Our Muddled Masses

It would appear that America needs a miracle to escape the “new normal” of low growth. We know of no means to induce miracles, but there is a next best thing. Perhaps it is not accidental that the Holy Land was called the land of milk and honey rather than gold and oil. You need skilled farmers to manage the capital of bees and herds properly, to assure living from their returns only while not using up the capital.

Behind the seeming miracles of economic history, we uncover a common thread: the sudden arrival of skilled immigrants. “Short of admitting a few million skilled, entrepreneurial immigrants,” David P. Goldman and I wrote in an earlier essay (“The Needle’s Eye,” December 2009), America must increase savings, investment, and exports to climb out of its economic slump. Innovation can multiply the effect of savings and investment, however. To get innovation, one first needs innovators. That is one reason that the immigration issue should be at the top of the national agenda: The right immigration policy will contribute mightily to America’s prospects for recovery. There is also this: American immigration policy threatens to become an economic as well as a humanitarian catastrophe.

Without innovation, America faces prolonged stagnation. The outlook seems bleak. Between 1988 and 1998, manufacturing productive growth rose from less than 2 percent to more than 5 percent per annum. By 2008, it had fallen back to the 2 percent range as the great wave of innovation abated. This outcome is not inevitable, however. America has been obtaining a disproportionate flow of skilled innovators by attracting these “vital few” to its shores. Without their contribution, America may neither sustain the economic growth required to absorb the penurious many nor raise their standards of living. The impact of the vital few does trickle down.

The problem lies in policy. American sentiment toward immigrants has swung from boomtown hospitality to churlish xenophobia in the course of the present recession. The burden of illegals is blamed for at least part of the budget crisis in states such as Arizona and California. As state budget problems worsen, people with the least clout will be pushed aside: When a state is facing cold budget cuts, foreigners get less sympathy. California is considering a ballot initiative to refuse state benefits to the children of illegal immigrants, and local governments in some jurisdictions are using extralegal means to drive immigrants out. The latter happened in Arizona, where a sheriff known for hard-line immigration enforcement vowed to press ahead with an illegal immigrant sweep, defying a revised Department of Homeland Security policy that took away his federal authority to make such arrests.

It is hard to blame opponents of immigration. Earlier this year, the Pew Hispanic Center reported that California’s estimated 2.7 million illegal residents”7 percent of the state’s population”add $4 billion to $6 billion in costs. Cutting off state payments for the American-born children of immigrants supposedly would save about $640 million a year. By similar estimates, Arizona’s illegal immigrant population is costing the state’s taxpayers about $1.3 billion per year. Whether these estimates are exact or only in the ballpark, it is clear that poor migrants drain state finances under the present institutional and regulatory landscape, and the drain is substantial.

The consequences of such flows of migrants are not “economic miracles,” even if historians label them as such: They are predictable, and they depend, almost without exception, on the rapid absorption of talented immigrants. The implications for today should be clear: The world is training more talented and ambitious young people than at any time in human history. Where the best of them choose to live and work will have a dominant effect on comparative well-being for both the poor and the rich, and tolerance”a significant advantage of the United States”is key to such choice.

America still is better positioned to create such miracles than are most other places. The obstacle to bringing in and retaining the vital few lies in a combination of present wrong-headed immigration policy and domestic institutions that have not been adjusted to the increased mobility of people”and the flow of migrants in particular”since the fall of the Berlin Wall twenty years ago. But would-be migrants’ opportunities at home are growing, and America’s ability to continue to attract talent is hindered by a misguided immigration policy. This is illustrated, in part, by the fact that, at present, applications by American businesses for specialized work visas for immigrants have a backlog of over five million.

This situation is the consequence, in part, of the present seemingly unbridgeable gap within the United States between, on one side, humanitarian concern and, on the other, budgetary soundness and the rigidity of institutional arrangements that came into being in the less mobile world before the fall of the Berlin Wall. President George W. Bush failed to find a compromise position between the opposing camps, and the Obama administration has avoided treading in the minefield for the moment. A sound basis exists, however, for a solution that will preserve America’s role as an immigrant nation while strengthening, rather than overtaxing, its people. Immigration opponents must be dissuaded from barring the door against their own best interests. Immigration advocates may have to acknowledge that to make room for the many, America must tilt immigration toward the vital few whose contribution to economic growth is disproportionately high.

No other political issue today seems to attract as much passion founded on uninformed opinion as does the topic of migration, and no political issue is of such consequence to America’s economic future. In the absence of leadership on immigration policy, the matter will be resolved brutally and hurtfully, as the trends in California and Arizona suggest. With Washington immobile on this issue, states and cities are taking matters into their own hands under conditions of crisis; the consequences of this are dire, not only for illegal immigrants, but also for the United States. Such paths of least resistance lead to a vicious circle in which economic stagnation nurtures xenophobia, and hostility toward immigration stifles innovation by inducing the vital few to seek more tolerant shores.

