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Get the Conditions Right for Remittances to Matter

Zahid Hussain's picture

Recent evidence suggests that remittances have a positive impact on economic growth. This post will examine evidence based on an international panel data set that captures the surge in migration and remittances observed during 2006-09. The dataset includes 70 countries spanning from 1990 to 2009. This to our knowledge is the most recent data set that has been used in empirical remittance work. The recent effort of countries to decrease money laundering, use of improved technology and decrease in transaction costs is leading to a decrease in the unofficial portion of remittances. There has also been a surge in migration and remittances in the last half of the past decade. Thus this dataset should more comprehensively capture the growth impact of remittances compared to previous studies. Different models used to calculate the impact of remittances on growth are detailed in the report titled Bangladesh: Towards Accelerated, Inclusive and Sustainable Growth—Opportunities and Challenges, Volume II, Main Report, published in June 2012.

The impact of remittances on per capita GDP growth is economically significant

The Ordinary Least Squares estimates of the impact of remittances on growth show that when the variables to control for the political and economic environment and institutional quality are employed, the coefficient on remittances tends towards significance. This implies that stability in the political and economic environment and quality of the institutions is a critical condition for remittances to promote economic growth.

In order to view to what extent the political and economic stability affects the impact of remittances on growth, the interaction between remittances and some control variables are used in the model. The interaction between inflation and exchange rate shows the effectiveness of remittances during macro-economic volatilities, interaction with domestic credit examines the link between remittances and financial depth and interaction between the different risk indexes test how risk perception and institutional quality affect the impact of remittances on growth.

The results show that the interaction terms per se are almost always insignificant. Nevertheless, including these interaction terms seems to significantly boost the effect that remittances have on economic growth. An increase of 1 percentage point in the remittance share of GDP increases per capita GDP growth by 0.12 percentage point at the lower end and 0.74 percentage point at the higher end. All conditioning variables display expected results. The results support the convergence hypothesis—-countries starting from low level of income grow faster as indicated by the significant negative impact of initial per capita GDP in almost all the models. The results also suggest that economic risk is most significant from a country growth perspective.

The impact estimates are robust

The impact of remittance gets stronger when the risk indices and the interaction terms are added. A 1 percentage point increase in the share of remittances in GDP can lead to an increase in per capita GDP growth that varies from 0.26 percent to 0.55 percent. From the different specifications, it appears that remittances have a larger impact when the impact of remittance on growth is conditioned by the risk variables and interaction terms. A basic model without controlling for political and institutional environment and interaction terms yields a coefficient of 0.28 while controlling for all the risk and the interaction between risk and macro stability variables gives a higher value of 0.49.

The magnitude of the impact of remittances estimated in this study is relatively larger than the previous estimates. Another key observation is that remittances tend to have larger impact when controlled for political and economic environment. The results of this study also reflect the increase in the importance of remittances to the developing countries in recent years.