Empirical Framework of the Study
6.4 Definitions and Expected Signs of the Variables Used in the Determinants of Remittances Model
Definitions and expected signs of the variables used in the model are given in Table 6.1.
The study includes remittance-GDP ratio as dependent variable. Our explanatory variables are not strictly exogenous because we include lagged dependent variable as an exogenous variable in the dynamic panel data. In addition to lagged remittance GDP ratio, we use domestic inflation rate, official exchange rate, home and host country’s income level, broad money to GDP ratio and political freedom as explanatory variables. Moreover, a time dummy of 9/11, 2001 has been incorporated to see whether there is any change in remittance inflows that come through formal channel.
Our first variable is the income level of the migrant in its host country. Whatever the motivation of the migrant is, the expected sign of the variable is positive. If the earnings of the migrants increase, he will remit more.
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Our second variable is the income of the family of the migrant. If the altruistic motivations dominate the remitting behavior, the expected sign of the variable is negative. When the income level of the family in the home country declines, the migrants send more money for his family at home to assure the same level of utility. In the case of insurance motivation, a decrease in the income of the family in the home country will also decrease the remittances, because the migrant will think that his assets at home are not properly taken care of. This also means that the bargaining power of the family members decreases.
This is also valid for investment motives. When the income of the family in the home country increases, the migrant will send more money for financial investments or for inheritance reasons, because his potential of inheritance will increase.
Third variable is exchange rate. Bilateral exchange rate between host and home country plays an important role in workers’ motive to remit. Two opposing effects may arise as a result of exchange rate depreciation; namely, wealth effect and substitution effect (Bouhga-Hagbe, 2004). Depreciation or devaluation of home currency reduces the prices of goods and services in the foreign currency, which allows a remitter to buy more foreign goods rather than domestic ones. On the other hand, the remitter is better-off as her income increases in the domestic currency, thereby encouraging her to buy more goods (including real estates) and services in home country. Bouhga-Hagbe (2004) points out that even though depreciation may temporarily increase the flow of workers’ remittances in the home country, in the long run, it might undermine remitters’ confidence in the economy. When altruistic motivations are concerned, for an appreciation of the origin country’s currency, the expected sign of the variable is positive. To ensure the same amount of income in the national currency, the migrant is obliged to send more in foreign currency. However, in case of depreciation, migrant can decrease the amount of remittances because he can ensure the same amount in the local currency with less foreign currency. If altruistic motive are the dominant motivation in the remitting decision, the expected sign of this variable is negative both for investment and insurance motivations.
The impact of an appreciation of the local currency in case of insurance motivation would be the same as the impact of inflation. The migrant would prefer to remit more later to offset the impact of the appreciation of the local currency (because he must send more money in the form of foreign currency). In case of investment motives, especially for the investment in housing, the migrant is expected to decrease the amount of remittances in
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case of an appreciation of the origin country’s currency. This is because the cost of the construction increases in the currency of his host country.
Table 6.1: List of Variables, Definition and Expected Signs Name of the
variables Definition of the variables Expected
signs Remittance-GDP
Ratio Personal remittances comprise personal transfers and compensation of employees. Data are the sum of two items defined in the sixth edition of the IMF's Balance of Payments Manual: personal transfers and compensation of employees. It is measured as a ratio of GDP.
Dependent Variable
Lagged Remittance-
GDP Ratio The immediate past values of the Remittance-GDP
ratio. +/-
Inflation Rate Inflation as measured by the annual growth rate of the GDP implicit deflator shows the rate of price change in the economy as a whole.
+/-
Official Exchange
Rate The annual value of domestic currency in terms of
US Dollars. +/-
Per Capita GDP of
Home Country GDP per capita of a typical South Asian country is gross domestic product divided by midyear population. Data are in current U.S. dollars.
-
Per Capita GDP of
Host Country Average GDP per capita of a typical South Asian country’s GDP divided by midyear population.
Data are in current U.S. dollars.
+
Broad Money to
GDP Ratio Broad money is the sum of currency outside banks, demand deposits other than those of the central government, time, savings, and foreign currency deposits of resident sectors other than the central government, bank and traveler’s checks, and other securities such as certificates of deposit and commercial paper.
+/-
Political Rights Political Rights are measured on a one-to-seven scale, with one representing the highest degree of political freedom and seven the lowest.
+/-
Post 9/11,2001 A dummy to capture post-September 11, 2001, when the US and other migrant-host countries improved regulation on international money transfers, which has discouraged migrants from using informal channels to remit.
+
Migrant Population
Ratio Total number of migrants are divided by population size to get data on migrant population ratio +
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Fourth variable is the domestic inflation in the home country. When the altruistic motives dominate the remitting decision, the expected sign of the inflation variable will be positive. With an increase in the inflation in the home country, the real income of the family will decrease. To offset the decrease, the migrant will remit more. However, in case of insurance motivation, the migrant will prefer to remit later for not to afford the inflationist effect. In case of investment motivation, inflation would not have any effect.
Fifth variable is broad money to GDP ratio. The more developed and efficient the financial sector of recipient countries is, the more likely that it allows migrants to send money through formal channels as it lowers the transaction costs and increases the accessibility of recipients to the money sent through the formal banking system. Hence, we will assess whether financial sector development has any positive impact on remittance flows using the ratio of broad money to GDP.
Our sixth variable is Political Rights (PR) that is extracted from the Freedom House Foundation (2014). In this case, the political rights index is used to capture the qualities of democratic governance and institutions in a typical South Asian home-country. It ranges between 1 for low democratic governance (including dictatorship and autocratic regimes) and weak institutions, and 7 for high democratic governance and strong institutions. It is assumed that good institutional quality has a positive impact on remittance inflows.
Seventh variable is used as Dummy variable. World Bank (2006) observe that the recent worldwide surge in the flow of workers’ remittances has been brought about mainly by regulatory tightening following the terrorist attack on USA on September 11, 2001. Two different factors are supposed to have contributed in this regard; one is the increase in monitoring by financial regulators on remittance service providers, which caused a shift of remittances from informal to formal sources. Another may have resulted from the uncertainty of deportation among undocumented migrants, inducing them to send a larger proportion of their income. Gupta (2005) includs a dummy variable (D2001) to reflect post September 11, 2001 effect had had no unusual pattern in remittances. Therefore, D1 is used to reflect post 9/11, 2001 effect and it takes the value of 1 for 2002-20012 periods and 0 otherwise for inflow of workers’ remittances from the rest of the world.
Our final variable is emigrant population ratio. It is commonly believed that increase in the number of migrant workers abroad is directly correlated with level of remittances.
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However, compositional features of migrants are also important in determining the amount of remittance sent home (World Bank, 2006). Moreover, Freund and Spatafora (2005) find in their work that the level of migration is likely to be the most important determinant of the size of remittances. This variable will be expressed as the logarithm of migrants abroad in our estimation. The key issue that needs to be properly addressed is the endegeneity bias since the desire to send remittances is among the main reasons behind the migration decision of most people. We control for the endegeneity bias through the IV estimation.
The female labor market participation rate, the population density, the percentage of urban population, and the passport cost as a share of GDP per capita of home country are employed as an instrument for the level of migration.