Bilateral Remittances: Countercyclical or Not?

Are Bilateral Remittances Countercyclical? Forthcoming, Open Economies Review Jeffrey Frankel Harpel Professor, Harvard Kennedy School Immigration Seminar Series, Harvard Migration & Integration Program, Harvard Center for Population & Development Studies 9 Bow Street, 12-1:30 pm September 23, 2010

Importance of remittances • Total recorded workers’ remittances received by developing countries increased 73% from 2001 to 2005, • reaching a total of $167 billion. • By 2008 they had further doubled, to $338 billion. • Remittances have grown more rapidly than private capital flows, or official development statistics. • They now constitute more than 15% of GDP in: Tajikistan, Tonga, Moldova, Kyrgyz, Lesotho, Samoa, Lebanon, Guyana, Nepal, Honduras, Haiti, Jordan & El Salvador. • Until recently, macroeconomic aspects of remittances were even more neglected than the economic study of migration in general.

Which countries are the biggest recipients? • Outlook for Remittance Flows 2010-11, D.Ratha, S.Mohapatra & A. Silwal, • Migration & Remittances Team, World Bank, April 23, 2010

To which countries are remittances most important? • Outlook for Remittance Flows 2010-11, D.Ratha, S.Mohapatra & A. Silwal, • Migration & Remittances Team, World Bank, April 23, 2010

Even in low-income countries overall, remittances finance roughly half the current account deficit • Outlook for Remittance Flows 2010-11, D.Ratha, S.Mohapatra & A. Silwal, • Migration & Remittances Team, World Bank, April 23, 2010

What about the 2008-09 global recession? • Estimated remittances to developing countries fell 6 % in 2009, • to $316 billion. • = a much smaller decline than private capital flows. • With improved global prospects, they are forecast to increase 6.2 % in 2010 • and 7.1 % in 2011 -- • World Bank, Migration & Remittances Team, April 23, 2010

Remittances fell in the recession, but held up much better thanprivate capital flows,even FDI.

Hypothesis: Remittances can play the stabilizing role that capital flowsare in theory supposed to play • In theory, capital flows should bring a variety of benefits: • smoothing short-term income disturbances, • financing high-return investment opportunities in low K/L countries • and so substituting for labor flows to high K/L countries or factor-based trade, • and disciplining policies and institutions in the recipient country.

In practice, however, capital flows fail to deliver on this promise: • Rather, private capital flows are often procyclical: • pouring in during boom times and disappearing in recessions. • Rather than flowing on average from high K/L countries to low, capital often “flows uphill.” • Rather than rewarding countries that follow sound economic policies, financial markets often abet irresponsible budget deficits, • including among autocratic and kleptocratic rulers.

3 cycles of net private capital flowsto emerging markets, by regionpeaking in 1982, 1997 and 2008 Source:Capital Flows to Emerging Market Economies, IIF, 1/27/09.

Brief summaryof remittances literature • (1) Theory • Rapoport & Docquier (2005) review the New Economics of Labor Migration. • In theory, emigrants’ decisions to send remittances should be based on intertemporal optimization, usually with a household utility function.

(2) Bilateral Data • Ratha & Shaw (2005), in the absence of hard bilateral data, allocate the totals across partners. • Schiopu & Siegfried (2006) create bilateral data set between some EU countries & neighbors. • Jiménez-Martin, Jorgensen, & Labeaga (2007) estimate bilateral workers’ remittance flows from all 27 members of the EU, to recipient countries. • Lueth & Ruiz-Arranz of IMF (2006, 2008) the largest known bilateral data set to date. • IDB has data on bilateral remittances from US to countries, esp., in the Central American region.

(3) Evidence on cyclicality • World Bank (2006): p.c. remittances respond significantly to p.c. income in the home country. • Clarke & Wallstein (2004) and Yang (2007):remittance receipts rise in response to natural disaster. • Kapur (2003): they rise in response to economic downturn. • Lake (2006): remittances into Jamaica respond to the difference between US and Jamaican income. • Yang & Choi (2007): they respond to rainfall-induced economic fluctuations. • IMF finds less countercyclicality. • Sayan(2006) : 12-developing-country study finds none. • Lueth & Ruiz-Arranz(2006, 2008): similarly, procyclical.