The global exchange of human capital influences economic outcomes as much as the exchange of financial capital. Because it is easier to regulate the exchange of human capital, though, the world has been slower to adapt to this reality. Until the 1990s the large industrial democracies enjoyed a monopoly on both kinds of capital. Money and top talent, the latter often nurtured in the global south, had only the industrial north as a prospective destination. And capital and talent within the dozen Western democracies could move mainly among those nations, mostly in response to fiscal and regulatory changes. But while capital markets became more fluid among the Western countries, the movement of people among them remained restricted, and the Unites States stood out as having the most democratized capital markets. This allowed for the best matching of capital and talents, no matter where the latter came from.

As a result, the cream of the Asian crop, the greatest addition to the world’s talent pool in history, found superior training as well as superior opportunity for entrepreneurship and employment in the United States. The contribution of highly skilled immigrants to America’s tech boom and the productivity surge of the 1990s is well documented. A quarter of high-tech firms in the United States had at least one Asian founder. Foreign-born students still receive more than three-fifths of all engineering PhDs granted in the United States. There is nothing new in such trends.

The miracle of seventeenth-century Europe was neither Spain nor Portugal”both of which fit the “finding oil and gold” mold”but Amsterdam, in Holland, a city and country whose riches were created despite an endowment of natural disasters, the land being below sea level. Later, in the twentieth century, there was West Germany, rising miraculously from the ashes of World War II. There are more recent miracles such as Hong Kong, Singapore, Israel, and Dubai. These miracles have some common features, the migration to their shores of critical masses of the vital few”human capital not given opportunities in their countries of origin”being one of them.

The Dutch formed the first European republic, a nation tolerant toward all religions (while the rest of Europe still discriminated severely against many) and with sound rights to property. These factors opened opportunities for relatively unhindered trade and financial innovation. But it would be misleading to say that “the Dutch” performed this economic miracle. There was globalization during the seventeenth century, even if nobody bothered to use the term. The Dutch did not make this miracle: Seventeenth-century fishermen did not become bankers and financiers within ten years. Immigrants”Jews thrown out of Spain and Huguenots thrown out of France prominent among them”brought about the miracle.

The histories of Israel, Hong Kong, Singapore, Taiwan, and West Germany have much in common with that of Amsterdam. In each of these places, the state provided a relatively decent umbrella of law and order compared with what was offered by neighbors. This gave people a greater stake in what the business society was doing: attracting immigrants and entrepreneurs from around the world. In turn, the influence of these critical masses of talent radiated around the world and made people richer in distant places, too. Other places such as Malaysia and even Australia and Europe, as hard as their governments have tried with massive investment funds to create venture capital, have not been as successful. You need the vital few in a tolerant environment to properly deploy that capital. If a place does not attract them, governments create statistical venture capital but not real capital. It’s the ability to attract and retain talent that sheds light on the above miracles.

Sir Stamford Raffles designed Singapore as a port at the beginning of the nineteenth century and backed it with an administrative, legal, and educational system that was open to its multiracial population of Chinese, Malays, and Europeans. Taiwan (after the seventeenth century), Singapore, and Hong Kong offered immigrants opportunities denied them in the Chinese hinterland, which was dominated at first by warlords and a status-conscious bureaucracy and later by a communist bureaucracy. Hong Kong benefited from waves of emigration from China, in particular from the inflow of Shanghai merchants and financiers when Mao Zedong “liberated” China in 1949. The arrival of these immigrants, an approximation of a flat tax, and a relative lack of local politics certainly helped Hong Kong. Now the present Chinese diaspora of about 55 million brings its network and know-how back to the more open China of today.

The post“World War II West German miracle fits this pattern, too, although in popular memory its success is associated more with the Marshall Plan, which is often used as an example of a particularly successful government policy. Behind this miracle, though, was a large transfer of talent: From 1945 to 1961, Western Germany accepted 12 million immigrants, for the most part well trained”a transfer of human capital relative to which the Marshall Plan assistance becomes rather insignificant. About 9 million of these immigrants were Germans from Poland and Czechoslovakia; 2.5 million more escaped from East Germany between 1949 and 1962. Many were destitute but had their skills.

Since 1990 Israel has done spectacularly”wars, terror, and relatively high taxes notwithstanding. Many observers have suggested ways to emulate what was done there; but, for the most part, no country can, simply because there is no other country that would accept a 20 percent addition to its population within three years, which is what Israel did. In fact, the accumulation in Israel of debts and deficits at the time of the Russian immigrants’ arrival between 1989 and the early 2000s led to a radical financial deregulation, lowered taxes, and privatization, because the government realized that there was no other way to absorb a million people. Before 1990 Israel had no venture capitalists, and there were no Israeli equity offerings on United States stock exchanges. In 1990“91 the total amount of venture capital raised in Israel was a meager $58 million. By 1996 more venture capital”$421 million”was flowing to Israel than to any other country except the United States.

Today Israel’s venture capital industry still raises more funds than any other venue except the United States. In 2006 alone, 402 Israeli hi-tech companies raised over $1.62 billion”the highest amount in the past five years. That same year, Israel had 80 active venture capital funds and over $10 billion under management, invested in over 1,000 Israeli start-ups. By 2007, with 71 companies listed on NASDAQ, Israel had become second only to the United States, having leapfrogged now third-place Canada.

