The impact of remittances on economic growth evidence from selected ASEAN developing countries

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACT OF REMITTANCES ON
ECONOMIC GROWTH: EVIDENCE FROM
SELECTED ASEAN DEVELOPING
COUNTRIES

BY

NGUYEN HAI TRA MI

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, SEPTEMBER 2014


UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIALSTUDIES
THE HAGUE

THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACT OF REMITTANCES ON
ECONOMIC GROWTH: EVIDENCE FROM
SELECTED ASEAN DEVELOPING
COUNTRIES
A thesis submitted in partial fulfilment of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

NGUYEN HAI TRA MI

Academic Supervisor:
Dr. LE CONG TRU

HO CHI MINH CITY, SEPTEMBER 2014


DECLARATION
I declare that “The impact of remittances on economic growth: Evidence from
selected Asean developing countries” is my own work. It has not been submitted to
any degree at other universities.

I confirm that I have made by effort and applied all knowledge for finishing this
thesis in the best way.
Ho Chi Minh City, September 2014

NGUYEN HAI TRA MI

i


ACKNOWLEDGEMENTS
First and foremost I would like to show my gratitude to my supervisor, Dr. Le Cong
Tru, for invaluable comments, remarks and engagement through the learning
process of the thesis. Then I would like to send my sincere thanks to Associate Prof.
Dr. Nguyen Trong Hoai, Dr. Pham Khanh Nam and Dr. Luca Tasciotti for giving
me helpful remarks on my TRD as well as keeping me on the right track. Last but
not least, I am deeply indebted to my parents, my brothers and sisters for
understanding and giving me spiritual assistance. I will wholeheartedly be grateful
forever for your love.

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ABSTRACT
Over the last decades, remittances have been regarded as one of the important
sources of financial flows to developing countries. Nevertheless, whether remittance
serves economic growth or not is so far still a key empirical question. This paper
attempts to examine this issue. In particular, the investigation covers seven Asean
developing countries over the period of 2000 to 2011. A logistic regression
technique is employed to evaluate the impact of remittances on economic growth.
To account for the inherent endogeneities in the relationship between remittances
and economic growth, a Generalized Method of Moments (GMM) approach is used.
The regression results of the study show that, at best, remittances should not be
treated as a source of capital flows and have a negative impact on economic growth
because they are used for bad economic performance of the recipients. This

suggests that policy makers should have the recipients to allocate large amount of
remittances in investment as contribution to economic growth.

Key words: remittances, economic growth, Generalized Method of Moments,
capital flows.

iii


TABLE OF CONTENTS

DECLARATION ....................................................................................................... i
ACKNOWLEDGEMENTS ..................................................................................... ii
ABSTRACT ............................................................................................................. iii
TABLE OF CONTENTS ........................................................................................ iv
LIST OF TABLES ................................................................................................ vi
LIST OF FIGURES ............................................................................................... vi
LIST OF ABBREVIATIONS .............................................................................. vii
Chapter 1 INTRODUCTION...................................................................................1
1.1. Background to the Study ..................................................................................1
1.2. Migration and Remittance flows in ASEAN countries ....................................3
1.3. Research objectives ..........................................................................................5
1.4. Research questions ...........................................................................................6
1.5. Justification of the study...................................................................................6
1.6. Organization of the study .................................................................................7
Chapter 2 LITERATURE REVIEW ......................................................................8
2.1. A definition of remittance ................................................................................8
2.2. Determinants of remittances ...........................................................................10
2.2.1. Microeconomic determinants ..................................................................10
2.2.2. Macroeconomic determinants ..................................................................13

2.3. Contribution of remittances to growth ...........................................................15
2.3.1. Capital accumulation ...............................................................................15
2.3.2. Labor force growth ..................................................................................17
2.3.3. TFP growth ..............................................................................................17
2.4. Empirical Review ...........................................................................................20
2.5. Chapter summary............................................................................................23
2.5.1. Empirical literature summary ..................................................................23
2.5.2. Conceptual framework.............................................................................25

iv


Chapter 3 METHODOLOGY ...............................................................................30
3.1. Data collection ................................................................................................30
3.2. Control variables ............................................................................................31
3.3. Research Methodology ...................................................................................34
3.3.1. Descriptive analysis .................................................................................34
3.3.2. Econometric model ..................................................................................34
3.4. Estimation techniques .....................................................................................36
Chapter 4 DATA ANALYSIS AND RESULTS ...................................................39
4.1. Descriptive Analysis .......................................................................................39
4.1.1. Trends of economic growth .....................................................................39
4.1.2. Trends of remittances flows to selected Asean countries ........................41
4.1.3. Trends in remittance inflows and economic growth indicator in Asean
countries .............................................................................................................44
4.1.4. Remittances and other capital inflows .....................................................45
4.1.5. Descriptive statistics analysis ..................................................................46
4.1.6. Correlation matrix among independent variables ....................................47
4.2. Regression Results..........................................................................................48
Chapter 5 CONCLUSION AND POLICY IMPLICATIONS ............................53