(4) Why does the question of remittance cyclicality matter? • (i) It is especially important because governments in remittance-receiving countries often reflexively treat them as a source of foreign exchange to be “harnessed” for national development, • rather than letting recipients spend it on “unproductive” uses such as imports of consumer goods. • This thinking is common even among benevolent governments, let alone kleptocracies.

Applicability,continued • (ii) The Dutch Disease. • On the one hand, • Martin (1990): steady remittance flows can undermine incentives for governments to create sound institutional frameworks, • a sort of natural resource curse for remittances. • Amuendo-Dorantes & Pozo (2004): a rise in remittances to LAC countries leads to real appreciation, prime symptom of Dutch Disease. • Acosta, Lartey & Mandelman (2009): • For El Salvador, remittances again raise the relative price of nontraded goods, • though ALM also find welfare-improving smoothing behavior . • On the other hand, Rajan & Subramanian(2005) : although the Dutch Disease analogy does extend to foreign aid, it does not extend to remittances.

Applicability,concluded • (iii) Optimum Currency Area criterion • The OCA question: • When do benefits of a common currency outweigh costs? • e.g., facilitating trade & other international transactions • Vs. losing the freedom to run one’s own monetary policy. • The textbook answer: • A country that has cushions against any asymmetric shocks (labor mobility, fiscal transfers, capital flows...), because it has less need of a monetary policy different from that of the anchor country. • My claim: remittances belong on the list if they are countercyclical. • In a downturn, they can help substitute for monetary expansion & depreciation. • Singer (2008): remittances are, and should be, a determinant of the currency decision.

Not all senders are industrialized countries • Roughly 10 per cent come from developing countries. • South Africa, for example, receives many immigrants from neighbors to work in its mines, farms, & factories, and sends remittances back to the countries of origin. • In many Gulf countries, immigrants (called ex-patriate workers) > than ½ of the private-sector labor force. • For example, outward remittances from Saudi Arabia are about 7% of all remittances globally . • (not included in the developing country statistic) .

The hypothesis is that remittances respond not just inversely to income in the receiving country, but also positively to sending-country income. • One would need to control for sender-country income even if only the coefficient of recipient-country income were of interest. • It should be in the equation in theory. • Omitting it in practice often produces the wrong sign. • But cyclicality with respect to sender-country income is also of interest in its own right:

South Africa and the Gulf are two places where the Dutch Disease and OCA motivations are particularly relevant. • When mineral prices are low (e.g., 1990s), it is useful to South Africa to have the “unilateral transfers” deficit in the balance of payments automatically moderate. • When mineral prices are high (e.g. 2003-08), outward remittances provide a brake on reserve inflows and inflation – a particularly important point in these two regions debating regional monetary unions.

My estimation of remittance cyclicality i) Table 1: The Lueth & Ruiz-Arranz (IMF) bilateral data set, which includes 64 pairs of countries. Cross-section covering 2005. ii) Table 2: LRA bilateral data set, Panel study, covering 1979 to 2005 . iii) Table 3: Splicing of LRA data set with the EU & Central American (IDB) data sets.

Country-pairs with high bilateral migration also, of course, tend to show high bilateral remittances. Remittances between included country pairs are around US$113.6 billion. Total of 540 observations: 266 for 2003 and 274 for 2004.

Remittances per lagged migrant are positively correlated with cyclical differential Sources: Western Hemisphere data: FOMIN & the Central Banks, data from 2003-2004; Jiménez-Martín, Jorgensen & Labeaga (2007). Data from 2003-2004; Lueth & Ruiz-Arranz, IMF(2006); data from 2003-2004.

Table 1: Cross-section, with LRA bilateral data set • Cross-section includes 64 pairs of countries, 2005. • Lagged stock of migrants (in 2000) has highly significant effect on remittances, as in Freund & Spatafora(2005). • We also control for sender-country income per cap. • The variable of interest is the difference in cyclical position between the sender country and the recipient country. • In this table, cyclical position is computed as the (log) difference between GDP in 2005 and the long run trend value of GDP. • The estimated coefficient is positive and highly significant. • The t-statistic is almost 4. • Use of gravity IV for migrant stock makes little difference.

Table 2: panel study with the LRA data • 64 pairs of countries, 2005. 1979-2005 panel. • => 1200 or more observations • Lagged stock of migrants replaced by its determinants: • geographical, historical, & cultural. • Cyclical difference now captured by unemployment. • 2(a) The estimated coefficient on us-ur is negative, as now hypothesized, and highly significant. • The t-statistic is now 9. • 2(b) The same when applying fixed effects for countries or country-pairs.

