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Are Bilateral Remittances Countercyclical? Implications for Dutch Disease and Currency Unions. Jeffrey Frankel Harpel Professor, Harvard Kennedy School, and CID
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Are Bilateral Remittances Countercyclical? Implications for Dutch Disease and Currency Unions Jeffrey Frankel Harpel Professor, Harvard Kennedy School, and CID Presented May 26, 2009, at a panel on “Macroeconomic Impacts of Migration and Remittances,”at conference on Immigration and Global Development: Research Lessons on How Immigration and Remittances Affect Prosperity Around the World, co-hosted by Center for International Development at Harvard University and the Center for Global Development in Washington DC.
Importance of remittances • Total recorded workers’ remittances received by developing countries increased 73% between 2001 and 2005, reaching a total of $167 billion. • They have grown more rapidly than private capital flows, or official development statistics. • They constitute more than 15% of GDP in Tonga, Moldova, Lesotho, Haiti, Bosnia, Jordan, Jamaica, Serbia, El Salvador and Honduras. • Until recently, macroeconomic aspects of remittances have been even more neglected than the economic study of migration in general.
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. • Commodity-producer procyclicality: part of the Dutch Disease. • 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, and 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 the rhetoric of kleptocracies.
Applicability, continued • (ii) The Dutch Disease. • On the one hand, Martin (1990): steady flow of remittances can undermine the incentive for governments to create a sound institutional framework,– a sort of natural resource curse for remittances. • Amuendo-Dorantes & Pozo (2004): a rise in remittances to LACA countries leads to real appreciation, a prime symptom of Dutch Disease. • On the other hand, Rajan & Subramanian (2005): although the Dutch Disease analogy does extend to foreign aid (leading to real appreciation & slow growth), it does not extend to remittances.
Applicability, concluded • (iii) Optimum Currency Area criterion • The OCA question: • For what countries do the benefits of adopting a common currency outweigh the costs? • e.g., facilitating trade & other international transactions • Vs. losing the freedom to run one’s own monetary policy. • The textbook answer: • A country with few asymmetric shocks, so it seldom needs a monetary policy different from that of the anchor country; or • A country that has cushions against asymmetric shocks: labor mobility, fiscal transfers, capital flows... • My claim: remittances belong on the list • assuming countercyclicality. • 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 proces are low, 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. 2003-2008), 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 and 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 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 dedicated research assistance; Erik Lueth and Marta Ruiz-Arranz for generously making data available, Maurice Kugler & Hillel Rapoport for comments; and Robert Hildreth, the Center for International Development, and the MacArthur Foundation 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/
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.