Macro Effects of Remittances on Economic Growth

Abstract

In this paper, I investigate the background (what it is), significance (why it is important), and use of remittances (how it is utilized) in the economy of Pakistan and also as commonly, the overall living standard of those receiving remittances; health, education expenditure, literacy rate, brain drain, use of water, food and other necessities.

Besides, I will explore the econometric analysis between remittances and its macroeconomic consequence (on GDP, Inflation, Employment, Balance of Payments) as well as the economic analysis of the remittances and its effect on migration ratio, inequality ratio, and poverty gap.

Introduction

Remittance is the transfer of money by a foreign worker to his or her home country. It is counted as the 2nd largest source of capital inflow to many developing countries, except foreign direct investment that accounts for more sources of external finance. Remittance exceeds inflows which not only promotes economic growth in developing economies but also makes the receiving countries become more dependent on global economies, rather than sustaining their own local economies.

Global Impact

In the past, remittances received little attention from governments and financial markets because they were usually sent in small amounts. But now they are large in the aggregate and are important to developing countries. World Bank estimates $240 billion in total remittances in 2007, a staggering jump from only $31.2 billion in 1990. Remittances exceed all other imports of private and public capital in 36 developing countries.

Pros and Cons

The advantages of Remittances include the finance that is much needed investment in recipient countries work as a contribution to increased productivity. It is believed to reduce poverty as assumed that it is mainly due to the poor that migrate and send back remittances. Remittance increases the income in households which also increases consumption. It is more stable than foreign direct investment or foreign portfolio investments. Unskilled workers may return to their home countries with useful skills acquired abroad. Also, recipients have a higher propensity to own bank accounts.

Just when we talk about its advantages, we cannot avoid its disadvantages;

Remittances promote idleness among the recipients as they are more dependent on global economies. It may also cause appreciation of receiving country’s currency which will lead to lower net exports and negative economic growth.

Some emigrants may be educated or highly skilled causing what commonly known as “brain drain”.

· Loss of human capital lowers productivity and economic growth.

· Home country invested time, effort and money on their education.

· Migration of skilled workers worsens the distribution of income between rich and poor countries.

Trend of Remittance Flows

Most of the developing world has been increasing flows of remittances by double digits annually from 1990 to 2005.

Source: Global Economic Prospect 2006, and World Development Indicators, 2007, Washington DC: World Bank.

Cause of Remittance Growth

15.1% growth in Eastern Europe and Central Asia

· 1990s changed to free market economies

· Permitted labor migrations to oil-rich Middle East and industrialized Western Europe

17.3% growth in East Asia and Pacific Region

· Expansion of economic activity caused labor shortages in Japan, South Korea, Hong Kong, Taiwan and Singapore in the 1990s

· Increased migrant labor originating from Thailand, the Philippines and Indonesia

12.2% growth in South Asia

· Implementation of an economic liberalization program in India.

· Lifted regulations to foreign exchange and travel abroad for work

· Explosion of information technology industry in the US attracted large numbers of South Asians, mostly Indians.

14.0% growth in Latin America and Caribbean

· The implementation of NAFTA and the economic boom of the 1990s sharply increased the demand for workers in the US and Canada.

Why Migrate?

Migrants care about the households well being and remit to improve living conditions for example; Household Consumption. Then it can be self interest motives for example; Investment in home country. People also migrate for better education and health standards, in overall improvement in living standard. Asia is the centre of global migration, and as well the top remittances recipient. Pakistan comes under top 10 remittance recipient.

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How people migrate?

In Pakistan, people mostly migrate through migration agents, it is recorded about 81% of them are through agents, 17% through family relatives sponsoring in the country and 2% through tourist visa.

Modes of Transferring Remittances

In Pakistan,

· Informal via Hundi (money changers)

· Informal by hand

· Through financial institutions

Trends and Flows of Remittance in Pakistan

The World Bank provides data for Pakistan from 2005 to 2012. The average value for Pakistan during that period was 8373.53 million U.S. dollars with a minimum of 4277 million U.S. dollars in 2005 and a maximum of 13978.2 million U.S. dollars in 2012.

