By Guilherme Bandeira, Jordi Caballe and Eugenia Vella
This paper studies the role of emigration in a deep recession when the government implements fiscal consolidation. We build a small open economy New Keynesian model with search and matching frictions, emigration of the labour force, and fiscal details. Our simulations for the austerity mix during the Greek Depression show that fiscal austerity accounts for one third of the output drop and more than 10% of migration outflows, whereas the rest is attributed to the macroeconomic environment. A counterfactual without migration underestimates the fall in output by one fifth. The model also sheds light on the two-way relation between emigration and austerity. Labour income tax hikes induce prolonged migration outflows, while spending cuts exert only a small effect on emigration which can be positive or negative depending on opposite demand and wealth effects. On the flip side, emigration increases the required tax hike and time to meet a given debt target due to endogenous revenue leakage. For tax hikes, emigration acts as an absorber of the austerity shock by diluting the output costs per resident through shrinking population. Yet, in terms of unemployment, temporary gains are reversed over time due to the distortionary effects of taxes on employment.
There is some literature on the effect of tax hikes on emigration. There is some, but it is not as bad as some make it sound. This paper goes further with its analysis of the recent Greek austerity: it also considers the budget cuts and debt targets. Those appear to have a negligible impact on emigration, but emigration has a larger impact on debt service, as the same debt needs to be carried by fewer people.