The question of whether remittances promote economic growth has not been conclusively answered by any theoretical or empirical study. Unarguably, remittances lead to an increase in the level of income in the recipient country and plausibly help reduce poverty (Gupta et al., 2007), but it is not at all
65 obvious that remittances increase output and promote long-term economic growth.
Based on household survey data from various African countries, few empirical studies have investigated the role of remittances in reducing poverty (Lucas and Stark, 1985; Adams, 1991; Sander, 2004; Azam and Gubert, 2005; Adam, 2006). The macroeconomic impacts of remittances in Africa have not been sufficiently explored by researchers for at least two reasons. One theoretical strand suggests that workers‘ remittances are mainly used for consumption purposes and, hence, have minimal impact on investment. In other words, remittances are widely viewed as compensatory transfers between family members who lost skilled workers due to migration. Nevertheless, Stahl and Arnold (1986) argue that the use of remittances for consumption may have a positive effect on growth because of their possible multiplier effect. Moreover, remittances respond to investment opportunities in the home country as much as to charitable or insurance motives. Many migrants invest their savings in small businesses, real estate or other assets in their own country because they know the local markets better than their host countries, or probably expecting to return in the future. In about two-thirds of developing countries, remittances are mostly profit-driven and increase when economic conditions improve back home.
There are a number of channels through which Workers‘ remittances can positively affect growth. At the household level, remittances may ease credit constraint of households and encourage entrepreneurial activity and private investment (Yang, 2004; Woodruff and Zenteno, 2004). Many households in developing countries have very limited access to credit markets. Remittance inflows could help such households to set up their entrepreneurial activity.
Apart from physical investment, remittances could also be used to finance
66 education and health, which are also key variables in promoting economic growth. At the aggregate level, remittances could improve a country‘s creditworthiness and thereby enhance its access to international capital markets. In the view of World Bank (2006), the calculation of country credit ratings by major international creditors depends in part on her volume of remittance flows. The higher the volume of remittance flows the better the credit rating rank the country could reach. Unarguably, access to more international credit potentially could increase both physical and human capital investment in a country, thereby enhancing economic growth.
Rempel and Lobdell (1978) use household survey data from rural Kenya and conclude that remittances from rural-to-urban migrants have little impact on the development of the region of origin. By contrast, Collier and Lal (1984) show in the case of rural Kenya again, that remittances enable the recipient families to hold more productive capital than the others. They thus bring out the role of migration and remittances as a means to overcome capital market imperfection, and to bring home some capital for funding productive investment. This fact had also been described to some extent by Bates (1976), in the case of Zambian migrants. This effect is emphasized even more strongly in Collier and Lal (1986), in the case of rural Kenya again.
Poirine (1997) provides some further analysis of ―remittances as an implicit family loan arrangement‖, emphasizing both the collective organization of the financial flows within the family. Remittances are then viewed as absorbing random shocks, like bad crops or illness, thus providing some informal insurance services (e.g. Gubert, 2002). It is fair to say that the empirical literature on migration and remittances has devoted more attention to income distribution issues. In his early study of migration from Kasumpa village in Zambia, Bates (1976) shows that households earning lower incomes in the
67 village receive more remittances from town than richer ones, after controlling for demographic composition. Stark, Taylor and Yitzhaki (1988) show that this type of transfers reduces income inequality in a Mexican village having migrants in the USA, but suggest that the poorest are excluded from migrating.
Banerjee and Kanbur (1981) and Faini and Venturini (1993) conclude, by different routes, that migration benefits more the middle income classes of the society of origin than the two extremes of the distribution, in India and Southern Europe respectively.
By contrast, Gustafsson and Makonnen (1993) conclude that poverty in Lesotho would go up by about 15% were the flow of transfers sent by the migrants working in the mines in South Africa to stop. Azam and Gubert (2004) show that this issue is probably more subtle than it looks, as the correlation between poverty and low measured (earned) income can be misleading. Lucas and Stark (1985) analyze various potential motivations explaining why migrants transfer some income to their relatives remained in the village, for testing various forms of altruistic or egoistic behaviour. Using survey data on Botswana, they conclude that mixed motivations of moderate altruism or enlightened egoism seem to prevail. Their empirical analysis supports the view that the migrants do provide some insurance services, by transferring more money when a drought threatens the livestock. They also show that wealthier families receive more than poorer ones, suggesting that the migrants are defending their inheritance rights or their ability to come back to the village with dignity. Hoddinott (1992) gets a similar result using a household survey conducted in Kenya.