Remittances are an important and growing source of foreign exchange for Pakistan. Remittances have quadrupled in the last eight years to more than $7 billion in 2008 (4.2 percent of GDP); the recent increase in the flow of remittances to Pakistan originates mainly from host countries in the Gulf. The rise in remittances from the United Arab Emirates has been particularly strong (a doubling in 2006/7–2008/9), bringing remittances from that country close to the level of remittances from the United States ($1.7 billion in 2008/09). Remittances from Saudi Arabia and other GCC countries tripled in 2005/06–2008/09, while remittances from the United States and Europe (including the United Kingdom) have only risen moderately.

By 2007 remittances had become the second most important source of foreign exchange after exports of manufactured goods. Even in the boom years of 2005–07 remittances were a more important source of foreign exchange inflows than direct and portfolio investment. Historically, remittances have been relatively stable compared to direct investment and portfolio inflows; more recently, remittances have also been more stable than aid inflows.

The recent increase in workers’ remittances to Pakistan appears to have coincided with a sharp rise in migration. Worker migration to the United Arab Emirates, however, has declined by 43 percent from its peak in April 2008 to about 12,000 workers in June 2009. While in 2008 the United Arab Emirates was the destination for about half of all Pakistani migrants, in the second quarter of 2009 it received only one-third of all Pakistani migrant workers. The drop in migration to the United Arab Emirates was offset by an increase in migration to Saudi Arabia (from a monthly average of 11,500 in 2008 to 18,400 in the second quarter of 2009). Labor migration to the European Union (including the United Kingdom) tripled from January 2007 to June 2009, but the volumes are still small (400–600 workers per month).

Another interesting observation is the shift in the pattern of labor migration from Pakistan since the beginning of the global crisis and the contrast with remittances. The number of Pakistani workers migrating to the United Arab Emirates has gradually declined since mid-2008, while the opposite is true for migration to Saudi Arabia and a diverse set of other countries (although the absolute numbers are much smaller for that group of host countries).

Geopolitical events can also affect remittances, especially in the case of Pakistan. In the wake of the September 11, 2001 terror attacks the United States and other Western countries increased scrutiny of bank accounts of Pakistani nationals. Some anecdotal evidence suggests that to avoid the risk of their funds being frozen or confiscated, Pakistanis abroad transferred part of their accumulated savings to Pakistan and increased the share of their monthly savings held in Pakistan.

In the long run, the question whether Pakistan will be able to sustain the recent increase in remittances depends on whether the rise in labor migration is to continue and, more importantly, if the composition of the migrating workforce continues to tilt in favor of highly skilled workers. Obviously, any positive impact of a continued export of high-skilled labor should be carefully weighed against the potential cost of this ‘brain drain’.

Research Question

Problem Statement

One of the main objectives of this paper is to identify how important remittances are for the economy of Pakistan. Furthermore, it is to evaluate the link between increasing remittances’ and economic prosperity; the effect of Remittances on some of the major macroeconomic variables; GDP, Education, Poverty gap, Literacy rate, health and overall living standard. Last but not the least; it’s the objective also to check the effect of increasing migration rate on remittances.

Research Objective

I propose to examine the advantages and disadvantages of the remittance growth. In addition, I would like to investigate the historical background, importance and significance of Remittances in the context of Pakistan. Also as commonly, the overall living standard of those receiving remittances; health, education expenditure, literacy rate, brain drain, use of water, food and other necessities.

Besides, I will explore the econometric analysis between remittances and its macroeconomic consequence (on GDP, Inflation, Employment, Balance of Payments) as well as the economic analysis of the remittances and its effect on migration ratio, inequality ratio, and poverty gap.

Importance/Benefits

• This research paper will benefit the government in making decision regarding the trade laws, especially for Remittances.

• This will also help the researchers in the similar field, to further explore the study of Remittances in Pakistan.

