Institute of Social and Economic Research, Osaka University

Economics Department of the University of Pennsylvania

Illegal Immigration and Resource Allocation
Author(s): Slobodan Djaji
Source: International Economic Review, Vol. 38, No. 1 (Feb., 1997), pp. 97-117
Published by: Wiley for the Economics Department of the University of Pennsylvania and
Institute of Social and Economic Research, Osaka University
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INTERNATIONAL ECONOMIC REVIEW

Vol. 38, No. 1, February1997

ILLEGAL IMMIGRATION AND RESOURCE ALLOCATION*

BY

SLOBODAN DJAJIC

GraduateInstituteof InternationalStudies, Switzerland

This paper studies the effects of illegal immigrationand the associated

expansionof the undergroundeconomyon the allocationof resources,commodityprices,and wages of workers,both in the shortrun (whenoccupational
mobilityis restricted)and in the long run (when the skill-compositionof the
labor force is endogenous).The paper goes on to considersome of the fiscal
implicationsof illegal immigrationand the related expansionof underground
activity.Effects of sanctionsagainstemployershiringillegal aliens and measures to legalizethe statusof clandestineforeignworkersare also examined.

1. ILLEGALIMMIGRATION
AND THE UNDERGROUNDECONOMY:
AN OVERVIEW

Pressures underlying migratory movements have been rising over the last two
decades and are likely to expand further in the years to come. In many developing
countries, population growth is running far ahead of the pace of jobs creation.
Political, ethnic and religious conflicts are pushing an ever larger number of
refugees in the direction of the more stable and prosperous countries. Above all,
migration is encouraged by the expanding per-capita income differentials between
rich and poor nations, while technical advances in transportationand communications are reducing the cost of international migration.
A combination of all these factors has created an environment in which current
and potential future migration flows are becoming increasingly more volatile and
unpredictable with respect to both origin and magnitude. The receiving countries
have responded by trying to restrain immigration.Rules for granting refugee status
or for issuing residence and work permits, as well as tourist visas, are becoming
increasinglyrestrictive, targeting in particularthe nationals of developing countries
and potential asylum seekers (see OECD 1992).
A combination of restrictive immigrationpolicies and expanding migratorypressures has produced rapid growth in the stock of undocumented aliens in industrial
countries. In the U.S.A. the number of illegal migrantshas grown quicklysince the
late 1960s, reaching a figure of between three and six million by 1980, and has
continuously increased since then, except in the late 1980s when a one-time drop
was due to legalization (Chiswick 1988a). According to a report issued by the
Commissionof the European Communities(1991, p. 38), of the approximatelythree
million foreigners living in Greece, Italy, Spain, and Portugal in 1987, only about
* ManuscriptreceivedMay 1994;revisedMay and November1995.
For their helpful comments,I thank two anonymousreferees and the participantsin various
seminarsand meetings,includingthe December1992conferenceon Migrationand Developmentin
Davos, Switzerland,where the first draftof this paperwas presented.

97

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DJAJIC

one half were legal residents. The remaining 1.5 million were irregular migrants,
mainly from non-European countries. More recent estimates place the number of
illegals at 1.2 million in Italy alone (Russell and Teitelbaum 1992, p. 12).
While meaningful estimates of the number of clandestine foreign workers in
Western Europe are hard to come by, there are reasons to believe that the figures
are rather significant. Large stocks of legal foreign residents living in the European
Union serve not only to facilitate entry, job acquisition and sheltering of illegal
immigrants,but also to reduce the probabilityof detection by the authorities.
Foreign workers lacking legal status normallytake jobs which are at the bottom of
the social ladder. Reflecting the supply and demand conditions and various constraints influencing the markets for illegal foreign labor, these are jobs which
typically involve low wages, which tend to- be temporary, and where working
conditions are harsh, unpleasant, often unsafe, and lack compliance with labor
legislation. There are no unions, no social security and very little legal protection.
These jobs involve seasonal help in agriculture(such as in the U.S.A., Italy, Greece,
Spain and Germany) work in hotel and restaurant trades (as in Italy, Greece,
Switzerlandand France) and garment making(as in the U.S.A., France, and Spain).
Illegal foreign workers are also employed in the construction industry, in the
personal services sector, as street vendors, and throughout the expanding underground economy.2
For its part, the underground economy has flourished in industrializedcountries
for a number of reasons. A major one is that, by hiring irregular workers, an
employer can avoid paying payroll taxes. In a country like Italy, where payroll taxes
add 50 to 60% to basic pay, the incentives for hiring irregular workers are
significant. Other advantages for employers include the possibility of paying by
piece-rate, avoiding the constraints imposed by trade unions and labor legislation,
and flexible labor utilization in terms of working hours and layoffs. Underground
activities are particularlyconcentrated in industrieswhich are labor-intensive,where
economies of scale do not play a major role, and where demand conditions are
volatile. In such an environmentthe use of irregularworkersoffers employersmajor
possibilities for cutting labor costs while at the same time providing irregular
workerswith advantagesthat are not availablein the official labor market(Del Boca
and Forte 1982). These include income-tax evasion and the possibility of attaining
greater flexibility of working time (Contini 1982, p. 201 and 1989, p. 239). And while
legal residents normally participate in the underground economy as a matter of
choice, illegal aliens, because of their very status, are compelled to do so.
2.

ECONOMIC IMPACT OF ILLEGAL IMMIGRATION

Rapid growth in the number of illegal immigrantsand their participation in the

underground economies of the U.S.A. and Europe has stimulated a lively debate
over the economic consequences of undocumented immigration. It is argued that
illegal foreign workers displace low-skilled natives, depress wages, and neutralize
market pressures that would otherwise result in a rising trend of wages (see the
2 See the Commissionof the EuropeanCommunities(1991),De Grazia(1982),
Mingione(1988),
OECD (1992),Portes(1989),Ricca (1984),and Weinert(1991).

