The Role of Remittances in Developing Countries
What are Remittances?
Remittances are transfers in the form of goods or money that migrants send back home to their families. People often from the third world countries migrate to developed countries in the hopes of getting better jobs and better lives. The main reasons for their emigration include poverty, unemployment, lack of opportunities etc. Many people in the developing countries depend upon the remittances received from their families abroad. Every year, millions of people migrate to the Middle East, the United States, Japan, Australia etc. for better job opportunities.
According to "Workers' Remittances: An Important and Stable Source of External Development Finance" by Dilip Ratha, each year about "a million people enter the United States legally and 500,000 illegally. The numbers are similar in Europe. Immigration to many Asian countries - among them the Republic of Korea, Malaysia, Taiwan, and Thailand - surged in the 1990s." Over the course of the past several decades, the flow of money has increased drastically. In 1980, remittances were at $43.3 billion dollars (U.S. currency) and by 1995, they had increased to US$ 70 billion. Last year, in 2005, international migrant remittances exceeded $232 billion.
How are Remittances Transferred?
Remittances are usually transferred in the form of goods or cash. Workers send remittances in different ways: they can send it through wire-transfers, bring remittances back to their home country. In the case where the remittance is deposited in an agency, the agency then delivers the remittance to the requested destination. Remittances are also transferred through unofficial channels. "Unrecorded flows through informal channels are believed to be at least 50 percent larger than recorded flows"
Statistics
Remittances are a significant portion of external financing. In 2004, remittances were recorded to be the the second largest source of external financing, after Foreign Direct Investment. "Remittances (appear to be) the least volatile source of foreign exchange earnings for developing countries in the 1990s" (Ratha). While remittances have been continually increasing since the 1990s, FDI has fluctuated, especially during the last decade as shown in the graph below.
"According to World Bank in 2006, the magnitude of remittances in many developing countries has surpassed official development assitance (ODA), private equity flows, and foreign direct investment (FDI), and their rate of growth has outpaced that of official and private capital flows".
Remittances encompass a large part of their Gross Domestic Product (GDP). "Remittances to low-income countries were larger as a share of GDP and imports than were those to middle income counries" (Ratha). In comparing larger countries with smaller ones, it appears that remittances in terms of the U.S. dollar flow out to larger countries. However, in terms of GDP, remittances flow out to smaller countries.
Importance of Remittances
Remittances are:
- targeted to meet specific needs
- finance the purchase of basic consumption goods, housing, and children's education and health care
- provide capital for small businesses and entrepreneurial activities
- pay for imports and external debt service
- used by banks to raise overseas financing using future remittances as collateral
- tend to be more stable than capital flows
- tend to be counter-cyclical
Remittances play a huge role in developing countries' economy, individual households, and businesses. Studies have also shown that people at the low income, poverty, or unemployed level often migrate to different countries to work and send their earnings back home. When the household receives remittances in addition to income from production, the household seeks to spread these remittances across consumption and leisure according to their respective marginal utilities. The reduction of steady labor supply leads to a decrease in income but it is not enough to offset the additional resources from remittances. Therefore the total household income increases in the presence of remittances which leads to an increase in household in consumption, confirming the widespread belief that remittances helps in poverty reduction and improves the living standard.
For Example: In Nepal, poverty reduced from 42% to 31% between 1996 and 2004 (World Bank).
Business Point of View:
Remittance transactions is a huge business in itself and it is getting more popular as more remittances are being sent between countries. They contribute to the expansion of wire transfers and courier companies as well as money exchanges. Also, besides consumption, households save excess money in banks and that money can be used for investment purposes. Remittances often provide a significant source of foreign currency, increase national income, finance imports and contribute to the balance of payments
From this information, it is deduced through our macro-economic models that
Y = C + I + G + (X - M)
So, when C? and I? THEN Y? --> Y? = C? + I? + G + (X - M) = GDP?
Hence, GDP increases.
For Example: The World Bank estimates that in Haiti they represented about 17 percent of GDP in 2001, while in some areas of Somalia, they accounted for up to 40 percent of GDP in the late 1990s.
Downside of Remittances
- Labor shortage created by emigrating workers
- Appreciation of real exchange rate --> makes economy less competitive internationally
- Remittances create dependency --> undercutting recipients' incentives to work, slowing economic growth
- Human cost: family separation, exploitation of laboreres in foreign countries (hard labor, low wages), job risk, etc.
- No investment - remittances tend to be more compensatory in nature
- Remittances often transferred through unofficial channels - therefore statistics are false and misleading
It is also said that remittances fail to help the economy and decrease the likelihood of an improved economy. The inflow of funds can be deceptive if it creates dependence among the recipients, encourages the continued migration of the working age population, and decreases the likelihood of investment by the government or foreign investors because of an unreliable workforce.
Conclusion
What Can Be Done?
- Redirect remittances to official channels
- Facilitate investment by migrants in employment generating activities and enterprise creation in labour-exporting countries
- Regulate migration processes in order that they will not be subject to exploitation, etc.
- Small investment opportunities, such as micro-credit, to lessen emigration and dependency on remittances
Sources
Ratha, Dilip. "Remittances: A Lifeline for Development". www.IMF.org
Ratha, Dilip. "Workers' Remittances: An Important and Stable Source of External Development Finance". www.IMF.org
Ralph Chami, Cosimano, and Gapen - "Beware of Emigrants Bearing Gifts" www.IMF.org
www.WorldBank.org
"Migrant Worker Remittances, Micro-Finance and the Informal Economy" www.IMF.org
Pastor and Rogers 1985 - Migrant Worker Remittances
