The Remittance Effect: Do Remittances Help Development?

A rapid increase in global migration has led to an average of nine percent annual growth of remittances¹ globally (“Migrants,” 2013). For countries like Tajikistan, the Kyrgyz Republic, Lesotho, and Nepal, remittances constitute as much as 20 to 40 percent of national GDP (“Migrants,” 2013) and, in many other developing countries, remittances outstrip official development assistance as well as foreign direct investment (Grabel, 2009, p.87). Remittance literature has extolled this rising volume of remittances for having a substantial positive impact on development and poverty, especially in comparison to the impacts of official development assistance (“Impact of Remittances,” 2011).

This paper will argue against the establishment of a quick, causal link between remittances and development. Insofar as development includes not only economic growth, but also quality of life and human welfare, remittances can have no effect or even detrimental effects on development. The first section will employ Jeffrey Sachs’ development model to explain why many studies have shown that remittances are beneficial for countries’ development. The second section will problematize these optimistic remittance studies on three grounds: basic methodological problems, the interaction of remittances with domestic and international politics, and, finally, the masking of unequal effects on human capital in the household level.

Studying remittances has become very important because they are steadier and more reliable than development assistance and foreign direct investment. Indeed, the $414 billion worth of remittances expected to be received by developing countries in 2013 is truly the bread and butter for many people (“Migrants,” 2013). However, remittances and development are not so simply linked; remittances have developmental potential, but their effects on development should be considered in particular socio-political-economic contexts.

Remittance Optimists: The Case For Remittances-as-Development

Much economic research shows a link between remittances and poverty reduction, but these studies do not explain how exactly remittances help reduce poverty. Jeffrey Sachs’ model of development can be used as a framework to understand the argument of remittance optimists. Sach’s model shows how remittances help in savings, investment, overall GDP, and how they act as a buffer against adverse productivity shocks. Sachs’ theory does not directly adress remittances – what is central to his development model is foreign aid. However, his theory can be used to understand how remittances fit with popular development paradigms today, as well as to help understand flaws in remittances.

For Jeffrey Sachs, development is consubstantial to breaking out of the poverty trap² via GDP growth. ‘Growth’ is obtained by a combination of high savings, development of human capital, and technology and trade, among others.³

There is evidence that remittances are fulfilling some of Sach’s prerequisites to development: Yero Baldé, for example, found that a 10% increase in remittances increases household savings by 7% and investment by 6.5% (Balde, 2011, p. 247). Other studies show that remittances raise household consumption as well as increase household investment in education and health care (Nallari and Griffith, 2011, p.126).

Moreover, Sachs identifies a potential setback in development—“adverse productivity shock” (Sachs, 2005, p. 55)—against which remittances can protect national economies. Adverse productivity shocks are unexpected occurrences, like natural disasters or financial crises. Remittances seem apt to buffer against these shocks because they are countercyclical (Ratha, 2007): Remittances tend to rise during economic crises, natural disasters, or political conflicts. For example, the number of remittances rose during financial crises in Mexico in 1995 and Indonesia and Thailand in 1998, acting as buffers during those times (Ratha, 2007). Therefore, remittances not only seem to help overcome poverty but also act as a buffer against adverse productivity shocks.

Studies have indeed documented a reduction in poverty due to remittances. After surveying 7,276 households in Guatemala in 2000, Richard J. Adams found that international remittances decrease the squared poverty gap by 21.9%.⁴ Even more convincing effects on poverty are shown by Richard H. Adams and John Page’s study of 71 low-income and middleincome developing countries. They conducted an analysis of the effects of remittances on poverty headcount, poverty gap, and squared poverty gap⁵, and showed that official international remittances have a statistically significant negative impact on all three poverty measures.

However, remittances are not this generation’s panacea for the poor to “gain a foothold on the ladder” of development (Sachs, 2005, p.73). There are flaws and caveats to the idea of remittances as a cure for lagging development.

Flaws and Caveats in Remittances-as-Development

Most remittance research is plagued by sample omissions and a shallow definition of ‘migrant.’ Furthermore, remittances are embedded in social and political economy contexts that constrain their development potential.

