The impact of remittances on economic growth evidence from selected ASEAN developing countries

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACT OF REMITTANCES ON ECONOMIC GROWTH: EVIDENCE FROM SELECT

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACT OF REMITTANCES ON

ECONOMIC GROWTH: EVIDENCE FROM

SELECTED ASEAN DEVELOPING

COUNTRIES

BY

NGUYEN HAI TRA MI

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, SEPTEMBER 2014

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIALSTUDIES

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACT OF REMITTANCES ON

ECONOMIC GROWTH: EVIDENCE FROM

SELECTED ASEAN DEVELOPING

COUNTRIES

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

DECLARATION

I declare that “The impact of remittances on economic growth: Evidence from selected Asean developing countries” is my own work It has not been submitted to any degree at other universities

I confirm that I have made by effort and applied all knowledge for finishing this thesis in the best way

Ho Chi Minh City, September 2014 NGUYEN HAI TRA MI

ACKNOWLEDGEMENTS

First and foremost I would like to show my gratitude to my supervisor, Dr Le Cong Tru, for invaluable comments, remarks and engagement through the learning process of the thesis Then I would like to send my sincere thanks to Associate Prof

Dr Nguyen Trong Hoai, Dr Pham Khanh Nam and Dr Luca Tasciotti for giving

me helpful remarks on my TRD as well as keeping me on the right track Last but not least, I am deeply indebted to my parents, my brothers and sisters for understanding and giving me spiritual assistance I will wholeheartedly be grateful forever for your love

ABSTRACT

Over the last decades, remittances have been regarded as one of the important sources of financial flows to developing countries Nevertheless, whether remittance serves economic growth or not is so far still a key empirical question This paper attempts to examine this issue In particular, the investigation covers seven Asean developing countries over the period of 2000 to 2011 A logistic regression technique is employed to evaluate the impact of remittances on economic growth

To account for the inherent endogeneities in the relationship between remittances and economic growth, a Generalized Method of Moments (GMM) approach is used The regression results of the study show that, at best, remittances should not be treated as a source of capital flows and have a negative impact on economic growth because they are used for bad economic performance of the recipients This suggests that policy makers should have the recipients to allocate large amount of remittances in investment as contribution to economic growth

Key words: remittances, economic growth, Generalized Method of Moments,

capital flows

TABLE OF CONTENTS

DECLARATION i

ACKNOWLEDGEMENTS ii

ABSTRACT iii

TABLE OF CONTENTS iv

LIST OF TABLES vi

LIST OF FIGURES vi

LIST OF ABBREVIATIONS vii

Chapter 1 INTRODUCTION 1

1.1 Background to the Study 1

1.2 Migration and Remittance flows in ASEAN countries 3

1.3 Research objectives 5

1.4 Research questions 6

1.5 Justification of the study 6

1.6 Organization of the study 7

Chapter 2 LITERATURE REVIEW 8

2.1 A definition of remittance 8

2.2 Determinants of remittances 10

2.2.1 Microeconomic determinants 10

2.2.2 Macroeconomic determinants 13

2.3 Contribution of remittances to growth 15

2.3.1 Capital accumulation 15

2.3.2 Labor force growth 17

2.3.3 TFP growth 17

2.4 Empirical Review 20

2.5 Chapter summary 23

2.5.1 Empirical literature summary 23

2.5.2 Conceptual framework 25

Chapter 3 METHODOLOGY 30

3.1 Data collection 30

3.2 Control variables 31

3.3 Research Methodology 34

3.3.1 Descriptive analysis 34

3.3.2 Econometric model 34

3.4 Estimation techniques 36

Chapter 4 DATA ANALYSIS AND RESULTS 39

4.1 Descriptive Analysis 39

4.1.1 Trends of economic growth 39

4.1.2 Trends of remittances flows to selected Asean countries 41

4.1.3 Trends in remittance inflows and economic growth indicator in Asean countries 44

4.1.4 Remittances and other capital inflows 45

4.1.5 Descriptive statistics analysis 46

4.1.6 Correlation matrix among independent variables 47

4.2 Regression Results 48

Chapter 5 CONCLUSION AND POLICY IMPLICATIONS 53

5.1 Conclusion 53

5.2 Government Policy Recommendation 54

REFERENCES 56

APPENDIX 61

LIST OF TABLES

Table 1.1 Migrant Remittances in Asean Countries 4

Table 2.1 Summary of variables 23

Table 2.2 Summary of variables (continued) 24

Table 4.1 GDP per capita growth rate in selected Asean countries 40

Table 4.2 Remittances (current US$ million, period 2000-2011) 41

Table 4.3 Remittances (% of GDP, period 2000-2011) 43

Table 4.4 Descriptive Statistics 47

Table 4.5 Correlation Matrix 48

Table 4.6 Static model results 49

Table 4.7 Dynamic GMM regression results 51

Table 0.1: Data definitions 61

Table 0.2: Remittances (% of GDP, period 2000-2011) - Descriptive statistics 62

Table 0.3: Ordinary Least Squares 63

Table 0.4: Fixed Effects Estimation 64

Table 0.5: Generalized Method of Moments 65

LIST OF FIGURES Figure 1.1 Remittances, FDI, private debt & portfolio equity and ODA 2