Azam and Gubert (2005) in their paper on migrant remittances and economic development in Africa emphasized that migration cannot be understood as an individual decision, but must be regarded as a collective decision made by the
68 extended family or the village. The study also noted that remittances are to a large extent a contingent flow, aimed at buttressing the family‘s consumption in case of adverse shock. However, this insurance system involves some moral hazard, as those remaining behind tend to exert less effort to take care of themselves, knowing that the migrants will compensate any consumption shortfall, with a high probability. Their result was able to provide insight into a puzzle that bugged the remittances-development literature for nearly three decades: the rich families are more likely to send some migrant away, and thus get more remittances, while they earn less income in the village, because of moral hazard.
Wealth makes them lazy, while low income does not make them poor. Quartey (2006) investigated the impact of migrant remittances on household welfare in Ghana. The study employed micro data based on the Ghana Living Standard Survey (1 to 4) and found that remittances improve household welfare and help to minimize the effects of economic shocks to household welfare. This study was limited to the individual beneficiary of remittances income and this can hinder generalization. A considerable measure of aggregation will be required for these findings to be able to provide adequate guide for macroeconomic policy direction on the subject of remittances.
Empirical evidence from outside Africa reveals that remittances have a potential, positive, impact as a development tool for the recipient countries. In a study that relies on a definition of remittances that includes workers‘
remittances and compensation of employees, Solimano (2003) noted that the development effect of remittances can be decomposed into effects on savings, investment, growth, consumption, and poverty and income distribution. The impact on growth of remittances in receiving economies is likely to act through savings and investment as well as short-run effects on aggregate demand and
69 output through consumption. The total saving effect of remittances comes from the sum of foreign savings and domestic savings effects. Workers‘ remittances are a component of foreign savings and they complement national savings by increasing the total pool of resources available to investment. The direct effects of remittances on investment are bound to be on small community projects.
According to Buch et al (2002), remittances can influence economic growth directly or indirectly. However, the degree of the latter channel strongly depends on supporting governmental policies and a supporting economic environment for investment activities. Glytsos (2005) analyzes the effect of remittances on investment, consumption, imports and output. The author uses a sample of five countries and estimates short and long run multipliers of remittances. He finds that the effect of reducing remittances would be greater than the effect of raising them. Ziesemer (2007) proposes a savings channel that relates remittances with growth. He finds that remittances have a positive impact on growth, due to the ability to increase saving rates in countries with a per capita income of less than US $1200.
Funkhouser (1992) as well as Woodruff and Zenteno, (2004) identified a number of channels through which remittances could raise economic growth and these include: when an increase in remittances raises investment, remittances could be expected to affect growth positively. If this effect is large enough, then remittances could alleviate the credit constraints faced by most people in developing countries.
The implication of this result is that the positive effect of remittances on investment or on economic growth is likely to be larger for countries where the financial system is relatively underdeveloped. This position of possible substitutability between remittances and financial development is supported
70 empirically by other studies (for example, Fajnzylber and Lopez, 2007, and Giuliano and Ruiz-Arranz, 2005). Singh, Haacker and Lee (2009) found an overall effect is negative and significant. This result is consistent with the finding of Chami, Fullenkamp, and Jahjah (2003) regress per capita real growth on investment, change in remittances, and net private capital inflows as well as regional dummy variables; they obtain positive coefficients for both investment and net private capital inflows, but the coefficient of remittances comes out negative. They therefore suggest that remittances are unlikely to promote economic growth because of a moral hazard problem (i.e., reduced labour market participation), as well as other factors. They therefore questioned whether remittances can be a source of development capital.