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ILLEGALIMMIGRATION

99

surveyby Greenwood and McDowell 1986). In addition, it is said that the availability
of unskilled legal and illegal migrants lowers the pace of structuraladjustmentand
technological progress, reducing the economy'scompetitiveness in the international
market (Harrison 1992). If capital is mobile across sectors, illegal immigrationmay
draw capital to the underground economy, depriving the rest of the economy of
capital and causing it to stagnate (Ichino 1992). Illegal aliens are also said to draw
benefits from the host country'ssocial programswithout always making the corresponding contribution to the programs'budgets.
On the other hand, those who advocate legalization of the status of illegal
immigrants argue that low-skilled foreign workers are needed and that their presence benefits the economy. In the U.S.A., inflows of illegal foreign workers often
meet labor market shortages that even the Labor Department considers genuine
(Abrams and Abrams 1975). If the domestic labor market is sufficiently segmented,
native workers are largely insulated from the direct employment effects of illegal
immigration(Piore 1979, Greenwood and McDowell 1986, and Ichino 1992). Moreover, foreign workers, in the role of consumers, contribute to an expansion of the
market, stimulate investment spending, and further the process of employment
creation (Bernard 1953). For some sectors of the economy-agriculture in the south
of California and of Texas or the garment industryin large cities such as New York
and Los Angeles-the availabilityof cheap, clandestine foreign labor is essential to
the survivalof a large number of enterprises. Finally, goods and services produced
by the migrants are likely to cost less, benefiting the nation's consumers.
Formal theoretical analysis of the economic consequences of illegal immigration
began with the pioneering work of Ethier (1986), which considers the implicationsof
alternative immigrationpolicies and enforcement measures for the level of welfare
and the distribution of income in a host country. Subsequent studies, including the
works of Bond and Chen (1987) and Djajic (1987), examine the implications of
international interdependence in the context of two-countrymodels. In general, it is
found that efforts to stem illegal immigrationare likely to benefit native unskilled
workers at the expense of other productivefactors such as capital and skilled labor.3
The present paper studies the effects of illegal immigrationon the allocation of
resources, commodity prices and wages of various classes of workers, both in the
short run (when occupational mobility is restricted) and in the long run (when the
skill-composition of the labor force is endogenously determined). Thus, Section 3
develops a simple analytic framework suitable for the analysis of the resourceallocation effects of illegal immigration.The economy is assumed to produce three
3A numberof empiricalstudies have attemptedto quantifythe effects of immigrationon wages
of nativeworkers.As reportedin surveysby Greenwoodand McDowell(1986) and Borjas(1994),
evidenceseems to indicatethat immigrationmaycause a slightdecreasein wages and employment
of domesticlow-skilledworkers.A studyby Bean, Lowelland Taylor(1988)deals explicitlywith the
effects of illegalimmigration.Theirmainfindingsmaybe summarizedas follows:"Theconcernthat
undocumentedimmigrationfrom Mexicomaybe depressingthe earningsof native-bornworkersis
not borne out by these results.... It is also noteworthythat the effects of increasesin the supplyof
this group are negligible on native-bornMexican Americans,the group that a priori may be
expectedto be most affected...."(p. 46).
See also Grossman(1984) for an attemptto measurethe impactof illegal immigrationon the
wagesof nativeworkersby meansof a simulation.Resultsof an employee-employer
surveyfocusing
on issues relatedto employmentof illegal immigrantsare presentedin Chiswick(1986, 1988b).

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DJAJIC

goods which are distinguished in terms of whether a good is internationallytraded

or nontraded, whether it is produced with the aid of skilled or unskilled labor, and
whether firms producingthe good use clandestine or documentedworkers. Section 4
examines the short- and long-run effects of an exogenous inflow of clandestine
foreign workers on factor rewards, relative commodityprices, and the allocation of
resources within the economy. It also considers the implications of such an inflow
for the flow of taxes to the government and the cost of providing each worker,
whether legal or illegal, with a constant flow of public services. Section 5 studies the
consequences of imposing tougher sanctions on employers who hire illegal aliens
and of a policy legalizing the status of clandestine foreign workers.Finally, Section 6
concludes the paper.
3.

THE ANALYTIC FRAMEWORK

Let us consider an economy in which certain legal production activities are

conducted outside of the formal or official sector, within the so called "informal"or
"underground"economy. Let us assume that, in contrast with the formal sector, in
the underground economy the fiscal authorities are unable to collect taxes, labor
legislation cannot be enforced, workingconditions are harsh, and native workers are
employed clandestinely side by side with illegal immigrants.
Only some production activities can be successfully conducted by entrepreneurs
operating underground. We shall assume that these activities consist of producing
an internationallynontraded intermediategood or service, Z, with the aid of capital
and clandestine unskilledlabor. This good or service is used as an essential input in
the production of a final good in one of the sectors of the formal economy.4
The formal economy, in turn, consists of two sectors, X and Y, both producing
final goods. Good X is made with the aid of capital, skilled labor, and a units of
4The motivationfor this modellingstrategyis based on the observationthat a large numberof
enterprisesemployingclandestinelabor tend to be small businesseswhich supplysemi-finished,
labor-intensiveproductsto largefirmswhichare the last linkin the subcontracting
chain.As noted
by Weiss (1987),in the case of Italy, " . . . becauseof trade union controls,large firmsare not in a
position to deregulatethe conditionsof employmentwithin the workplace.But by decentralizing
partof the productionprocessto smallfirmsusingnonunionlabor,largercompaniescan keep their
hands clean and let smaller,shadyfirms do the dirtywork of runningsweatshopsand homework
operations."See also Contini(1982, 1989)for an illuminatingdiscussionof factorscontributingto
the expansionof the undergroundeconomyand the practiceof subcontractingin Italy since the
1960s.
Recent experience of some Western European countries seems to suggest, however, that
clandestineworkersfromEasternEuropeare findingemploymentpredominantly
in constructionor
services, where they produce final rather than intermediategoods. This raises the question of
whetherthe presentmodel is relevantto suchcases. It can be relevantif we thinkof constructionof
a buildingas consistingof a series of activities,some of which(e.g., layingbricksor mixingcement)
may be executedby using clandestineworkers,while others require(due to strict enforcementof
safety regulations)properlylicensedskilledworkerssuch as architects,engineers,crane operators,
or electricians.If we now interpretZ to includethose activitiesperformedby clandestineworkers,
we can thinkof Z as an essentialinputwhichis used, alongwith legal skilledlaborand capital,in
the constructionof a building. On the other hand, when illegal immigrantsperformpersonal
servicessuch as housekeeping,gardeningor child care, or workas self-employedtradersand street
vendors,a somewhatsimplermodel is called for. Morewill be said aboutthis in Section6.

