Effect of remittances on poverty, income distribution and growth

Unlike public development cooperation and foreign direct investment, remittances have grown steadily in recent decades and today serve as an important source of revenue in countless households throughout the developing world.

Does financial support from migrants represent a step toward solving the problem of poverty in developing countries? Or does it simply place these countries in a new kind of dependent relationship?

Opinions vary greatly as to how remittances affect the fight against poverty, income distribution, spending habits, education, health, investment and growth as well as the balance of payments in developing countries. This is due, in part, to the lack of accurate data and the variety of research methods used to analyse it.

Combating poverty

The influence of remittances on individual recipient household incomes can be seen as a positive one, at least in the short term. The principle advantage of remittances is that they are paid directly to individuals and families. Unlike state- controlled development assistance and direct investments from foreign countries, the money does not flow into companies and other organisations. Rather, it raises available household income, which in turn enables families to meet their own specific needs. It must be emphasised, however, that it is difficult to draw a direct comparison between remittances and the above-mentioned sources of development-related financing: Remittances represent a source of private capital, and it is therefore solely at the discretion of the migrants and their families to decide on the money's use.

Mexico's National Population Council (CONAPO) estimates that 1.4 million Mexican households benefited from remittances in 2004. For beneficiaries, this financial influx represents, on average, 47% of the family income. Similarly, the Philippines has come to the consensus that households receiving remittances are financially better off, because they average a monthly income that is 45% above the national minimum wage. In addition to increased income, remittances also offer beneficiaries a certain amount of security. While foreign direct investments have been especially subject to fluctuation, remittances have served as a stable, steadily increasing financial inflow to developing countries since 1990 (see Figure 1). Due to their consistency even during economic troughs, remittance payments offer recipients an extremely reliable source of income. Anti-cyclical increases are common, i.e. migrants abroad increase the scope of their family support during times of economic crisis. Such behaviour helped buoy the Philippine economy during the Asian financial crisis. It was possible to avoid a recession solely through a surge in remittances, which sustained domestic consumption and helped the country overcome a slump in exports. Following Hurricane Mitch in 1999, El Salvador's government used this behaviour to its advantage, asking its citizens living in the US to increase support to families back home.

The immediate increase of available family incomes is a vital means of support, especially for middle- to low-income households. This added income not only increases recipients' living standards, it also minimises vulnerability during times of crisis or natural disasters.

Income distribution

A comparison of data from different case studies does not reveal a consistent pattern concerning the effects of remittances on income distribution; in some cases, it even reveals conflicting results. These variations can be attributed, in part, to traditional patterns of migration. As a rule, individuals from the middle class tend to migrate first, as only they can afford the high costs involved. As soon as migration networks are established, the cost of migrating decreases significantly, making it possible for poorer groups of people to emigrate. It is assumed that remittances reflect this migration trend and, therefore, temporarily increase income disparities in the sending countries. At first, remittances from middle-class migrants increase the level of income in middle-class households, widening the income gap, before poorer households are able to improve their income by sending a family member abroad.

Spending habits

The improved income situation enjoyed by recipients of remittances also brings with it changes in spending habits. Additional financial resources are used primarily for daily expenditures, home construction, land purchase, medical care and education. A smaller fraction of the money is saved and possibly invested. The majority of funds, however, are used to cover ongoing living expenses. For a long time it was believed that spending on consumption did not generate lasting economic development. Current economic studies now tend to deviate from this line. The increase in household spending is now said to stimulate ongoing demand for consumer goods and services, which, in turn, triggers production and results in the creation of new jobs. This theory has already been supported by economic analysis which shows that increases in spending have a multiplier effect (see below).

The second largest expenditure target is home and land ownership. Although this tends to have a positive effect on the construction sector, it may have some negative consequences. In Egypt, for example, the price of land for agricultural purposes increased 600% between 1980 and 1986. This increase in demand was due, in part, to remittances. Such growth in demand for non-tradable goods like property and real estate can lead to a rise in inflation. Similarly, negative effects can occur if domestic production cannot keep up with the increased demand. This can result in an increase in imports and/or an appreciation of the exchange rate, impairing domestic production as exports become more expensive on the international market and, as a result, less competitive. However, strong fluctuations of this sort have not been proven empirically.

Education and health

Many experts see the main value of remittances in improved education and health. A considerable portion of remittance spending goes to educating young relatives back home. A number of studies have already shown significant improvements in the educational level of younger generations. For example, the increased cash flow to the Philippines during the financial crisis in Asia led to a significant increase in school enrolment, a decline in child labour as well as a general increase in spending on education. Estimates for El Salvador indicate that remittances, as compared to other sources of income, reduce the likelihood that urban children will quit school early by 10%.

