Economic growth, international labour mobility, and unanticipated non-monetary shocks

Abstract

Economic growth models often assume that the labour force of a country is fixed and unaffected by international conditions. In recent years, however, observed large labour flows internationally have questioned this assumption. In this paper, we extend a standard economic-growth model and examine the adjustment of a small open economy, operating under conditions of international labour mobility (ILM) in the presence of two unanticipated shocks: an asset-market shock and a goods-market shock. Our findings suggest that the presence of ILM affects the dynamic adjustment of the economy, in response to the two unanticipated shocks. In particular, we show that ILM reduces the variability of the real exchange rate following each shock. However, ILM may worsen or improve conditions of economic growth depending upon the nature of the unanticipated shock. This result has straightforward policy implications for open economies facing asymmetric shocks: countries prone to asset-market shocks stand to loose under ILM and should, therefore, adopt measures hindering ILM while countries prone to goods-market shocks stand to gain from ILM and should thus try to adopt measures encouraging ILM.