage

The basic migration theory is applied to markets with minimum wage being present (Chassamboulli and Palivos, 2013). They stated that an increase in immigration leads to a change in the wage levels for the lower-skilled natives that can be substituted by immigrants. The effect is dependent on the presence of the minimum wage in the country, how the minimum wage is determined, and the bargaining position of the workers. An influx of immigrants lowers the average wages since foreign-born workers are prepared to accept lower wages, leading to an increase in job entries allowing the native workers to be placed in a better bargaining position. The assumption that all immigrants are unskilled are said to be perfect substitutes. Therefore, immigration increases, ceteris paribus, decreases the marginal product, which in this case, lowers the wage for unskilled foreign-born workers and raises the native workers’ wages (Chassamboulli and Palivos, 2013).

Human Capital Theory

Human capital is defined as the intangible resources and intellectual capital that individuals possess as a result of the accumulation of education, knowledge, previous work experiences, and on-the-job training. The human capital theory can trace its roots to the year 1960 when Theodore Schultz defined that human capital consists of “knowledge, skills and abilities of the people employed in an organisation” Schultz (1961, p140). Over many years, the definition of human capital has been criticised and modified by Becker (1993), Bontis et al. (1999), Frank and Bernanke (2007), and Acemoglu and Autor (2009). For the purpose of this thesis, we will focus on the most recent definition by Thomas et al. (2013, p3) ”the people, their performance and their potential in the organisation”.
The human capital approach provides assistance to policymakers assessing the relationship between education, economic, and social benefits, leading to a more effective policy ensuring the desired economic growth is achieved. However, the human capital theory has received criticism when neglecting factors such as culture and social capital that should be taken into consideration when assessing the relationship between education and higher wages.

Mincer’s wage equation

In the field of labour economics, Jacob Mincer (1974) has modelled the human capital earning function in order to investigate both nature and causes of inequalities in incomes on a micro-level. The Mincer equation stems from the early method of the Human Capital model. Expanding to be able to understand earnings differentials amid different cohorts. Defined by Mincer, the model implies that the decisions in regard to schooling are based on the value of future earnings (i.b.i.d).
A complete wage equation model would include the following human capital variables: log( ) = 0 + 1 + 2 + 3 2 +⋅⋅⋅ + where the term Ui contains factors affecting an individual’s wage.
The equation has embodied years of education, and of potential experience. In addition to that, Mincer’s empirical work has shown that the earnings of an individual were growing as a concave function of age, which is known as the “age-earning profile”. In previous research, Mincer (1958) mentioned that the curve for high-educated workers was steeper compared to low-educated ones. Age was considered another variable representing the accumulated work experience and the education level of workers, which is reflected in a higher level of income. The Mincer equation has established the causal effect of education and experience on the income, hence, revealing the causes and nature of income inequality between individuals. (Jones, 2005; Lehman, 1953 and Simonton,1999) the described age-productivity curve as an inverted U-shaped curve where the productivity peaks between the age of 20 to 40.
The Mincer equation (1974) stated that there is a positive relationship between the education of an individual and their later earnings. However, it is not that simple. Jacob Mincer (1974) indicates that this could be understood as the outcome of a productivity-enhancing influence of schooling. In agreement with the Human Capital Theory, which explains that the productivity of an individual is directly affected by education, where the wage is reflected by the productivity of the worker (Rospigliosi, 2014).
Mincer’s model makes the assumption that investments in human capital affect earnings positively through an increase in productivity (Mincer, 1974). It is important to note that there is some degree of opportunity cost through the consumption of time. The variable experience allows for the observation of reality that even after finishing their education, individuals tend to invest in human capital. Mincer states that this occurs at a declining rate over the years (i.b.i.d). Therefore, the Experience squared variable is added in order to take into account for nonlinearity.
A critic of the Mincer model is that the correlation is affected by the training or educational investments that are pursued by individuals after completing their education (Mincer, 1974) – mentioning that these investments are not spread evenly over the population with these investments is an important factor that is played when determining wage level (i.b.i.d). With the weakening of the correlation between educational investments and education, the variable ‘experience’ squared is a reason to why it is included in the equation.

