Remittances domestic investment in the east and southeast asia

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES VIETNAM- THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS '' ' , REMITTANCES- DOMESTIC INVESTMENT IN THE EAST AND SOUTHEAST ASIA A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By NGUYEN THI HAl YEN Academic Supervisor: Dr NGUYEN HUU DUNG HO CHI MINH CITY, NOVEMBER 2011 CERTIFICATION "I certificate that the substance of the thesis has not already been submitted for any degree and is not currently submitted for any other degree I certify that to the best of my knowledge and help received in preparing the thesis and all source~ used have been acknowledged in the thesis." Signature • Nguyen Thi Hai Yen Date: ACKNOWLEDGMENTS My deepest gratitude to all persons and organizations for their support, provision of assistance and information that made this thesis possible; My dearest thanks to my supervisor, Dr Nguyen Huu Dung, for his continuous support, constructive follow-up, and insightful, helpful comments; Thanks to the lecturers and staff of the project, who helped improve my knowledge and fulfill the programme; " My appreciation to Dr Cao Hao Thi & Mr Duy for their assistance in econometric techniques; Finally, I am indebted to my parents and my elder brother for their love for and support of me, keeping me in good condition for learning I would like to reserve the pleasure of the graduate for them I am also grateful to my close friends for their warm encouragement 11 ABSTRACT Over the past decades, remittances have grown to become one of the largest sources of external financial flows to developing countries, left ODA far behind and even exceeded FDI in some countries While it is undeniable that remittances have poverty-alleviating and consumption-smoothing effects on households in receiving economies, empirical questions are whether they directly impact investment and if not through which channels they have positive effects on investment This thesis goes in search of the answers to these questions by employing different methodologies including Ordinary Least Square, Fixed Effect and Generalized Method of Moments However, research scope is limited within some economies in East and South-east regions The results show that remittances have no direct impact on investment but when being combined other channels such as financial development and institution Remittances are complementary to financial development in stimulating investment Meanwhile, relationship between remittances and institution quality is not clear Some indicators indicate remittances are complementary to institution quality in boosting investment; whereas the others are substitutionary Key words: Remittances, Investment, East & Southeast Asia, Financial Development, Institution Quality 111 CONTENT CERTIFICATION ACKNOWLEDGMENTS ABSTRACT CONTENT LIST OF TABLES LIST OF ABBREVIATIONS CHAPTER 1: INTRODUCTION 1.1 Problem Statement 1.2Research obj 1.3Research Qu 1.4 Research Methodology 1.5Structure of t CHAPTER II: LITERATURE REVIEW 2.1 The concepts of remittance 2.2Motivation a 2.3 Relationship between remittances and investment 2.4Empirical stu CHAPTER III: RESEARCH METHODOLOGY 3.1 Data and variable description 3.1.1 Data 3.1.2 Description of variables ofinterest 19 3.2Model specif 3.3 Methods of parameter estimations ~ 3.3.1 Ordinary Least Squares (OLS) estimator 3.3.2 Fixed Effect (FE) estimator 3.3.3 Generalized Method of Moments (GMM) 3.3.4 Application of GMM estimator in the thesis corresponding to each specification IV CHAPTER IV: EMPRICAL RESULTS 31 4.1 Descriptive statistics 31 4.1.1 Remittances in East and Southeast Asia 31 4.1.2 Investment and economic growth in East and Southeast Asia 32 4.1.3 Financial development, openness and lending interest rate in East and Southeast Asia 32 4.1.4 Institution quality in East and Southeast Asia 33 4.2 Bivariate correlation of the variables of interest 34 4.2.1 The relationship between remittances and variables of interest 34 4.2.2 The relationship between investment and the other variables 34 • 4.2.3 The relationship between financial development and other variables 36 4.3 Empirical Results 37 4.3 Examining the impact of remittances on domestic investment using OLS estimation technique 37 4.3.2 Examining the impact of remittances on domestic investment using fixed effect (FE) estimation technique 50 4.3.3 Examining the impact of remittances on domestic investment using Generalized Method of Moment (GMM) estimation technique 61 4.4 Brief discussion about the best model 73 CHAPTER V: CONCLUSION, RECOMMENDATION & LIMITATION 75 5.1 Conclusion 75 5.2 Policy recommendation 78 5.3 Limitation and suggestion for further study 80 REFERENCE 82 APPENDIX 88 v LIST OF TABLES Table 1: Variable description, Expected sign & Data Source 22 Table 2: OLS- REM 37 Table 3: OLS- REM- FD 39 Table 4: OLS - REM - FD (M2) - INST 43 Table 5: OLS- REM- FD (BANCRE)- INST 45 Table 6: OLS- REM- FD (PRlCRE)- INST 47 Table 7: FE -REM 50 Table 8: FE - REM - FD 52 Table 9: FE - REM - FD (M2) - INST 54 Table 10: FE - REM - FD (BANCRE) - INST 56 Table 11: FE -REM - FD (PRJCRE) - INST 58 Table 12:.GMM- REM 61 Table 13: GMM- REM- FD 63 Table 14: GMM- REM- FD (M2)- INST 66 Table 15: GMM- REM- FD (BANCRE)- INST 69 Table 16: GMM- REM- FD (PRICRE)- INST 70 Table A: Descriptive statistics on interested variables without institution quality 88 Table B: Descriptive statistics on institution quality indicators 88 Table C: Bivariate correlation of the variables of interest 89 LIST OF ABBREVIATIONS FD Financial Development FDI Foreign Direct Investment FE Fixed Effect GOP Gross Domestic Product GLS Generalized Least Square GMM Generalized Method of Moment IMF International Monetary Fund INST Institution ODA Official Development Assistance OLS Ordinary Least Square REM Remittances WB World Bank 11 - CHAPTER I: INTRODUCTION This chapter will explain the reason for carrying out the thesis, its objectives and research questions In addition, a brief of methodology is also mentioned in this part Finally, the structure of the thesis will be presented 1.1 Problem Statement: Rapid economic growth and sustained development are goals pursued by almost governments and policy-makers Investment is a crucial motive for growth and development process Investment, of course, requires capital Most of developing countries, unfortunately, usually encounter shortage of capital Capital source from domestic savings is rather limited due to living standard of residents generally is still low Therefore, attracting foreign capital flows is one of the leading national policies for development Regarding foreign capital flows, portfolio investment is high volatile and may cause negative effects for the economy without appropriate and active management (Silva et al., 2009) Foreign Direct Investment (FDI) with relatively stable characteristics compared to portfolio investment usually attracts lots of attention and interest thank to its big benefits such as capital supply, job creation, technology transfer, and managerial know-how FDI, however, typically requires a physical investment as well as transparency, stability and soundness in political environment and macroeconomic policies in the country A foreign capital flow which has recently received much interest from economists is remittances Remittances, the amount of money transferred by migrants to their families in home countries, have steadily increased since the mid1980s Statistically, recorded remittances reached an estimated volume of US$206 billion in 2006, compared to US$19.6 billion in 1985 (Ambrosius et al., 2008) The latest available data shows that remittance flows to developing countries reach US$328 billion, accounting for over 70% total global remittances in 2008 (see Key Indicators for Asia and the Pacific 2009) The volume of them is nearly the same with foreign direct investment and twice higher than official development aid that help them rank at the second position in term of external finance source for developing countries Moreover, out of non-trade foreign currency inflows, remittances are in general the most stable, least volatile (Chami et al., 2008; Global Development Finance 2003) Thanks to the characteristic of stability, these inflows may counter negative effects caused by the falling in capital flows such as FDI, debt, and equity flows in recipient countries during an economic downturn (Silva et al 2009) and hence consolidate macroeconomic stability (Bugamelli and Paterno, 2008) Furthermore, m developing countries, the financial system is commonly underdeveloped and the economy has a low degree of monetization since they usually suffer a low ratio of credit to GDP and a low ratio of broad money supply to GDP (Ambrosius et al., 2008) The authors insist: "A large proportion of the population and typic~lly the small and micro enterprises of the informal sector find difficult to access bank credit and thus operate outside the financial sector, with low capital intensity and low productivity" A recent study by Aggarwal et al (2005) shows that remittances promote financial development; whereas the finding of Bettin and Zazzaro (2009) holds that these inflows play substitute for underdeveloped financial sector in developing countries in stimulating investment and growth Remittances' impacts on poverty, education, inequality are extensively exploited; whereas research on remittances-investment nexus is still limited, leaving a big gap that needs further exploration This gap derives from a common perception that remittances mainly serve for consumption purposes, not for investment That is why this thesis would like to exploit this aspect The thesis seeks to find out the impact of remittances on investment in East and Southeast Asian developing countries There are some reasons for choosing these regions in the thesis Firstly, they are one of the largest recipients of international remittances among all developing regions in which some are in the top remittance-receiving CHAPTER V: