The Effect of International Remittances on Economic Growth in Sub-Saharan Africa

Master's Thesis , 2021 , 75 Pages , Grade: 3.75 (good)

Economics - Economic Cycle and Growth

This paper is about the effect of international remittances of economic growth in sub-Saharan Africa.

For many developing economies, remittances constitute the single largest source of foreign exchange, exceeding export revenues, foreign direct investment (FDI), and other private capital inflows.

This study aims to examine the effect of international remittances on economic growth in SSA countries using a panel data approach. The System Generalized Method of Moments was used as the main model of analysis. The sample consists of 29 SSA countries for the period 2004-2019.

The study findings show that international remittance has a positive and significant effect on economic growth in SSA. The study recommends that SSA countries should be designing policies and strategies that facilitate less costly and hassle-free flow of remittances into national development. There is a need to have well-established institutional frameworks to train, support, and ensure the welfare of emigrants abroad by the provision of information or services to assist migrant welfare and promote remittances and investment in the home country.

Contents

1. INTRODUCTION
1.1 Background of the Study
1.2 Problem Statement
1.3 Research questions
1.4 Hypothesis
1.5 Objectives:
1.6 Significance of the Study
1.7 Scope of the Study
1.8 Limitation of the Study
1.9 Organization of the Research Report

2. LITERATURE REVIEW
2.1 Definitions of Remittance
2.2 Theories of Remittance
2.2.1 Developmental Pessimistic Structuralism Theory
2.2.2 Developmental-Remittance Pluralist Theory-Optimistic view
2.2.3 Theories of Motives for a Migrant to Remit
2.3 Economic Growth Theories
2.3.1 The Harrod-Domar Model 14
2.3.2 The Solow Model 14
2.3.3 The Endogenous Growth Model 15
2.4 Empirical Literature 16
2.4.1 Economic Growth effects of remittances 16
2.4.2 Economic growth effects of control Variables
2.5 Conceptual Framework

3. RESEARCH METHODOLOGY
3.1 Data type and source
3.2 Methods of Data Analysis
3.3 Model Specification
3.4 Definition of variables and Priori Expectations
3.5. Diagnostic Tests

4. RESULT AND DISCUSSIONS
4.1 Descriptive Analysis
4.2 Econometrics Analysis
4.2.1 Diagnostic tests Results
4.2.2 Dynamic Panel Analysis

5. CONCLUSIONS AND RECOMMENDATIONS
5.1 Conclusion
5.2 Recommendations

REFERENCES

APPENDIX

Appendix 1: Top 10 countries received the highest Personal remittances (current US$) in 2019

Appendix 2: The least 10 countries received Personal remittances (current US$) in 2019

Appendix 3: Normality of the error terms in line (pnorm e)

Appendix 4: Variance inflation factor

Appendix 5: Breusch-Godfrey LM test for autocorrelation

Appendix 6: white test -Cameron & Trivedi's decomposition of IM-test

Appendix 7: Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Appendix 8: Ramsey RESET test using powers of the fitted values of lnRGDPV

Appendix 9: Descriptive Statistics

Appendix 10: Matrix of correlations

Appendix 11: Graphical Relationship between real gross domestic product and remittance

Appendix 12: Dynamic panel-data estimation, two-step system GMM

Appendix 13: Instrumental variables (2SLS) regression

Appendix 14 Tests of endogeneity

Appendix 15: Personal remittance received in US$ from 2004 to 2019

Appendix 16: Breusch and Pagan Lagrangian multiplier test for random effects

Appendix 17: Hausman (1978) specification test

Appendix 18: RGDP and Remittances Trends of top ten remittance recipient countries

Appendix 19: Sub-Saharan African countries

List of Tables

Table 3.1:Variables and their expected associations summary

Table 4.1: Top 10 countries received the highest Personal remittances (current US$) from 2004 to 2019

Table 4.2 panel data summary

Table 4.3 Two step system GMM Regression results

List of Figures

Figure 2.1 Channels in which Remittance affect Economic Growth

Figure 2.2 Conceptual Framework frame work (figure-2.2)

Figure 4.1: Total remittance received for selected 29 SSA countries from 2004 to 2019

Figure 4.2: Total RGDP for selected 29 SSA countries from 2004 to 2019

Figure 4.3: The relationship between the RGDPV and REMV in US$ for 29 selected SSA countries

