This week, I asked Graeme Westwood to coauthor Macro Signposts to discuss the outlook for U.S. labor markets, immigration, and the potential impact on growth and inflation. Graeme is an economist focusing on the U.S. and Canada.

Unless explicitly stated, views expressed do not constitute official PIMCO views.

Immigration: a Remedy for Inflation?

By Tiffany Wilding and Graeme Westwood

At the Federal Reserve press conference earlier this month, Chair Jerome Powell emphasized how increased immigration into the U.S. has supported labor supply and potential real GDP growth, while helping ease labor market imbalances and inflationary pressures. The Chair had mentioned immigration before in the context of easing labor market imbalances, but we hadn't previously heard such nuanced views from him on this topic.

The Fed's most recent macroeconomic forecasts, from September, suggest that supply-side gains should allow for U.S. inflation to moderate back to target without a meaningful rise in the unemployment rate. (Read more in our 27 September 2023 edition of Macro Signposts and in our blog post following the September Fed meeting, "Fed Seems Confident in Soft Landing, But We See Risks."). We interpreted these gains to stem mainly from a forecasted acceleration in productivity; however, Powell's comments suggest that immigration may also be playing a key role in the Fed's outlook for a soft landing.

Immigration has indeed been strong this year and could remain elevated in 2024, potentially driving significant gains in U.S. labor supply. However, since elevated immigration affects both the supply and demand in an economy, its net impact on inflation is complicated and uncertain. In fact, higher immigration that isn't contributing to labor supply or productivity could very well be inflationary.

A closer look at the data could help clarify the key trends and implications.

U.S. immigration flows
U.S. immigration has played a key role in satisfying the strong demand for labor during the post-pandemic recovery. According to Labor Department data, the growth in the foreign-born labor force has nearly matched (99%) the 3.2 million individual rise in the overall labor force since October 2019. And foreign-born workers represent more than the entirety of the 2.6 million increase in employed workers – meaning native-born employment is still slightly below its pre-pandemic level.

Understanding the drivers of elevated immigration flows can be challenging given the patchwork of government agencies involved. However, piecing together data from the U.S. State Department, Citizenship and Immigration Services, and Customs and Border Protection suggests elevated immigration flows in the past few years can be divided into two main categories.

First, there has been a normalization in the pace of immigration visa issuances following a pandemic-related slowdown in 2020 and 2021. Annual limits in most major categories, which are set by Congress, are broadly similar to pre-pandemic levels, while temporary worker non-immigrant visa issuances have reverted back to trend. These include specialty occupation visas (HB-1s) and Trade NAFTA Professional visas (TNs), among others.

Second, asylum and related applications have been well above the pre-pandemic trend, and could continue to rise. Government approvals for these types of applications are up meaningfully over the last two years, but haven't kept pace with the soaring rate of applications. More than 900,000 applications for asylum were pending as of the second quarter of 2023 – up meaningfully from the average backlog of 180,000 during the 2013–2019 period, according to U.S. Citizenship and Immigration Services data. There's also a stifling backlog (seven times the pre-pandemic average) in Temporary Protected Status (TPS) applications, which are granted to individuals from certain countries that are experiencing ongoing armed conflict, environmental disasters, or other extraordinary and temporary conditions. TPS allows eligible individuals to live and work legally in the U.S. for a designated period of time. Both asylum applicants and TPS applicants may apply for employment authorization documents (EADs), allowing them to enter the workforce while they remain in the U.S. We believe many immigrants are getting EADs, though there is a backlog of 1.6 million applications, according to U.S. Citizenship and Immigration Services data and our calculations.

Overall, foreign-born workers have supplied around 1 million more eligible workers per year over the last two years, and will likely continue to provide a steady source of labor. As the government gradually works through the backlogs of asylum, TPS, and EAD applications, the influx of employable migrants will likely remain above pre-pandemic levels at least through 2024.