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ILLEGAL IMMIGRATION

101

the intermediate input Z per unit of output, while good Y requiresjust capital and
unskilled labor. For simplicity, let us assume that a is constant. The production
functions for the three sectors are given by
(1)

X =mintf(Sx,

(2)

Y=g(LyKy)

(3)

Z = h(Lz Kz)

Kx), Z/ca,

where Sx is the amount of skilled labor employed in sector X, Kj is the stock of

capital employed in sector j (1= X, Y, Z), Ly is the number of unskilled workers
employed in sector Y, and Lz N + M is the number of clandestine unskilled
workers, natives (N) and illegal migrants (M), employed in the underground
economy. Each of the production functions is linear homogeneous with the usual
properties (i.e., the marginal productivityof each factor is positive but diminishing
and increased utilization of one factor raises the marginal productivity of the
other).5
While output Z of the undergroundeconomy is assumed to be nontraded, both X
and Y are internationallytraded. However, global demand for these final goods is
not infinitely elastic. Let us assume that Py, the equilibriumrelative price of good Y
in terms of the numeraire commodityX, is an increasingfunction of the quantityof
X produced in the economy relative to the quantityof Y.
(4)

Py = PY(X/Y), Pr(-) >0 .

Capital is perfectly mobile internationallyas well as among the three sectors. On

the world market, the rental rate on capital is fixed at r units of the numeraire X
per unit of capital.
The stock of native workers is assumed constant with the number of retiring
employees being equal to the number of natives just entering the labor force.
Immigrationis prohibited and emigration does not occur as natives of our prosperous economy have no incentive to seek employment abroad. Accordingly, the
economy's labor force is of a given size, except for possible changes in the stock of
illegal foreign workers, which we take to be exogenous.6
At any point in time the number of skilled workers, those eligible for employment
in sector X, is given. So is the number of unskilled native workerswho are assumed
to be mobile between sector Y of the official economy and sector Z of the
underground economy. For a native unskilled worker, the principal advantage of
5 In a paper that was broughtto my attention
after this studywas completed,Dell'Aringaand
Neri (1987) present an interesting simple model of illegal immigrationand the underground
economy. In contrast with the present study, they focus on an economy producinga single
commodity(some of it in the formalsector and the rest underground)
with a given stock of capital.
6 This is an importantassumption.It sets aside the issue of usingpolicymeasuresto deter illegal
immigration.While the questionof deterrenceis touchedupon later in the paper,it can be properly
treatedonly in a richerframeworkof analysiswherethe variouschoicesavailableto potentialillegal
migrantsare modelledexplicitly.The focus of the presentstudyis on the economicconsequencesof
illegal immigration,takingas giventhat the migrantshave alreadyarrived.

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DJAJIC

having a job in sector Z consists of not having to pay income and social security
taxes. The disadvantageis that one is not eligible for certain social benefits or legal
protection and working conditions are more "harsh"than in the formal sector Y.
Let us assume that native unskilled workers are indifferent between the two
sectors only if the official (gross) unskilledwage V in sector Y is related to the wage
U paid in the underground economy as follows:
(5)

V(1-t)=U/(1+

where t is the sum of income and social security tax rates (assuming they fall
entirely on the employees) and S reflects the premium that native workers require
as compensation for the net disadvantagesof being employed in the underground
economy.
Firms operating in the undergroundeconomy are subject to penalties for hiring
labor in a clandestine manner. The expected penalty per worker,whether domestic
or foreign, is assumed equal to a constant proportion o of the wage U. Accordingly,
the cost of unskilled labor to a firm operating in the undergroundeconomy is given
by U(1 + ar). This amount is taken to be smaller than the unskilled wage V in the
formal economy. Otherwise, in the context of the present model, it would not be in
the interest of entrepreneursin sector Z-the only sector in which there is scope for
underground activity-to hire workers in a clandestine manner.
As is spelled out in the Appendix, we assume that employer penalties consist of
fines which do not constitute a real social cost and that the total revenues from fines
are equal to enforcement expenditures, thus preservinga balanced budget.
While native unskilled workers are perfectly mobile between sectors Y and Z,
provided (5) is satisfied, they cannot become eligible for skilled employment in
sector X without having participatedin a costly trainingprogram.7For the required
investment in human capital to pay off for an individual at the beginning of his
working life, we assume it is necessary that the skilled wage W in sector X exceeds
the unskilled wage V of sector Y by tk percent. Accordingly,native entrants into the
labor force are willing to work as unskilled laborersonly if V ? W/(1 + g), and seek
to become skilled workers if Ve< W/(1 + tk).In a long-runequilibrium,defined as a
state of the economy in which the skill composition of the labor force is stationary,
(6)

V=W/(1+

while in the short run the number of skilled workers is fixed and V may be either
greater or smaller than W/(1 + tk).
Assuming that firms behave competitively, profits are driven to zero in equilibrium. Prices of the three goods produced by the economy must then be equal to unit

7 Trainingis assumedto take place before a workerreachesthe age of entryinto the laborforce.
Accordingly,the processof skill formationdoes not absorbmanpowerfromthe labormarket.

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103

ILLEGAL IMMIGRATION

costs. Since good X is the numeraire,we have

aSXW+ aKxr= 1 - aPz,

(7)
(8)

aLYV+ aKyr = PY,

(9)

aLZU(1

+ cr) + aKZr = Pz,

for activities X, Y, and Z, respectively,where Pz is the price of good Z in terms of

X, and aij is the quantity of factor i (i = S, L, K) required per unit of output in
activityj (Q= X, Y, Z). These per-unit input requirements are, of course, functions
of the relevant factor prices.
Along with conditions (5) and (6), equations (7) through (9) can be solved for the
long-run values of the five endogenous price variables: W, V, U, Py, and Pz. A
graphic solution is provided in Figure 1. The XX schedule depicts the relationship
between W and Pz implied by equation (7). With the rental rate r fixed on the
world market, an increase in Pz must be accompanied by a decline in W for the
production cost in sector X to remain equal to the value of output.
Similarly,the ZZ schedule depicts the relationshipbetween W and Pz implied by
equations (5), (6), and (9). Using (5) and (6) we may write U as a function of the
skilled wage.
(10)

U=W(1-t)(1+

)/(l+

By substituting this expression for U in (9), we obtain a positive relationship

between W and Pz, which is depicted by the ZZ schedule. The point of intersection
between XX and ZZ in Figure 1 determines the long-run values of W and Pz.
These, in turn, determine the steady-statevalue of V with the aid of (6), of U with
the aid of (10), and of Py with the aid of (8). Knowing Py, we can solve for Y as a

zZ

FIGURE 1

FIGURE 1

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DJAJIC

104

function of X by inverting (4) to obtain Y= sr(Py)X. In addition, Z/X= a by

assumption. Using these last two relationships along with the full-employment
condition that the economy's labor endowment L = asxX + aLYY + aLZZ, we can
solve for the steady-state value of X.
(11)

X=L/[asx+aLY(.)