CONCLUSION, RECOMMENDATION & LIMITATION The chapter briefly summarizes the content of the thesis before stating drawn conclusions Then, based on those results, some recommendations are raised in order to better take advantage of these flows for economic development Finally, the thesis present limited points which need improving in further researches 5.1 Conclusion: The main objective of this thesis is to find the impact of remittances on domestic investment in East and Southeast Asia regions In other words, the thesis look for the answer to questions: whether remittances enhance domestic investment of economies in the regions and through which channels remittance inflows could positively affect investment outlays Due to the omission of data and the lack of continuous observations for some countries within the study period of 1995-2008, the thesis paper uses panel data of economies representing East and Southeast Asia regions including Cambodia, China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Thailand and Vietnam that receive significant remittances and have available data resources The empirical study is carried out based on the data panel data with annual observation within the period 1995-2008 employing different estimation techniques: Ordinary Least Square, Fixed Effects and Generalized Method of Moments The OLS estimator is a rather simple methodology but easily encounters issues like heteroskedasticity, autocorelation endogeneity that may lead to biased coefficients The other techniques are more suitable to deal with such problems; typically Fixed Effects accounts for unobserved country effects and GMM Arellano and Bond (1991) addresses the potential endogeneity of remittances and other variables In each estimation methodology, analysis of the impact of remittances on investment is separated in steps with specific models to clearly consider the direct impact of remittances on investment as well as roles of other 75 channels in such remittances-investment nexus Specifically, the relationship between remittances and investment is first examined without consideration of channels, then factors like financial development and institution are in turn added in the models to study interactions between them and remittances on investment Furthermore, a set of control variables such as economic growth, economic openness and lending interest rate is included in models in order to isolate the effects of the variables Eventually, the empirical results of the thesis are summarized as follows: Firstly, remittances are statistically significant but negatively assocated with investment across estimation methodologies It means that remittances have no diryctly positive impact on investment Remittance inflows in regions of interest are generally transfered not to search for investments opportunities but to help migrants' family members finance the purchase of life's necessities for social insurance purpose Remittances here may play a role of lifting people out of poverty but they not typically tum their recipients into entrepreneurs These capital inflows are not necessarily asscociated with an increase in domestic investment or a more efficient allocation of domestic investment (Chami et al., 2008) They may increase saving and investment level at least for recipient households via remittance-used-expenditures on housing, land and even jewelry Such saving is, however, likely to have no effects on a country's overall economic activity When land and houses are changed hands, for instance, the aggregate investment is unchanged Secondly, the interation of remittances and financial development are positively correlated with investment regardless of the estimation methods Whatever the measure of financial development, the marginal impact of remittance flows on investment is modest but robust and positive, confirming the existence of complementary role between remittances and the aggregate quantity of finance in stimulating domestic investment of the economy It implies that remittances can foster investment through the channel of financial development or remittances have 76 a positive effect on investment only if the domestic financial system is welldeveloped This result supports the finding by Mundaca (2005) rather than that by Giuliano and Ruiz-Arranz (2006) on the relationship between remittances and financial development While Mundaca finds that remittances have stronger effect on growth where financial system is rather developed since financial development potentially leads to better use of remittances, hence boosting growth; Giuliano and Ruiz-Arranz (2006) show that remittances are significantly positive with growth in economies where financial sectors are underdeveloped Thirdly, the impact of remittances on investment through the channel of and institution is not identical but varied across estimation methodologies and specifications subject to each institution-quality indicator Accordingly, it is hard to confirm which effect of remittances and institution on investment: complementary or substitutionary The interaction between remittances and institution quality on investment is greatly statistically significant in two estimation methods: OLS and fixed effect but not in GMM This interaction is relatively large, even goes further beyond interaction between remittances and financial development in the first two estimators, yet it gets less significant even nil in the other GMM Next, apart from measure M2, the other measures of financial development: bank credit and private credit are positively correlated with investment across specifications This result once again supports previous theoretical and empirical literature suggesting financial development plays positively important role in stimulating investment efficiency and hence boosting economic growth via its main function of mobilizing and channeling financial resources for feasible projects Then, economic growth is entirely positively accompanied by investment across specifications, indicating close relationship between them Investment is alway regarded as the key instrument to growth and development of the economy The empirical results of the thesis once again affirm this consistent correlation which is stated and proved in theoretical and empirical literature 77 Next, rather different to previous findings, openness is negatively associated with investment across OLS and Fixed Effect estimations and even has nil effect in GMMmethod Finally, lending rate points out its role as cost of investment via negative association with investment across regression methods except Fixed Effect estimator 5.2 Policy recommendation: Based on empirical results, remittances not directly lead to a higher domestic investment rate, so they should not be regarded the same with other capital sources like FDI, ODA .in enhancing long term economic growth and development However, it is hard to deny the positive role of these inflow in alleviating poverty since they increase the welfare of receiving households and help them stand firm during hard time like periods of economic crisis cycle, natural disasters In such harsh periods, the poor usually suffer most Accordingly, governments should take appropriate measures in order to consolidate positive impacts of remittances, especially to the poor In some countries, transferred remittances are levied taxed directly that results in unexpected consequences Volume of remittances declines, reducing poverty-alleviating effects; or remiters move towards informal transfer channels, causing a significant drop in official remittances that must have been allocated to productive projects All of actions like these will cause a large loss in welfare Instead of imposing direct tax on remittances, governments should apply consumption-based taxation which ensures both benefits for remittance-receiving households and income for governments' budgets as well as minimizes distortionary impacts on economic activity Regression results also implies that financial development plays a positive role to remittances-investment nexus The financial sector helps allocate mobilized capital sources to productive projects better and hence pushes yields on investment up It can be inferred that the more remittances flow through financial sector, the 78 higher return on investment is obtained Therefore, it is ensential to encourage transfering remittances through formal channels, especially financial institutions by reducing related costs concerning this kind of transaction A survey conducted by World Bank (2006) points out nearly 50 percent of remittance volume goes through informal channels since these channels supplies transfer services with much lower costs compared to through formal ones Governments should issue policies to encourage financial institutions to actively take parts in money transfer market and orient towards a reduction of transaction costs with the aim to attract more remittances and enhance development of financial sector for better use of remittances Not a small part of recipients live in rural areas where advanced technology such as information technology, payment system has not yet been popular This makes remittance source flowing formal channels limited More engaging by financial institutions in these areas will increase official remittances and this needs supports by governments Remittances have a complex nature as they may bring positive and/or negative effects for recipient economies A challeng faces governments and policy-makers is how to design and implement policies with aim to promote and orient these inflows towards yield-generating activities for long & short term benefits and concurrently to minimize unexpected side-effects A developed infratructure together with qualified institutions are always prerequisite to the stable & strong growth & development process as it alleviates transaction costs in markets and consolidate residents and investors' faith and hence induces more investment, higher returns & more benefits Governments should make more