5.1. Conclusion ......................................................................................................53
5.2. Government Policy Recommendation ............................................................54
REFERENCES ...........................................................................................................56
APPENDIX ..............................................................................................................61

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LIST OF TABLES
Table 1.1. Migrant Remittances in Asean Countries ............................................................. 4
Table 2.1. Summary of variables ......................................................................................... 23
Table 2.2. Summary of variables (continued)...................................................................... 24
Table 4.1. GDP per capita growth rate in selected Asean countries .................................... 40
Table 4.2. Remittances (current US$ million, period 2000-2011) ...................................... 41
Table 4.3. Remittances (% of GDP, period 2000-2011) ...................................................... 43
Table 4.4. Descriptive Statistics .......................................................................................... 47
Table 4.5. Correlation Matrix .............................................................................................. 48
Table 4.6. Static model results ............................................................................................. 49
Table 4.7. Dynamic GMM regression results ...................................................................... 51
Table 0.1: Data definitions................................................................................................... 61
Table 0.2: Remittances (% of GDP, period 2000-2011) - Descriptive statistics ................. 62
Table 0.3: Ordinary Least Squares ...................................................................................... 63
Table 0.4: Fixed Effects Estimation .................................................................................... 64
Table 0.5: Generalized Method of Moments ....................................................................... 65

LIST OF FIGURES
Figure 1.1. Remittances, FDI, private debt & portfolio equity and ODA ............................. 2
Figure 1.2. Personal remittance inflows (% of GDP) in Asean countries, 2012 ................... 5
Figure 2.1. Remittances effect on economic growth ........................................................... 19
Figure 2.2. Conceptual Framework ..................................................................................... 26

Figure 4.1. GDP per capita growth rate in selected Asean countries .................................. 40
Figure 4.2. Remittances (current US$ million, period 2000-2011) ..................................... 42
Figure 4.3. Remittances (% of GDP, period 2000-2011) .................................................... 43
Figure 4.4. Trends in Remittance inflows and GPD in selected Asean countries ............... 44
Figure 4.5. Remittances, Foreign direct investment and Net official development assistance
and official aid (US$ billions) ............................................................................................. 46

vi


LIST OF ABBREVIATIONS
FDI

Foreign direct investment

GMM

Generalized Method of Moments

ODA

Official development assistances

vii


Chapter 1 - INTRODUCTION
This chapter introduces the thesis topic and identifies the main issues which
will be covered in the following sections. The background and motivation to the
study will be introduced first. Then the research objectives and research questions

will come later. The chapter will ends with the contribution of the study and the
thesis structure.
1.1. Background to the Study
Nowadays migration has been an increasingly crucial characteristic in the
globalization world, especially for developing countries. It has been a major issue to
consider by policy makers towards economic development. Under migration
context, remittances, an evidence for the ties connecting migrants with their family
members in the home country, have grown significantly over years. The World
Bank estimates that worldwide officially recorded remittance flows reached $550
billion in 2013, in which developing countries received biggest share of these flows
($414 billion). However, the figure does not reflect true size of remittance flows as
it should be larger when there are unrecorded remittance flows through unofficial
channels.
Over the past three decades, remittance flows speeded up and now are
expected to continue to be in the increasing trend with over $700 billion worldwide
by 2016. The fast increase in remittances may result from two factors. Firstly,
migration between developing and developed countries has risen significantly in the
last 20 years (WorldBank, 2007). Secondly, transactions costs for international
payment transfer between individuals have declined thanks to technological
improvements (Giuliano and Ruiz-Arranz, 2006). Looking at Figure 1.1, we can see
that remittance flows are now nearly three times the size of official development
assistance (ODA), and larger than private debt and portfolio equity flows to
developing countries (WorldBank, 2013) . Remittances as a source of foreign