Figure 1.2 Personal remittance inflows (% of GDP) in Asean countries, 2012 5

Figure 2.1 Remittances effect on economic growth 19

Figure 2.2 Conceptual Framework 26

Figure 4.1 GDP per capita growth rate in selected Asean countries 40

Figure 4.2 Remittances (current US$ million, period 2000-2011) 42

Figure 4.3 Remittances (% of GDP, period 2000-2011) 43

Figure 4.4 Trends in Remittance inflows and GPD in selected Asean countries 44

Figure 4.5 Remittances, Foreign direct investment and Net official development assistance and official aid (US$ billions) 46

LIST OF ABBREVIATIONS

FDI Foreign direct investment

GMM Generalized Method of Moments

ODA Official development assistances

Chapter 1 - INTRODUCTION

This chapter introduces the thesis topic and identifies the main issues which will be covered in the following sections The background and motivation to the study will be introduced first Then the research objectives and research questions will come later The chapter will ends with the contribution of the study and the thesis structure

1.1 Background to the Study

Nowadays migration has been an increasingly crucial characteristic in the globalization world, especially for developing countries It has been a major issue to consider by policy makers towards economic development Under migration context, remittances, an evidence for the ties connecting migrants with their family members in the home country, have grown significantly over years The World Bank estimates that worldwide officially recorded remittance flows reached $550 billion in 2013, in which developing countries received biggest share of these flows ($414 billion) However, the figure does not reflect true size of remittance flows as

it should be larger when there are unrecorded remittance flows through unofficial channels

Over the past three decades, remittance flows speeded up and now are expected to continue to be in the increasing trend with over $700 billion worldwide

by 2016 The fast increase in remittances may result from two factors Firstly, migration between developing and developed countries has risen significantly in the last 20 years (WorldBank, 2007) Secondly, transactions costs for international payment transfer between individuals have declined thanks to technological improvements (Giuliano and Ruiz-Arranz, 2006) Looking at Figure 1.1, we can see that remittance flows are now nearly three times the size of official development assistance (ODA), and larger than private debt and portfolio equity flows to developing countries (WorldBank, 2013) Remittances as a source of foreign

currency earnings also play an increasingly important role in many emerging markets with weakening balance of payments It is true in the case of South Asia, with India being an outstanding example The depreciation of the Indian rupee has boosted remittance flows that provide much support to the balance of payment of this country With the depreciation of over 20% in the Indian rupee in 2013, the country could experience a surge in remittances flows and gain total value of US$

71 billion (about 3.7 percent of GDP) That has made a major contribution to India’s economy (WorldBank, 2013) In addition to that, in some countries, remittances flows even accounted for more than 20 percent of gross domestic product (GDP) For example, in 2012, in terms of GDP share, the top of recipients

of remittances were Tajikistan (48%), Kyrgyz Republic (31%), Lesotho and Nepal (25% each), and Moldova (24%) (WorldBank, 2013) As a result, remittances might have a significant impact on the welfare of recipient households, and on the growth of recipient economies

Source: World Bank Development Indicators and World Bank Development

Prospect Group

Figure 1.1 Remittances, FDI, private debt & portfolio equity and ODA

Many studies have found the positive benefits of remittances on well-being

of recipient households, specifically helping to reduce poverty, making consumption easier and allowing for investment in health care and education (De Haas, 2005) However, in contrast to remittance impact on recipient households, the role of remittance in economic growth has been still in debate In theoretical literature, the effects of remittance are mixed and complicated On one side, researchers in favor of remittances suggest that remittances are often used for investment and enhancing financial development, leading to improved capital allocation and consequently accelerating economic growth, especially in underdeveloped financial system (Giuliano and Ruiz-Arranz, 2005) On the other hand, the others find zero or negative impact of remittance on economic growth (Barajas et al., 2009; Chami et al., 2003; IMF, 2005; Ratha, 2003) They show out remittances’ reverse effect on inflation and labor market participation, and remittances also cause unnecessary appreciation of the local currency of the recipient which then leads to expensive goods produced at home and thus decreases export competitiveness (a “Dutch disease” problem)

1.2 Migration and Remittance flows in ASEAN countries

ASEAN region includes 10 countries: Brunei Darussalam, Laos, Cambodia, Indonesia, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam The region has become an important source of migrant workers for those countries that suffer from labor shortage around the world (except Brunei Darussalam and Singapore which are two developed countries and not taken into account in this study for remittance impact on economic growth) As such, remittances sent by these migrants to their home countries have increased significantly over years They have greatly assisted these countries to reduce the shortage of foreign exchange reserve and paid the import bills

The migrants transfer remittances to their home countries because of their altruistic motive or investment purposes (Solimano, 2003) According to World

Bank data, the remittance inflows to Asean countries have been rising since 2000, with an approximate 66% increase in 10 years from 2004 to 2013 The Philippines have always headed the pack in the region with estimated 26.05 US$ billion in

2013, followed by Vietnam (10.65 US$ billion), Indonesia (7.88 US$ billion), Thailand (5.32 US$ billion), Malaysia (1.48 US$ billion), Myanmar (2.51 US$ billion), Cambodia (0.28 US$ billion), Laos (0.12 US$ billion) More outstandingly, the Philippines and Vietnam stood in top 10 recipients of remittances list in 2013, together with other countries like India, China, Mexico, Nigeria, Egypt, Arab Rep., Bangladesh, Pakistan and Ukraine