Chami et al. (2009) found evidence supporting the notion that remittance flows provide a stabilizing influence on output. If remittances are predominantly consumed rather than invested, any growth effects through higher investment could be subdued. Even in this case, however, remittances could foster investment by reducing the volatility of consumption and contributing to a more stable macroeconomic environment. Giuliano and ruiz-Arranz (2005) provide evidence of the positive effects of remittances on the growth of less developed countries. In a cross sectional study of 37 African countries, Fayissa and Nsiah (2008) explored the aggregate impact of remittances on economic growth and found that remittances boost growth in countries where the financial systems are less developed by providing an alternative way to finance investment and helping overcome liquidity constraints.
Similarly, Fayissa and Nsiah (2010) found that remittances have a positive and significant effect on the growth of Latin American Countries where the financial systems are less developed by providing an alternative way to finance investment and helping overcome liquidity constraints. Most of the
71 empirical works have focused on migrant-exporting countries with rather similar characteristics; however, the debate about the impact of remittances is still ongoing. Chami et al (2005) report a negative effect of remittances on growth and productivity using cross-country panel data. Their argument here is that migration deprives the economy of the most productive workers, or that remittances have adverse effects on those staying behind, or both.
Different researchers are not in agreement about whether or not remittances serve as an important source of investment capital. The basic principle is that either directly or through the process of intermediation and leverage, remittances will tend to increase investment, thus increasing potential growth.
Durand, Kandel, Parrado, Massey (1996) noted that, in the case of Mexico, under the right circumstances (a high-paying US job, secure attachment to the US labour force, access to complementary resources in Mexico), the odds of productive investment of remittances rise substantially.
Ratha (2003) cites positive effects of remittances on investment in receiving countries such as Mexico, Egypt, and Sub-Saharan Africa. In these countries, remittances have financed the building of schools, clinics and other infrastructure. In addition, return-migrants bring fresh capital that can help finance investment projects. The relationship between household investment and workers‘ remittances in developing countries are found to be positive in a number of studies. For example, Brown (1994) relying on a micro-level analysis of the use of remittances by households, investigates the relationship between remittances, savings and investment in Tonga and Samoa. The study found that remittances make a significant contribution to savings and investment in the island economies. Mesnard (2004) examines impacts of remittances on Tunisia using a life-cycle model. The study reveals that workers who have limited access to the financial market tend to invest their remittances
72 receipts. Yang (2004) finds that remittances lead to improved child schooling, reduce child labour, increased education expenditure, and facilitate investment.
The major role of remittances in receiving countries is to stimulate consumption and investment in those countries, help relax foreign exchange constraints and contribute to poverty alleviation (Adams, 2007). Their contribution to development depends on their macroeconomic impact and how they are used in receiving countries. There is evidence that they are more directed to consumption than investment, which perhaps explains why no link between them and long-term growth has been found (IMF, 2005: chapter 2).
The focus of the recent remittances literature is therefore toward the macro and micro implications of remittance flows.
Acosta et al (2007), finds that in addition to the usual nominal exchange rate channel, remittances result in a shrinkage of, and resource re-allocations away from, the tradable sector through (i) increasing prices in the non tradable sector, and (ii) reducing the labour supply to, and thereby increasing the production costs of, the otherwise labour-intensive non tradable sector. Using micro data from Morocco, Van Dalen et al (2005) find that remittances have a potential to stimulate further migration among the family members left behind.
These studies in all are quite emphatic on the possibility that the benefits of remittances, if any, could be less pronounced.
Remittances also finance consumption; thus, private savings will increase less than proportionally than an increase in income from external remittances.
Bendixen and others (2003) in a study of remittances for Ecuador shows that around 60 percent of remittances in Ecuador are spent on food, medicines, house rents and other basic commodities. The study shows that less than 5 percent of remittances are used in the acquisition of residential property. The
73 combined effects of remittances on investment and consumption can increase output and growth. The sustainability of this effect is an open discussion. If remittances are a response to recent migration, remittances may be transitory and thus their effects on investment, consumption and growth can be more of a temporary basis. In contrast, if migrants form associations and their commitment to their home country becomes ―institutionalized‖ then, their positive developmental effects of remittances may become more permanent.
The impact of remittances on growth in cross country studies is inconclusive.