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currency earnings also play an increasingly important role in many emerging
markets with weakening balance of payments. It is true in the case of South Asia,
with India being an outstanding example. The depreciation of the Indian rupee has

boosted remittance flows that provide much support to the balance of payment of
this country. With the depreciation of over 20% in the Indian rupee in 2013, the
country could experience a surge in remittances flows and gain total value of US$
71 billion (about 3.7 percent of GDP). That has made a major contribution to
India’s economy (WorldBank, 2013). In addition to that, in some countries,
remittances flows even accounted for more than 20 percent of gross domestic
product (GDP). For example, in 2012, in terms of GDP share, the top of recipients
of remittances were Tajikistan (48%), Kyrgyz Republic (31%), Lesotho and Nepal
(25% each), and Moldova (24%) (WorldBank, 2013) . As a result, remittances
might have a significant impact on the welfare of recipient households, and on the
growth of recipient economies.

Figure 1.1. Remittances, FDI, private debt & portfolio equity and ODA

Source: World Bank Development Indicators and World Bank Development
Prospect Group

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Many studies have found the positive benefits of remittances on well-being
of recipient households, specifically helping to reduce poverty, making
consumption easier and allowing for investment in health care and education (De
Haas, 2005). However, in contrast to remittance impact on recipient households, the
role of remittance in economic growth has been still in debate. In theoretical
literature, the effects of remittance are mixed and complicated. On one side,
researchers in favor of remittances suggest that remittances are often used for
investment and enhancing financial development, leading to improved capital
allocation and consequently accelerating economic growth, especially in
underdeveloped financial system (Giuliano and Ruiz-Arranz, 2005). On the other

hand, the others find zero or negative impact of remittance on economic growth
(Barajas et al., 2009; Chami et al., 2003; IMF, 2005; Ratha, 2003). They show out
remittances’ reverse effect on inflation and labor market participation, and
remittances also cause unnecessary appreciation of the local currency of the
recipient which then leads to expensive goods produced at home and thus decreases
export competitiveness (a “Dutch disease” problem).
1.2. Migration and Remittance flows in ASEAN countries
ASEAN region includes 10 countries: Brunei Darussalam, Laos, Cambodia,
Indonesia, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. The
region has become an important source of migrant workers for those countries that
suffer from labor shortage around the world (except Brunei Darussalam and
Singapore which are two developed countries and not taken into account in this
study for remittance impact on economic growth). As such, remittances sent by
these migrants to their home countries have increased significantly over years. They
have greatly assisted these countries to reduce the shortage of foreign exchange
reserve and paid the import bills.
The migrants transfer remittances to their home countries because of their
altruistic motive or investment purposes (Solimano, 2003). According to World

3


Bank data, the remittance inflows to Asean countries have been rising since 2000,
with an approximate 66% increase in 10 years from 2004 to 2013. The Philippines
have always headed the pack in the region with estimated 26.05 US$ billion in
2013, followed by Vietnam (10.65 US$ billion), Indonesia (7.88 US$ billion),
Thailand (5.32 US$ billion), Malaysia (1.48 US$ billion), Myanmar (2.51 US$
billion), Cambodia (0.28 US$ billion), Laos (0.12 US$ billion). More outstandingly,
the Philippines and Vietnam stood in top 10 recipients of remittances list in 2013,
together with other countries like India, China, Mexico, Nigeria, Egypt, Arab Rep.,

Bangladesh, Pakistan and Ukraine.
Table 1.1. Migrant Remittances in Asean Countries
Country
Philippines
Vietnam
Indonesia
Thailand
Malaysia
Myanmar
Cambodia
Laos
Total

Amount
26.05
10.65
7.88
5.32
1.48
2.51
0.28
0.12
54.29

Source: World Bank

As a percentage of GDP, the Philippines ranked the first position with 9.8%
of GDP in 2012, followed by Vietnam standing at the second with 7.1%. While
these significantly high shares implies large contribution of remittances in the
domestic income in these two countries, remittance numbers of other countries in

Asean region seem not be so much weighted in GDP, with only 1.8% for
Cambodia, 1.3% for Thailand, 1.2% for Lao PDR, 0.8% for Indonesia, 0.4% for
Malaysia (see Figure 1.2).