Table 1.1 Migrant Remittances in Asean Countries

Source: World Bank

As a percentage of GDP, the Philippines ranked the first position with 9.8%

of GDP in 2012, followed by Vietnam standing at the second with 7.1% While these significantly high shares implies large contribution of remittances in the domestic income in these two countries, remittance numbers of other countries in Asean region seem not be so much weighted in GDP, with only 1.8% for Cambodia, 1.3% for Thailand, 1.2% for Lao PDR, 0.8% for Indonesia, 0.4% for Malaysia (see Figure 1.2)

Source: World Bank

The leading migrant host countries are the United States, United Kingdom, Canada, Japan, Australia, Germany, and Singapore All of these countries have more developed economy than that of the Asean countries This implies that the economic conditions in developed countries could create better employment opportunities and attract more migrants (Shahbaz and Aamir, 2009)

1.3 Research objectives

In general, the whole picture can be drawn as that, migrants usually leave their home country to work and live abroad, supporting their family members with flow of remittances Therefore, these flows bring about direct or indirect effect on millions of people Remittance flows can help lift many people out of poverty because they play as a steady income to be spent on daily consumption and other necessities such as medicine and shelter The remittance effect on poverty reduction

is widely recognized (Barajas et al., 2009) Besides this effect, however, the way in which remittances contribute to economic growth is still an open question In many

Figure 1.2 Personal remittance inflows (% of GDP) in Asean

countries, 2012

cases, remittances flows are seen as similar to FDI and other private capital flows While FDI and other private capital flows have positive impact on economic growth, remittance flows are therefore inferred to impose similar effect Ratha and Mohapatra (2007) have mentioned that remittance flows are an important source of external finance for developing countries

Following this argument, there is a belief that remittances are similar to FDI and other private capital flows that contribute to economic growth Therefore, the overall objective of this paper is to examine the impact of remittance on economic growth in Asean developing countries In specific, the paper aims to determine the contribution of remittances to output growth in these countries

1.5 Justification of the study

There has been a lot of interest and debates among researchers and policy makers towards the nature of remittances and their effect on economic growth Following that stream, my paper aims at finding out whether there exists the potential impact of remittances on the economy of 7 Asean developing countries The reason for my choosing Asean is that remittance income has emerged as one of largest sources of foreign exchange earnings for these countries, while very few

researches have been made towards the economic impact of remittances in this region There is also no cross-country empirical analysis on remittances covering these countries of Asean region Following the model of some empirical studies, my paper will make some modifications by adding different variables which are, in particular, variables of traditional sources of economic growth I will use different estimation methods that are based on POLS (pooled ordinary least squares), fixed effects, random effects and GMM (Generalized method of moments) models that help to solve the heterogeneity of Asean economies and find out how traditional sectors contribute to economic growth of these countries The findings of the study hopefully contribute to policy implications not only for these countries but also for other developing countries that depend on remittance income

1.6 Organization of the study

The remainder of this paper is structured as follows Chapter 2 provides the literature review both in theoretical and empirical studies regarding the remittance impact on economic growth Chapter 3 describes the data and research methodology Chapter 4 comprehends the research results Chapter 5 is conclusions and recommendations and discussions of the limitations and directions for further studies

Chapter 2 - LITERATURE REVIEW

As stated in the introduction, remittance inflows are expected to potentially have large effects on the recipient country This chapter aims to review theoretical and empirical review for examining those effects The chapter is divided into five sub-sections The first two parts presents the definition of remittances and its determinants, both at a microeconomic and macroeconomic level The next part discusses the channels through which remittances may impact the growth rate of recipient economy with a growth accounting framework Then empirical studies on the subject are summarized in the next part The final part provides the conceptual framework

2.1 A definition of remittance

A remittance is generally a cash transfer from a migrant worker to recipients in

the country of origin According to the Balance of Payment Yearbook of the International Monetary Fund (IMF), remittance is divided into 3 categories:

 Workers’ remittance or in cash from workers residing abroad to recipients

in the country of origin

 Compensation of employees such as the wages, salaries, and other remuneration, in cash or in kind, paid to individuals who work in the host country for less than a year

 Migrants' transfers refer to net wealth of migrants who move from one country to another and stay for more than one year

Despite above clearly defined categories, there have been some problems in implementing them due to limitations of data quality and scope (Jongwanich, 2007) They are mostly misclassification of remittances with other capital inflows, no record for some formal remittances and limited calculation of inflows through informal channels For that reason, many scholars have used different calculation ways for having appropriate remittance credits While some totalize just compensation of employees and workers’ remittances (Taylor, 1999), others sum up

three above categories for a final remittance figure (Ratha, 2003) There is another method of calculating remittance flows from Daianu (2001) which summing up compensation of employees, workers’ remittance and “other current transfers of other sectors” This is regarded as the most appropriate method to overcome the discrepancies referred above (OECD, 2006)