Economic implications: growth and inflation
Elevated immigration flows into the U.S. are boosting both potential supply and cyclical real demand.

What does this mean for economic growth? A simple calculation using 2022 labor productivity and the increase in foreign-born employment during 2023 relative to the five-year pre-pandemic average suggests this higher labor input growth increased U.S. GDP by 0.5 to 1.0 percentage points. This amounts to near-term potential growth of maybe 2.3%–2.8% annually, compared with the Fed's 1.8% long-run median estimate. However, this calculation is subject to two major caveats.

First, it implicitly assumes that average productivity of additional migrants equals that of the average current U.S. worker. However, the distribution of jobs accessible to migrants likely isn't consistent with that of the general population. According to analysis from the St. Louis Fed, foreign-born workers historically have had a more dispersed range of education outcomes: A higher percentage of the foreign-born population does not have a high school degree when compared with the native population, yet a higher percentage of the foreign-born population holds a graduate degree. This may be especially true for asylum seekers. The recent rise in the number of unemployed individuals, despite still elevated job openings, suggests that immigrants might have different skills than those required for available jobs. This may also contribute to rising labor market frictions that could keep wage inflation sticky.

Second, labor demand has been extremely strong in the post-pandemic recovery period. Going forward, a reversion in the vacancy-to-unemployment ratio toward its pre-pandemic level suggests the same degree of employment growth may not be feasible even if immigration flows remain elevated. This trend was also evident in the latest U.S. employment report, which suggested that individuals coming into the labor market are having a tougher time finding a job, contributing to increasing unemployment.

The impact on inflation is even more complex. In order for increased immigration to moderate inflation, broadly speaking, it needs to add more to the supply side of the equation (via labor supply, output, or productivity) than to the demand side (via consumption of goods and services, including housing). While many immigrants are on both sides of that equation, many others are legally or systemically limited to the demand side, such as spouses and children of individuals on work visas, international students, asylum seekers who have not received EADs (we note again the staggering backlog in applications), and individuals whose skills don't match current jobs available.

These complexities mean that the inflationary impact from higher immigration is likely to vary across sectors depending on the match between migrant skills and sectoral labor demand, as well as the ability for sectoral supply to respond to stronger demand from this new population. For example, while more labor supply should ease worker shortages in lower-skill industries, elevated migration flows can drive inflationary pressures in regional housing markets where supply cannot respond quickly to increased demand.

In Canada, for example, where we estimate immigration is boosting GDP growth by 1.5 to 2 percentage points, wage inflation is still running at elevated levels, while immigration flows are contributing to rental inflation; high interest rates and long lead times mean that new housing supply hasn't matched elevated demand. The housing problem isn't as acute in the U.S., where the rental vacancy rate hovers around 7.1% according to the U.S. Census Bureau, versus 1.9% in Canada according to the latest data from Canada Mortgage Housing Corporation.

Bottom line
Elevated U.S. immigration processing and work permitting backlogs suggest that foreign-born workers are likely to remain a strong support to the U.S. labor force and to real GDP growth in 2024. Forecasters are right to factor this into their projections given the potential supply benefits. However, it is important to remember that because immigration boosts both demand and supply in an economy, the impact on inflation is uncertain. Depending on the degree of labor demand, certain segments of migrant populations might have a skill mismatch with available jobs, and U.S. unemployment overall has been edging higher despite elevated job openings. Also, absent a housing supply response, regional rental markets may face tightening vacancy rates that in turn create pockets of shelter inflation.

In other words, while stronger immigration should support U.S. growth, we doubt it contributes meaningfully to disinflation. In fact, it could even complicate the path back to the 2% inflation target.

This report, like future reports, summarizes the vast array of data analysis that we do at PIMCO. Please don't hesitate to ask us about the underlying data and analysis. If you would like to reach out, please email [email protected].

For regular insights on U.S. policy via email, please write to [email protected] and ask to receive the Washington Watch.

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