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Figure 1.2. Personal remittance inflows (% of GDP) in Asean
countries, 2012
9,8%

10,0%
9,0%
8,0%
7,0%
6,0%
5,0%
4,0%
3,0%
2,0%
1,0%
0,0%

7,1%

1,8%
1,3%

1,2%

0,8%
0,4%

Source: World Bank

The leading migrant host countries are the United States, United Kingdom,
Canada, Japan, Australia, Germany, and Singapore. All of these countries have
more developed economy than that of the Asean countries. This implies that the
economic conditions in developed countries could create better employment
opportunities and attract more migrants (Shahbaz and Aamir, 2009).
1.3. Research objectives
In general, the whole picture can be drawn as that, migrants usually leave
their home country to work and live abroad, supporting their family members with
flow of remittances. Therefore, these flows bring about direct or indirect effect on
millions of people. Remittance flows can help lift many people out of poverty
because they play as a steady income to be spent on daily consumption and other
necessities such as medicine and shelter. The remittance effect on poverty reduction
is widely recognized (Barajas et al., 2009). Besides this effect, however, the way in
which remittances contribute to economic growth is still an open question. In many

5


cases, remittances flows are seen as similar to FDI and other private capital flows.
While FDI and other private capital flows have positive impact on economic
growth, remittance flows are therefore inferred to impose similar effect. Ratha and
Mohapatra (2007) have mentioned that remittance flows are an important source of
external finance for developing countries.
Following this argument, there is a belief that remittances are similar to FDI
and other private capital flows that contribute to economic growth. Therefore, the

overall objective of this paper is to examine the impact of remittance on economic
growth in Asean developing countries. In specific, the paper aims to determine the
contribution of remittances to output growth in these countries.
1.4. Research questions
To answer the overall aim, the paper questions are as follows:
Main questions:
 How do remittances affect recipient country’s economic growth in Asean
developing countries?
Sub questions:
1. Do remittance flows enhance real Gross Domestic Product (GDP) of selected
Asean countries?
2. What are the various policy options that can be adopted to better manage
remittance usage for adding to economic growth?
1.5. Justification of the study
There has been a lot of interest and debates among researchers and policy
makers towards the nature of remittances and their effect on economic growth.
Following that stream, my paper aims at finding out whether there exists the
potential impact of remittances on the economy of 7 Asean developing countries.
The reason for my choosing Asean is that remittance income has emerged as one of
largest sources of foreign exchange earnings for these countries, while very few

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researches have been made towards the economic impact of remittances in this
region. There is also no cross-country empirical analysis on remittances covering
these countries of Asean region. Following the model of some empirical studies, my
paper will make some modifications by adding different variables which are, in
particular, variables of traditional sources of economic growth. I will use different
estimation methods that are based on POLS (pooled ordinary least squares), fixed

effects, random effects and GMM (Generalized method of moments) models that
help to solve the heterogeneity of Asean economies and find out how traditional
sectors contribute to economic growth of these countries. The findings of the study
hopefully contribute to policy implications not only for these countries but also for
other developing countries that depend on remittance income.
1.6. Organization of the study
The remainder of this paper is structured as follows. Chapter 2 provides the
literature review both in theoretical and empirical studies regarding the remittance
impact on economic growth. Chapter 3 describes the data and research
methodology. Chapter 4 comprehends the research results. Chapter 5 is conclusions
and recommendations and discussions of the limitations and directions for further
studies.

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Chapter 2 - LITERATURE REVIEW
As stated in the introduction, remittance inflows are expected to potentially
have large effects on the recipient country. This chapter aims to review theoretical
and empirical review for examining those effects. The chapter is divided into five
sub-sections. The first two parts presents the definition of remittances and its
determinants, both at a microeconomic and macroeconomic level. The next part
discusses the channels through which remittances may impact the growth rate of
recipient economy with a growth accounting framework. Then empirical studies on
the subject are summarized in the next part. The final part provides the conceptual
framework
2.1. A definition of remittance
A remittance is generally a cash transfer from a migrant worker to recipients in
the country of origin. According to the Balance of Payment Yearbook of the
International Monetary Fund (IMF), remittance is divided into 3 categories:

 Workers’ remittance or in cash from workers residing abroad to recipients
in the country of origin
 Compensation of employees such as the wages, salaries, and other
remuneration, in cash or in kind, paid to individuals who work in the host
country for less than a year
 Migrants' transfers refer to net wealth of migrants who move from one
country to another and stay for more than one year.
Despite above clearly defined categories, there have been some problems in
implementing them due to limitations of data quality and scope (Jongwanich, 2007).
They are mostly misclassification of remittances with other capital inflows, no
record for some formal remittances and limited calculation of inflows through
informal channels. For that reason, many scholars have used different calculation
ways for having appropriate remittance credits. While some totalize just
compensation of employees and workers’ remittances (Taylor, 1999), others sum up