Although the main sources of remittance data are from annual balance of payments records of countries, its actual value seems not being truly reflected because the recorded one is just through official channels Flows through informal channels, which are not recorded, have been experienced to be significant, particularly for low-income migrants as they contribute considerable large share in total remittances (Puri and Ritzema, 1999) According to these authors, remittance data has faced the situation of underestimation The level of under recording is different among countries There are two types of leakages: one due to erroneous (imprecise accounting), and the other due to the choice of informal, unsupervised channels for remittances The first type of leakages is erroneous due to the practice

of treating all informal remittances as foreign exchange leakages from the labor exporting country These leakages include remittance items such as: (1) “personal imports” of migrant workers (for example, goods imported return migrant workers under duty free allowance facility or brought along with them under personal baggage, and (2) the savings brought home on return (in the form of cash or travelers’ cheques) and then later converted into local currency at domestic banks (Athukorala, 1993) Choices of informal channels for remittance, second type of leakages, are retaining part of migrant worker savings in personal accounts with overseas banks, or hand carrying part of remittance in form of cash and traveler’s cheques when migrants return home

Some reasons are given to explain why remittances are leaked to unofficial channels, mostly related to the convenience of migrants and their families According to Puri and Ritzema (1999), there are four reasons Firstly, remittances have to be transferred through informal non-banks (regardless of transaction costs)

due to the inadequacy, inefficiency and even destroy of banking and foreign exchange facilities Secondly, differences in price between the remittance sending and receiving countries may lead to the practice of sending or carrying remittances

in the form of goods (remittance in kind) for the recipient personal use or for resale

in the informal market Thirdly, when the exchange rate in remittance receiving country is overvalued which means an implicit tax on remitters through official channels, the migrants tend to use informal foreign exchange market instead Fourthly, when financial depression happens, negative real interest rates are applied

on domestic savings, there’s a tendency that money balance is driven to foreign bank accounts

2.2 Determinants of remittances

To understand why migrants remit money to their family in home country is necessary for studying economic impact of remittances There may be two reasons for this need Firstly, the amount of remittances depends on the migrant’s underlying reasons to migrate and reasons to remit, from which the size and timing

of remittances determine their effect on economic activity at home Secondly, the purposes of remittances also affect the recipient’s uses of these flows This will be

in turn impact the economic growth in the home country (Chami et al., 2008) There are many studies discussing remittances’ determinants, mostly divided into 2 categories: microeconomic determinants and macroeconomic determinants If the microeconomic ones are about the cases of migration and the migrant’s connection with family at home, the macroeconomic ones related to economic conditions and policies in both sending and receiving countries (Lucas, 2004)

2.2.1 Microeconomic determinants

Microeconomic determinants of remittances are reflected in the motivations

to remit Analytical literature identifies four different types of motivation behind the

sending of remittances (Stark, 1991) (Brown, 1997) (Poirine, 1997) They can be summarized as follows:

Altruistic motive: The purpose of sending remittances back home by the

migrant is for the well-being of his family By doing this, the migrant feels satisfactory with the well-being of his family In addition, as compared to the family members in home country, the migrant usually has higher level in education This may enable him to receive higher income in the foreign country that offers better average wage to workers than the home country can do In this model, remittances are anticipated to decrease over time because connection between the migrant and his family members in two different countries becomes weaker in the long run In some other cases, the migrant may have the intention of living abroad for a long time or even retire there His family, therefore, go to live with him This will cause decreased remittance flows to home country

Self-interest motive: The migrant sends remittances to home country when he

or she feels about a safe place for saving and investment Usually they buy land, property and financial assets, etc His or her family then looks after these assets for the migrant during migration period and becomes a trustworthy and well-informed agent Another motivation to remit is the inspiration to receive an inheritance from his parents By sending remittances to contribute to the wealth of the family, the migrant will have more chances to get inheritance from his family in the future

Loan repayment: This type of motive is often taken by those who are

financed the costs of migrating by his family as investment in education abroad After finishing studying, the migrant settles in the foreign countries and start to pay back money to his family in form of remittances In this case, the family seems like making a profitable investment in their family member – the migrant who can achieve higher earnings in a foreign country than his family members who live and work at home As such, remittances are seen as an integral part of an implicit contract between the migrant and his family In this model, remittances are expected

to arise depending how long it takes for the migrant to start working in the foreign

country and during his working period As soon as the migrant can join the abroad

labor market, the remittances can be transferred back to the home country with an amount subject to his income level at that time Consequently, remittances may not reduce over time as they do in the altruistic model

Co-insurance: This kind of motive is usually taken when the migrant and his

family want to diversify risks This is because the capital markets and insurance markets are insufficient in the home country and hence there are few choices of financial assets to limit the risks In addition, a serious problem of the poor migrants, constraint to borrowing, may make them spend less in consumption or investment With the assumption that there is no positive correlation in economic risks between the home and the foreign country, the family has a good way to diversify risks – sending their member to abroad to work, earn money and support his family with financial issues in bad periods The migrant is also benefited by this way since the bad periods can also happen in the foreign country, from which he can rely on his family at home The family, in this situation, plays a role as insurance for the migrant Generally, in this model, emigration can be regarded as co-insurance strategy, in which remittances play the role of an insurance claim

