Chapter 2 Literature Review
2.17 Foreign Remittances And Growth In Sadc Countries
The controversial question of whether foreign remittances foster economic growth remains unresolved among economists (Wadood and Hossain, 2015, Siddique et al., 2012). Empirical research as well as theoretical studies have failed to settle this issue. Although foreign remittances cause a rise in the host country’s income and significantly alleviate poverty (Gupta et al., 2007), their impact on productivity and long run economic performance is not certain as there are several channels through which they can influence growth. A rise in remittance inflows can raise
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investment which in turn can spur long-term economic growth. In addition, remittances can reduce the liquidity constraints encountered by people in less developed economies (Woodruff and Zenteno, 2007). The positive impact of remittance flows is larger for countries with relatively less developed financial markets (Singh et al., 2011).
Regardless of the increasing significance of foreign remittances in aggregate foreign capital flows, the impacts of remittance volatility and its relationship to financial deepening have not been adequately examined. It has also been observed that foreign remittances drive productivity growth in economies with less advanced financial markets by providing a cheaper source of finance (no collateral required) and supply liquidity to domestic markets (Giuliano and Ruiz-Arranz, 2009).
Furthermore, while foreign remittances have become a significant component of gross international financial flows to developing economies, the linkages between remittances and output growth have yet to be fully examined, especially with respect to low-income countries.
Arguably, they are used to cater for basic needs such as food and shelter and are hence considered to have limited effect on long-term growth (Giuliano and Ruiz-Arranz, 2009). Giuliano and Ruiz- Arranz (2009) also consider the crucial interactions between remittances and the financial sector that should feed into economic growth. For instance, when markets deepen, this lowers the cost of transacting, thus attracting more remittances to high return projects and in turn promoting growth.
Similarly, and according to Freund and Spatafora (2008), remittance transfer costs have been observed to be lower in developed financial systems and when exchange rates are less volatile.
Furthermore, when used appropriately, remittances can be a good replacement for inefficient credit markets in financing domestic enterprises, thus avoiding the need for collateral security and the prohibitive borrowing costs in developing markets (Giuliano and Ruiz-Arranz, 2009). A similar but micro-study of 30 communities in Mexico revealed that income from workers’ remittances from the US is a critical source of initial capital for 21% of new businesses (Massey and Parrado, 1998). Thus, remittances can provide a better option of external funding and provide liquidity to the markets, spurring growth in developing economies. However, the situation is different when it comes to developed economies which attract the bulk of global remittances. Based on empirical analysis, advanced financial systems are able to attract more remittances as it is cheaper to transact but remittances appear to be failing to amplify their impacts on economic growth (Giuliano and Ruiz-Arranz, 2009). In their study, Giuliano and Ruiz-Arranz (2009) use a large cross section of
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developing countries to examine the interactions between remittances and financial development on economic growth. The findings confirm that workers’ remittances play a crucial role in driving growth in less developed financial markets after controlling for endogeneity. Furthermore, the study shows that remittances are mostly pro-cyclical, indicating that these flows respond to investment opportunities.
In contrast, Barajas et al. (2009b) indicate that foreign remittances have no impact on long-term economic growth, but acknowledge their poverty-alleviating and consumption-smoothing effects.
Barajas, Chami, Fullenkamp, Gapen, and Montiel (2009b) reiterate that as billions of US dollars are moved worldwide through official channels (US300 billion was moved worldwide in 2007), it is highly possible that huge sums of remittances are also finding their way through informal channels. These volumes of remittance flows imply that they are economically important to most economies. They have become large relative to most private financial flows with an average remittance to GDP ratio of 3.6% (Chami et al., 2008). However, the flow of remittances to developing economies has not been uniform, with some receiving significantly more than others.
Given these volumes and disparities, remittances are attracting the attention of economists and policy makers who are keen to investigate their role in economic growth (Barajas et al., 2009b, Chami et al., 2009b). Foreign remittances are mostly spent on consumption necessities such as shelter, health, food and clothing and their impact on long-term economic growth is not well understood. Due to their role in consumption, volatility in remittance flows is anticipated to have short-run impacts on output. A number of scholars have investigated remittance multipliers for economies, with mixed results. United Nations’ (2003) studies or policy makers that treat remittances as similar to other private capital flows often report positive effects on long-term growth (Barajas et al., 2009b). The possibility of remittances promoting economic performance and hastening economic development is based on the fact that they are regarded as uncontrolled, private financial flows that not only finance consumption, but investment. Rajan and Subramanian (2005) found very limited evidence to show that remittance flows have contributed to the growth of developing countries; indeed, they may have retarded growth. Similarly, Barajas et al. (2009b) argue that when remittance flows are accurately estimated, and the estimation technique is properly designed, no substantial positive impact of remittances on long-term output growth can be found;
rather, a significant undesirable association is observed between remittances and economic
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performance. Furthermore, some economies experienced remittance flows in excess of 10% of GDP for several years, but there is no empirical evidence to show that this spurred economic growth. These arguments suggest that foreign remittances are merely sent to lift people out of poverty or for insurance motives, rather than to finance entrepreneurship. There is thus a need for recipients to understand the role of remittances and possibly obtain advice from institutions that can assist them to make the best use of them (Barajas et al., 2009a). Most of the existing empirical literature is based on micro-economic studies that utilize primary and survey data. The macro- financial implications of workers’ remittances and their variability have not been fully examined and there is no consensus on the macro-economic determinants of remittances and what shapes their variability (Buch and Kuckulenz, 2004).