Figure 4.4: Normality of the error terms jarque-bera test

ACRONYMS

FE-Fixed Effect

GCIM-Global Commission on International Migration

GDP- Gross Domestic Product

GFCF-Gross Fixed Capital Formation

IMF- International Monetary Fund

LFPR- Labor Force Participation Rate

MENA-Middle East and North Africa

MTOs - Money Transfer Operators

ODA-Official Development Assistance

POLS-Pooled Ordinary Least Square

REM- Remittance

RE-Random Effect

SGMM- System Generalized Method of Moments

SME- Small and medium-sized enterprises

SSA- sub-Saharan Africa

TROP - Trade Openness

WB - World Bank

WDI- World Development Indicator

Abstract

For many developing economies, remittances constitute the single largest source of foreign exchange, exceeding export revenues, foreign direct investment (FDI), and other private capital inflows. This study aims to examine the effect of international remittances on economic growth in SSA countries using a panel data approach. The System Generalized Method of Moments was used as the main model of analysis. The sample consists of 29 SSA countries for the period 2004­2019. The study findings show that international remittance has a positive and significant effect on economic growth in SSA. The study recommends that SSA countries should designing policies and strategies that facilitate less costly and hassle-free flow of remittances into national development. There is a need to have well-established institutional frameworks to train, support, and ensure the welfare of emigrants abroad by the provision of information or services to assist migrant welfare and promote remittances and investment in the home country.

Key words: Remittance, sub-Saharan Africa, Economic Growth, System GMM

CHAPTER ONE

1. INTRODUCTION

This section introduced the background of the study which includes background of the study including general debates about the role of remittance on economic growth, geographical area of sub-Saharan Africa countries, and the urgency of the study; statement of the problem; research questions, Hypothesis, objectives of the study; the significance of the study; scope and limitation of the study.

1.1 Background of the Study

In recent decades, remittances have become an important source of foreign capital for many developing countries. However, there is no general consensus in policy debates on the impact of remittances on economic growth and poverty.

For many emerging economies, global remittances represent the single largest source of foreign exchange, exceeding export revenues, foreign direct investment (FDI), and different nonpublic capital (World Bank, 2013). Remittance -flows were five times higher than foreign aid in 2019 ($714 billion vs $153 billion) among this 78% of the worldwide proportion of remittance -flows to low-and middle-income countries (UNECA, 2020). Remittances to Sub-Saharan Africa grew from $34 billion in 2016 to $38 billion in 2017, and are expected to continue to grow into 2019(World Bank, 2018:33). Hence SSA is an interesting and dynamic case to examine. But less attention is given to remittance as determinants of economic growth.

In Kenya, remittances suited the highest source of foreign exchange by the end of 2019, ahead of coffee, tea, and horticultural exports (Mwaniki 2019). In Nigeria, remittances have a significant impact on economic growth - they contribute about 6.1% of GDP and are seven times higher than ODA flows (PWC 2020). Official remittance inflows to Nigeria account for over one-third of remittance flows to sub-Saharan African countries. In countries with a high share of remittance to GDP ratios, such as Liberia (FPA 2019) and the Gambia (Jeffang 2020), remittances account for over 31% and 22% of GDP respectively in 2019. The reduction in remittances will directly affect over 60% of households dependent on remittances at the micro-level and external reserves at the macro level ( Bisong, Ahairwe, and Njoroge, 2020).

In fragile and conflict-affected societies, like Somalia, this case poses extra problems for over 40% of the families which can be depending on remittances (Majid et al., 2020). Over the years, remittances to growing international locations (aside from China) have accelerated to three times the ODA flows and is predicted to be better than ODA and FDI blended within the following years (Barne & Pirlea, 2019). Yet the COVID-19 pandemic has now undermined remittance flows and widened the home financing gaps. Since FDI flows also are decreasing, this leaves ODA as a crucial and resilient alternative that improvement companions can grow to bridge a part of the prevailing monetary gaps between the various low-profits families and SMEs.

Average remittance costs in SSA increased, from 9.7 percent in the 2016 first quarter to 9.8 percent in the 2017 first quarter (World Bank, 2017). The region has the highest remittance costs in the world. Non-bank financial institutions are the most expensive channel of money transfer, but contribute the least in volumes transferred. Post offices on the other hand are the least expensive at around 5.9%. According to the World Bank (2020e), remittance costs as low as 5% are leading to a loss of about US$16 billion annually (WB 2020f).

Of an estimated 23.2 million migrants from sub-Saharan Africa, 26% live in OECD countries and 65.6% in Africa (World Bank, 2016b). The largest home countries of migrants were Burkina Faso, the Democratic Republic of the Congo, Cote d’Ivoire, Nigeria, Somalia, and Sudan. Africa hosted 18 million migrants, with the majority going to Cote d’Ivoire, Ethiopia, Kenya, Nigeria, and South Africa. As a result, the amount of remittances transferred varies across sending and recipient countries. According to World Bank 2010 the stock of emigrants of Ethiopia was 620.1 thousand which is 0.7% of population and the amount of inward remittance flows was 0.387 billion US$.

This study was conducted in sub-Saharan Africa, the area of the continent of Africa that lies south of the Sahara. Sub-Saharan African countries are a diverse group with widely differing needs on account of their geographical situation. According to Global Trends in 2019 the population in Sub-Saharan Africa is growing and the population is 1.1 billion.