It is not easy to distinguish between above motivations Many empirical studies have tested motivations by regressing remittances on a set of variables and revealed controversial results This is due to insufficient data on migrants and receiving households’ characteristics and on timing of remittance flows (Rapoport and Docquier, 2005) The motives are different from households and exits within households as well All of them are important for deciding to remit Pozo (2005) observed in Latin America that altruism is an important motive underlying the remittances from migrants to families, but in many cases, the migrants also remit to insure for bad times in foreign country

2.2.2 Macroeconomic determinants

Many empirical papers have studied macroeconomic determinants of remittances and figured out a list of variables that can be expected to have significant effect on the volume of remittances to receiving countries Outstanding variables are the number of migrant workers, the economic situation in the host and home country, inflation, exchange rate movements, the relative interest rate between the sending and receiving country, and government policies and political stability in the receiving country as determinants of remittance flows (Buch and Kuckulenz, 2004) (Pozo, 2005) (Russell, 1992)

The number of migrant workers in the host country surely determines remittances as the higher number of workers, the higher volume of remittances According to Freund and Spatafora (2005), a double in the stock of workers would lead to a 75 percent increase in remittance flows The economic situation in the home country is an important determinant because remittances would tend to be transferred more to home country where happen negative shocks On the other hand, it is also important for economic activity in the host country to determine remittance flows With better economic conditions, the migrants would have more chances of employment and getting more money, thus then be able to remit more (IMF, 2005) Remittances may also be discouraged and shifted from the formal to informal sector under the condition of bad economic government policies and institutions in the home country such as black market premiums and exchange rate restrictions (IMF, 2005) Macroeconomic instability like high inflation or real exchange rate overvaluation may have similar negative effects, whereas better developed financial sector may induce remitting easier and less costly Furthermore, political instability may also deter migrants from sending remittances because of the risk of expropriation or theft An unstable political and macroeconomic environment is not helpful for investment and may therefore prevent remittances Last but not least, the differential in interest rate between the sending and receiving country can bring about investment opportunities in the home country, thus result in

increased remittance flows back to home (Elbadawi and Rocha, 1992) Remittances also respond to return to asset potential in the home country as compared with that

in the host country The better return to assets at home, the greater chances the migrant will have for investment and therefore enhance remittances (IMF, 2005)

However, from many empirical studies, there is no consent on the macroeconomic determinants of remittances According to Buch and Kuckulenz (2004), the magnitude of remittances that a country receives is not clearly impacted

by the traditional variables such as economic growth, the level of economic development, and proxies for the rate of return on financial assets This can be explained that just as many microeconomic motives underlie the decisions to remit, many different macroeconomic determinants may similarly exist together

We can see from the above assessment of remittance literature that there are different motives under a remitting decision but no clear implications for economic impact of remittances How are remittances spent or used? Are they spent on consumption or used for investment? In other words, are they compensatory or opportunistic? Scholars have tried to answer these questions but had different outcomes According to Chami et al (2008), if remittances are opportunistic in nature and sent to home country where having good economic conditions, they are regarded as capital flows and can be analyzed accordingly Nevertheless, if they are compensatory transferred money, they are different from capital flows and thus have different economic impacts compared to capital flows In a study of De Haas (2005), remittances have been witnessed to be consumed on food, houses, cars and other goods, but not on investment since the 1970s As a result, remittances are thought to lead to a passive and dangerous dependency on remittances Chami et al (2005) found that remittances are best regarded as compensatory transfers A panel regression on remittances is made for 113 countries over 29 years; specifically a country’s ratio of remittance to GDP is regressed on the interest rate differential between the country and the United States and on the difference in the country’s GDP per capita and United States’ GDP per capita Regression results are negative

and significant coefficients on the income gap This reflects that when income in the home country decreases, higher amount of remittances would be sent home As such, remittances are compensatory transfers, not any source of capital for economic development Another example for remittance flows as compensatory transfers is the financial crises in Asia from 1998 to 2001 Despite decreased private capital flows, remittance flows continue to increase under the crises

On the other hand, Buch and Kuckulenz (2004) say that remittance flows share similarities with private and official capital flows although they still have different determinants, in particular, have different behavior over time It is not surprising with these similarities because payments of migrants to their relatives at home are motivated both by market-based considerations and by social considerations The migrants remit to protect their families from unfavorable economic developments, while also consider the opportunity costs of sending remittances instead of investing abroad Remittances are therefore market-driven

2.3 Contribution of remittances to growth

From the above microeconomic and macroeconomic determinants on remittance, there’s a need to understand the channels that remittances impact economic performance in order to formulate good policies to maximize their overall economic impact Among the variety of channels, there are outstandingly three types through which remittances can effect on economic growth They are capital accumulation, labor force growth and total factor productivity (TFP) growth (Barajas et al., 2009)