Studies that focus on the labour supply response of recipient households find that remittances lower growth (Chami, Fullenkamp, and Jahjah, 2003; Azam and Gubert, 2005). However, Fajnzylber and López (2008) in a cross-country study of Latin American countries found evidence which suggests that indeed, remittances are more effective in raising investment and enhancing growth in countries with higher levels of human capital, strong institutions, and good policy environments. They also found that increases in remittances apparently have more of an investment and growth impact in countries with less developed financial sectors. In general, studies that link remittances to investment, where remittances either substitute for or improve financial access, tend to conclude that remittances stimulate growth (Giuliano and Ruiz-Arranz, 2005; Toxopeus and Lensink, 2006). While the evidence on the contemporaneous impact of remittances on growth may be mixed, it is likely that remittances can affect long-term growth by fostering financial deepening.
Stark, (2004), and Mountford, (1997) highlight the positive impact of remittances to include its impact on human capital development in home countries, which often is linked to increased demand for and access to education among those left behind. The positive impact of remittances is
74 broadened to include technology and knowledge transfer and other benefits o f brain circulation, and the potential benefits deriving from Diaspora links.
Docquier and Rapoport (2004:27) summarize the main effects of the successful experience of migrants abroad: ―successive cohorts adapt their education decisions, and the economy-wide average level of education partly… or totally catches up, with a possible net gain in the long run‖ and ―the creation of migrants‘ networks that facilitate the movement of goods, factors and ideas between migrants‘ host and home countries‖. It must be emphasized here that the existence of a positive impact on countries of origin rests on the assumption that a significant number of graduates of new courses and new schools, who initially enrolled with the aim of going abroad eventually had a change of orientation, thus, end up contributing to the provision of a higher value of goods and services to the domestic economy.
Remittances can be expected to cause a widening of the external trade account deficit (including services as travel), or a narrowing of the current account surplus. As remittances increase purchasing power in the receiving country they augment domestic demand. Bouhga-Hagbe found that in the case of Morocco, ―remittances almost cover the trade deficit and have contributed to the recent surpluses of the external current account, as well as the overall BOP.
The BOP surpluses have contributed to the strengthening of Morocco‘s external position through the accumulation of reserves, which now cover the external public debt (Bouhga-Hagbe, 2004).
The impact of remittances on the real exchange rate and export competitiveness, and the Dutch disease effect, is another area of debate. In countries receiving remittances the currencies could appreciate, which might be harmful to their long-run economic growth (a Dutch disease effect). As in
75 the case of any other transfer (for instance, official aid), the effect depends on the proportion of such flows spent on domestic goods, in particular non- tradables (Gupta, et al, 2006). Since remittances are private transfers dispersed over a large number of poor households it has been argued that their impact on domestic demand differs from that of donor-funded infrastructure projects (World Bank, 2006). Remittances may in fact be self-correcting as an overvalued currency deters remittances, and hence Dutch disease effects are not sustained (Rajan and Subramanian, 2005). However, studies in Latin America (Amuedo-Dorantes and Pozo, 2004) and Cape Verde (Bourdet and Falck, 2006) have found evidence that remittances do have Dutch disease effects on the competitiveness of the tradable sector. In countries where remittances inflows are large compared to the size of the economy, where supply constraints are a significant hindrance to the expansion of the non- tradables sector, and where a significant portion of remittances are spent on domestic goods policymakers will need to be alert to the possibility of a Dutch disease phenomenon. Moreover, remittances may reduce the labour supply or labour market participation of recipients. If these negative factors dominate, remittances could be detrimental to economic development in SSA (Chami, Fullenkamp, and Jahjah, 2003).
Elbadawi and Rocha (1992) present a detailed theoretical review and insightful analysis of the literature on the causes of immigrant remittances, which applies well to all remittances. They divide this literature into two main strands:
the "endogenous migration" approach, and the "portfolio" approach. The endogenous migration approach is based on the economics of the family, which include but not limited to motivations based on altruism. The portfolio approach isolates the decision to remit from the decision to migrate, and likewise avoids issues of family ties. In this view, the migrant earns income