Review of the Literature

Richard H. Adams Jr. and Alfredo Cuecuecha write in their paper “Remittances, Household Expenditure and Investment in Guatemala” published in 2010, that a nationally-representative household data set from Guatemala to analyze how the receipt of internal remittances (from Guatemala) and international remittances (from United States) affects the marginal spending behavior of households.

Two findings emerge. First, controlling for selection and endogeneity , households receiving international remittances spend less at the margin on one key consumption good—food—compared to what they would have spent on this good without remittances. Second, households receiving either internal or international remittances spend more at the margin on two investment goods—education and housing—compared to what they would have spent on these goods without remittances. These findings support the growing view that remittances can help increase the level of investment in human and physical capital in remittance-receiving countries.

Vaqar Ahmed, Guntur Sugiyarto, and Shikha Jha in their paper “Remittances and Household Welfare: A Case Study of Pakistan” published in Feb, 2010 examine the impact of remittances on economy and household welfare in Pakistan by using a general equilibrium framework and microeconometric analysis. The first approach is to highlight the macroeconomic and sectoral effects of a reduction in remittances, while the second is to show how remittances decrease the probability of being poor and affect the household consumption expenditure and hence poverty. The findings suggest that reduction in remittances will reduce gross domestic product, investment, and household consumption, which in turn will increase poverty also, the probability of households becoming poor decreases by 12.7% if they receive remittances. The poverty headcount ratio and Gini coefficient decline by 7.8% and 4.8%, respectively, for household-receiving remittances. Given the important role of remittance, the key challenge for the government is to provide incentives to attract more remittances sent through formal channels and ensure their productive use.

Udo Kock and Yan Sun explain in their paper “Remittances in Pakistan—Why have they gone up, and why aren’t they coming down?” published in August 2011, the flow of workers’ remittances to Pakistan has more than quadrupled in the last eight years and it shows no sign of slowing down, despite the economic downturn in the Gulf Cooperation Council (GCC) and other important host countries for Pakistani workers.

This paper analyses the forces that have driven remittance flows to Pakistan in recent years. The main conclusions are: (i) the growth in the inflow of workers’ remittances to Pakistan is in large part due to an increase in worker migration; (ii) higher skill levels of migrating workers have helped to boost remittances; (iii) other important determinants of

Remittances to Pakistan are agriculture output and the relative yield on investments in the host and home countries.

Richard H. Adams Jr. and John Page in their paper “Do International Migration and Remittances Reduce Poverty in Developing Countries?” published in 2005, write as summarized that few studies have examined the impact of international migration and remittances on poverty in the developing world. This paper fills this lacuna by constructing and analyzing a new data set on international migration, remittances, inequality, and poverty from 71 developing countries. The results show that both international migration and remittances significantly reduce the level, depth, and severity of poverty in the developing world. After instrumenting for the possible endogeneity of international migration, and controlling for various factors, results suggest that, on average, a 10% increase in the share of international migrants in a country’s population will lead to a 2.1% decline in the share of people living on less than $1.00 per person per day. After instrumenting for the possible endogeneity of international remittances, a similar 10% increase in per capita official international remittances will lead to a 3.5% decline in the share of people living in poverty.

Abbas, Faisal in his paper “Remittances from West Asian countries and Pakistan’s Political Economy” published in 2011, writes about the importance of remittances to economies with huge trade deficits and budgets. Political policy regime and its impact on attracting remittances and sending labor force to various countries have important development policy relevance. This paper aims at presenting some political economy hypotheses using Pakistan as a case study. The idea is to descriptively analyze the impact that remittances can have in an economy (specifically, Pakistan) over a period of time due to important nature of migration and foreign inflows in the form of remittances. Furthermore, this study make use of the available data for four decades of the labor force migrating from Pakistan to West Asian countries as well as monetary inflows i.e., remittances coming to Pakistan. Another aspect of this paper is to analyze the data of skill categories of labor migrants to west Asian countries. It is observed that labor migration to Pakistan is of cyclical nature. Labor migration predominantly to West Asian countries is not permanent and heavily in favor of less skilled or unskilled workers. Although, the trend is somehow changing in favor of skilled and highly qualified skill category but the number of labor migrants in West Asia relative to Europe and USA is still far beyond. Government of Pakistan has taken number of initiative to promote labor migration, skill enhancement programs for migrant workers but still there is a lot of room for improvement. The recent initiative of State Bank of Pakistan, Ministry of Finance called ‘Pakistan Remittances Initiative (PRI)’ is one such step in this direction.

