What is the place premium?

What is the place premium?

What is the place premium?

Wage differentials within a country can be explained by factors such as work experience, years of education, or career choices. Yet things get more complicated when comparing wages from workers living in different countries. When we do so, we need to take into account an extra factor: migration barriers. This is exactly what economists Michael Clemens, Claudio Montenegro and Lant Pritchett do in their latest paper.

Using a sample of workers from 42 developing countries plus the United States, the authors find that there is a substantial wage gap between workers in developing countries and US workers even after controlling for observable (education, skill, experience, age, or sex) and unobservable characteristics. This is what the authors call the place premium.

The concept of place premium may be better understood with an example. Imagine two identical individuals living in the same country. They earn exactly the same salary for doing the same job. Suddenly, one of them decides to migrate to a wealthier country to start doing the same job he used to do in his own country. Overnight, the worker moving abroad will see her real, PPP-adjusted earnings increase substantially.

This can be explained in part by productivity differentials: in those countries with more capital and better technology, workers tend to earn higher wages for doing the same job than in low-productivity countries. How large is this difference? According to the authors, low-skill immigrants who received education in their country before moving to the US earn, on average, 7 times more than identical workers (i.e., with the same observable and unobservable characteristics) that had to remain in their home country.

Interestingly, this wage gap is considerably lower when there are no migration barriers. Even though not all barriers can be removed (geographical and cultural remain even if we abolished all artificial barriers such as visa requirements and migrations quotas), evidence available suggests that, in the absence of artificial barriers, the place premium is lower as labor mobility tends to reduce wage differentials.[1]

Therefore, if we abolished policy barriers, the place premium would decrease considerably. Yet a lower place premium isn’t necessarily positive. After all, the place premium is just a ratio between wages in two countries, so it tells us nothing about absolute living standards. In order to analyze the impact of eliminating policy barriers on aggregate welfare, we need to look at how such a policy would affect the world economy.

Michael Clemens estimates that world GDP would increase by between 67 and 147 percent. The most benefited would be migrant workers, who would see their wages increase dramatically.  The impact on wages of workers in sending and receiving countries is more difficult to estimate. For sending countries, economic theory suggests that wages would go up as companies would pay higher wages to retain workers. For receiving countries, existing evidence shows that  immigration does not have important effects on labor market outcomes.

Given the importance of location in determining wages, less restrictive immigration policies that made it easier for workers from developing countries to move to high-productivity countries would be much more effective in reducing poverty than any development aid program ever implemented.


[1] The authors estimate that, for Puerto Ricans, who can move freely to the United States, the place premium is around 1.3.

Luis Pablo de la Horra

Luis Pablo de la Horra
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