+aLza],

where L Sx + Ly + N + M is the total number of workers available in the economy. The equilibrium values of Y and Z are then obtained by noting that
Y=

r( )X and Z = aX.
4.

ILLEGAL IMMIGRATION, WAGES, PRICES AND THE ALLOCATION

OF RESOURCES

Let us now consider the implications of an exogenous increase in the stock of

illegal immigrantsemployed in the undergroundeconomy. It is useful to distinguish
between the short- and long-run effects. As noted earlier, the number of skilled
workers is fixed in the short-run and therefore equation (6) need not be satisfied,
while in the long-run the number of skilled workers is endogenous and condition (6)
holds.
Considering first the short-run effects, an increase in the number of illegal
migrants employed in the underground economy tends to lower U and V in the
same proportion since native unskilled workers are perfectly mobile between sectors
Y and Z. With perfect international and intersectoral capital mobility, the rental
rate on capital is not affected in any of the three sectors and hence the cost of
producing both Z and Y must fall. Furthermore,due to a lower wage-rental ratio,
firms in these two sectors switch to relatively more labor-intensive techniques of
production.
The decline in the cost of production in the underground economy lowers Pz.
Production of X thus becomes more profitable, drivingup W to the point where the
zero profit condition for sector X is satisfied. With an increase in W and no change
in r, producers of X turn to a more capital-intensive technique of production,
thereby expanding output even though the supply of skilled labor is fixed. Recalling
that Z is nontraded and that the per-unit requirementof Z in sector X is constant,
it follows that outputs of X and Z increase in the same proportion. Output of Y,
however, increases by an even larger percentage, to the point where Py declines on
the market by as much as the fall in the unit cost of production associated with the
drop in V. Whether Py declines or increases relative to Pz depends on whether
the distributive share of labor in sector Y is greater or smaller than it is in the
underground economy. One would expect that sector Z is the most labor intensive
of all three sectors, in which case Py/Pz increases.
Row 1 of Table 1 provides a summary of these short-run, factor-reward and
resource-allocation effects of an increase in the stock of illegal migrants (algebraic
solutions are provided in the Appendix). It is interesting to note that the short-run
impact of illegal immigration on the income of native skilled workers is positive,
while on that of unskilled workers is clearly negative. With an increase in W and a
decline in Py, skilled workers are unambiguously better off as their real wage

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ILLEGAL IMMIGRATION

105

TABLE 1
EFFECTS OF AN INCREASE IN THE STOCK OF ILLEGAL FOREIGN LABOR

On Variables:
Row 1

S-R

L -R (CaseA)

Row 3
S -R (Case B)

Row4
L -R (CaseB)

(Case A)

Py

Pz

Py/Pz

Y/X

Sx

Ly

Row 2
0

T T

T
T

increases in terms of both consumption goods. By contrast, unskilled workers, legal

as well as illegal, experience a loss of real income as they suffer a drop in wages
which is larger in percentage terms than the decline in Py.
In the transition between the short run and the long run the stock of skilled labor
increases and that of unskilled labor declines as natives about to enter the labor
force are encouraged by the increase in W/V to acquire skills. As the stock of
unskilled labor diminishes V and U rise. This augments the cost of production in
sectors Y and Z, causing Py and Pz to rise. At the same time the rising stock of
skilled labor in sector X, along with a higher Pz, tends to lower W. In the long run
the ratio of W to V is restored to its steady-statevalue of 1 + tk, and all factor and
commodity prices return to their original levels. Output of each sector expands in
relation to the pre-inflow equilibrium,but the relative quantities of the three goods
produced remain the same. As recorded in Row 2 of Table 1, the only other effects
which can be observed in the long run concern the allocation of native labor among
the three sectors. An increase in the stock of illegal immigrants serves to push
natives out of the underground economy and into sector Y and to induce a larger
number of natives to become skilled workers. Thus, by encouragingnative workers
to invest in human capital, illegal immigrationserves to increase the averagelabor
income of native workers, while leaving relative factor and commodity prices
unchanged.
Government'sincome and social securitytax revenues are given by t(WSx + VLy).
With each sector of the economy expanding in the same proportion as the labor
force, both in terms of employment and output, per capita revenues remain unchanged. Consequently, if the initial revenues were just sufficient to finance the
provision of go units of public services per worker, an inflow of illegal aliens does
not alter that budgetary balance in the long run. Revenues from taxing the income
of workers employed in sectors X and Y at the rate t will continue to cover the cost
of providing go units of public services to each worker, legal as well as illegal, even
though illegal residents do not contribute directly to the tax system.8
8

In order to simplifythe analysis,the productionfunctionfor public servicesis not modelled

explicitly.If one were to do so, assumingthat publicserviceswere producedaccordingto a constant
returns-to-scaleproductionfunctionusingcapitaland labor(skilledand/or unskilled),none of the
conclusionsof the precedingparagraphwould be affected.Each of the (now four) sectorswould
expandin the same proportionas the stock of laboravailableto the economy.

