Do remittances help growth back home?

As Robert Lucas has highlighted, it is a puzzle why capital does not flow in much larger quantities to poor countries. There, capital is scarce and has high returns. A counterpart of this is that labor should be moving away from poor countries to where it is mopre scarce. This is indeed happening, although rich countries put restrictions to this flow. But when it happens, it turns out that rather large remittances are sent back home by migrants workers, to the point that it now surpasses other capital flows. It becomes then important to understand whether this capital influx is put to good use.

Michael Gapen, Adolfo Barajas, Ralph Chami, Peter Montiel and Connel Fullenkamp study te impact of remittances on economic growth. It is weel known that they have a positive impact on poverty alleviation or consumption smoothing at the household level, but the macroeconomic impacts are not well understood.

It turns out remittances have no positive impact, and it may even have a negative impact on growth. The authors obtain this result performing panel growth regressions on 84 countries. How would this result be obtained? Remittances can have a positive impact, through relaxing credit constraints, providing more resources and insurancing macroeconomic stability. However, they are probably directed towards households with a high propensity to consume, and thus not contribute to investment. And for other households, it may also increase consumption significantly if remittances are perceived to be permanent income. Finally, remittances may adversely affect labor force participation and total factor productivity.

One important consequence of this is that one should not take remittances as a substitute for foreign direct investment. Also, remittances can have positive and negative effects, and policy makers should find ways to direct them towards positive channels, like improving credit markets and building collateral for productive loans.