Report No. 37026 The Development Impact of Workers' Remittances in Latin America (In Two Volumes) Volume I: Main Findings August 25, 2006 Finance, Private Sector and Infrastructure (LCSFR) and Chief Economist Office (LCRCE), Latin America and the Caribbean Region Document of the World Bank MTO Money Transfer Operator MXP MexicanPesos NBER NationalBureauo f EconomicResearch ODA Official DevelopmentAssistance OECD Organisationfor EconomicCo-operationandDevelopment OFAC Office ofForeignAssets Control OLS OrdinaryLeast Squares Method PPP PurchasingPower Parity PRAF Programade AsignacibnFamiliar PROFECO Procaduria Federaldel Consumidor PRS Political Risk Services PWT PennWorld Tables REER RealEffective ExchangeRate RPS Redde ProteccionSocial RSP RemittancesService Providers SA SouthAsian Region SSA Sub SaharaAfrican Region SWIFT Society for Worldwide InterbankFinancialTelecommunication UK UnitedKingdom UNDP / PNUD UnitedNationsDevelopmentProgram US/ USA United States ofAmerica USAID United States Agency for InternationalDevelopment USD United States Dollars WAZ w Weight-for-Age Anthropometric Z Score The World Bank WDI World Development Indicators WIDER woccu World Institutefor DevelopmentEconomics Research World Council of Credit Unions Vice President: Pamela Cox Chief Economist: Guillermo Perry Sector Director: Makhtar Diop SectorManager: SusanGoldmark Task Managers: Pablo Fajnzylber and 3 TABLE OF CONTENTS: ACKNOWLEDGMENTS ............................................................................................................ 6 EXECUTIVE SUMMARY .......................................................................................................... 7 IINTRODUCTION 12 I1HOWRELEVANT ARE REMITTANCESINLAC? .. ................................................................................................................... ....................................................... 15 I11PROFILE OFREMITTANCES RECIPIENTS 15 IV WHAT DOWE KNOW ABOUT THE MIGRATION PATTERNSOF LATIN .. ............................................................... AMERICANS? ............................................................................................................................ 20 V DO REMITTANCES REDUCEINEQUALITY AND POVERTY? ................................ 23 VI REMITTANCES. GROWTHAND INVESTMENT 27 VI1 REMITTANCESAND OUTPUTVOLATILITY 30 VI11 REMITTANCES AND HOUSEHOLDSAVINGS .... ........................................................ ........................................................... ........................................................ 32 I X REMITTANCES AND HOUSEHOLDEXPENDITURES 34 X REMITTANCES AND HUMAN CAPITAL .. ............................................. ....................................................................... 37 XI REMITTANCES. LABOR SUPPLY AND ENTREPRENEURSHIP 41 XI1 REMITTANCES AND FINANCIAL SECTORDEVELOPMENT 44 XI11 REMITTANCES AND THE REAL EXCHANGE RATE: ARE THERE DUTCH ... ............................ .............................. DISEASEEFFECTS? ................................................................................................................ 51 XIV CAN FISCAL POLICY HELP TO MITIGATE SOME OF THE POTENTIAL . NEGATIVE IMPACTS OFREMITTANCES? ...................................................................... 54 XV PRIVATEAND PUBLIC TRANSFERS: I S THERE CROWDING OUT? XVI POLICY COMPLEMENTARITIES: WHAT CANPOLICY MAKERS DOTO .. .................55 ENHANCE THE DEVELOPMENT IMPACT OFREMITTANCES? ................................ 57 XVII THE REGULATORY FRAMEWORK: HOW TO FACILITATE REMITTANCES . FLOWS? ...................................................................................................................................... 60 MULTILATERAL INITIATIVES ...................................................................................................... 61 ENHANCING PAYMENTSYSTEMS ................................................................................................ COMPETITION ........................................................................................................ 62 IMPROVING 64 TRANSPARENCY ......................................................................................................................... 65 ACCESSIBILITY TO FORMALREMITTANCE SERVICES................................................................... 66 SECURITY ISSUES ....................................................................................................................... 67 XVIII OVERALL CONCLUSION: THE DEVELOPMENT IMPACT OF . REMITTANCES INLATIN AMERICA ................................................................................. 68 REFERENCES ............................................................................................................................ 71 4 LISTOF TABLES: Table 1. International flows to low and middle income countries................................................ . Income .......................... 13 Table 3. Poverty Headcounts inCounterfactual Scenario o f No-Migration................................. Table 2 Gini Coefficient inCounterfactual Scenario o fNo-Migration 25 26 Table 4. Remittances and Economic Growth 29 Table 5 35 Table 6 Remittances and Children Education by Mother's Education........................................ ..Access ............................................................................... to Remittances and Expenditure Shares............................................................. 