Israel was the beneficiary of immigration “shock.” Of the million Russians who moved to Israel during the 1980s and 1990s, more than 55 percent had postsecondary education, and more than half held academic and managerial positions in their former country. Fifteen percent were engineers and architects, 7 percent were physicians, 18 percent were technicians and other professionals, and 8 percent were managers. By 1998 Israel had 140 scientists and engineers per 10,000 members of its labor force. This made Israel the world leader in the scientist and engineer workforce, followed by the United States with 80 and Germany with 55 scientists and engineers per 10,000 members of its labor force. The influence of Israel’s scientists and business leaders radiates now around the world, to Russia and Eastern Europe in particular.

At the height of the last tech boom in 1999, Chinese and Indian engineers were at the helm of 24 percent of the technology companies started in Silicon Valley. Recent updates of that study show that 60 percent of PhDs in engineering in the United States are awarded to foreign nationals. Of that percentage, about 85 percent of those of Indian and Chinese origin are still in the States five years after graduation. Other statistics are perhaps even more revealing. In high-tech and engineering companies in the United States between 1995 and 2005:

• In 25.3 percent of the companies, at least one key founder was foreign-born.

• Of all immigrant-founded companies, 26 percent had Indian founders; 7 percent had founders of British and Chinese origin; 6 percent had founders from Taiwan; Japanese and German founders each led 5 percent; 4 percent had founders from Israel; 3 percent had founders from Canada; and 2.5 percent had founders from Iran.

• In Massachusetts the single largest founding group was Israelis, at 17 percent.

• Indian entrepreneurs dominated in New Jersey, leading 47 percent of all immigrant-founded start-ups.

• Immigrants also represented 24.2 percent of international patent applications filed from the United States in 2006. Chinese filed the largest number of patents, followed by Indians, Canadians, and British.

This is by no means a random sample of the migrating population: Immigrants from China and India constitute less than 1 percent of the American population. The above numbers show, statistically, why the issue is not simply one of counting immigrants with diplomas. Not all degrees reflect the same knowledge”or the same entrepreneurial spirit that wishes to seek out risk capital in the United States.

As the above cases show, the view that migration has a negative effect on the local population is false. Much depends on what type of migration we are talking about and under what conditions the migrants come. Attracting top human capital is a key because the place to which top human capital moves”or is expected to move and stay”will also be the place that will have no trouble attracting tangible capital as well. Both human and tangible capital increase the performance of teams and, in particular, the compensation of the relatively unskilled. And when all become richer, there is more to give to the poorer, whether within the United States or, through remittances, to those in the countries of origin of the vital few.

If this is the case, what is to be done?

Many of the policies that now hinder the flow of the vital few to the United States came into being in the more immobile world”a place of communist countries behind Iron Curtains and ruthless dictatorships in much of the rest of the world except the Western countries, Japan, and Australia”that came into being after Word War II and lasted until November 9, 1989, when the Berlin Wall fell. These policies no longer fit today’s more mobile world. Until they are changed, however”and the sooner, the better”the least the United States can do is try, explicitly, to attract the vital few to its shores and, at the same time, speed up the domestic production of talent. (This is achievable by reducing the number of years youngsters spend in school.)

Congress should first increase visas for skilled immigrants”those who would invest in their own entrepreneurial ventures in the United States in particular. Congress also should facilitate a temporary worker program, but without instantaneously bestowing on those workers the many monetary government benefits for which America’s already taxpaying citizens are eligible. For immigrants in the United States who do not have proper documentation but who have built up equity in this country, opportunities should be provided to obtain legalization if they can demonstrate good moral character. Such an “earned” legalization should be achievable and verifiable in an accountable manner.

The United States should pay special attention to its 100 million“population neighbor to the south. Once again, Mexico is heading backward: diminishing the legal channels available to its young, entrepreneurial, and willing-to-work-hard population and driving them either into desperate attempts to migrate illegally to the United States or into the entrepreneurial, although criminal, drug trade. Although the United States has tried almost every political option to induce Mexico’s leaders to democratize its capital markets and give better options to its youth, it has met with no success. There seems, however, to be another, peaceful option remaining that has not yet been pursued: allowing more young, hardworking, entrepreneurial Mexicans to move legally to the United States. Perhaps by so weakening Mexico’s tax base, some of that country’s leaders will come more quickly to their senses. Policies pursued at present, such as closing America’s borders to Mexico’s vital few, will induce the latter to move to South America and Spain, leaving the masses of relatively unskilled and destitute Mexicans behind”people who then may try desperately to get into the United States, walls or no walls. How does such a policy serve the United States’ interest over the long term? In short, it does not.

America’s economic policy at present amounts to reshuffling debt between public and private entities. It offers no remedy for the dismal “new normal” of minimal economic growth that America now confronts. Urgent economic self-interest as well as ethical demands require a fundamental change in immigration policy.

Reuven Brenner holds the Repap Chair at McGill University’s Desautels Faculty of Management and is author of The Force of Finance and A World of Chance.