I. Methodological Shortcomings

One of the easiest criticisms of the ‘remittance-as-development’ discourse is sample omission. Many economic analyses suffer from a lack of remittance and migration data across countries and time. For example, although Adam and Page’s study showed an attractive reduction in all three measures of poverty, there are grave data omissions. For example, India, densely populated and a receipient of a large volume of remittances, is included in the study, but some of the countries with highest absolute poverty headcounts ($1.25/day) in 2005, like Congo and Niger, are excluded due to unavailability of poverty and remittance data.

Furthermore, a large volume of remittances are transferred from informal sectors like ‘hawala’ in Pakistan and ‘hundi’ in India, and these are omitted from official remittance data (Orozco, 2011, p.63). This lack of data should caution researchers against deducing policy recommendations from such studies, because the countries where remittances matter the most are often the ones with the least data, and thus, the most excluded or underrepresented in samples (Kapur, 2003).

Furthermore, the effects of remittances on poverty is compounded by the narrow operational definition of ‘migrant.’ Most remittance-optimistic studies do not consider socio-political characteristics of migrants like education level and income level prior to migration. This is a crucial missing piece in the puzzle: Studies have shown that skills and education of migrants do matter for remittance determination and usage.

In Bangladesh, for example, the poorest families with little to no education tend to produce temporary migrants (Zaman and Mashfique, 2013, p.111). The average education levels of migrants tend to be higher than the average education levels of their home countries (Kapur, 2003). Studies that ignore socio-political characteristics of migrant families are reductive, and thus, we must not be quick to extol those that show an increase in education and health investments due to remittances.⁶ This result could very well be due to socio-political characteristics of migrants before they migrate, and might be abetting transient poverty as opposed to long-term structural poverty. Ultimately, these studies are inconclusive about abject structural poverty.

II. Politics of Remittances

Unlike the studies on other international capital flows, like developmental assistance and foreign direct investment, academic literature has downplayed the political economy context of remittances (Grabel, 2009, p.86). Like Sachs, some researchers assume that development needs governments “oriented toward development” (Sachs, 2005, p. 59), but do not examine how governments can be incentivized to underdevelop a country or a neighboring one.

A powerful reason why remittances might not lead to development is because their flow and effects depend on bilateral relations and geography between countries. As such, remittances can be a powerful foreign policy and economic warfare tool. Devesh Kapur identifies what he calls a “source-destination dyad” (2003) in a remittance economy whereby two countries have longstanding unidirectional remittance flow. Examples include Mexico as a source of migrants and USA as a destination, and Burkina Faso as a source of migrants and Cote d’Ivoire as a destination. Because of this dyad, a civil war between 2001 and 2004 in Cote d’Ivoire “rapidly reverberated” into Burkina Faso (Kapur, 2003): Burkinabe remittances took a deep plunge during the civil war in Cote d’Ivoire. Similarly, in the aftermath of the September 11 terrorist attacks in New York, the US government put global pressures on diasporic remittances going to countries like Pakistan and Somalia for fear of terrorist funding.

In Somalia, where remittances were being controlled by a single firm, the effects of the United States shutting down that firm in 2001 were an economic and humanitarian disaster (Kapur, 2003). As the cases of Burkina Faso and Somalia show, remittances still depend on geography in terms of migrant flows and on bilateral relationships in terms of the amount and effects of remittances. A civil war or change in foreign policy in destination countries can severely diminish the amount of remittances received and their macroeconomic impacts.

Developmental effects of remittances not only depend on international diplomatic relations but also on domestic politics – for example, the public moral hazard problem. This refers to the possibility that, because remittances are countercyclical, they incentivize governments to shirk their responsibility to provide basic public goods and maintain citizens’ welfare. This effect might be most pronounced during natural disasters and crises when the countercyclical nature of remittances can relieve the government of its responsibility of providing social programs and institutional support to the public (Grabel, 2009, p.94). Moreover, the moral hazard might also extend to the household level: As Ralph Chami et al. put it, “Compensatory remittances that insure the public against adverse economic shocks ... reduce households’ incentives to pressure the government to implement reforms to facilitate economic growth” (Chami, 2008). Households that expect and depend on remittances can also be de-incentivized to participate in the labor market, thus slowing economic productivity (Grabel, 2009, p.97). Far from helping development, remittances have a dangerous potential to exacerbate domestic political problems and hamper the economy.

Thus, it is important to remember that remittances operate in a context of political economy. They are not only affected by politics, like source-destination dyads, but they also affect politics, like public moral hazard. Their development capacity relies not only on the economics enumerated in section one, but on these powerful, political factors as well.Continued on Next Page »