Table 3: cross-section study (2003-04) with extended composite data set Sources: Western Hemisphere data: FOMIN & the Central Banks; EU data: Jiménez-Martín, Jorgensen & Labeaga, EC (2007); Lueth & Ruiz-Arranz, IMF(2006). • Approximately 330 bilateral observations. • Lagged stock of migrants (2000) . • Cyclical difference again captured by GDP/trend. • The estimated coefficient >0 & highly significant. • So is the coefficient on currency union dummy. • under OLS, but not under IV. • Causality between CU & remittances is unclear.

To summarize the findings, • splicing together a larger bilateral data set from three data sets used by others, • has allowed a moderately strong verdict on the question of cyclicality. • It runs contrary to the analogy with capital flows /the Dutch Disease: • Remittances respond positively to the cyclical position in the sending country and negatively to the cyclical position in the receiving country.

Policy implications • This counter-cyclical pattern is precisely what one wants. • It suggests that emigrants’ remittances can play some of the stabilizing role that capital flows often promise but seldom deliver. • If the finding holds up under further investigation, it carries at least two specific policy implications. • First, it suggests governments should not try to harness remittances in the name of national development, but rather should allow emigrants to transact freely. • Second, it suggests that remittances belong on the list of Optimum Currency Area criteria, • along with trade, labor mobility, & transfers.

Acknowledgements I wish to thank: Olga Romero for research assistance; Erik Lueth & Marta Ruiz-Arranz for generously making data available, Maurice Kugler & Hillel Rapoport for comments;and the MacArthur Foundation, the Center for Inter-national Development, and Robert Hildreth for support.

Jeffrey FrankelJames W. Harpel Professor of Capital Formation & GrowthHarvard Kennedy School http://ksghome.harvard.edu/~jfrankel/index.htm Blog: http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/

APPENDICESReferences on procyclicality of government spending in developing countries • Gavin & Perotti (1997); • Lane and Tornell (1999), • Kaminsky, Reinhart, & Vegh (2004), • Talvi & Végh (2005), • Mendoza & Oviedo (2006), • Alesina, Campante & Tabellini (2008).

References on failures of capital flows • Flows in practice fail to deliver on the textbook promises.[1] • Rather than smoothing short-term disturbances, private capital flows are often procyclical: • pouring in during boom times, disappearing in recessions,[2] • especially among commodity-producers • Rather than flowing from high capital/labor countries (e.g., the US) to low capital/labor countries, capital often “flows uphill.”[3] • Rather than rewarding only countries that follow sound economic policies and punishing those that follow bad policies, capital flows sometimes aid & abet irresponsible budget deficits.[4] [1] Prasad, Rogoff, Wei, & Kose (2003, 04); Prasad & Rajan (2008). [2] Kaminsky, Reinhart, & Vegh (2005); Reinhart & Reinhart (2009); Perry (2009);Gavin, Hausmann, Perotti & Talvi (1996); Mendoza & Terrones (2008). [3]Lucas (1990); Alfaro, Kalemli-Ozcan & Volosovych (2005); Gourinchas & Jeanne (2007); Prasad, Rajan & Subramanaian (2007); Kalemli-Ozcan, Reshef, Sorensen & Yosha (2009). [4] Lane & Tornell (1998).

Outlook for Remittance Flows 2010-11, D.Ratha, S.Mohapatra & A. Silwal, • Migration & Remittances Team, World Bank, April 23, 2010

Remittances began to recover in 2009 in India & the Philippines Source: Reserve Bank of India

Appendix Figure 1a :Bilateral stock of migrants (normalized by populations), versus remittances (normalized by GDPs) Sources: Central America data: FOMIN & the Central Banks. data from 2000-2007; Jiménez-Martín, Jorgensen, & Labeaga, (2007), data from 2000-2005; Lueth & Ruiz-Arranz (2006). Data from 1979-2005.

Appendix Figure 1b :Bilateral stock of migrants (normalized by populations), versus remittances (normalized by GDPs) Sources: Central America data: FOMIN & the Central Banks. data from 2000-2007; Jiménez-Martín, Jorgensen, & Labeaga, (2007), data from 2000-2005; Lueth & Ruiz-Arranz (2006). Data from 1979-2005.

Appendix Table 2: IMF data set

Bilateral Remittances: Countercyclical or Not?