8


three above categories for a final remittance figure (Ratha, 2003). There is another
method of calculating remittance flows from Daianu (2001) which summing up
compensation of employees, workers’ remittance and “other current transfers of
other sectors”. This is regarded as the most appropriate method to overcome the
discrepancies referred above (OECD, 2006).
Although the main sources of remittance data are from annual balance of
payments records of countries, its actual value seems not being truly reflected
because the recorded one is just through official channels. Flows through informal
channels, which are not recorded, have been experienced to be significant,
particularly for low-income migrants as they contribute considerable large share in
total remittances (Puri and Ritzema, 1999). According to these authors, remittance
data has faced the situation of underestimation. The level of under recording is

different among countries. There are two types of leakages: one due to erroneous
(imprecise accounting), and the other due to the choice of informal, unsupervised
channels for remittances. The first type of leakages is erroneous due to the practice
of treating all informal remittances as foreign exchange leakages from the labor
exporting country. These leakages include remittance items such as: (1) “personal
imports” of migrant workers (for example, goods imported return migrant workers
under duty free allowance facility or brought along with them under personal
baggage, and (2) the savings brought home on return (in the form of cash or
travelers’ cheques) and then later converted into local currency at domestic banks
(Athukorala, 1993). Choices of informal channels for remittance, second type of
leakages, are retaining part of migrant worker savings in personal accounts with
overseas banks, or hand carrying part of remittance in form of cash and traveler’s
cheques when migrants return home.
Some reasons are given to explain why remittances are leaked to unofficial
channels, mostly related to the convenience of migrants and their families.
According to Puri and Ritzema (1999), there are four reasons. Firstly, remittances
have to be transferred through informal non-banks (regardless of transaction costs)

9


due to the inadequacy, inefficiency and even destroy of banking and foreign
exchange facilities. Secondly, differences in price between the remittance sending
and receiving countries may lead to the practice of sending or carrying remittances
in the form of goods (remittance in kind) for the recipient personal use or for resale
in the informal market. Thirdly, when the exchange rate in remittance receiving
country is overvalued which means an implicit tax on remitters through official
channels, the migrants tend to use informal foreign exchange market instead.
Fourthly, when financial depression happens, negative real interest rates are applied
on domestic savings, there’s a tendency that money balance is driven to foreign

bank accounts.
2.2. Determinants of remittances
To understand why migrants remit money to their family in home country is
necessary for studying economic impact of remittances. There may be two reasons
for this need. Firstly, the amount of remittances depends on the migrant’s
underlying reasons to migrate and reasons to remit, from which the size and timing
of remittances determine their effect on economic activity at home. Secondly, the
purposes of remittances also affect the recipient’s uses of these flows. This will be
in turn impact the economic growth in the home country (Chami et al., 2008). There
are many studies discussing remittances’ determinants, mostly divided into 2
categories: microeconomic determinants and macroeconomic determinants. If the
microeconomic ones are about the cases of migration and the migrant’s connection
with family at home, the macroeconomic ones related to economic conditions and
policies in both sending and receiving countries (Lucas, 2004).
2.2.1. Microeconomic determinants
Microeconomic determinants of remittances are reflected in the motivations
to remit. Analytical literature identifies four different types of motivation behind the

10


sending of remittances (Stark, 1991) (Brown, 1997) (Poirine, 1997). They can be
summarized as follows:
Altruistic motive: The purpose of sending remittances back home by the
migrant is for the well-being of his family. By doing this, the migrant feels
satisfactory with the well-being of his family. In addition, as compared to the family
members in home country, the migrant usually has higher level in education. This
may enable him to receive higher income in the foreign country that offers better
average wage to workers than the home country can do. In this model, remittances
are anticipated to decrease over time because connection between the migrant and

