Although international migration continues to be a central issue in public discussions, the real puzzle is that so little of it actually occurs, given the very large and (according to some observers of economic growth) non-converging wage and income differentials that exist across countries. In Discussion Paper No. 1229, Research Fellow Michael Burda examines a possible explanation, which rests on the insight that migration decisions are an investment, involving fixed and, to some extent, unrecoverable costs and uncertain future returns. This 'real option' framework for investment decisions underlies the analysis.

The author first derives the option value of waiting under simple conditions in a two-period set-up. Next, he proposes a more complicated model of migration by economic agents with very long time horizons. The option value of waiting derived under these conditions is related in complex ways to interest rates, fixed costs and, especially, the uncertainty governing the evolution of income at home and abroad. The 'bad news principle' of investment theory also applies to the migration case, and it has interesting implications for equilibrium across labour markets. In rational intertemporal equilibrium in a simple model of two regional labour markets, low migration rates today may coexist with large and increasing current wage differentials. This puzzling outcome explains why efforts expected to close regional inequality in the future may paradoxically lead to larger wage differentials and less migration today.

Migration and the Option Value of Waiting
Michael C Burda

Discussion Paper No. 1229, August 1995 (HR)