Brain Drain, Skills Mismatch and the Fiscal Multiplier

We examine how international labor mobility shapes the transmission of fiscal policy in the presence of skills mismatch. We develop a small open economy DSGE model with heterogeneous households, endogenous skill-specific migration decisions, search and matching frictions, over-qualification and capital-skill complementarity (CSC) in production. We show that the effect of migration on the fiscal multiplier depends critically on the presence of CSC, which influences the skill composition of migrants. Following a fiscal contraction, the economy experiences predominantly high-skilled emigration. This "brain drain" mitigates the increase in skills mismatch by easing congestion in domestic labor markets, but it also exacerbates the recession through a demand-depressing mechanism, which translates into a higher fiscal multiplier. By contrast, in an economy without CSC, emigration is mainly low-skilled-driven by competition from high-skilled mismatched stayers for low-skill jobs-and has little effect on the fiscal multiplier. Highlighting the joint dynamics of labor mobility, fiscal policy, and skills mismatch, the results carry important implications for the design of stabilization policies in open economies.