Remittances Increase GDP with Potential Differential Impacts Across Countries
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The United Nations’ Sustainable Development Goals (SDGs) identify remittances as a lifeline for many struggling families and communities in developing countries. Remittances is directly used to provide food for families, access health services and quality education, as well as clean water and sanitation. Compared to foreign aid, the household-to-household nature of remittances makes remittances an important and direct vehicle in achieving accelerated poverty reduction. Indeed, there is strong and unambiguous evidence that supports the argument that remittances alleviate poverty in developing countries.
Despite the direct benefits of remittances in poverty alleviation, the aggregate growth effects on recipient economies remain unclear. This is because there are several countervailing factors of the impact of remittances. On one hand, remittances can impact growth positively via investment and access to credit. Specifically, in a typical developing country where labor supply is abundant but opportunities for formal employment are limited, remittances can help initiate self-employment. Remittances can facilitate the growth of new small-scale businesses and foster entrepreneurship by relaxing credit constraints, which is common in the informal sector of developing countries. On the other hand, remittances can hurt the recipient economies by fostering conspicuous consumption and discouraging saving. Furthermore, for low-wage worker who receive remittances, if the amount of remittances surpasses the recipient’s expected earnings from work, this external income flow can discourage labor force participation, induce voluntary unemployment and foster a culture of dependency in the recipient countries. Given these broad and varying channels of remittances and different country characteristics, it is stringent to assume that the impact of remittance on output is the same across countries. A natural and practical assumption instead would be that the remittance-output relationship is different across countries. Beyond these economic reasons, a recent study highlights the several empirical challenges that makes it difficult to uncover a positive aggregate effect of remittance on output.
Against this backdrop, our recent study investigates the long-run relationship between remittances and real GDP in 80 developing countries with careful attention to the potential differential impact of remittances across countries. Our main finding is encouraging: On average, we find that a 10% increase in remittance is associated with a 0.66% permanent increase in GDP. It is important to contextualize this average result: Given the evidence of negative spillover effects of other non-market transfers such as social insurance programs and the immense benefits of remittances in alleviating poverty, this relatively benign aggregate impact of remittance on output we find is a desirable outcome. Importantly, our finding highlights that remittances are not simply outgrowing foreign aid in terms of size, but they may be relatively less harmful to growth, and perhaps, a useful driver of long-term output compared to foreign aid.
The more noteworthy finding of our research is the large heterogeneity in the long-run remittance-output relationship across countries, which the average impact conceals. In particular, we find that the associated response of real GDP following a permanent increase in remittance varies from −0.53 percent in Bosnia and Herzegovina to 0.59 percent in Dominican Republic. We find that differences in the size/sign of the impact of remittances on investment across countries partly explains this observed heterogeneity in output-remittance relationship. More precisely, in countries where the increase in remittances is associated with an increase in investment, we observe a stronger positive relationship between remittance and output. Interestingly, the impact of remittances on output is not correlated to the size of the remittances (i.e., remittance-output ratio) received. For example, remittances appear to have the same impact in South Africa where the remittance-GDP ratio is 0.1% and Lesotho where the ratio is 29.4%. Moreover, with approximately the same remittance-output ratio (i.e., 3.4%), remittance has a positive impact on Sri Lanka but a negative impact on output in Pakistan. Another interesting finding is that on average, remittances are likely to have a bigger positive impact in upper-middle-income countries than in low and lower-middle-income countries. What factors generate this differential impact across income groups is an interesting subject to study going forward.
Policy-wise, our findings suggests that policies that ease the impediments of remittance flow and reduce the transaction costs of remittances are welcome. However, as the cross-country impacts of remittances vary, policymakers should remain cautious in pushing one-size-fits-all arguments. Finally, to get the most bang for the buck, developing country governments can design policies that encourage the use of remittances for investment purposes.
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