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DJAJIC

It should be noted, however, that the empirical evidence available for the U.S.
economy seems to indicate that a very small percentage of illegal aliens do in fact
receive free public services. Illegals are typically young males who are afraid of
being apprehended if they request government assistance. Moreover, they are
normally unaccompanied by a wife or children, who may be heavier users of public
services. At the same time a large majoritydo pay Social Security and income taxes
through the automatic withholding system. In a sample of illegal immigrantsstudied
by North and Houstoun (1976), 77% paid Social Security taxes and 73% paid
income taxes. There is overwhelmingevidence pointing to the conclusion that illegal
immigrantsare in fact making a positivenet contributionto the public coffers.9
Throughout the analysiswe have assumed that both migrantsand native unskilled
workers are employed side by side in the undergroundeconomy. That situation may
be called "case A." When a sufficiently large stock of illegal immigrants exists in
relation to the size of the undergroundeconomy, a point is reached where all native
workers are employed in the official economy as skilled or unskilled workers and
only migrants can be found in sector Z. At that stage we switch from "case A" to
"case B."'0 In "case B," U is no longer tied to V by means of (5) as there is no more
native labor in the undergroundeconomy that can support the value of U in relation
to V by leaving sector Z and joining sector Y. In this new setting, the effects of
illegal immigrationon factor rewards and the allocation of resources are somewhat
different.
In the short run, an increase in the stock of illegal foreign labor lowers U,
increases output of Z and lowers Pz. A lower Pz stimulates expansion of sector X,
generating an increase in W as well as in the capital intensity of production. The
increase in output of X relative to Y causes Py to rise on the market, supportingan
increase in the official unskilled wage V, as well as in the capital-labor ratio of
sector Y. Accordingly,output of Y expands even though Ly is fixed. These findings
are summarized in Row 3 of Table 1, with algebraic derivations presented in the
Appendix.
In contrast with case A, we observe that in the short run an increase in the stock
of migrants raises the wage of all native workers and not only those who are skilled.
Whether V does or does not increase relative to W depends on the parameters of
the model. As shown in the Appendix, inelastic demand with respect to Py in the
9As reportedby Simon(1989,pp. 295-296), ". . . everystudythat providesdollarestimatesshows
that when the sum of the tax contributionsto city, state and federalgovernmentare allowedfor,
these tax paymentsvastly exceed the cost of the servicesused by a factor of perhapsfive, ten or
more.... On balance, then, the conclusionis quite the opposite of what is commonlysupposed:
nativesexploitillegalimmigrantsthroughthe publiccoffersby takingmuchmorefromthe illegalsin
taxes than is spent on them in publicexpenditures."
10Atfirst glance, "case B" may appearto representa ratherunrealisticsituation.However,in
some countries,it seems that in a numberof underground-economy
occupations,jobs are filled
almostexclusivelyby migrants.Accordingto the Commissionof the EuropeanCommunities(1991,
p. 99), in Italy ". . . a numberof activitiesare not acceptedby the native workersunder existing
conditions(e.g., workas a domesticservant)."Similarly,in Spain,in the case of domesticserviceand
mining,Spanishworkersare hardto find.

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ILLEGAL IMMIGRATION

107

goods market, a small distributiveshare of skilled labor in sector X, and a low (high)
elasticity of substitution between capital and labor in sector Y (sector X) all
increase the likelihood that the value of V/W rises in the short run.
The nature of the transition to the steady state depends on whether V/W
increases or declines on impact. A rise in V/W leads to an increase in the number
of unskilled native workers and a decline in the number of those who are skilled.
This results in a tendency for V to fall and W to rise, output of Y to expand and
that of X to contract, and for both Py and Pz to fall in relation to their short run
values. Alternatively, if V/W initially declines, all these variables move in the
opposite direction in the transition to the steady state.
The long-run effects of an increase in the stock of illegal migrantsin case B are
summarizedin Row 4 of Table 1: Both W and V rise in the same proportion, U and
Pz fall, Py increases (although less than in proportionto the increase in V), output
of both X and Y expands, Y/X diminishes, and the skill composition of the native
labor force can change either way, depending on the values of the model's parameters.
Real income of native workers, skilled and unskilled, clearly improves as their
productivityand wages rise in terms of both final goods. Skilled natives benefit from
the inflow of illegal aliens because it reduces the cost of the intermediate good used
in sector X, the sector employing skilled labor. Unskilled natives benefit as the
economy expands, increasing the demand for good Y, the good produced by
unskilled labor. By contrast, clandestine foreign workers bear the adverse consequences of illegal immigration as the real wage paid in the undergroundeconomy
falls in terms of both X and Y."

5.

EMPLOYERSANCTIONSAND LEGALIZATION
MEASURES

In response to growth in the stock of illegal foreign workers, the receiving

countries have expanded their efforts to stop further inflows of illegal aliens, and
also to make it more difficult for foreign workers to obtain authorized employment.
Among the policies used to achieve these related objectives are measures that
penalize employerswho hire undocumented foreign workers. In the U.S.A., comprehensive employer sanctions have been introduced with the passing of the Immigration Reform and Control Act of 1986. Similar measures have already been applied
for some time in Australia, Canada, and the countries of Western Europe. In the

11It is importantto note that these favorablewage effects of illegalimmigrationmaynot appear

under alternativespecificationsof the model with respect to tradabilityof the three commodities
and the responsivenessof world prices to changes in the economy'spattern of production.For
example, if output of the undergroundeconomy is tradable at a given world price Pz, illegal
immigrationentails only an expansionof the undergroundeconomy,leavingall factorrewardsand
productionin other sectors unaffected.Similarly,if the economyfaces a given P* on the world
market,the wage of nativeunskilledworkersis independentof the stockof illegalimmigrantswhile
the skilled wage rises or remains constant in response to inflows of illegal foreign workers,
dependingon whethersuch inflowsloweror leave unchangedthe value of Pz facingthe producers
in sector X.

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DJAJIC

last few years additional, stronger measures of the same type have been passed into
law in a number of industrial countries.12
The next two sections examine the implications of such measures on factor
rewards and the allocation of resources under two alternative assumptions:In one
case, stiffer sanctions have a direct impact only on the hiring of illegal aliens (case
B). In the other case they are assumed to increase the expected cost of hiring not
only foreign, but also (to some extent) native clandestine workers.
5.1. TougherSanctions thatAffect Only the Cost of HiringIllegalAliens. If the
measures affect only the employment of illegal foreign workers and have no direct
implicationsfor clandestine natives employed in the undergroundeconomy (or, as in
case B, if there are no natives employed in the underground economy), then the
only consequence of tougher sanctions is to lower the wage received by migrantsby
the amount equal to the increase in the expected (sanction-inclusive)cost of hiring
illegal aliens. Wages of all native workers, relative commodity prices and resource
allocation all remain unaffected.
Although not modelled explicitly in the present study, there are two obvious
channels through which tougher measures could have an impact on native workers
even in case B. First, contrary to what has been assumed in Section 3, in a more
general setting the government's enforcement budget need not be continuously
balanced. Tougher sanctions may then reflect an increase in fines imposed on firms
convicted of hiring illegal aliens while enforcement expenditures are held constant.
Such a policy change would generate a surplus in the enforcement budget, enabling
the government to transfer excess revenues to native workers. It would serve to
redistribute income from illegal aliens to native workers. Alternatively, if tougher
measures consist exclusively of an increase in enforcement expenditures which are
not fully covered by a larger number of fines collected (given the enforcement
technology), all the net costs-in the presence of perfect international capital
mobility-would be a burden to the native workers.
Second, tougher enforcement measures and/or fines may serve to deter future
immigration flows, as well as induce (or compel by means of deportation) return
migration, lowering the economy's stock of illegal aliens. If the stock of illegal
12
Quotingsome of the examplesreportedby OECD (1992)will sufficeto illustratethe trend:
In France,for instance,a new measure(Act of 31 December1991)increasesthe penaltiesthat
can be imposedon employersof undocumentedaliens and on the organizednetworksthat smuggle
them in .... Anyone convictedof resortingto services of an undocumentedimmigrantworker,
whetherdirectlyor throughan intermediary,is jointlyliablewith that intermediaryfor the payment
of anyfines, taxesor other chargesincurred,as well as that of both employer'sand employee'ssocial
securitycontributionsand the wages due to the worker.
The Netherlandsintroducedin 1991 new employersanctions.Employersare now liable for the
cost of expulsion of the foreigner concerned.The Dutch authoritieshave also recruitedmore
inspectors... and havesteppedup the frequencyof controls.... Germanyintroducedon 1 July1991
a rule stipulatingthat... an employertakingon a foreignworkermust informthe social security
authoritiesof the recruitmentdate... . In the economicsectors knownnot alwaysto complywith
the laws governingthe employmentof foreigners(for instance,the buildingtrade, cleaning and
other services)the authoritiescheck on employersand maychallengethem at any time to produce
their workers'social securitycards(p. 32).