Immigration impact on the labour market

Altonji and Card (1991) and Card (1990) examined the effect of immigration on low skilled native-born workers. The effect of different skill levels whilst observing the impact of immigrants across different countries has been studied by Brucker̈ et al. (2014). The effect of immigration differs across countries, depending on the labour market institutions. These institutions such as minimum wage and collective bargaining can affect how the average wage level responds to a labour supply shock, such as immigration (Brucker̈ et al., 2014). When analyzing the labour outcome, country differences are disregarded in this paper since only one country is being investigated, Sweden.
A study conducted that focused on the immigration impact on the labour market was Card (1990). The outcome for natives on the labour market after an increase in the immigration flow was estimated. The flow, in this case, was a large share of Cubans that had immigrated to the United States. With comparisons being made in an affected and unaffected state, he implied that the immigration flow had actually had no impact on the wage level for the lower-skilled native workers in the impacted state.
Another study later emerged by Kugler and Yuksel (2008) where they estimated the effect of wages on native-born and immigrants that had resided prior to an unexpected immigrant flow to America. Their result was that there was an increase in natives’ wages in comparison to the recent flow of foreign-born workers. These two studies focus on the immigration flow consisting of mostly workers with a lower education but still both provide different results. The reason for this could be that the study conducted by Kugler and Yuksel (2008), observed the impact of the immigrant workers that had been legalized to work in the U.S in contrast to Card (1990).
The estimation of labour market effect of immigration was also conducted by Brucker̈ et al., (2012). A distinction can be made between Brucker̈ (2012) and both Card (1990) and Krugler and Yuksel (2008). Brucker̈ acquired micro-data in order to be able to analyse the effects of wages on natives through their different skill sets; education, experience, and origin. Three countries were analysed; Denmark, Germany and the United Kingdom due to the differences in the labour markets. The difference across these three countries consists of the minimum wage, the bargaining opportunities, and the unemployment benefits. With different characteristics in the labour market, each country will react in a different way when a labour supply shock such as immigration is applied. Brucker̈ (2012) assumed there was imperfect competition, which is contrary to a large share of previous studies that were conducted. In order to observe how immigration impacts wages in different skill levels, measurement of the elasticity of the wage-setting curve, and the elasticity of substitution between labour- and capital-intensive workers was measured. Brucker’s̈ findings were that the effect on unemployment was bigger in both Germany and Denmark. The U.K’s wage level change was more flexible, meaning that in the U.K., the wages respond more when a labour supply shock is applied, thus, changing the labour market.
It is difficult to apply U.S studies of the labour market to the Swedish labour market since different policies and regulations are apparent. Bratsberg et al. (2014) estimated the effect on native wages when a labour supply shock was introduced, in this case, immigration in Norway. Differentiating from other studies, the immigrants were classified in groups of origin. They measured the immigrants share where any wage adjustment will identify the slope of the labour demand curve when an increase in labour supply was acknowledged. The different skill groups were measured in four different levels of education and eight levels of experience. The study exhibited that native-born workers’ wages decreased after an inflow of immigrants.
Contradicting the results of the Bratsberg (2014), with a study conducted on the labour market in Denmark was Foged and Peri (2014). The purpose of this study was to approximate whether an increase of low-educated foreign-born workers impacted native workers’ wages. The study measured the data over time by focusing on the impact of non-European individuals. An observation was made to capture the effect of immigrants moving within different municipalities and regions. The results were that an increase in the labour supply through the flow of lower educated non-European immigrants lead to a reallocation of low educated natives to greater job positions, where wage levels either increased or there was no effect.
Since the main focus of this paper is to analyse the labour market in Sweden, it is important to observe what previous empirical studies in the chosen country indicate. Lundborg (2014) also observes the share of immigrants’ impact on the natives’ wage level. Taking into account the different labour market institutions, host country and wage bargaining. Lundborg (2014) makes the assumption for a market where prospective employees and the firm negotiate the wage. In this case, the market is not assumed to be of perfect competition which contradicts the basic immigration theory (Borjas, 1994), where perfect competition is assumed. The result demonstrates that an increase in the share of immigrants with respect to natives, lowers the wage levels but only in the short-run and only if the foreign-lower individual has a low reservation wage in comparison to the native-born worker. Meaning if the foreign-born individual had a lower wage rate where they would be willing to accept a job than the native, then the wage level will decrease temporarily. After time, the wage level will return to its original point.
As Lundborg (2014), Corrales and Vega (2014) also examine the Swedish labour market but focus on the share of immigrants that possess a higher level of education. They estimate the impact of immigration by taking the log of relative average monthly wages in a group of individuals with the same age. Dividing into different levels of education and work experience, they estimated the elasticity of the relative wages in the different cohort groups when a labour supply shock was applied, in this case, immigration. The result was that there was a negative effect on the native-born wages when an influx of foreign-born individuals migrated to Sweden.

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Regional disparities

Agglomeration economies and spatial sorting of workers are factors that reshape the wage level between different regions within one single country. The recent study done by Combes et al. (2008) and Mion and Naticchioni (2009) has explained how high-skilled labour undertake self-selection and relocate themselves in metropolitan cities. The reason behind it is to take advantage of not only the availability of job opportunities, but also of the abundance of the positive knowledge spill-over that will contribute to their unobserved skills (e.g., communication skills or any other skills that will build up their performance). Glaeser (1999) and Rauch (1993) mentioned that workers in big cities are incentivized to accumulate human capital faster due to the knowledge spill-over, which will be reflected in higher wages. Due to the industries being clustered in metropolitan cities, and the tendency of higher-skilled labour of self-selecting themselves, the spatial wage disparities have appeared. According to Malmberg (1998), industries tend to cluster in order to profit from both internal and external economies of scale, which will contribute to higher production efficiency, hence, compensating for the high land/rent prices and wage costs. The reasons behind regional disparities are due to the uneven and nonhomogeneous distribution of factors of production, hence, endowing resources differently across regions. Education level, demographic structure as well as migration flows provoke regional disparities, and all the three factors can result in “circular causation” (Malmberg, 1994; Myrdal, 1956 and Westlund, 2004), that can be explained as the manufacturing production being concentrated close to the market or where the high demand on those products is present.
It is crucial to mention the matching externality, which was first brought to light by Helsley and Strange (1990), where an increase in the number of agents matching increases the quality of each match. Due to monopsony power, wages differ from the marginal product of the workers (Duranton; Puga, 2003). Where firms compete for the workers, and in this case, are required to pay higher wages when an increase in the number of competitors is present. When a matching externality is present, a worker is able to locate an employer that is more of a match to their skills (i.b.i.d). Duranton and Puga (2003) stated that this occurs only when the workforce is growing, and the number of firms are increasing. The matching model has been adapted to many different situations (Helsley; Strange, 1990). If there is strong complementarity present between high-skilled workers, it is to the individuals’ advantage to pay the costs of living in the city where there is a match with other high-skilled workers (Spence, 1973).

