Perspective Unlimited

Wednesday, July 25, 2007

The Economics of Foreign Talent / Workers

This post was first written by Aaron Ng, who posed a really difficult question: whether immigration of skilled workers (talent) lowered the wages of native skilled workers. The same question could also be asked for unskilled workers, whether the influx of unskilled workers depressed the wages of the low-skill, low-income groups.

As we know, immigration is a hot-potato issue that has burnt the fingers of politicians every where from US, Europe to Singapore. The use of economic models are not particularly instructive here because different model settings provide dramatically different answers. At the risk of losing some readers, it is actually a good exercise to try to acquaint with some basic (and not so basic) economic concepts that can help us understand the labour market impact of immigration.

Neoclassical Theories

First, let's try to answer this question with neoclassical theories. By this, we are saying that markets are competitive, work without frictions and in addition, absent of any non-tradable goods. In this setting, all workers are paid the marginal value of the product they are producing.

In a small open economy like Singapore, a large part of what we produce are traded internationally. The influx of workers regardless of types will have no impact on wages (this may come as a surprise to non-economists). The logic is elegantly simple in fact. If more skilled workers enter Singapore, the economy shifts towards the production of goods with more skill content. If more unskilled workers enter Singapore, the economy shifts towards low skilled goods. Since the final prices of goods determine wages, and that Singapore has no influence on these prices internationally, wages are completely unaffected by whichever goods Singapore produces. Immigration has no impact on native wages (this was actually a final year exam question at the LSE recently, the famous Rybczynski Theorem).

For a large country, the effects can be dramatically different since which sector that country specialises in will obviously change international prices or terms of trade. The downward pressure on blue-collar wages here could have nothing to do with immigration. Rather, it is probably because a large producer (like China) has entered that market thereby lowering prices and wages (think electronics) everywhere. Conversely, whatever China demands, prices go up. Mining, pretty much a blue-collar type of industry, is doing really well in Australia precisely because of this China effect.

Depart from the neoclassical setting however, the effects of immigration can be completely different or even messy. Suppose not all goods produced are tradable internationally. There are some goods or services that are inherently non-tradable (think Balassa-Samuelson). If cheap foreign labour enters these non internationally traded markets, price will fall, and so will wages there. Similarly, if a segment of the economy has been protected from foreign competition, the natives there will be earning economic rent. The influx of foreign talent or firms into that sector will obviously reduce that rent and incomes of natives there (think lawyers, doctors etc). These groups surely would resist letting foreign talent or firms into their sector.

Bargaining Power

Lucky Tan suggests that the availability of foreign workers have made firms reluctant to hire native Singaporeans, depressing their wages. Again, this is entirely rationalisable economically. For example, the search and matching class of models (pioneered by a LSE professor Pissarides) tells us just that. When workers and firms meet, both sides have to agree on the wage rate before they enter into a productive relationship. Relative bargaining power will then determine how this economic surplus is split. Reducing workers' bargaining power, which presumably the availability of foreign worker does, will lead to lower wages.

Let me be quick to add that the rise of various emerging economies have also reduced Singapore's bargaining power. Transnational capital, footloose by definition, goes where returns is highest. Before China and India, Singapore was one of the few investment friendly places in Asia. The game has changed dramatically since. In the US for example, labour's share of GDP has fallen in recent years while capital's share has risen. Many commentators are quick to attribute the erosion of labour's bargining power to globalisation.

New Economic Geography

Let me finish this post with a positive spin - immigration can actually increase wages of natives. This is in fact a key prediction of new economic geography models. Firms (under suitable assumptions) have incentives to cluster and agglomerate, and immigration can be part of this agglomeration process. And where they do concentrate, they drive up productivity through various mechanisms. Because of the positive externality that they derive from clustering at certain locations, no firm then have an incentive to leave since they become far less productive elsewhere. When that happens, the location becomes sticky, commanding higher rent and wages. My favourite example is London obviously.

Two Handed Economist

President Harry S. Truman once said in exasperation that he wanted an economist who was one-handed because his economic advisors would typically give him economic advice stating, "On the one hand….And on the other...." This is even more true when it comes to the economic effects of immigration as different economic settings give rather different conclusions. But being a two-handed economist is no bad thing here. It is a sign of intellectual humility to recognise the complexities of the world and not make one-dimensional arguments.

Friday, July 13, 2007

The Lone Tree Hill Incident at Lim Chu Kang

This post has nothing to do with economics. It is about 2LT Lee's letter that skipped the chain of command, weaved into a story about my one major regret. This incident happened more than a decade ago, but I have carried the burden of a blemished conscience ever since.

It was a night in March 1996, my battalion was carrying out a routine exercise in Lim Chu Kang in preparation for the battalion proficiency test. My company was two months away from ORD, and that test would be our last exercise. Armed with a scholarship, I was eagerly looking to ORD and going overseas. In my battalion, there was this young scholar captain who was transferred from another unit. His aloofness also made it easy for others to gang up on him. Because of his lack of experience in our formation, he was only given a platoon commander's job rather than the OC appointment which a captain would usually be accorded with. I suspect other captains, OCs themselves, viewed this scholar with a mixture of contempt (since he transferred from a supposedly less tough unit) and career-envy (he was scholar-tracked, so to speak).