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ILLEGALIMMIGRATION

109

foreign workers does in fact diminish, this secondary,repatriationeffect of sanctions

entails changes in the economy which are precisely the opposite of those observed in
response to an inflow of illegal foreign workers. Recalling that an inflow raises the
real wage of every native worker in case B, an outflow of foreign workers, triggered
by tougher sanctions, would lower real wages of both skilled and unskilled natives.
While keeping in mind these possible extensions of the model, let us continue to
assume in what follows that the stock of illegal aliens is exogenously given and the
enforcement budget is continuouslybalanced.'3
5.2. Effects of TougherSanctions WhenNatives WorkClandestinely. If natives
are employed in the underground economy (case A), an increase in fines and
enforcement of laws pertainingto employmentof clandestine foreign labor may also
serve to increase to some extent the expected cost of hiring clandestinenative
workers.The policy will then affect all wages as well as the allocation of resources,
even if it does not cause illegal foreign workers to leave the economy. Let us now
examine these effects in the short run and in the long run.
In the context of our model, policy changes that raise the employers' expected
cost of hiring clandestine labor are reflected in an increase in o-. If the cost of hiring
a clandestine native differs from that of hiring a clandestine migrant,the value of owill differ for the two categories of workers. In terms of Figure 1, an increase in the
value of a- pertaining to employment of clandestine native workers shifts the ZZ
schedule to the right, resulting in a lower W and a higher Pz in the long run. The
values of V and U fall in the same proportion as W, where U should now be
interpreted as the underground economy wage received by native workers. To the
extent that the employers'expected penalty for hiring a clandestine foreign worker
exceeds that for hiring a clandestine native, the underground economy wage that
firms are willing to pay migrants is correspondingly lower than U.14 Long-run
changes in wages of the three sectors accompany changes in the allocation of
resources and relative commodityprices. A lower V indicates that Py is also lower,
although by a smaller percentage, and that output of Y expands relative to X and
Z. These adjustments in the pattern of production imply that the economy undergoes a decline in the number of skilled workers, an increase in the number of
unskilled workers in the official economy, and a decline in the number of clandestine natives. Thus, while native workers might be expected to benefit from tougher
enforcement measures, it turns out that they all suffer a cut in real income (not only
in terms of the numeraire X, but also in terms of good Y) and a smaller number of
13The work of Ethier (1986) providesan interestinganalysisof the distinctionbetween border
enforcement and internal enforcementpolicies in a setting where firms either can or cannot
distinguishillegalimmigrantsfromother unskilledworkersandwhereillegalforeignworkersmayor
may not incurcosts in tryingto pass themselvesoff as legal workers.While a similaranalysiscould
be conducted in the context of the present model, space limitationssuggest that it would be
preferableto do so in the contextof anotherpaper(Djajic1996).
14 Using the superscript 4 to indicate that the variablepertains to illegal foreign workers,
U4'(1+ oa)= U(1 + or). Thus if the penalty for hiring foreign workersis greater than that for
natives, o->o> and hence Up < U.

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DJAJIC

110

TABLE2
SANCTIONS
EFFECTSOF TOUGHEREMPLOYER

On Variables:
Row 1
S-R

(Case A)

Py

PZ

Py/Pz

Y/X

Sx

Ly

00

Row 2
L-R

(Case A)

natives ends up being skilled in the long run. Their only consolation is that illegal
foreign workers experience an even larger decline in real income.
The direction in which the key variables are affected in the short run is the same
as in the long run with only one exception. The number of skilled workers employed
in sector X is constant in the short run and declines only in the long run. Short- and
long-run effects on the key variables are summarizedin Table 2 in Rows 1 and 2,
respectively.
5.3. Amnesty. Countries with large numbers of clandestine foreign workers
have attempted in a number of cases to deal with some of the consequences of
illegal immigrationby legalizing the status of some, but usually not all such workers
(see the Commission of the European Communities 1991). In the context of the
present model, legalization of the status of a clandestine foreign worker may be
interpreted to imply, as it often does in reality, that he or she is also required to
leave the underground economy and obtain employment in one of the official
sectors.15 If we assume that both native and foreign clandestine workers are
employed in sector Z (case A), then the only effect of the legalization measure is to
force foreign workers out of the underground economy and into sector Y, where
they switch places with an equal number of (perfectly mobile) native unskilled
workers who end up in sector Z. Production of the three goods, factor rewards,
commodity prices, and the government's tax revenues remain unaffected in that
case, both in the short run and in the long run. This is recorded in Rows 1 and 2 of
Table 3.
Alternatively, if only foreign workers are employed in sector Z (case B), then a
policy of legalizing a certain number of clandestine foreign workerswill increase the
supply of unskilled labor in sector Y of the official economy while lowering
the supply of clandestine workers in sector Z. As shown in Row 3 of Table 3, in the
short run, this shift in the supply of unskilled labor from the underground to the
official economy raises the wage U in sector Z and lowers the wage V in sector Y.
In response to these changes in the supply of labor and wages, there is an
increase in output of good Y, a decline in Py, and a decline in the capital-labor
ratio employed in sector Y. In sector Z, output falls, Pz rises, and the capital
15Legalizationprocedureoften requiresof an illegal alien to become employedin the official
economy.In Spain,for example,Law of Foreignersof 1985 allowsfor the legalizationof an illegal
residentprovidedhe or she applies for such a procedureand producesthe requireddocuments,
includinga laborcontract.See the Commissionof the EuropeanCommunities(1991,p. 87).