39 Table 7. Remittances and Health Outcomes................................................................................. 40 Table 8. Access to Remittances, Hours Worked and Labor Force Participation.......................... Table 9. Remittances and Entrepreneurship, by Income Quintile................................................ 43 Table 10. Correlation between Remittances and Indicators o f FinancialDevelopment...............44 46 Table 11 .Remittances 47 Table 12. Remittances and Access to Financial Services inGuatemala, Haiti and the Dominican and Financial Development (panel estimates) ......................................... Table 13. Remittances and FinancialDevelopment across Mexican Municipalities...................49 Republic................................................................................................................................ 51 LIST OF FIGURES: 16 Figure 2. Households receiving remittances by quintile o f the non-remittances income Figure 1.Remittances to Latin America in2004.......................................................................... 18 Figure 3. Income and Remittances Distribution by Income Quintile ........................................... distribution............................................................................................................................ 19 Figure4.Educationprofile o fnative population versus the Migrants for LatinAmerican countries................................................................................................................................ 22 Figure 5 .. Scatterplots o f Remittances, Growth and Investment.................................................. ...................... 28 Figure 7. Country Estimates o f Remittances' Sensitivityto Own Output Figure 6 Remittances' Sensitivity to Output Fluctuations inRecipient Countries .................................... 30 31 Figure 8 .The response 32 Figure9.Differences inSaving rates by RemittanceRecipient Status........................................ o f Remittances to Macroeconomic Crises............................................... 33 Figure 10. Expenditure inNon-Durables (including food) and Education by Remittance 36 Figure 11. Expenditure inNon-Durables (including food) and Education by Remittance Recipient Status and Counterfactual Income Quintile: Mexico........................................... Figure 12. Differences in School Enrollment Rates for 12-17 years old by Remittances Recipient Recipient Status and Counterfactual Income Quintile: Nicaragua....................................... 37 38 Figure 13.Labor Force Participation o f Adults (20-59 years old), by Gender and Remittance Status..................................................................................................................................... Figure 14. Remittances and the real exchange rate....................................................................... Recipient Status.................................................................................................................... 42 52 59 Figure 16.Fees and exchange rate costs....................................................................................... Figure 15. The impact o f remittances on growth.......................................................................... 66 Figure 17.Channels for SendingRemittances to L A C (2004) ..................................................... 67 5 ACKNOWLEDGMENTS The Development Impact of Remittances in Latin America is the product o f a collaborative effort o f two units o f the Latin American Region o f the World Bank: the Chief Economist Office and the Finance, Private Sector and Infrastructure Group. The report was prepared by a team ledby Pablo Fajnzylber and Humberto Lopez, and comprising Pablo Acosta, Cesar Calderon, Massimo Cirasino, Paola Granata, Mario Guadamillas,Maria Soledad Martinez Peria, Yira Mascaro, Florencia Moizeszowicz, Caglar Ozden, Pedro Olinto, and Emanuel Salinas. Luis Molina, from the Bank o f Spain, also collaborated with the project while he was visiting the World Bank in early 2006. Guillermo Beylis and Namsuk Kim provided excellent research assistance at different times during the project. Extensive and excellent advice has been received from Guillermo Perry, Susan Goldmark, Ernesto May, Maurice Schiff, Jose Guilherme Reis, and especially from our peer reviewers, Omar Arias, and Samuel Muzele Maimbo. Comments on some o f the background papers for this report were also received from many participants at the Latin American Region seminar series on Remittances and Development organized inthe context o f this project, as well as from Makhtar Diop, Edmundo Murrugarra and Dante Mossi. Ernesto Lopez Cordova, Jose de Luna Martinez, Manuel Orozco and Anna Paulson provided the data and information used in Chapter 5. To all o f themwe are grateful without implication. 