The Effect of Trade and Migration on Income

This paper explores the relationship between openness to trade and to immigration on income per person. To address endogeneity concerns we extend the instrumental-variables strategy first used by Frankel and Romer (1999). We show that distance (geographical and cultural) can be used to build a strong predictor of openness to immigration and to trade. Our instrumental-variables estimates establish a robust, positive effect of openness to immigration on long-run income per capita, using demanding econometric specifications that account for trade openness, the role of institutions, and early development. In contrast the positive effect of trade openness on income is not robust to controlling for the direct effects of geography, providing support for the critique by Rodriguez and Rodrik (2001). We also show that the main effect of migration operates through total factor productivity, consistent with a theory where immigration increases the variety of skills available for production. We provide further evidence in support of this mechanism by showing that the degree of diversity (by origin country) in migration flows has an additional positive effect on income. Finally, we also find that immigration increases (ethnic and linguistic) fractionalization, which are associated to negative effects on income per capita. However, the direct gains from greater skill diversity appear to be larger than the costs arising from increased fractionalization. We do not find evidence of increased income inequality due to openness to immigration or trade.