In general there are a lot of debates and controversies about the impact of remittance on economic growth as a result of the research done so far on the role of remittance to economic growth. All these and other reasons make this issue to be researchable at the moment.

1.2 Problem Statement

Both theoretical and empirical literature on how remittances affect the economic growth of recipient countries is contradicting. This makes it difficult to conclude how remittance impacts the economic growth of recipient countries.

The available theoretical literature on the growth effects of remittances can be categorized into two main schools of thought. These are the “migration optimists”, who argue for positive growth effects of remittance. The migration optimists demonstrate the positive indirect growth effects of remittance through channels such as increased savings, investment capitals, human capital investment, extra employment, and the overall multiplier effects of consumption on aggregate demand output (Adenutsi, 2010). The “migration pessimists” argue that remittances have either negative growth effects or zero impact on economic growth. On the “Economic Implications of Remittances and Migration”, the impact of remittances on growth is unclear. Some scholars also believe that migrant remittances have positive growth effects in recipient economies ((Pradhan, et al., 2008), (Fayissa and Nsiah, 2010), (Muchemwa, 2012)). Different scholars claim that remittances have no impact on the economic growth of recipient countries or no causal relationship between remittances and economic growth of developing countries (Barajas et al., 2009b). Empirical results depicts that there exists a statistically significant long-run negative relationship between remittance and economic growth in Benin, Burkina Faso, Lesotho, and Togo. But it was only in Senegal that depicted a positive and statistically significant relationship between remittance and growth (Mabula et al., 2019).

As most of African countries face foreign exchange scarcity, remittance is becoming one source and which can contribute a lot to these countries. Remittances often cover an important part of developing countries’ trade deficits. By generating a stable stream of exchange earnings, remittances can improve a country's creditworthiness for external borrowing and, through innovative financing mechanisms, they will expand access to capital and lower borrowing costs. While large and sustained remittance inflows can contribute to currency appreciation. Remittances have proved to be less volatile, less pro-cyclical and, therefore, a more reliable source of foreign currency than other capital flows to developing countries such as foreign direct investment and development aid (GCIM, 2005).

The research on the role of remittance on economic growth in sub-Saharan Africa is limited with mixed findings which make policy makers in dilemma in decision making. The mixed research findings so far are the main problem taken to be filled in this research. Therefore the author of this research was interested to study this issue to get clear evidence on the impact of remittance on economic growth. As a result this research will try to shed light on this goal.

1.3 Research questions

Research questions of this study are:

i) What are the trends of international remittances and economic growth in SSA?
ii) What is the effect of remittances on economic growth in SSA?

1.4 Hypothesis

In statistical hypothesis testing, two hypotheses are compared. These are called the null hypothesis and the alternative hypothesis. The null hypothesis is the hypothesis that states that there is no relation between the phenomena whose relation is under investigation. The alternative hypothesis, as the name suggests, is the alternative to the null hypothesis: it states that there is some kind of relation. The alternative hypothesis may take several forms, depending on the nature of the hypothesized relation; in particular, it can be two-sided (for example: there is some effect, in a yet unknown direction) or one-sided (the direction of the hypothesized relation, positive or negative, is fixed in advance) (Altman 1990).

The null and alternative hypothesis made for this study was as follows

H0: Remittances have no positive effect on economic growth in SSA

HA: Remittances have a positive effect on economic growth in SSA

1.5 Objectives:

The general objective of this study is to assess and examine the effect of international remittances on economic growth in sub-Saharan Africa for the period 2004 to 2016.

The specific objectives of this study are:-

1. To assess the trends of international remittances and economic growth in SSA.
2. To examine the effect of international remittances on economic growth in Sub-Saharan Africa.

1.6 Significance of the Study

The link between worker's remittance and economic growth is one of the most debatable issues in the modern academic scenario. Some argue in favor of it while others are against it. The inconclusive theoretical foundation along with the diverse empirical findings so far has put policymakers in a dilemma in explaining which way the relationship is working and through which channels.

Thus, it is believed that this study will contribute to clarifying the role of remittance on economic growth in the case of SSA countries and the existing literature on the area. Besides, the outcome of the study is expected to help policymakers, as an input, in decision making concerning devising policies about the inflow of worker's remittances.

1.7 Scope of the Study

The study focused on examining the role of international remittance on economic growth in sub­Saharan African countries. Due to the data availability, it covers 29 sub-Saharan African countries with a period of 16 years (2004 -2019).

1.8 Limitation of the Study

This research was carried out depending on the data availability of remittance which is sent through formal financial institutions, which does not include money or goods sent by the informal way which can limit the data accuracy. Due to data availability, the study did not cover all sub­Saharan Africa countries.