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ILLEGAL IMMIGRATION
TABLE3
EFFECTSOF LEGALIZING
THE STATUSOF SOMECLANDESTINE
FOREIGNWORKERS

On Variables:

Py

Pz

Py/Pz

Y/X

Sx

Ly

Row 1
S-R (Case A)

L - R (Case A)

Row 3
S-R (Case B)

0?

Row 2

Row4
L-R (Case B)

I T

tT

intensity of production increases. These changes also affect sector X, where the
increase in Pz entails a decline in the skilled wage W. This in turn lowers the capital
intensity of production and hence output of good X. Production of X falls in the
same proportion as that of Z.
In essence, the amnesty programin case B deprives native workers of the benefits
they enjoyed as a result of an increase in the stock of illegal aliens. With an amnesty,
Pz is driven up, reducing the rents enjoyed by individualswith the status of a skilled
native worker. Similarly,by shifting foreign workersfrom the undergroundeconomy
and into sector Y, the amnesty cuts the income of those with the status of a native
unskilled worker. Only the illegal aliens enjoy an increase in real income. Those who
legalize their status get a hike in wages as they switch from the underground
economy to sector Y. Those who remain undergroundbenefit from an increase in U.
The long-run effects, summarized in Row 4 of Table 3, are similar to those
observed in the short run. The only importantdifference is that the supply of skilled
workers, Sx, may either rise or fall in the transition to the steady state, depending
on whether W/V increases or declines in the short run.
5.4. Effects of an Amnesty When IllegalForeign WorkersAre Skilled. To this
point I have assumed that illegal foreign workers are unskilled. However, as noted
by a referee, it is often observed that clandestine foreign workers are "underemployed" in the sense that they are skilled, but have to work "underground"as
unskilled workers to avoid getting caught. If amnesty is given to them, they will work
in the formal sector as skilled workers. To analyze the effects of an amnesty under
this alternative assumption, we need to distinguish once again between cases A
and B.
In case A, legalization of a certain number of clandestine foreign workers would
have no long-run effects on prices, outputs and factor rewardsfor reasons that are
alreadyfamiliar. However, in the short run, allowing foreign workers to move out of
the underground economy and into skilled jobs in sector X tends to lower W while
raising V and U. At the same time it raises Pz and Py, while the ratio PyIPZ rises
or falls depending on whether sector Y or sector Z is relatively more labor
intensive. Outputs of X and Z increase, while that of Y declines. In summary,an
amnesty in this case lowers in the short run the real income of skilled natives while

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DJAJIC

increasingthat of unskilled natives, unskilled illegal foreign workers, and (to a larger
extent) skilled foreign workers who benefit from the amnesty directly.16

6.

CONCLUDING REMARKS

In considering the effects of an inflow of illegal foreign workers, the analysis of

this paper has drawn a distinction between the short run (when occupational
mobility is restricted) and the long run (when the skill-compositionof the labor force
is endogenously determined). An increase in employment of illegal foreign workers
within the undergroundeconomy was found to have a favorable short-runeffect on
wages of skilled native workers. However, it may have either a negative or a positive
short-runimpact on the wages of unskilled natives, depending on whether natives do
(as in case A) or do not (as in case B) compete with migrantsfor unskilled jobs in
the underground economy. These findings are largely consistent with the evidence
on the economic impact of illegal immigrationreported by Simon (1989, Chapter 15)
as well as with the argument that inflows of migrants may not be detrimental to
native workers if the labor market is segmented and migrantsare employed in those
occupations that the natives find unacceptable.
In the long run, allowing for interoccupational mobility of native workers, an
inflow of illegal foreign labor has no effect on wages of natives when both natives
and foreigners are employed in the undergroundeconomy. Alternatively,when only
foreign workers occupy jobs in the undergroundeconomy, all native workers enjoy
an increase in real wages. In the context of the present model, skilled natives benefit
because illegal immigration reduces the cost of the intermediate good used by the
sector employing skilled labor. Unskilled natives benefit because the economy
expands, increasing the demand for the services of unskilled labor. Thus, the model
illustrates the possibility that all nativeworkersmay benefitfrom illegalimmigrationas
the inflow of foreign workers enables them to enjoy larger scarcityrents.
Imposition of stiffer sanctions on employers found to be hiring illegal aliens was
found to have no effect on wages of natives if native workers do not participate in
the clandestine labor market. If they do participateand tougher sanctions raise the
cost of hiring not only foreign, but also clandestine native workers, real wagesof all
nativesdecline.Accordingly,employer sanctions do not seem to be an effective policy
instrument when used with the objective of raising the real income of native
workers. Similarly,in the context of the present model, legalization of the status of
clandestine foreign workers has no positive effects on the real income of natives. It
16In case B, however,some of the effects of grantingamnestyto skilled foreignworkersare
ambiguous.What is clear is that W declines and U and PZ increasein the short run to the point
where outputsof Z and X are maintainedequal to each other in spite of the transferof legalized
foreignworkersfrom sector Z to sector X. Whetheroutputsof Z and X are higheror lower in
relationto their originallevels dependson the model'sparametersand in particularthe elasticities
of factorsubstitutionand the distributivesharesof laborin Z and X. WhetherPy (and hence V)
rises or falls depends,in turn,on whetherX is higheror lower.The long run effects, however,are
identicalto those in case A. This is becauseof the long-runmobilityof nativeworkerswhichenables
them to choose between skilled and unskilledprofessions,making it impertinentwhether the
amnestyallowsforeignworkersto take skilledor unskilledjobs.

