Free labor mobility and GDP

Free labor mobility has not slowed growth A recent study by Europe Economics claims that the liberalization of labor mobility between Switzerland and the EU has taken a toll on Swiss per capita GDP: without it, GDP per capita would currently be 4 to 6 percent higher. This conclusion is wrong. Yes, GDP per capita has stagnated in Switzerland since 2007. This is a global phenomenon that reflects the economic crisis of 2007. In fact, Switzerland is doing better than its neighbors, which suggests a beneficial effect of free movement. The figure below shows that since 2007 the growth of GDP per capita - and thus of the standards of living - has markedly slowed down. We have gone from 1.7 percent annual growth between 1995 and 2007 to 0.4 percent since then. Another way of looking at the situation is to calculate the trend from 1995 to 2007, then project it to today (dotted line) and compare it with the actual level. This shows a gap of 9.7 percent in GDP per capita, equivalent to more than one month of income. Swiss GDP per capita (index 1995=100) 150 140 9.7% 130 120 110 100 Average annual growth Average annual growth 1995-2007: 1.7% since 2007: 0.4% 90 80 2000 2005 2010 2015 1995 GDP per capita Trend 1995-2007 The gap has been clear since 2007, when the liberalization measures introduced in 2002 were extended. So the fault lies with liberalization of immigration? Not so fast. 1

The financial crisis explains the growth slowdown Imagine that you buy a new fan, and – bad luck – a severe heat wave occurs on the day you plug it in for the first time. That day you will be a little warmer than usual. Will you conclude that your purchase was a bad idea? Of course not: you will simply wait until you use the new fan on a more normal day to see if it works better than the old one. The same goes for evaluating economic policies. The liberalization of immigration is not the only change that occurred in 2007. There was also the global economic crisis, which led to a lasting decline in growth in all industrialized countries. Since Switzerland is a small country highly dependent on the global economic cycle, it was naturally affected. How can we distinguish between the effects of the liberalization and those of the financial crisis? We could build a detailed model of the Swiss economy to estimate the various channels of economic activity, which would be tedious. Another approach is to compare our growth with that of other countries that have not experienced a substantial change in their migration policy. The figure below shows the growth rates of GDP per capita for Switzerland, a series of small European countries which are similar to ours, and the larger countries (the data are from the IMF). It shows the average annual growth between 1995 and 2007 (green bars), between 2007 and 2019 (blue bars) and the difference between these two periods (red bars). 2

-3% Annual average growth of GDP per capita Switzerland -2% -1% 0% 1% 2% 3% Austria Belgium Average 1995-2007 Denmark Average 2007-2019 Netherlands Difference Norway Sweden France Germany Italy Spain United Kingdom United States Swiss growth has slowed down by just over 1 percent. This is bad news, but other countries have experienced an even worse situation, especially small countries with slowdowns of 1.5 to 2 percent. In fact, only Germany did better. We can also calculate the gap between the GDP per capita in 2019 and the level it would have reached if the trend from 1995 to 2007 had continued. The figure below shows the result, with the gap for Switzerland reaching 9.7 percent. All other countries show even larger gaps, with Germany being the only one that outperforms Switzerland. 3

Gap between 2019 level and 1995-2007 trend -30% -25% -20% -15% -10% -5% 0% Switzerland Austria Belgium Denmark Netherlands Norway Sweden France Germany Italy Spain United Kingdom United States More specifically, the gap amounts to more than 15 percent for small European countries. In other words, Switzerland's GDP per capita is at least 5 percent higher in relative terms. From this angle, the liberalization of immigration has been beneficial to our country. Admittedly, more refined calculations would be needed to firmly ground such a conclusion. However, the value of 5 percent or more is in line with the study by Economiesuisse in 2016 that concluded that GDP per capita has been boosted by 5.7 percent. It should be stressed that that study is a solid and well-gorunded econometric analysis, of higher quality than the one by Europe Economics. Compare what is comparable The Europe Economics study estimates the decline in GDP per capita caused by the liberalization by comparing Switzerland's development with that of similar countries that have not changed their migration policy (a synthetic control approach). This is a valid approach, provided that before the liberalization the reference countries indeed evolved in a similar way to that of Switzerland. However, the study's own figures show that this is not the case. 4

The figure below shows the evolution of GDP per capita since 1980 for Switzerland (solid line) and the average of the reference countries (dotted line), both lines being put at the same level in 2002. As the dotted line is now higher than the Swiss line, the study concludes that the liberalization has penalized us. But we clearly see that the two lines followed very different paths between 1980 and 2007, which invalidates the analysis. Since the dotted line climbed faster than the Swiss line before 2007, it is hardly surprising that it continues to do so afterwards. The conclusion of the analysis is blatantly erroneous. Moreover, while the reference group includes several countries, it is in fact dominated by Germany (as the study acknowledges), which as we have seen is in a particularly favorable position. Has migration liberalization reduced investment? Europe Economics argues that the increased supply of labor has led to complacency among Swiss firms, lowering their incentive to invest and innovate. What should we make of this argument? What does economic theory tell us? The simplest model of the choice between consumption and investment (the Ramsey's model) indicates that an increase in the rate of population growth does 5

not affect GDP per capita and stimulates investment. The reason is simply that capital and labor are complementary factors of production, and an increase in employment increases the return on capital. This provides an incentive for firms to invest more, allowing GDP to grow at the same rate as the population. This basic model can, of course, be adjusted in a number of ways. For example, if we consider that increasing investment can only be done gradually, then GDP per capita will experience a temporary decline because the economy will be temporarily undercapitalized. But don't the data show a decline in the share of investment to GDP in 2007? Yes, as in any recession. Investment is in fact the most volatile part of GDP, and a recession is always driven by a larger decline in investment. It is therefore not surprising that the investment-to-GDP ratio fell in 2007, only to rise back to its usual values later on (the statistical analysis in the appendix to the Europe Economics study shows precisely this rise). What about innovation? As population growth increases the size of the market, it should rather encourage firms to innovate more in order to benefit from a better return on their research efforts in the end. In fact, if we really believe that a comfortable situation induces companies to reduce their innovation, then we have found the magic recipe to stimulate innovation. It would be enough to make life difficult for companies, for example with high minimum wages, in order to force them to innovate in order to survive. Unsurprisingly, no one proposes such an absurd recipe. 6