2.3.1 Capital accumulation

Remittance inflows can affect the rate of capital accumulation in recipient economies in different ways Firstly, remittances can have a beneficial influence in case that financing of investments comes from domestic sources of income, then remittances may induce direct increase in capital accumulation For example, under

undeveloped financial system, households face financial constraints, so remittances directly help ease these constraints, leading to physical capital increase Research conducted in Mexico and the Philippines suggests that remittances can lift these constraints as remittances help households to accumulate more assets in farm equipment, increase higher levels of self-employment and micro-enterprise investments (Woodruff and Zenteno, 2004; Yang, 2005) Remittance inflows thus could help households to set up their own entrepreneurial activity Secondly, remittances can improve the creditworthiness of domestic investors, then lowering the cost of capital and enhance the country’s access to international capital markets (WorldBank, 2006b) A country credit is calculated by international agencies partly depending on the magnitude of remittance flows The higher the magnitude of remittance flows the higher ranking of credit rating for a country Moreover, remittances can help a country to get more access to international capital markets by securitizing future remittance flows, which effectively strengthen the capacity of governments or private sector entities to borrow They play as collateral to raise external financing in international capital markets (Ratha, 2013) Thirdly, remittance flows may affect domestic capital accumulation by impacting domestic macroeconomic stability They make the economy less volatile and therefore may reduce the risk premium that firms demand in order to undertake investment, making domestic investment more attractive (Chami et al., 2009)

Besides physical capital, remittances can also finance investment in education and health care, which are the two key variables in promoting long-run economic growth For education, there is a possible link between remittances and education when remittances ease credit constraint and make greater access to education for the poor (Rapoport and Docquier, 2005) López-Córdova (2005) made research in Mexico and found out that remittances lead to increased school attendance and greater literacy levels in those regions receiving more remittances They contribute to household income and limit the likelihood of young members of family abandoning school in order to work

Regarding health effect, remittances help to reduce infant mortality Córdova, 2005) The author found that a 1 percent increase in remittances received

(López-by households reduces the number of children who die in the first year (López-by 1.2 percent Furthermore, a study by Hildebrandt and McKenzie, (2005) also concludes that remittances can enhance higher birth weights for children in households receiving them

2.3.2 Labor force growth

Effect of remittances on economic growth may be also through their effects

on the growth rate of labor inputs In particular, they could impact the labor force participation in the economy This is because when receiving remittances, households tend to substitute this income with the labor income, from which moral hazard problem may arise and induce the recipients to work less and consumer more This idea was first raised by Chami et al (2003) As the remittance flows are made under asymmetric information and far distance between the remitter and recipient, monitoring and enforcing the usage of this transferred money is very difficult There are many anecdotal evidences as well as academic studies for this labor effort effect For example, Kozelt and Alderman (1990) and Itzigsohn (1995) found negative impact of remittances on the labor force participation of households Thus, remittances appear to serve as a drag on labor supply

2.3.3 TFP growth

The last channel through which remittances can affect economic growth is the total factor productivity growth Their effect is through efficiency of domestic investment and through the size of domestic productive sectors that bring about dynamic production externalities Remittances may enhance the efficiency of investment by improving the quality of domestic financial intermediation (channeling funds from savers to borrowers) In other words, they may affect the ability of formal financial system in the recipient economy to allocate capital For

example, when the financial markets are underdeveloped, remittances will help loosen the credit constraints imposed by households by a small financial sector and therefore contribute to GDP growth Furthermore, remittances also increase the amount of funds flowing through the banking system This will help to improve financial development and thus to higher economic growth through creating economies of scale in financial intermediation

In other words, remittance can alter the quality of domestic financial intermediation If the family member is less skilled in allocating capital than official domestic financial intermediaries, the efficiency of domestic investment would decrease rather than increase

The second channel through which remittances impact TFP is changing the size of domestic productive sectors that generate dynamic production externalities Empirical studies suggest that large and sustained remittance flows can result in rising demand for domestic currency that may lead to a real exchange rate appreciation This is the Dutch disease effect, which in turn can make exports from remittance receiving countries less competitive The industries or companies that produce the exports may transfer the know-how to the rest of the economy or provide the opportunities for other local companies to get into the competition, thus increasing competitiveness, especially in manufacturing sector (Acosta et al., 2007) (Montiel, 2006) As a result, due to the exchange rate changes caused by remittances, these companies may become less competitive, leading to reduced productivity level and the chance of closing business Amuedo-Dorantes and Pozo (2004) investigate the effect of remittances on the real exchange rate in 13 Latin American and Caribbean countries The authors discovered that remittances have potential to cause economic costs on the export sectors of receiving countries by reducing their competitiveness They find that when remittances are doubled, the real exchange rate is appreciated to 22 percent However, other studies have different conclusion Remittance flows seem stable and persistent over long periods, the Dutch disease effects of remittances should not be concerned more than those of

natural resource windfalls and other cyclical flows According to Ratha (2013), the exchange rate under remittance flows is easier to manage than an abrupt shock due

to a natural resource windfall With large remittance flows, governments can choose

to liberalize trade policies and allocate a larger part of government expenditures on infrastructure The author comments that with these measures, exports tend to be increased, leading to improved labor productivity and competitiveness

Figure 2.1 provides us a general overview of remittance theory in its affect

on economic growth discussed above The graph starts where remittances go into the recipient economy to and ends at the point where these inflows produce growth