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ILLEGAL IMMIGRATION

113

either leaves their wages unchanged (as when natives are employed in the underground economy) or it redistributes income from natives to illegal aliens (as when
only foreign workers are employed underground).
Having discussed the consequences of illegal immigration in the context of a
highly stylized model, it is appropriate to ask how sensitive the results are to
changes in the underlyingassumptions.An inspection of alternativespecifications of
the economy's structure reveals that the results are rather robust. If, for example,
the illegal foreign workers are used in a sector producing a final (instead of an
intermediate) good, an inflow of clandestine foreign workers would tend to lower
the price of that sector's output, increasing the real income of native workers
employed in other sectors at any given level of nominal wages. In addition, by
causing the economy to expand, such an inflow serves to stimulate the demand for
goods produced by native labor throughout the economy, resulting in higher wages
and/or more favorable employment conditions. In general, with an externallygiven
rate of return on capital, a negative effect on the real income of native unskilled
workers is observed only if such workers are employed in the undergroundeconomy
along with illegal aliens and if the price of their output falls. Introduction of an
additional, fixed factor of production into the model (such as land), would generate
effects of illegal immigrationwhich are less favorablefrom the perspective of native
workers, although not that of the landlords or the host countryas a whole. However,
in assessing the full economic impact of illegal immigration,one should also bear in
mind the possible adverse congestion effects in both consumption and production,
as well as the negative externalities related to the activities of illegal aliens in the
economy.
APPENDIX

Short-runeffects: Case A. To solve for the short-runeffects of an increase in the

stock of foreign workers in the undergroundeconomy, we recall that equations (4),
(5), (7), (8), and (9) are satisfied at all times. In addition, Z = aX, X = Sx/asx(W/r),
Y = Ly/aLY(V/r), Z = Lz/aLZ(U/r) and T = Lz + Ly, where T is the total stock
of (domestic and foreign, legal and clandestine) unskilled labor. For a constant r
and Sx, logarithmic differentiation of these ten equations yields
(A.1)

(A.2)

PY=ED(X-Y)
A

V= U
PPz

(A.3)

OsxW=

(A.4)

OLYV=PY

(A.5)

OLZU= Pz

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DJAJIC

(A.6)

Z=X

(A.7)

X = OKX'UXW

(A.8)

Y=LY+

(A.9)

Z=LZ+

(A.10)

T= AZ Z + (1 - Az)Ly

OKYUYv

OKZUZU

where a "A" indicates percentage change, ED is the inverse of the elasticity of

substitution on the demand side, p aPz/(1 - aPz), oj> 0 is the elasticity of
factor substitution in sector j ( = X, Y, Z), Oij is the distributiveshare of factor i
(i = K, L, S) in activityj ( = X, Y, Z), and AZ is the fraction of total unskilled labor
T employed in the undergroundeconomy. This system of ten equations can be easily
solved for PY, X, Y. V, U, W, PZ, Z. and Ly as functions of T, the percentage
change in the stock of unskilled labor due to illegal immigration. We obtain the
following results, which are summarizedin Row 1 of Table 1:
A

<0

(A.11)

U/T = V/T =-(,ED/AzA)

(A.12)

W/T= (POLz ED/0sxAzA) > 0

(A.13)

Py/T=

-(OLYED/AzA) < 0

(A.14)

Pz/T=

-(OLzED/AzA)

(A.15)

X/T= Z/T= OKXUXPOLZED/0SXAZA

>0

(A.16)

Y/T=

<0

(ED/AZA)[(OKXO-XPOLZ/OSX)

+ (OLY/ED)] > 0

(A.17)

L/i=Y/ [OLY+ (ED POKX XOLZ/OSX) + EDOKyUY]/AzA>0

(A.18)

LZ/Ti= (ED/AZA)[(OKXO-XPOLZ/OSX)+ OKZo-Z]> 0

where
A

[OLY+

(EDOKXO-XPOLZ/OSX) + EDOKYOy] [(1

AZ))/Az]

D[(OKX UX POLZ/ OSX) + OKZUZ] > 0

Short-runeffects: Case B. When none of the native workers are employed in the
undergroundeconomy (case B), we note that the system of equations (A.1) through
(A.10) must be modified before we can examine the short-runeffects of an increase
in the stock of illegal foreign workers. First, (A.2) does not hold because the wages

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ILLEGAL IMMIGRATION

of native unskilled workers are no longer directly tied to the wage prevailingin the
underground economy. In addition, Ly= 0 in (A.8) because the stock of unskilled
labor in sector Y is constant. Finally, (A.10) can be dropped and Lz can be treated
as exogenous and equal to the percentage change in the stock of illegal immigrants.
It is then simple to solve (A.1) and (A.3) through (A.9) for the values of U, V, W,
Py, Pz, X, Y, and Z as functions of Lz.
(A.19)

U/Lz =

-( Osx/PLZ)/8

<O

(A.20)

V/Lz =

ED0KXofX/(OLY+

EDOKYY)

(A.21)

W/Lz = 1/8 > 0

(A.22)

X/LZ

(A.23)

Y/Lz =

Z/LZ

= OKX fX!8>0

Py/Lz

(A.25)

Pz/Lz =

ED0KYCTY) 8>0

OKY(TYED0KX(TX/(0LY+

= OLYEDOKXoX/(OLY+

(A.24)

8>0

ED0KYoY)8>

-(OLzOsX/pOLz)/8<O

where 8
hKXOX+(0KZ oZ@Sx/pOLz)>0
Row 3 of Table 1. Note that

V/Lz < W/Lz as 6KXffX

Tese

findings are summarized in

(OLY/ED) + OKYOY*

Employer Penalties and Enforcement Expenditures. It has been assumed in the

paper that employer penalties consist of fines which do not constitute a real social
cost and that the total revenues from fines are equal to enforcement expenditures,
thus preserving a balanced budget. The mechanism that maintains this balance may
be described as follows: For any given level of fines per infraction (F), total fine
revenues (R), are an increasing function of E, a variablewhich reflects the amount
of expenditure incurred by the authorities to detect, prosecute and impose fines on
violators. Let us assume that R = w(E; F), where to1,w2>0 and to,, <0. The
authorities choose F and then set E = c(E; F). Solving this equation for E
(assuming that the enforcement technology is such that a unique solution does exist
for the chosen value of F), we obtain the level of enforcement spending, E*(F),
which maintains a balanced budget. Tougher employer sanctions, in this context,
imply a decision by the authorities to raise not only F, but also E so as to maintain a
balanced budget. This is reflected in a higher value of cr, because of both an
increase in the level of fines and in the probabilityof detection.
For simplicity of exposition, enforcement activity is not modelled explicitly as a
fourth sector of the economy. As is clear on the basis of the preceding analysis, in
the event that enforcement measures absorb E% of the economy's labor force,
long-run output and employment of each sector would be smaller by e%. By

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DJAJIC

contrast, absorption of capital by enforcement activities has no effect on the

allocation of resources among sectors X, Y, and Z because of perfect international
capital mobility.

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