1.9 Organization of the Research Report

Concerning the structure of the paper, it is composed of five chapters. The first chapter presents introductory materials, which include the background of the study, problem statement, research objective, research questions, the significance of the study, and the scope and limitations of the study. The second chapter includes a theoretical and empirical literature review and conceptual framework. In the third chapter, the paper contains the method of analysis and model specification of the study. With this background, the report presents an analysis and interpretation of the data gathered in the fourth chapter. Finally, in the fifth chapter, the report concludes with the conclusions and recommendations of the study.

CHAPTER TWO

2. LITERATURE REVIEW

2.1 Definitions of Remittance

Based on IMF (2009), remittances signify household income from foreign economies coming mostly from the temporary or permanent movement of individuals to those economies. Remittances include cash and non-cash items that flow through formal channels, like via electronic wire, or through informal channels, like money or goods carried across borders. They largely contain funds and noncash items sent or given by individuals who have migrated to a replacement economy and become residents there, and therefore the net compensation of border, seasonal, or other short-term workers who are employed in an economy during which they're not resident. For many economies, remittances represent a large and stable source of funds that sometimes exceed official aid or financial inflows from foreign direct investment. Remittances may have a big impact on poverty reduction and may finance the economic process in receiving economies.

Remittances are not a substitute for other forms of development finance, but are a critical financial flow for many developing countries. Remittances can take many forms, whether cash, in“ kind and social, all of which possibly enable family members to improve their diets, access education and health care, make investments in family and farm businesses and improve the quality of their lives. The role of each form is examined as follows (UNCTAD 2018: 133).

Cash remittances

Cash remittances are commonly understood as flows of money in physical currency or via banking and finance systems between migrants and their families. Aggregate estimates of international migrant remittance flows show that cash remittances are greater than official development assistance and also more stable than foreign direct investment and are thus a critical and stable source of external finance for Africa.

In-kind remittances

In-kind remittances are goods that migrants send home, ranging from regular parcels of food and personal items to medicine, clothing, consumer durables, business equipment and other large items. In-kind remittances may help receiving households satisfy their consumption of certain items that may be difficult to obtain, particularly in rural areas, enabling households to widen their diets or acquire medicine or educational supplies. Certain in-kind remittances such as branded goods or consumer durables may also confer an additional social value for both migrants and recipients, and may also be traded locally. Sending goods rather than money may help ensure that migrants have control over the use of the funds and that the goods are used for their intended purposes.

As referred in (Alvarez et al., 2015), the two items within the balance of payment outline that are greatly related to remittances are “compensation of employees” and “personal transfers.” These standard components are recorded in the accounting. Compensation of employees denotes the income of border, seasonal, and other short-term workers who are employed and working in an economy where they are not resident and of residents employed by nonresident entities. Compensation of employees signifies “remuneration reciprocally for the labor input to the assembly process contributed by a person in an employer-employee relationship with the enterprise.” The compensation of employees embraces wages and salaries in cash, wages and salaries in a related way, and employers’ social contributions. All transactions in a similar way should be valued at current market prices, that is, this exchange value. Personal transfers contain all current transfers in cash or in a similar way made or received by resident households to or from nonresident households. Personal transfers thus include all current transfers between resident and nonresident individuals. “Personal transfers” replaces an item called “workers’ remittances” within the quality presentation. According to BPM5, workers’ remittances are current transfers by migrants who are employed in new economies and thought of residents there (IMF, 2009)

As the World Bank (2006) broadly defined here as cross-border person to-Person payments of relatively low value. To compile and report remittances data, institutions adopt specific definitions of what constitutes a remittances transfer. World Bank Migration and Remittances Fact book (2010):- defined as remittances as the sum of workers' remittances, compensation of employees, and migrants' transfers. While these are three different series, this publication suggests that compilers of data are not good at distinguishing between these series and tend to mix them. The concepts of remittance had been linked to the theory of migrations. Its definition however can be linked to its motives, effects, uses, kind of transfer and the channel of funds transfer.

2.2 Theories of Remittance

People send money back to their country of origin because of several factors in other words we can call them motivations behind remittances. This includes pure altruism, where a migrant is worried over the economic situation back home, thus remit without expecting anything in return. Another one is pure self-interest mostly influenced by selfish motives and lastly is tempered altruism or enlightened self-interest where remittance could be reimbursement for financial support provided before departure. This section is about reviewing various theoretical literatures on remittance and economic growth.