Figure 2.1 Remittances effect on economic growth

The positive linkage argument was theoretically strengthened in a paper by Carling (2004) presented at Workshop B9 at the 9th International Metropolis Conference, Geneva Remittances, when being transferred to recipient households,

will be used for either consumption or investment When remittance income is consumed, there will be a benefit to the overall economy because some of the transfers are spent on domestically produced goods and services, which may result

in a multiplier effect (Stahl and Arnold, 1986) In addition, when remittances are saved in financial institutions, this will help to increase credit availability and can enable entrepreneurs to invest in their business and thus have positive effect on economic growth Remittances can serve as a substitute for a loan that allows recipient households to finance investment, both in physical capital and human capital By this way, remittances spur economic growth (Michael and Maurice, 2008)

On the negative side, remittance inflows can create two main problems which then result in reverse effects on economic growth Firstly, remittances are burdened with a moral hazard problem in which recipients make less efforts to work and more to consume This will hamper economic growth in the long term Chami

et al (2003), De Haas (2005) also pointed out that when remittances are used for consumption, this may suggest that remittances are compensatory in nature and can lead to the passive and dangerous dependency Secondly, remittances can cause Dutch disease effects in receiving countries Large remittance inflows or the large inflow of foreign currency can lead to real exchange rate appreciation, reduced international competitiveness capacity and thus decreased production of

manufactures and other tradable goods (Acosta et al., 2007; Montiel, 2006)

2.4 Empirical Review

Global studies on the effect of remittances to economic growth have shown mixed results It has still been in debate if remittances have a positive, negative, or any effect in economic growth of the recipient country

One of the most outstanding studies in this topic is the research of Chami et

al (2005) who found that remittance have a negative effect on economic growth The authors of the study did the analysis on 113 countries over a 29-year period

(1970-1998), specifically controlled for lagged income gap and the interest rate gap between the recipient country and the United States as determinants of remittances, and showed that workers’ remittances have a negative and significant effect on growth They then came to the conclusion that remittances are not served as capital for economic development but as compensation for poor economic performance In addition, a study of Barajas et al (2009) found no relationship between remittances and long-term economic growth of 84 developing countries over the period 1970-

2004 The ratio of remittances to GDP ratio was used as an instrument for capturing the effects of global reductions in transaction costs associated with a remittance transfer and changes in the microeconomic determinants of remittances Most of the estimations showed the negative signs in remittance variables and a main conclusion drawn from these estimation results is that remittances do not seem to make a positive contribution to economic growth On measuring the correlation between remittances and per capita output growth, or between remittances and such variables as education or investment rate, a study by the IMF (2005) found no significant effect of remittances on economic growth in 101 developing countries during the period of 1970-2003 Bettin and Zazzaro (2008) found that remittances have little contribution to economic growth and may even hamper growth in some recipient countries They could not find a positive impact of remittances on long-term growth; while often find a negative nexus of remittances and growth There are, according to these researchers, some main reasons to blame for these findings Firstly, the authors attribute the negative effect on the moral hazard problem caused

by remittance Household residents of the country of origin tends to lessen the incentive to work when receiving these remittance income, which then results in a reduction in the labor supply for the developing countries Secondly, remittances are seen to cause a situation like the Dutch disease According to Acosta et al (2009), when remittance inflows increase, they will make a decrease in labor supply and a rise in consumption demand that is trended to non-tradables From this, non-tradable prices will be higher, supporting an expansion of this sector and making

less labor participation in tradable sector Thirdly, remittances are considered to be not investment but be social insurance to help recipient households finance the purchase of life’s necessities

On the other hand, Fayissa and Nsiah (2010) found the impact of remittances

on growth is positive in 18 Latin American countries from the period of 1980 to

2005 Besides showing the positive relationship between remittances and economic growth in the long run, the regression results also get the researchers to come to conclusion that remittances are another source of financial investment like foreign aid and FDI in developing countries In particular, it is suggested from the study that in order to enhance economic performance, Latin American countries not only can invest on traditional sources of growth such as physical and human capital, trade, FDI, but they also can raise the remittance inflows by reducing the transfer cost With the same objective of examining the workers’ remittances and economic growth nexus, a research by Das and Morshed (2011) was covered in top 11 remittances recipient developing countries from the period 1985 to 2009 By taking the panel cointegration and pooled mean group estimation method, the researchers found a positive and significant effect of remittances on economic growth

Jongwanich (2007) investigated the remittance effect on economic growth and poverty in Asia and the Pacific developing countries The result showed that remittances have a significant direct effect on poverty reduction, while seeming to have a positive but marginal impact on economic growth by improving domestic investment and human capital Imai et al (2011), though discovering that the volatility of remittance is harmful to economic growth and remittances should not

be seen as a substitute for aid, as a whole confirmed the beneficial effect of remittance on economic growth

2.5 Chapter summary

2.5.1 Empirical literature summary

The following table summarizes and compares the common variables used in previous empirical literature to determine the responsiveness of economic growth to remittances and the traditional sources of economic growth The table may not express the exact name of variables employed by the authors but it means to review the most significant ones

Table 2.1 Summary of variables

Fayissa and Nsiah (2010)

Net private capital flows *

Methodology Panel

regression

Panel regression

Panel regression

Panel regression

Data set

113 countries, 1970-

1998

84 countries, 1970-

2004

66 developing countries, 1970-2005

17 Latin American countries, 1980-2005

Table 2.2 Summary of variables (continued)

