• 03 May 21
  • Posted by Ahmad, Nazneen , Francois, John Nana , Keinsley, Andrew , Nti-Addae, Akwasi
  • Financing Development

The role of remittances in economic development

Does the enormous flow of remittances into developing countries promote economic growth and, if so, do all recipient countries benefit equally? This column discusses new evidence on the relationship between remittances and GDP. While the average long-run effects of remittances on growth are consistently positive across 80 developing countries, there is also a notable variation in the remittance-output relationship.

In the last decade, remittances have outgrown traditional sources of finance flowing into developing countries such as foreign aid. According to the World Bank’s 2019 Migration and Development Brief, annual remittances to low and middle-income countries reached a record high of $529 billion in 2018.

What makes remittances unique as opposed to comparable financial flows like foreign aid is that they avoid the bottlenecks often experienced with official entities. In particular, remittances have a household-to-household feature, which avoids government agencies. Hence, money sent from abroad, after accounting for transaction costs, is directly received by households, who are often the true beneficiaries. It is therefore not surprising that several economists argue for the positive impact of remittances.

Dilip Ratha, lead economist on migration and remittances at the World Bank, succinctly describes remittances as ‘dollars wrapped with care’. Indeed, for many struggling families in developing countries, remittances can be used for basic needs such as food, sanitation, clothing, and energy for cooking. These economic activities have a direct effect on poverty reduction in low-income households living below or near the poverty line.

Beyond the immediate effects of remittances on poverty alleviation, when used to fund small businesses, education, or health, they can raise the level of physical and human capital – factors that contribute to long-run growth. Notice that growth promoted by remittances can generate additional employment in recipient countries if the growth is inclusive. Consequently, remittances have the capacity to help eradicate poverty at the micro-level while also serving as a driver of growth at the macro-level.

A potentially negative impact of remittances on economic activity cannot be overlooked. For example, remittance flows may reduce work effort or induce voluntary unemployment. Consider an immigrant in the United States who regularly sends money back to family members in Bangladesh. If those recipients are unemployed or underemployed, and the amount being remitted is higher than the reservation wage in Bangladesh, then they might choose to work less or not participate in the labor market. This would have a negative impact on GDP in Bangladesh.

Remittance flows may also encourage conspicuous consumption and a culture of dependency. Such adverse effects can make it difficult for the potentially positive effects of remittances in aggregate in recipient countries to be realized.

Several studies have investigated the aggregate effect of remittances on GDP in individual countries or group of countries. The findings have been mixed, ranging from no effect to a small positive effect.

One recent study shows that the mixed results arise from several factors, including but not limited to the competing effects of remittances, as well as issues related to measurement errors in the data. Furthermore, a common theme of studies that focus on groups of countries is that they assume that the effect of remittances on output is the same for all countries. This conceals considerable differences in the remittance-output relationship.

In our recent study, we quantify the long-run impact of remittances on aggregate GDP in 80 developing countries. Our study takes a more realistic approach, recognizing that the impact of remittances on output can differ across countries for reasons such as the differential impact of remittances on investment in different countries.

We find that there is a consistently positive long-run relationship between remittances and output: on average, a 10% increase in remittances is associated with a 0.66% increase in GDP in the long run. Importantly, we find that the positive relationship between remittances and GDP is mediated by an investment channel. Specifically, if the increase in remittances is associated with an increase in investment, we observe a stronger positive relationship between remittances and output.

A central part of our study is highlighting the heterogeneity in the relationship, which the average effect does not capture. We therefore conduct country-by-county analysis, which uncovers that the long-run relationship between remittances and output indeed varies in size and sign across countries.

For example, the associated response of GDP following a permanent increase in remittances is -0.53% and 0.59% in Bosnia and Herzegovina, and the Dominican Republic, respectively. This suggests that the long-term effect of remittances on output is not uniform across countries.

In summary, while remittances unambiguously help in poverty alleviation, their aggregate impact on long-term growth differs across countries. Consequently, policies that target making money transfers easier and less costly will potentially encourage a sustained and permanent increase in output in the recipient economies. But economists and policy-makers should remain cautious in pushing a ‘one-size-fits-all’ argument for the aggregate impact of remittances in developing countries.

 

Authors:

Nazneen Ahmad is an associate professor of Economics at the Weber State University. Her research interests are mainly in the areas of macroeconomics, business cycles and international finance.

John Nana Francois is a Professor at the Paul and Virginia Engler College of Business at West Texas A&M University. His research has focused on debt relief and fiscal and monetary policy effectiveness, as well as, the macroeconomic outcomes of international capital flows to developing economies.

Andrew Keinsley is an assistant professor of economics at the Weber State University. Keinsley’s research focuses on the effects of monetary and fiscal policy on the macroeconomy. 

Akwasi Nti-Addae is an Economist at Owens Corning based in Toledo, Ohio. Previously, Akwasi was an Assistant Professor at Drew University.