Lowering taxes while keeping public spending high are key strategic policies that a country can adopt to attract mobile workers from other countries. However, attracting skilled labourers requires more than just policy tweaks, and it is also influenced by whether the country is technologically advanced.

These are some of the findings in the working paper titled ‘Fiscal competition and two-way migration,’ published by the Luxembourg Central Bank (BCL). Authors Patrice Pieretti, Giuseppe Pulina and Skerdilajda Zanaj from the University of Luxembourg, with Pulina having a second affiliation with the Luxembourg Central Bank, delved into theoretical models of two-way migration driven by strategic public policies across two competing countries.

The variables

Imagine two countries, each home to workers of varying skill levels who can move between them. The objective of both governments is to maximise their economic growth by attracting these mobile workers, aiming to achieve higher net revenues through wage taxation. To increase work productivity, the governments could improve transport and other social infrastructure, for example. Moreover, workers could be influenced by superior healthcare, housing, education, etc., as part of public spending by the governments. Thus, taxes and public expenditure emerge as key strategic variables that the governments can employ to attract mobile workers from one another. However, there is a third component as well--that is, the relative technological advancement of the two countries. Keep in mind that ‘advanced technology’ is both skilled workforce and sector-dependent, meaning that one country could be considered technologically advanced in one sector but could lag in another.

The migrations

Depending on their tax rates and public spending, both advanced and lagging countries can experience a two-way migration pattern among workers. The working paper authors argued that under normal conditions, most skilled workers would move to the more advanced country. However, the lagging country can counter this by lowering taxes or increasing spending on social incentives. If the benefits outweigh the costs of moving, the lagging country can retain some of its skilled workers and also attract foreign workers with fewer skills.

Interestingly, the lagging country doesn’t necessarily need to implement both measures, asserted the authors. The ‘optimal’ approach depends on the technology gap between the two countries. If the gap is small, the lagging country should invest more in public services than the advanced country, and let the advanced country attract highly skilled workers with lower taxes. This strategy allows the lagging country to still end up attracting more workers. However, if the technology difference is big, the best strategy for the lagging country would be to lower its taxes, despite the risk of losing more workers to the advanced country than it gains in return.

Irrespective of the chosen strategy, there is a strong message for policymakers: as the technology gap widens, the average skill level of migrating workers increases, meaning countries with advanced technology can more easily replace their less skilled workers with more skilled ones, further advancing their technological lead over time.

The small and big

Does the size of a country influence its economic strategies? According to the working paper, the impact is minimal. However, the authors explain that, based on principles of economics and game theory, the most likely outcome for a state of equilibrium reached within a market or game under the given conditions--whether through lowering taxes or investing in infrastructure--does depend on the technology gap.

The authors argue that when the technology gap is broad, a small lagging country would likely benefit more from increasing public spending than from lowering taxes. In other words, heavily investing in public infrastructure might be the best way to attract businesses and workers because the benefits outweigh the costs.

In contrast, when the technology gap is smaller, lowering taxes to attract workers becomes a more attractive strategy. In this scenario, the small lagging country could retain more high-skilled workers and attract more lower-skilled foreign workers compared to a larger lagging country.

The inevitable

While acknowledging the impact of economic, political, cultural, and historical factors on migration patterns, the authors argue that highly skilled workers typically move to more technologically advanced countries. In other words, although a country’s tax structure can help attract businesses and individuals, it may not be the most effective strategy for retaining and attracting specialised workers. Furthermore, the authors suggest in the working paper that when there is a significant technological gap between two countries, the best strategy for the less advanced nation is to lower taxes, while the more advanced country tends to increase its public spending.

The paper does not define the parameters for categorising countries as large or small and advanced or lagging. The authors, who agreed to provide their portraits, declined to comment for this article.

The 28-page working paper is available .