Based on analysis by Centre for Social and Economic Research Warsaw 2012 in “The economic benefits of remittances— A case study from Poland” yes, remittances have a clear and positive impact on Poland’s economic well-being:

· At the macroeconomic level – they do increase disposable incomes and consumer expenditure and accelerate GDP growth

· At the household level – they do alleviate poverty and reduce income disparities

However, the extent of these impacts should be kept in perspective. Although they are clearly visible, they tend not to be that strong. They are also quite selective – in that they clearly favor certain demographic groups and geographic locations.

Material and Methods (Research Design)

Research Design

This paper is a combination of descriptive (what is going on?) and explanatory research (why is it going on?). Some of the ideas identified, make it a qualitative research, such ideas are; knowledge, flexibility, efficiency, health, trade, substitution and other a quantitative such as econometric analysis between remittances and its macroeconomic consequence (on GDP, Inflation, Employment, Balance of Payments) as well as the economic analysis of the remittances and its effect on migration ratio, inequality ratio, and poverty gap.

Research Instruments

• Secondary data
• Statistical reports

Data Analysis

Data Analysis

For econometric evaluation, Eviews will be used.

Analysis Qualitative Research Data and Analysis Quantitative Research Data

Time

It took around 3/three months to complete the research process.

Methodology and Results

Dependent Variable: Y_PC
Method: Fully Modified Least Square (FMOLS)
Date: 05/19/14
Sample (adjusted): 1990 2010
Included observation: 20 after adjustments
Cointegrating equation deterministic: C
Long-run covariance estimate (Bartlett kernel, Newey-West fixed bandwidth = 3.0000

Variable

Coefficient

Std. Error

t-Statistics

Prob.

UT

-67.11060

49.25785

-1.362435

0.4031

PRR

-6.755161

28.43219

-0.237588

0.8515

NETM

-17.62713

16.98544

-1.037778

0.4882

ICPI

8.502761

8.010182

1.061494

0.4810

HET

156.5276

119.8196

1.306361

0.7894

BOP

4.82E-08

1.40E-07

0.343474

0.6473

FPI

14.77569

23.88366

0.618553

0.3445

C

-244.4850

4.657727

1.618553

0.7401

R-squared

0.993673

565.222

-0.432546

Adjusted R-squared

0.943056

Mean dependent var

766.0450

S.E. of regression

52.82999

S.D dependent var

221.3884

Durbin Watson stats

1.907484

Sum squared resid

2791.007

Long-run variance

297.4188

· The Coefficient column shows that 1 unit increase in GDP that brings a decrease of -67.11060 in UT. Similarly a decrease in Personal Remittances Received, Net Migration, and an increase in Inflation (Consumer Price Index), Health Expenditure (total), Balance of Payment, and Food Production Index.

· TheStd. errors column shows standard errors of each coefficient estimate.

· The t-statistic column is testing whether any of the coefficients might be equal to zero. If the errors ε follows a normal distribution, t follows a Student-t distribution. Under weaker conditions, t is asymptotically normal. Large values of t indicate that the null hypothesis can be rejected and that the corresponding coefficient is not zero.

· Probability shows that if the value is less than 10%, it is statistically significant.