2.2.1 Developmental Pessimistic Structuralism Theory

The economists like (De Almeida et al., 1973) argue that the effect of migration and remittances is just to sustain or maybe reinforce the issues of poverty instead of promoting growth/development. The position of this school is that migration aggravates the extraction of human capital which then results in the development of passive, nonproductive, and remittance­dependent societies in developing countries. As referred in (Tenaye, 2019), besides the drain syndrome, the huge departure of an energetic segment of the population causes a critical shortage of labor, depriving poor communities/countries of their most precious workforce (Lipton, 1980; Rubenstein, 1992). Lipton (1980) further argues that because it's mostly not the poorest that migrate the most, migrant remittances are very likely to increase inequality in labor-exporting communities. Lipton (1980), (Entzinger, 1985), and Lewis (1986) still argue that there's a high tendency that remittances would be spent on visible consumption and "consumptive" or nonproductive investments like the acquisition of real estate and, for that matter, are rarely invested in productive enterprises. In addition to this weakening, local economies and increasing dependency increased consumption and land purchases by migrants were also stated to exacerbate inflationary pressures (Russell, 1992) and soaring land prices (Appleyard, 1989; Rubenstein, 1992). Also, in socio-cultural respect, the consequences of migration and remittances were increasingly seen as detrimental to the general development of poor nations. Depending on the wealth of migrants was assumed to contribute to a change in rural tastes and preferences (Lipton 1980) that might increase the demands for imported goods, which further reinforces the system for continuous dependency. The unending desire for remittances has often been linked with the loss of social solidarity which undermines the socio-cultural integrity of labor exporting communities (Hayes, 1991).

As from the past due 1960s, optimistic views had been an increasing number of challenges under the joint impact of a paradigm shift in social and development theory towards historical- structuralism and dependency (Frank, 1966, 1969) views also as empirical studies and policy experiences that always didn't support optimistic views (De Mas, 1978, Penninx, 1982). Many sending country’s governments are comparatively positive towards the emigration of lower educated citizens, but the attitude towards the emigration of skilled people has mostly been more negative. It appeared to deprive poor countries of their scarce skilled and professional resources during which states have invested a couple of years of education (Baldwin, 1970). Moreover, views on the event contribution of migration and remittances reversed, with the dominant vision becoming that remittances rather fueled consumption and inflation in origin regions during which migrants rarely invested their money in productive enterprises.

As cited by (De Haas, 2010), the pessimistic views seemed to fit particularly well into cumulative causation theory elaborated by Myrdal (1957). Cumulative causation theory holds that capitalist development is inevitably marked by deepening spatial welfare inequalities. Once differential growth has occurred, internal and external economies of scale (agglomeration and multiplier effects) perpetuate and deepen the bipolar pattern characterized by the vicious circle of poverty within the periphery and thus the accelerated growth of the core region. So, economic activities in areas and countries with an initial advantage drain investment and encourage the out-migration of the foremost talented populations from peripheral areas and countries. Although positive “spread effects” also occur - like increased demand for agricultural products and raw materials trade from the periphery (or remittances) - these don't match the negative “backwash effects.” Myrdal, therefore, argued that, without strong state policy, the capitalist system fosters increasing spatial inequalities.

Migration is assumed to outspread inequality within migrant-sending communities. Because migrants tend to be the already employed, more entrepreneurial, open minded and comparatively better-educated people, remittances and other benefits of migration would also disproportionately accrue to the already better- off (Lipton, 1980, Zachariah et al., 2001). Therefore, migration won't contribute to poverty relief. The gradual undermining of traditional economies is even likely to extend the deprivation of the (non migrant) worst- off.

An additional well-known assumption within the migration and development works is that migrants and their families don't invest their money productively but rather spend their money on “conspicuous consumption” like an imported commodity, and on so- called non- productive enterprises like housing (Entzinger, 1985), Lewis, 1986). In his important review, Lipton (1980:12) concluded that recipients use remittances first to pay off debts incurred in financing migration or for the education of their children. Consistent with Lipton, quite 90 percent of remittances are spent on everyday consumption. Most consumption behavior serves to strengthen status, like high payments for bride prices, feasts, memorials, and therefore the construction of pompous, luxurious houses. Remittances can also directly want to finance the migration of relations (Van Dalen et al., 2005).

According to Lipton, investments only are available in the fourth place of remittance use. Besides, these were negatively evaluated as “consumptive investments”- a capital transfer quite capital creation - like the acquisition of land, the utilization of remittances to rent workers (e.g., for irrigation maintenance) where once family labor was used, or for labor-replacing mechanization instead of the generation of additional output or the higher use of scarce land inputs (for largely similar voices, see Rubenstein, 1992; Lewis, 1986; Zachariah, Mathew, and Rajan, 2001). Other studies mention a scarcity of creativity and innovation of migrant investors, which might render the establishment of typical labor migrant investments like grocery shops, small restaurants, and trucks, or “second rank propositions in an overloaded sector” (Penninx, 1982:802-803).

