Migration State and Welfare State: Competition vs. Coordination in an Economic Union

Abstract

We develop a model of an economic union with income redistribution, facing upward supplies of immigrants of various skills and wealth. We compare the policy competition equilibrium of the model to the coordination equilibrium. The model predicts that the completion equilibrium will be with a more generous welfare state (higher taxes) with more low skilled immigrants than the coordination equilibrium. The explanation is based on fiscal externalities due to income differences in the native born and immigrant populations. We argue that this type of a difference between the U.S. and the EU - the degree of coordination among the member states -- contributes to our understanding of observed policy differences between these two otherwise similar unions: the generosity of the welfare state and the skill composition of migration.