· R-squared is the coefficient of determination indicating goodness-of-fit of the regression. This statistic will be equal to one if fit is perfect, and to zero when regressorsX have no explanatory power whatsoever. Here it is 0.993673, which shows the strong goodness of fit and it shows that the regressors have a great explanatory power. This is a biased estimate of the populationR-squared, and will never decrease if additional regressors are added, even if they are irrelevant.

· Adjusted R-squared is a slightly modified version of , designed to penalize for the excess number of regressors which do not add to the explanatory power of the regression. This statistic is always smaller than , can decrease as new regressors are added, and even be negative for poorly fitting models.

Conclusion

Remittances are now an important source of foreign cash inflows for Pakistan in the past few years, which is expected to only increase and not fall. In this paper I used a new approach to explain the strong remittances for Pakistan. The results are hopeful, it shows that the number of people migrating is mostly skilled labor, and as they make investment returns in the host country; Pakistan, it does improve the economic condition of Pakistan. These results also show that the remittances are more elastic in Pakistan than those to other countries in the subcontinent. In 2009, after the Global Financial Crisis, remittances to Pakistan increased up to 25 percent compared to 21% in Nepal, 17% in Bangladesh and 9% in Sri Lanka, while remittances to India declined 31 percent. Pakistan also experienced a rush in labor migration since 2005. GCC countries are the primary source of remittances for countries like Pakistan, Nepal, Srilanka, India. Therefore, it can be said that the increase in remittances to Pakistan is a direct result of people migrating to other countries. As the raise in the share of high-skilled workers in Pakistan’s labor migration explains part of this inconsistency.

Keeping in mind the results discussed above, the migration of high-skilled Pakistani workers will boost the inflows in future as well.

However in the long run, the question is whether Pakistan labor migration will be able to uphold the situation, as increase in remittances is dependant on this. At the same time, the “brain drain” factor is increasing with the increasing Remittances.

The Coefficient column in the Fully Modified Least Square estimation shows that 1 unit increase in GDP brings a decrease of -67.11060 in Unemployment (total), this shows a negative relationship between GDP and Unemployment; GDP increases with the increase in Remittances. Similarly a decrease net migration, and an increase in Inflation (Consumer Price Index), Health Expenditure (total), Balance of Payment, and Food Production Index.

However, Durbin–Watson statistic explains whether there is any evidence of serial correlation between the residuals. As a rule of thumb, the value smaller than 2 will be an evidence of positive correlation, hence the results show that it is positively correlated.

In recent years, the positive impact of remittances on emerging economies has been the topic of significant debate; just like it is said that “remittances are the ‘third pillar’ of development (alongside foreign direct investment and overseas development assistance)”. Against this background it is important to explore the analysis of the true impact – particularly for a country like Pakistan, which has the high migration rate and is one of the highest remittance receivers.

The above analysis has proven to leave a positive impact of Remittances on Economic well being:

• At the macroeconomic level – It does accelerate GDP growth

• At the household level – it does create employment opportunities, and overall help the economy to move ahead.

After analyzing all this, one can safely conclude that remittances do have a positive impact on domestic economies.

References

Vaqar Ahmed, Guntur Sugiyarto, and Shikha Jha, “Remittances and Household Welfare: A Case Study of Pakistan”, ADB Economics, Working Paper Series, No. 194 | February 2010

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Udo Kock and Yan Sun, “Remittances in Pakistan—Why have they gone up, and why aren’t they coming down?”, International Monetary Fund, IMF Working Paper, Middle East and Central Asia Department, August 2011

Pradhan, Gyan, Mukti Upadhyay, and Kamal Upadhyaya. "Remittances and economic growth in developing countries." European Journal of Development Research 20.3 (2008): 497-506. Business Source Premier. EBSCO. Web. 1 Mar. 2011.

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2006. “Remittances, Poverty and Investment in Guatemala”. In C. Oxden and M. Schiff,

Eds, International Migration, Remittances and the Brain Drain. World Bank, Washington, DC.

Adams, R. H. Jr., and J. Page. 2005. “Do International Migration and Remittances Reduce Poverty in Developing Countries?” World Development 33:1645–69.