In pessimistic contexts, such “unproductive” expenditures are frequently thought to deteriorate local and regional economies and increase dependency. First, increased consumption and land purchase by migrants were reported to impress inflation pressures (Russell, 1992) and soaring land prices (Appleyard, 1989; Rubenstein, 1992), from which the already poorer non-migrants would suffer most - resulting in more inequality. Second, many purchased items (e.g., building materials, household appliances, refrigerators, TV sets, stylish clothing and fabrics, ornaments, modern foodstuffs, fertilizers, etc.) wouldn't be locally produced, but need to be imported from urban areas or from abroad. This is often assumed to possess the double effect of crowding out traditional, local production, and strengthening the economies of core areas, thereby intensifying the method of asymmetric growth and increasing regional inequalities between the core and periphery. Third, the scarce fruitful investments by migrants would be primarily made in urban areas outside the village or region of origin (Lipton, 1980; Lewis, 1986). This leakage of remittance investments out of migrant-sending areas further aggravates regional disparities in wealth. This all corroborates the predictions of cumulative causation theory, consistent with which migration increases instead of decreases spatial inequalities.

Migratory cumulative causation theory assumes that migration expands underdevelopment in migrant-sending societies through various feedback mechanisms (backwash effects), which in its turn fuels further out-migration, thereby perpetuating the vicious circle of the “migrant syndrome”. Put in Neo-Marxist terms, migration not only reproduces but also reinforces the capitalist system that supported class and spatial inequalities. The most positive effect of migration - the rise in family welfare for migrants themselves - is assumed to be only temporary and thus artificial or “cosmetic” (Lewis, 1986). One sided dependency on migrant remittances is even considered dangerous, supported by the idea that remittances will rapidly decrease after migrants have returned or have settled and begin to integrate into receiving societies, which might imply the gradual cutting of social and economic ties with origin societies.

2.2.2 Developmental-Remittance Pluralist Theory-Optimistic view

As referred in (De Haas, 2010), the pluralists provide more dynamic insight into understanding migration and development relationships, which connects the causes and consequences of migration more explicitly, and through which all possible positive and negative development responses are taken into account. Neo-classical migration theory perceives migration as a kind of optimal allocation of production factors to the advantage of both sending and receiving countries. During this attitude of “balanced growth”, the re-allocation of labor from rural, agricultural areas to urban, industrial sectors (within or across borders) are taken under consideration as a prerequisite for economic growth and, hence, as a constituent component of the entire development growth (Todaro, 1969:139). The free movement of labor - in an unconstrained market environment - will eventually cause the increasing scarcity of labor, coinciding with better marginal productivity of labor and increasing wage levels in migrant-sending countries. Capital flows are expected to travel in only the opposite direction, that is, from the labor-scarce to the capital-scarce migrant-sending countries. Finally, this process of factor price equalization (the Heckscher-Ohlin model)^[I] forecasts that migration ceases once wage levels at the origin and destination converge (Massey et al., 1998).

In a neoclassical world, the developmental role of migration is entirely assumed through factor price equalization. As Djajic (1986) acknowledged, earlier neo-classical migration theory ruled out the likelihood of again for non-migrants. Therefore, neo-classical migration theory has no place for money remittances flowing to origin countries (Taylor, 1999). Consistent with leading views of the 1950s and 1960s in development theory, return migrants were seen as important agents of change and innovation. It had been expected that migrants not only bring back the cash, but also new ideas, knowledge, and entrepreneurial attitudes. In this way, migrants were expected to play a positive role in the development and contribute to the faster spatial diffusion of modernization in developing countries. Also, remittances are attributed an important role in stimulating economic growth.

At the macro level, remittances were considered an important source of cash. At the macro and micro level, migration was expected to steer to the economic improvement of migrant-sending regions. Remittances would “increase income distribution and quality of life in a different place what other available development methods could bring” (Keely and Tran, 1989). Moreover, it had been expected that labor migrants or “guest workers” would re-invest substantially in enterprises in origin countries after their widely anticipated return. Migrant workers were seen as signifying “a hope for the economic development of their inborn land” (Beijer, 1970) and it had been widely thought that “large-scale emigration can contribute to the simplest of both worlds: rapid climb within the country of immigration and rapid climb within the country of origin” (Kindleberger, 1965:253).

2.2.3 Theories of Motives for a Migrant to Remit

The three identified theories to explain the flow of remittances are; Pure Altruism, Pure Self Interest, and Tempered Altruism which is also referred to as Enlightened Self Interest. Most discussions in the literature are centered on the first two of them. These theories illustrate that remittances are sent mainly as a result of pure altruistic and self-interest motives (De Haas, 2007:7; Schiopu and Siegfried, 2006:8; Hagen-Zanker and Siegel, 2007:4; Lucas and Stark, 1985:902).

Theory of Pure Altruism

This theory states that migrants remit money simply because they care about the wellbeing of the family members by providing them with additional income not only this but also smoothing consumptions, closing the gap of poverty, income poverty, school enrollments of primary and secondary increases which have significant contribution in increasing human capital. In a pure altruistic model, remittances tend to increase at any time the income of the potential remitter increases, unless the potential remitter's income is very low, probably below subsistence level. Under a Pure Altruism model, Brown (2006:63) suggests that there is an inverse relationship between the volumes of remittances and economic conditions holding in the 16 home countries. Under this model, favorable economic conditions in the home country would imply a reduction in the volume of remittance inflows. Altruistic remittances can be countercyclical to GDP patterns possibly because migrants tend to remit more during periods of economic deterioration Bank of Uganda (2007).