It is difficult to measure the real effect of increased health-related spending. For example, it remains to be seen whether Mexico´s migration trends alone are responsible for decreases in child mortality and increased birth weights, or whether this is also due, in part, to other factors. The most important migration-related benefits in the fields of health and education are – in addition to increased financial support – the heightened awareness and knowledge of these issues that migrants gain by living abroad.

Investment

Another crucial component of sustainable development is the accumulation of real capital, which requires new investments. In this context, remittances could produce the greatest impulse for the creation of capital and labour market expansion in developing countries if they were used to finance entrepreneurial activities. However, this type of spending tends to occur least often. Studies show that in Mexico, for example, 95% of monetary remittances are spent on consumption and a mere 5 to 8% saved for future investments. Despite this low level of savings, remittances do seem to have a positive effect on the creation of new businesses in Mexico. A study conducted on small businesses in urban areas of Mexico revealed that remittances account for nearly 20% of total capital stocks.

However, the relatively widespread criticism that remittances contribute very little to sustaining structural improvements and generating development remains valid. Finding ways to increase the proportion of investment spending is certainly a challenge for the future. At the same time, few migrants seem able to make the career move from worker to entrepreneur. It is up to national governments to create a healthy financial sector and an investment-friendly climate so as to increase personal savings (including from remittances) and investments.

Growth

Economic theory considers economic growth, i.e. increase in GDP, a basic prerequisite for escaping the poverty trap. To achieve growth, it is not the size of remittance payments that is important but rather – as argued above – the way in which the additional revenue is put to use. As previously discussed, the effects of savings and investment are greater than that of consumer spending. Nevertheless, consumer spending can also have positive multiplier effects for the economy as a whole. In the case of Mexico, it has been proven that for every dollar entering the country through remittances, the GDP increases by US$2.69 in urban areas and by US$3.17 in rural areas.

On the other hand, at the household level, isolated observations reveal that remittances may have a negative effect on growth. For example, Kenyan farmers with additional income from remittances have lower crop yields than those without financial support from abroad. The paradoxical phenomenon can be traced back to a change in incentives. The so-called moral hazard theory supports the notion that families in this situation no longer have an incentive to remain productive themselves, preferring to direct their energies into attracting support from relatives living abroad. Under these conditions, remittances could lead to a decline in economic growth. However, it is doubtful that such behaviour can be attributed to all individuals. In this regard, it is extremely difficult to gather data concerning this phenomenon.

Balance of payments

Finally, extreme increases in remittance values have a direct effect on a country's balance of payments. Monetary inflows not only fill the coffers of private households but also lead to an increase in the recipient side of the balance of payments. The entry of foreign currency into the country helps both to reduce foreign exchange shortages and to consolidate the balance of payments. Remittances, in contrast to other incoming payments from abroad, are advantageous, because they neither carry interest nor have to be repaid.

InfoTargeted emigration policy in the Philippines

There are many calls for political strategies to optimise the development potential of remittances. Up to now, only a few countries have developed official strategies pertaining to migration and remittances. The Philippines are among the few countries that, for decades, have managed emigration. Its "Overseas Employment Program" has fostered and regulated temporary labour migration since 1974. In the beginning, many workers were sent on labour contracts to the Middle East on account of the oil boom. The goal was to reduce unemployment in the Philippines and to increase the flow of foreign currency into the country. The current rationale behind the program's continued existence is that it helps combat illegal migration and prostitution, and that it improves working conditions in host countries. According to government figures, more than 7.3 million Filipinos lived abroad in 2004, representing 8% of the country’s population. Remittances received through official channels amounted to 5.2% of the GDP in that year. Saudi Arabia and Kuwait remain the major destinations for Filipino emigrants; however, private and governmental organisations place migrant workers in various countries worldwide. Since 1990, the government, under pressure from the population and external organisations, has been working harder to protect the rights and welfare of Philippine workers abroad. In order to protect migrant workers from exploitation, additional preparation courses for migrants were introduced to explain working conditions and migrants' legal position in host countries. To encourage increased remittance activity, special identification cards with integrated Visa cards and bank accounts were introduced, making the cost of money transfers more reasonable. Transfer fees amount to less than US$3 and exchange rates are subject to market conditions.

Views on Philippine emigration policy are divided. Its means of managing temporary migration are considered exemplary, as no other country has managed to generate such organised and protected migration flows. However, critics note that the stated goal of abolishing irregular emigration has not been met; instead, there seem to be two parallel migration movements. Moreover, the cost of brain drain on Filipino society is significant, and even after nearly three decades of this emigration policy, no lasting change can be observed.

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