The integration of immigrants and labour market barriers

Integration is another concept linked to migration, defined as:
“The process by which migrants become accepted into society, both as individuals and as groups….[Integration] refers to a two-way process of adaptation by migrants and host societies…[and implies] consideration of the rights and obligations of migrants and host societies, of access to different kinds of services and the labour market, and of identification and respect for a core set of values that bind migrants and host communities in a common purpose” (IOM, 2011).
When discussing migration and skill transferability, it is important to mention that foreign skills cannot be perfectly transferable. Bevelander (2000) and Chiswick et al. (2005) indicated those skills such as imperfect information about the labour market, excelling at the language of the host country, occupational licences and certification and task-specific skills. Therefore, the acquisition of country-specific skills with respect to the duration of residence in the host country is a fundamental part of the economic integration (see reviews in Lalonde and Topel, 1997; Powers and Seltzer, 1998; Zhou, 1997).
Zorlu (2013) has shed light on another aspect in the process of integration, where he showed that educated immigrants mostly enter the labour market through jobs requiring lower skills as a result of a low transferability of skills. This study was made in the Netherlands, and it has also shown that in the long run, those skills are being developed on an individual level, which improves their position. However, this improvement will experience some difficulties due to barriers and inequalities in several situations. Bevelander and Pendakur (2012) have also mentioned that immigrants are exposed to barriers when entering the labour market. These challenges can be expressed as language barriers, unestablished social capital, and insufficient work experience in the host country. According to Åslund; Forslund and Liljeberg (2017), it can take up to 15 years for immigrants to integrate.
Referring to Swedish Council for Higher Education (2015), 40% of the foreign qualification, at the upper-secondary level, post-secondary vocational education and higher education, were accepted and evaluated in a way that makes it equivalent to the Swedish educational qualification. On the counterpart, 60% of the foreign qualification were rejected unless the applicants undertake complementary courses. Therefore, the 60% of highly educated1 were not able to obtain a job that matches their skills and knowledge. Lemaitrê (2007) deemed this phenomenon as a waste of human capital.
Other studies such as Joona et al. (2014), Katz and Österberg (2013) and Dahlstedt (2011) have found that overeducation is relatively high among immigrants in Sweden; however, Joona et al. (2014) found that returns to overeducated immigrants are considerably low. This could be due to several reasons such as discrimination which is also considered as one of the barriers that hinder labour from entering the labour market. Others have found ethnicity, background and race as factors from which comes the devaluation of immigrants with high education (Bursell, 2007; Danielsson, 2008; Lemaitre,̂ 2007 and OECD, 2014). In this case, Carlsson and Rooth (2007) have provided some evidence on discrimination that occurs in the Swedish labour market; candidates with Swedish names, for instance, were given more consideration than candidates with non-Swedish names when applying for jobs.
Borjas (1999) and Brucker et al. (2002) have investigated an essential factor that relatively attracts immigrants. Welfare programs i.e., social benefits or unemployment benefits have proven to magnetise low-skilled immigrants, whilst high-skilled immigrants would prefer to establish themselves in countries where social spending is low, hence, lowering the tax burden on income.

Table of contents :

1 INTRODUCTION
1.1 BACKGROUND
1.2 PURPOSE
1.3 RESEARCH QUESTION
1.4 LIMITATIONS
1.5 OUTLINE
2 LITERATURE REVIEW
2.1 SUPPLY, DEMAND AND LABOUR MARKET EQUILIBRIUM
2.2 MINIMUM WAGE
2.3 HUMAN CAPITAL THEORY
2.4 MINCER’S WAGE EQUATION
2.5 IMMIGRATION IMPACT ON THE LABOUR MARKET
2.6 REGIONAL DISPARITIES
2.7 THE INTEGRATION OF IMMIGRANTS AND LABOUR MARKET BARRIERS
3 METHODOLOGY
3.1 HYPOTHESIS
3.2 ECONOMETRIC MODEL
3.3 DATA
4 EMPIRICAL RESULTS
4.1 ECONOMETRIC METHOD
4.2 DESCRIPTIVE STATISTICS
4.3 CORRELATION ANALYSIS
4.4 FINDINGS
5 DISCUSSION
6 CONCLUSION
7 REFERENCE LIST
8 APPENDIX

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