Theory of Self Interest

A migrant would send money home to increase their Visibility hence, eligible for inheritance, esteem, or other resources in the community of origin. Migrants send remittances in order to reimburse the household for past expenditures such as schooling or the cost directly related to migration. In the case of pure self-interest, they remit in order to purchase durable goods and invest in housing, land or businesses at home. Then have some contribution for the growth and development of that con country, since from endogenous growth theory ingestion capital to home country boost economic growth. The argument for pure self-interest theory is that remittances are not always countercyclical. There are some cases where volumes of remittances and economic performances reduce following poor economic conditions. In such conditions, there is no inverse relationship between remittances and economic performances Brown (2006).

2.3 Economic Growth Theories

Economic growth is the increase in the value of goods and services produced by an economy. It can also be referred to as the increase in the gross domestic product. It is a comparatively simple measure of output and provides a thought of how rich a rustic is compared with competitors and past performance. It is a beacon that helps policymakers steer the economy towards key economic objectives.

2.3.1 The Harrod-Domar Model

It was developed by Roy Harrod (1939) and Evsey Domar (1946). Being a growth model, it states that economic growth is mostly reliant on saving level and capital-output ratio. In a country, if the level of savings is high, it issues funds for firms to borrow and invest. Therefore, investment can boost the capital stock of an economy and prompt the advancement of an economy through an increase in the production of goods and services. The capital-output ratio determines the productivity of the investment that covers, if the capital-output ratio declines the economy will be much more productive, so greater amounts of output originate from fewer inputs. This again causes higher economic growth. This model assumes that no economy can grow without investment which is resolved by the level of total savings.

2.3.2 The Solow Model

It was developed by Solow (1956). He tried to create a model of economic growth by removing the essential assumptions of fixed proportions of the Harrod-Domar model. By re- moving this assumption, consistent with Solow, the Harrodian path of steady growth is often free of instability. In this way, this model admits the likelihood of factor substitution.

He came up with a production function that is interchangeable or has substitutability among factors of production model out- put growth as results of change in capital, labor, and knowledge or technology. Technology only affects the productivity of labor. It assumes that the assembly is increasing in each input and has diminishing marginal production. The model assumes an exogenous and homogeneous technology across countries, as countries accumulate technology at an equivalent rate; cross-country variation in output growth rates represents differences in capital accumulation. The unexplained variation within the growth of output after considering the outturn of capital accumulation is named the Solow residual.

In capital accumulation, there are a number of ways through which remittance can affect the rate of capital accumulation in beneficial economies. Therefore remittances can act as an auxiliary source of finance for financing investment in capital goods, excluding the domestic financial sector. For instance, if domestic households are facing financial constraints in their investment activities, remittance inflows may ease such constraints allowing a rise in the recipient households’ rate of accumulation of both physical and human capital. Another way, it can increase capital accumulation through macroeconomic stability, if through remittances the domestic economy is made less volatile against external shocks, then it will eventually improve the investment climate attracting more firms to come and invest.

Total Factor Productivity (TFP) Growth, remittance beneficiaries may affect TFP growth through effects of having a high degree of knowledge of internal investment with effect on the size of home productive sectors that produce dynamic production externalities. These effects depend on diverse factors which may show change from one economy to another. Remittance may lead to an increase in the magnitude of finances flowing through the domestic banking system. In that case, the magnitude of the banking sector to administer capital can go up and evolve in more efficient investments. Kasun (2019) criticizes the model by asserting that the model assumes identical technology for all countries. It does not assume domestic factors, which nations generally use for different technological progress.

2.3.3 The Endogenous Growth Model

The endogenous growth model is a supplement of the Solow growth model. The main objective of this model is to explain how technological progress and economic growth become self­sustaining. In this model, the steady-state growth is decided endogenously. The Frankel Romer Model being one among the endogenous models goes by the assumption that its technological knowledge grows automatically with capital. In this model technological knowledge is itself some kind of capital good, insinuating that it’s interpreted as an aggregate of various kinds of capital goods, where remittances are some of these aggregates. The endogenous growth theory acknowledges that for productivity to increase, labor needs to be augmented with more resources. These resources comprise physical and human capital and technology. This indicates that for growth to occur there must be an accumulation of factors of production.

Most theories and researches have tackled economic growth as a dependent variable to any input economic factors that could have either direct or indirect effect on any country’s growth, but remittance, which for this research is the main independent variable, does not get attention.