That fateful March night, my S3 asked that he became the point platoon to guide the battalion to the objective, which was the the so-called "lone-tree hill" in Lim Chu Kang. It was a very specific instruction that all officers understood. But in the middle of the battalion movement, my company commander - who was always out to impress - broke away from the battalion movement in order to find a shortcut to the target. Platoon commanders, including myself, tried to dissuade him since we would be going against S3's explicit instructions. But my OC was not to be moved. Our company broke off from the rest of the battalion, and went on a needless 3 km full combat order run just to show that we could reach the objective faster.

When the point platoon finally arrived twenty minutes later, that scholar captain was naturally surprised to see an entire company already at the RV point. He hadn't even realised that my company had broken contact from the rear. Understandably, he confronted my OC straightaway and the two, who never really liked each other, almost came to blows. The rest of the company, including the junior officers like myself, stood there not sure quite what to make of it.

Gradually, other companies arrived. What happened then was a blur - lots of shouting and shoving around to separate the two captains who by then were too steeped in the argument to back down. The rest of battalion just watched. S3 arrived and demanded to know that the commotion was about. My OC, in cahoot with other OCs there, turned around and accused the young captain of showing disrespect, and physically threatening a "senior" officer. Having not been a witness to that incident, S3 had to take the OCs words and reported the matter. Within a couple of days, the scholar captain was relieved of command and became a project officer. He did not take part in the battalion proficiency test, and his career became stunted as a result. The last I heard, he gave up on his army career.

At that time, I was very tempted to shoot an email to my formation chief and commanding officer to explain what happened - how my company commander pointedly violated commands to set up the scholar captain. The email was drafted, many versions, but all saved in my PC. I never did muster the courage to send, preferring to save myself from all the hassle. None of the other junior officers spoke up, they all probably made the same calculation like myself to ORD in peace than to end up in all kinds of trouble with the authorities. But I suspect they too carried the burden of not speaking up, for every time we met up, we would inevitably talk about the "lone-tree incident". I often wished I had the wisdom then to do the right thing. If I meet that captain on the streets again, I would apologise to him. This post, if he is reading, is just that - a belated apology from me for not speaking up all those years ago.

Whether 2LT Lee acted in cunning self-interest, in stupidity, naivety, or only because of his privileged background was largely irrelevant. Speaking up was the right thing to do. The rest were just details.

[Endnote: One of my army friends emailed me and mentioned that he met that captain recently, working in the insurance industry. My OC? I have been informed that he has since been promoted to battalion and then bridgade commmander. How would events have turned out if only one junior officer there spoke up? I often look back and wonder.]

Friday, July 06, 2007

Property Prices Spiraling Out of Reach? And Pitfalls of Property Price Index

Here I am back in Singapore. The effect of the property boom is clearly evident from the numerous construction sites and cranes dotting around downtown areas. The news media reports property market news almost every day. The classified ads screams at you - "Buy now before prices go up!", "Sure En Bloc, it's a matter of time!", "Don't miss the last chance for district 10!" - property agents appealing to both the greed and fear in you. Greed to make a pile from the current boom. And fear that your dream home will forever escape you if you do not act now. The latest URA data showed that property prices rose almost 8 per cent in the second quarter, on the back of a 6 per cent increase in the first.

But let's play a simple number game here. Imagine there are 100 units of property at Bishan, and another 100 units at Newton. They are of the same size, and they have the same starting price. Now, suppose that 10 units of Bishan units are transacted, all suffering a 10 per cent loss, while 10 units of Newton units are transacted with 10 per cent gain. What does the property price index show? If the property price index is based on the volume of transactions, it will show no movement. The gain in Newton is cancelled out by the loss in Bishan.

Now let's rewind and start again. There are 10 units transacted in Bishan, with a 10 per cent loss on each unit. But there are now 20 units transacted in Newton, all with 10 per cent rise. Look and behold. Weighted by the transaction volume, the index trends up, because Newton is now given more weight than Bishan. Come another quarter, if there are even more transactions in Newton, the price index will show even more upward increase, never mind the fact that all Newton units are selling only 10 per cent more - exactly the same as the first scenario. Before you know it, every one watching the price index becomes convinced that prices are shooting up and we have a frenzy in the making. And as they transact, their higher purchase price enters into the weighted index, further fuelling the impression that overall prices are rising.

Here, I thank an anonymous reader for pointing out to me URA's methods, which is something of a hybrid. Based on recorded transactions, the median for a location and housing type is picked. These then enter into the overall index using a value weight. Suppose again Bishan and Newton units are all sold at the same price initially. The transacted price for Bishan then falls 10 per cent, and the transacted price for Newton rises 10 per cent. Weighted by the moving value of the transactions, Newton will have a larger influence on the future direction of the index because it now has a higher value than Bishan. Again, there is a feedback effect where areas with rising prices are given an increasing weight in the index.