Morshed (2011)

Jongwanich (2007)

Net private capital flows

Other official flows

Methodology Panel

regression

Panel regression

Panel regression and 2SLS

Data set

11 top remittance-recipient developing countries, 1985-2009

17 developing Asia-Pacific countries, 1993-2003

24 Asian &

Pacific countries, 1980-2009

Notes:

NS means not significant

*, ** and *** mean significance level at 10%, 5% and 1% respectively

2.5.2 Conceptual framework

Below diagram visualizes the determinants in our study with their expected direction of their impacts to economic growth For a better review, these variables are divided into 3 groups: capital characteristics, business characteristics and human characteristics

Figure 2.2 Conceptual Framework

In this diagram, we have 7 hypotheses with respect to the impact of each variable to economic growth

Hypothesis 1: Remittances are a statistically significant factor in

determining economic growth

This is the main hypothesis that needs investigating in our study As discussed above, remittances are used for both consumption and investment that bring about different impacts to the economic growth When remittances are used to pay for goods produced in domestic market, this kind of capital flows would benefit

the economy as a whole Being saved in financial institutions, remittances also help

to ease credit constraint and facilitate recipients with easier access to larger source

of credit for investing in their business Remittances, therefore, are a good impetus for economic growth Nevertheless, the consumption of remittance income results

in decreased participation into labor force since the recipients tend to depend on remittances rather than their labor income Large inflows of remittances also cause real exchange rate appreciation and thus make exports less competitive in international markets Under these situations, the economy is finally adversely impacted These two opposite impacts of remittances on economic growth have been found in many empirical studies such as Chami et al (2005) with the negative finding or Jongwanich (2007) with positive one

In this study, however, we expect that remittances will help to stimulate economic growth since remittances represent the largest source of foreign exchange earnings as compared to FDI and official development assistance and official aid during the period of 2000-2011 in selected Asean countries This kind of flows also has a more stable growth than other kinds of capital and has been used in both consumption and investment The gradual growth year by year also leads us to the expectation of a positive contribution to the country output

Hypothesis 2: FDI is a source of capital flows that impose positive effect on

economic growth

The importance of FDI in enhancing economic growth has been figured out

in many researches Chami et al (2005) has found beneficial impact of FDI to output growth in developing countries during 1990s It is wide recognized an important vehicle for the transfer of technology and the transfer of soft skills through training and job creation An increase in FDI may be associated with improved economic growth due to the inflow of capital and increased tax revenues for the host country Host countries often try to channel FDI investment into new infrastructure and other projects to boost development

Hypothesis 3: The net official development assistance and official aid is a

source of capital flows that impose positive effect on economic growth

This kind of flow, from the perspective of governments, is a voluntary transfer of resources from one country to another At the Millennium Summit of

2000, the international community agreed on certain Millennium Development Goals (MDG) to be reached by 2015: Reducing extreme poverty, providing universal primary education, reducing child mortality, improving maternal health, preventing the spread of HIV/AIDS, ensuring environmental sustainability and developing a global partner ship for development World leaders have acknowledged that the achievement of these goals were much dependent on increased resource transfers as well as improved aid effectiveness through donor co-ordination Aid increase has been suggested in the Monterrey Consensus (UN 2004) and (UN 2005) Many authors have seen the importance of aid in economic growth and carried out researches with the finding of significant contribution to economic growth (Levy (1987); Moreira (2005))

Hypothesis 4: Trade openness helps to enhance economic growth

Under the wave of liberalization over last decades, the trading activities among countries have become increasingly exciting Trade openness has made capital being allocated more efficiently and enabled business owners have better innovations Among various empirical studies made towards the impact of trade openness towards economic growth, the studies by Freund and Bolaky (2008) and Chang et al (2009) have brought about better understanding of this impact when the authors found out positive relationship between these two variables

Hypothesis 5: Investment has a beneficial contribution to economic growth

Investment means an increase in capital spending, e.g buying new machines, building bigger factories If investment is effective then it should also increase the productive capacity of the economy For example, investing in skills and education can increase labour productivity Investment in new technology and capital can increase the productive capacity of the economy An important use of capital is to

increase the production of capital intensive goods The consumption of such goods generally increases with the growth of income through which capital accumulation promotes growth of income (Sundrum, 1993) An increase in the capital stock certainly needed to promote growth of production According to World Bank (1989), GDP growth is higher for those countries, which have relatively higher investment/GDP ratio As a result, there is a general agreement that, in all countries, the process of economic growth and investment/capital formation is closely interconnected

Hypothesis 6: School enrollment help to promote economic growth

Increased school enrollment means improvement in human capital that leads to higher economic growth rates and household income This argument has been figured out through many empirical studies which have demonstrated a positive relationship between human capital stock and economic growth (Mankiw et

al (1992); Barro and Sala-IMartin (1995))

Hypothesis 7: Population growth should impose negative effect on growth

It is easy to see that larger populations have fewer natural sources per person, less physical capital per worker and greater needs for new infrastructure This would impact economic growth adversely There are many studies on population and economic growth that support this argument such as earlier studies of Coale and Hoover (1958) Later studies developed more neoclassical versions of these ideas that all showed a lower per capita income due to more rapid population growth