Based on the Neoclassical theory, “the level and distribution of the national product based on the social endowments of production factors such as; labor and capital, technical conditions of production, and consumer preferences” (Cesaratto,1999). Besides, in regard to capital accumulation, economic growth was considered “Endogenous” from a neoclassical view since it depends on the community’s choice between saving (source of capital) and current consumption (Cesaratto, 1999).

2.4 Empirical Literature

2.4.1 Economic Growth effects of remittances

There are a lot of theoretical and empirical studies that examine the effect of remittances on macroeconomic variables, such as investment, consumption, and growth in recipient countries, yet the results of those studies remain inconclusive. There is empirical evidence that remittances add to economic growth, through their positive impact on consumption, savings, and investment. Remittances also can have a negative impact on growth in recipient countries by reducing incentives to work, and therefore reducing labor supply or labor force participation. This might cause an appreciation of the real exchange rate in recipient economies and generate a resource reallocation from the tradable to the non-tradable sector, or by adversely affecting long-run growth through the Dutch disease.

Several empirical studies found that there's a positive relationship between remittances and economic growth. A panel of 15 countries within the Middle East and North Africa from 1980 to 2009, (Mim and Ali, 2012) found a positive influence of remittances on consumption, investment, and economic growth. Channeled towards the buildup of human capital, remittances act effectively on the economic process in these countries. Also, econometric specifications supporting endogenous growth models find conclusive results. For instance, (Cooray, 2012) finds a positive impact of remittances on economic growth through education and financial sector development for the economies of South Asia in 1970-2008. Incorporating a sample of 34 countries in SSA for 1980-2004, (Baldé, 2011) suggests that remittances may have indirect positive effects on growth through savings and investment. Scholars such as (Nsiah, et al., 2013) found a positive relationship between economic growth and remittances, employing annual panel data from 1985—2007 for 64 countries consisting of 29 from Africa, 14 from Asia, and 21 from Latin America and the Caribbean region.

Scholars such as (Marzovilla et al., 2015) investigate the implications of REMs on the economic growth in Morocco by using a VAR methodology and variance decomposition analysis over the period 1980-2014 and conclude that remittances have been a critical growth driver.

There are also findings that remittances from migrants have positive impacts on poverty reduction and development in origin countries, mostly developing ones, substantially contributing to the achievement of the Millennium Development Goals. These positive impacts become greater when remittances can be saved and invested in infrastructures and productive capacity (Mashayekhi, 2013). Using the system generalized method of moments (GMM) in a panel data analysis there is strong evidence of a positive relationship between remittances and economic growth and also found that financial development acted as a complement in the remittances- growth relationship (Sghaier, 2021). Scholars such as, (Stratan et al., 2013) show that even in the case of Moldova, where remittances varied from 14 percent to 19.1 percent of GDP between 2006 and 2011, the correlation between remittance incomes and national growth is still ambiguous. While (Barajas et al., 2012) argue that the volume of remittances may vary depending on the economic downturns in sending countries.

The broader net economic impacts of remittances on national growth will strongly rely, on the one hand, on government policies to enhance their potentials and, on the other hand (and even more importantly), on how recipients use them (Chami and Fullenkamp, 2013).

Using annual time series data for the period 1984 to 2009 in Pakistan et al., 2011) empirically analyze the impact of workers’ remittances on private investment and total consumption. The result suggested that workers’ remittances have a significant and indirect positive impact on total consumption and private investment, which in turn have a positive impact on economic growth. In a discussion paper Siddique et al., 2010) using time series data over a 25 year period, found that growth in remittances does lead to economic growth in Bangladesh.

On the contrary, (Guha, 2013) applied the Dutch Disease theory to clarify the consequences of remittances on the economy and introduced a micro-macro framework to begin channels of transmission of remittances through the economy. Their findings focus on the fact that remittances can cause real exchange rate appreciation leading to sectoral production reallocation. The study argues that several shocks in remittances may take the economy towards a negative growth route resulting from the weakening of the traded sector. (Barajas et al., 2009b) examined the expansion impact of remittances in 84 recipient countries based on annual observations during 1970-2004 and found a negative effect on growth.

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¹ Hecksher-Ohlin Model: the Heckscher-Ohlin model is an economic theory that proposes that countries export what they can most efficiently and plentifully produce. The model emphasizes the export of goods requiring factors of production that a country has in abundance. It also emphasizes the import of goods that a nation cannot produce as efficiently. This theorem assumes that if factors of production are freely mobile among countries, then factor prices would be the same in all countries. The factor price equalization theorem says that if the prices of the output goods are equalized between countries engaged in free trade, then the price of the input factors will also be equalized between countries.

• College: Ethiopian Civil Service University
• Grade: 3.75 (good)
• Author: Gashaw Atilaw (Author)
• Publication Year: 2021
• Pages: 75
• Catalog Number: V1268390
• ISBN (PDF): 9783346715050
• ISBN (Book): 9783346715067
• Language: English
• Tags: remittance, sub-Saharan Africa, economic growth, system GMM