Of course, it is never easy to construct a summary statistic that can fully capture the overall price trends. This is even more so since housing property is highly heterogeneous (different) in locations, types and so many other attributes. It is often difficult to interpret the index given the thicket of statistical manipulation that is employed to create it.

But since the idea of this index is to reflect in some sense the affordability of housing space in Singapore, perhaps a good way is to use gross floor area as the weights - that is, Bishan and Newton be given the appropriate weights that reflect their total living space - thereby stripping away any components that might be endogenous in nature. Maybe this might give the lay person a much clearer picture just how affordable housing space in Singapore is.

Thursday, July 05, 2007

The HDB Lottery?

[This post was written on 21 June, but was accidentally deleted. It is reproduced here but some comments were lost].

How much does a good unblocked view in a good location add to the value of a property? A lot apparently. As every one probably knows by now, a flat in Tiong Bahru has just been sold for $720K, way above valuation, and double of what the owner paid 7 years ago. It came on the back of another headline catching sale of $672K, another HDB flat in the same area. As noted in the news article, the profit of $350K alone is enough to get the owner a flat in many other estates. The two sales have put those point blocks in Tiong Bahru in the spotlight.

Interestingly, I once visited a friend who lived in one of those blocks. Unfortunately, he did not have an unblocked view. In fact, situated on a lower floor and facing the busy Tiong Bahru Road, I found his flat rather too hot and noisy. The air certainly wasn't that fresh with so many double decker buses running a few floors below. I do not suppose it will fetch nearly the same price in the open market.New HDB flats in mature estates like Tiong Bahru, Toa Payoh, Bukit Merah have always been in high demand. They are much nearer to the city, near to all the amenities and the happenings in town. Here is a situation that the economist in me finds rather curious.

In a normal market, when demand outstrips supply, one would expect the price to move upwards to restore the equilibrium. But when HDB sells its flats, that is apparently not the case. Demand for flats in mature estates often outstrips supply. Rather than adjusting the list price upwards, balloting is usually carried out to determine which lucky applicants get to buy those flats.

That is not even the end of the role of Lady Luck. The lucky ones who are drawn to choose first have the chance of snapping up choice units - high floors, unblocked views, away from afternoon sun. Though HDB charges more for higher floors, the difference between the list price is far smaller than the difference in open market prices. For flats on the same floor, there is hardly any difference between superior facing (say view of city skyline) and so-so facing (say facing another block).

Effectively, the flat selection process becomes a "double-lottery". Those who are balloted to buy and choose first effectively become double winners - getting a choice unit in a choice estate. They pay more certainly, but not nearly as much as the premium the open market places on their flats. Those who did not win the ballot will have to settle for units in Jurong West (facing industrial estates), Punggol (facing the nice sungei) or Sembawang (facing Johor) where I used to live. There is often little potential for capital gains. After counting for interest and renovation cost, I just about broke even when I sold my flat last year. A friend of mine used to joke that Sembawang was the place where even the birds did not want to lay eggs. Oh well, at the very least, a flat in Sembawang is not even worth the $350K capital gain that lucky person enjoyed (you can verify from HDB website).

But it really begs the question, why doesn't HDB operate like a normal firm and use prices to equilibrate demand and supply rather than to depend on Lady Luck? In other words, have sharper price differences between the high floors (particularly those with great views) and low floors, and also between mature and outlying estates? In short, those who desire the great views and convenience, and who are able to afford, should be made to pay for it. By charging those choice units more means that the flat buyers will have to fork out more, thereby reducing the lottery gain (one could also see it as reducing consumer surplus) when they sell in the open market in a few years' time.

Now at this point, some of you will recognise that hey - that sounds like a monopoly exercising market power and practising price discrimination. One could interpret it that way for a simple understanding though it is not strictly so since flats on different floors are clearly not the same. However, since HDB is the only supplier of those blocks with those great views, it most definitely has pricing power to charge each unit as high as the reservation price - the maximum amount a potential flat buyer is willing to pay. This of course is price discrimination.

The word "discrimination" is slightly unfortunate here since it sometimes gives the wrong impression of the actual impact of a monopolist. Practicing price discrimination needs not be a bad thing from the economic point of view so long as it is done for benign reasons. It can even increase total welfare for the country. How so? By extracting the surplus from those who value the great views and convenience (who are paying higher price), HDB can then provide a transfer to those who can less afford to pay, that is, using the extra revenue to reduce the price of other flats to below their cost to help the poorer consumers. This cross subsidy might allow more or better flats to be built for those with less ability to pay, or be used to provide public goods like disabled access, linkways, gardens etc which because of the free-riding problem are usually under-provided. Of course, the subsidised flats will not come with a great view.

So which is a better way - charging willing and able first-time buyers top dollar for the view and convenience in order to cross-subsidise the financially less able buyers, or using a ballot system to decide who walks away with a windfall. It is interesting food for thought, isn't it?