his family members in two different countries becomes weaker in the long run. In
some other cases, the migrant may have the intention of living abroad for a long
time or even retire there. His family, therefore, go to live with him. This will cause
decreased remittance flows to home country.
Self-interest motive: The migrant sends remittances to home country when he
or she feels about a safe place for saving and investment. Usually they buy land,
property and financial assets, etc. His or her family then looks after these assets for
the migrant during migration period and becomes a trustworthy and well-informed
agent. Another motivation to remit is the inspiration to receive an inheritance from
his parents. By sending remittances to contribute to the wealth of the family, the
migrant will have more chances to get inheritance from his family in the future.
Loan repayment: This type of motive is often taken by those who are
financed the costs of migrating by his family as investment in education abroad.
After finishing studying, the migrant settles in the foreign countries and start to pay
back money to his family in form of remittances. In this case, the family seems like
making a profitable investment in their family member – the migrant who can
achieve higher earnings in a foreign country than his family members who live and
work at home. As such, remittances are seen as an integral part of an implicit
contract between the migrant and his family. In this model, remittances are expected
to arise depending how long it takes for the migrant to start working in the foreign

11


country and during his working period. As soon as the migrant can join the abroad
labor market, the remittances can be transferred back to the home country with an
amount subject to his income level at that time. Consequently, remittances may not
reduce over time as they do in the altruistic model.
Co-insurance: This kind of motive is usually taken when the migrant and his
family want to diversify risks. This is because the capital markets and insurance

markets are insufficient in the home country and hence there are few choices of
financial assets to limit the risks. In addition, a serious problem of the poor
migrants, constraint to borrowing, may make them spend less in consumption or
investment. With the assumption that there is no positive correlation in economic
risks between the home and the foreign country, the family has a good way to
diversify risks – sending their member to abroad to work, earn money and support
his family with financial issues in bad periods. The migrant is also benefited by this
way since the bad periods can also happen in the foreign country, from which he
can rely on his family at home. The family, in this situation, plays a role as
insurance for the migrant. Generally, in this model, emigration can be regarded as
co-insurance strategy, in which remittances play the role of an insurance claim.
It is not easy to distinguish between above motivations. Many empirical
studies have tested motivations by regressing remittances on a set of variables and
revealed controversial results. This is due to insufficient data on migrants and
receiving households’ characteristics and on timing of remittance flows (Rapoport
and Docquier, 2005). The motives are different from households and exits within
households as well. All of them are important for deciding to remit. Pozo (2005)
observed in Latin America that altruism is an important motive underlying the
remittances from migrants to families, but in many cases, the migrants also remit to
insure for bad times in foreign country.

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2.2.2. Macroeconomic determinants
Many empirical papers have studied macroeconomic determinants of
remittances and figured out a list of variables that can be expected to have
significant effect on the volume of remittances to receiving countries. Outstanding
variables are the number of migrant workers, the economic situation in the host and
home country, inflation, exchange rate movements, the relative interest rate between

the sending and receiving country, and government policies and political stability in
the receiving country as determinants of remittance flows (Buch and Kuckulenz,
2004) (Pozo, 2005) (Russell, 1992).
The number of migrant workers in the host country surely determines
remittances as the higher number of workers, the higher volume of remittances.
According to Freund and Spatafora (2005), a double in the stock of workers would
lead to a 75 percent increase in remittance flows. The economic situation in the
home country is an important determinant because remittances would tend to be
transferred more to home country where happen negative shocks. On the other
hand, it is also important for economic activity in the host country to determine
remittance flows. With better economic conditions, the migrants would have more
chances of employment and getting more money, thus then be able to remit more
(IMF, 2005). Remittances may also be discouraged and shifted from the formal to
informal sector under the condition of bad economic government policies and
institutions in the home country such as black market premiums and exchange rate
restrictions (IMF, 2005). Macroeconomic instability like high inflation or real
exchange rate overvaluation may have similar negative effects, whereas better
developed financial sector may induce remitting easier and less costly. Furthermore,
political instability may also deter migrants from sending remittances because of the
risk of expropriation or theft. An unstable political and macroeconomic
environment is not helpful for investment and may therefore prevent remittances.
Last but not least, the differential in interest rate between the sending and receiving
country can bring about investment opportunities in the home country, thus result in