expenditure on improvement of public infrastructure and public institution to take advantage of and promote strong points of remittances Besides, governments should cooperate with agencies to design appropriate models to encourage migrants and recipients to take part in productive activities Migrants may set up hometown associations, raise funds which will be used to support their home communities or to improve their country's infratructure These are similar to the model Mexico applied and got significantly 79 large success It is helpful if there are specific training courses or education programs for recipient communities to utilize additional income from remittances in the most effective way Finally, governments also take appropriate measures to better collect data on remittances Because there has not been yet a common criterion in classifying components which constitute remittances in some countries Consequently, data on these flows are scattered and even overlapped in categories or institution; and even worse these inflows are misclassified A large proportion of remittances is transferred not through formal channels that causes difficulties in data collection Even some types of formally-transferred-remittances are not recored Such weakness in data collection may lead to an imprecise evaluation of remittances' impacts 5.3 Limitation and suggestion for further study: This thesis examines the impact of remittances on investment across countries in East and South-east regions Individual countries may have experiences that differ from the aggregate results presented here Therefore, the possibility that preciseness in cross-country analysis may be reduced is unavoidable The data in the thesis are extracted from balance of payments statistics (WB) which mainly records data collected through formal channels, excluding those sent via informal ones such as friends, relatives Accordingly, underestimating remittances received by households is unavoidable Using data collected based on household surveys is highly recommended since they reflect more exactly volume of remittances and hence create favorable conditions for better estimation of these flows' impact on investment in particular and on other aspects in general In limited scope of the thesis, typically limited the number of observations other channels through which remittances may affect investment can not be presented In particular, these money flows may affect investment through improving heath of people, upgrading education levels Although the problem of 80 omitted variables is reduced given our specifications, it is imposible to eliminate the possibility that omitted variables drive some of the results Furthermore, the thesis did not explore in great detail the impact of remittances corresponding to levels of financial development as well as institution development to draw more thorough assessments There are many indicators which proxy financial development, even some are more appropriate than ones used in the thesis As we know that most of economies in the regions in question have bank-based financial structures, so employing indexes representing microeconomic efficiency of banks, total bank assets over GDP for instance, may capture more appropriately than M2; and Credit the fundamental function of allocating remittances to worthy investment projects Unfortunately, at the time of running regressions, such data have not yet been available on the webside of World Development Indicator of World Bank Similarly, the potential limitation is the use of governance indicators as the only measure of institution quality as they have not yet totally reflected characteristics of institution as well as of institutional development It is likely that the empirical finding may change if employing an alternative measure of institution quality, indexes of risk rating from the International Country Risk Guide (ICRG), for instance 81 REFERENCE Acosta, P., P Fajnzylber, and J H Lopez (2007) "The Impact of Remittances on Poverty and Human Capital: Evidence from Latin American Household Surveys", World Bank Policy Research Working Paper 4247, June 2007 Acosta, P A., and E Lartey (2009) "Remittances and the Dutch Disease" Federico S Mandelman Federal Reserve Bank of Atlanta Adams, R H (1998) "Remittances, Investment and Rural Asset Accumulation in Pakistan", Economic Development and Cultural Change, Vol Adenutsi, D 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Southeast Asia 31 4.1.2 Investment and economic growth in East and Southeast Asia 32 4.1.3 Financial development, openness and lending interest rate in East and Southeast Asia ... for investment That is why this thesis would like to exploit this aspect The thesis seeks to find out the impact of remittances on investment in East and Southeast Asian developing countries There... are rather significant and other data resources are available for the period 199 5-2 008 Namely, the Southeast Asia includes Vietnam, Thailand, Philippine, Malaysia, Indonesia The East Asia includes