13


increased remittance flows back to home (Elbadawi and Rocha, 1992). Remittances
also respond to return to asset potential in the home country as compared with that
in the host country. The better return to assets at home, the greater chances the

migrant will have for investment and therefore enhance remittances (IMF, 2005).
However, from many empirical studies, there is no consent on the
macroeconomic determinants of remittances. According to Buch and Kuckulenz
(2004), the magnitude of remittances that a country receives is not clearly impacted
by the traditional variables such as economic growth, the level of economic
development, and proxies for the rate of return on financial assets. This can be
explained that just as many microeconomic motives underlie the decisions to remit,
many different macroeconomic determinants may similarly exist together.
We can see from the above assessment of remittance literature that there are
different motives under a remitting decision but no clear implications for economic
impact of remittances. How are remittances spent or used? Are they spent on
consumption or used for investment? In other words, are they compensatory or
opportunistic? Scholars have tried to answer these questions but had different
outcomes. According to Chami et al. (2008), if remittances are opportunistic in
nature and sent to home country where having good economic conditions, they are
regarded as capital flows and can be analyzed accordingly. Nevertheless, if they are
compensatory transferred money, they are different from capital flows and thus
have different economic impacts compared to capital flows. In a study of De Haas
(2005), remittances have been witnessed to be consumed on food, houses, cars and
other goods, but not on investment since the 1970s. As a result, remittances are
thought to lead to a passive and dangerous dependency on remittances. Chami et al.
(2005) found that remittances are best regarded as compensatory transfers. A panel
regression on remittances is made for 113 countries over 29 years; specifically a
country’s ratio of remittance to GDP is regressed on the interest rate differential
between the country and the United States and on the difference in the country’s
GDP per capita and United States’ GDP per capita. Regression results are negative

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and significant coefficients on the income gap. This reflects that when income in the
home country decreases, higher amount of remittances would be sent home. As
such, remittances are compensatory transfers, not any source of capital for
economic development. Another example for remittance flows as compensatory
transfers is the financial crises in Asia from 1998 to 2001. Despite decreased private
capital flows, remittance flows continue to increase under the crises.
On the other hand, Buch and Kuckulenz (2004) say that remittance flows
share similarities with private and official capital flows although they still have
different determinants, in particular, have different behavior over time. It is not
surprising with these similarities because payments of migrants to their relatives at
home are motivated both by market-based considerations and by social
considerations. The migrants remit to protect their families from unfavorable
economic developments, while also consider the opportunity costs of sending
remittances instead of investing abroad. Remittances are therefore market-driven.
2.3. Contribution of remittances to growth
From the above microeconomic and macroeconomic determinants on
remittance, there’s a need to understand the channels that remittances impact
economic performance in order to formulate good policies to maximize their overall
economic impact. Among the variety of channels, there are outstandingly three
types through which remittances can effect on economic growth. They are capital
accumulation, labor force growth and total factor productivity (TFP) growth
(Barajas et al., 2009).
2.3.1. Capital accumulation
Remittance inflows can affect the rate of capital accumulation in recipient
economies in different ways. Firstly, remittances can have a beneficial influence in
case that financing of investments comes from domestic sources of income, then
remittances may induce direct increase in capital accumulation. For example, under

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undeveloped financial system, households face financial constraints, so remittances
directly help ease these constraints, leading to physical capital increase. Research
conducted in Mexico and the Philippines suggests that remittances can lift these
constraints as remittances help households to accumulate more assets in farm
equipment, increase higher levels of self-employment and micro-enterprise
investments (Woodruff and Zenteno, 2004; Yang, 2005). Remittance inflows thus
could help households to set up their own entrepreneurial activity. Secondly,
remittances can improve the creditworthiness of domestic investors, then lowering
the cost of capital and enhance the country’s access to international capital markets
(WorldBank, 2006b). A country credit is calculated by international agencies partly
depending on the magnitude of remittance flows. The higher the magnitude of
remittance flows the higher ranking of credit rating for a country. Moreover,
remittances can help a country to get more access to international capital markets by
securitizing future remittance flows, which effectively strengthen the capacity of
governments or private sector entities to borrow. They play as collateral to raise
external financing in international capital markets (Ratha, 2013). Thirdly,
remittance flows may affect domestic capital accumulation by impacting domestic
macroeconomic stability. They make the economy less volatile and therefore may
reduce the risk premium that firms demand in order to undertake investment,
making domestic investment more attractive (Chami et al., 2009).
Besides physical capital, remittances can also finance investment in
education and health care, which are the two key variables in promoting long-run
economic growth. For education, there is a possible link between remittances and
education when remittances ease credit constraint and make greater access to
education for the poor (Rapoport and Docquier, 2005). López-Córdova (2005)
made research in Mexico and found out that remittances lead to increased school
attendance and greater literacy levels in those regions receiving more remittances.
They contribute to household income and limit the likelihood of young members of
family abandoning school in order to work.

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