6 EXECUTIVESUMMARY Workers' remittances have become a major source o f financing for developing countries, and are especially important in Latin America and the Caribbean (LAC), which i s at the top o f the ranking o f remittances,receivingregions in the world. Remittances in L A C represent about 70 percent o f Foreign Direct Investment and are five times larger than Official Development Assistance. To a large extent this i s a recent phenomenon, which i s reflected in the scarcity o f standardized data both at the aggregate and the microeconomic level. In fact, two decades ago, remittances to L A C represented only one tenth o f their current value, in real terms. Not surprisingly, during recent years development practitioners inthe regionhave grown increasingly interested in understanding the nature, potential development impact and policy implications o f remittances flows. While there has been a recent surge in analytical work on the topic, the present report is motivated by the large heterogeneity in migration and remittances patterns across countries and regions, and by the fact that existing evidence for LAC i s restricted to only a few countries - e.g. Mexico and El Salvador. Thus, as the nature o f the phenomenon varies across countries, its development impact and policy implications are also likely to differ in ways that to the present are still largely unknown. This report attempts to help fill this gap by exploring, in the specific context o f Latin America and Caribbean countries, some o f the main questions faced by policy makers when trying to respondto increasing remittances flows. What i s the profile o f LatinAmerican migrants and remittances recipients? H o w do those flows affect poverty and inequality? D o remittances contribute to higher investment and faster growth or instead they are mainly directed towards consumption? Are remittances recipients more or less likely to keep their children in school? Does labor supply diminish as a result o f remittances inflows? Does financial development accelerate in recipient countries? Are there negative Dutch disease effects? What are the challenges faced by policy makers inorder to make the best o f remittances flows and enhance their developing impact? What are the changes needed inthe regulatory environment inorder to minimize transaction costs inremittances transfers and at the same time maintaining security inthe system? While the report does not expect to provide definitive answers to all these questions, the goal i s to present at least a well grounded general picture o f how the various economic effects o f remittances vary across the main recipient countries o f the region. That is not to say that the report i s based only on micro-econometric country case studies - performed when possible with a common methodological approach and using household survey data for as many as 11 countries. Indeed, the report also makes use o f cross-country analysis based on large samples o f countries encompassing other regions o f the world. However, whenever possible our approach is that o f using those cross-country frameworks to investigate potential L A C specificities in terms o f the development impact that remittances may have inthe region. A first set o f findings relates to the socio-economic characteristics o f L A C migrants and remittances recipients. With regard tO the latter, household surveys analyzed in the report show that their characteristics vary considerably across countries, both interms o f their position in the 7 income distribution and interms o f their educational attainment. Thus, while in some cases - e.g. Mexico and Paraguay - households with remittances come primarily from the bottom o f the income and educational distribution, an opposite pattern is found in others - e.g. Haiti or Nicaragua. As a result, the impact o f remittances on poverty and inequality cannot be expected to be the same across the different countries o f the region. Moreover, differences in migration patterns are also relevant for the size o f remittances flows, which the report shows to be inversely related to migrants' educational levels. The existence o f a sizable heterogeneity in migration patterns is confirmed by U.S. census data, which shows that Mexican and most o f the Central American migrants are drawn from the lower end o f the education spectrum o f their home countries. Incontrast, migrants from the Caribbean and South America tend to be proportionally more educated than those who remain behind. One possible explanation o f this finding is that it is relatively less costly for Mexican and Central Americans to migrate to the US whether through legal channels using family preferences or without proper documentation. On the other hand, the cost o f migration may be higher in South America and the Caribbean, making it an option only for those with higherlevels o f schooling and income. Another relevant finding related to migration patterns i s that while Mexico and Central America tend to top the ranking o f migrants in absolute terms, small Caribbean Islands clearly dominate the charts when migration i s measured in relation to each country's population. Thus, as o f 2000, on average 30 percent o f the labor force o f many Caribbean Islands had migrated, as opposed to about 10 percent for non Caribbean countries (6 percent for South America). Moreover, the data confirms that "brain drain" is a serious problem for many small Caribbean countries. Over 80 percent o f people born in Haiti, Jamaica, Grenada, or Guyana who have college degrees live abroad, mostly in the U.S..On the other hand, less than 10 percent o f the college graduates from South America and between 15 and 20 percent o f those from Mexico and Central America have migrated. As for the development impact o f migration and remittances, the report suggests both good and bad news. Among the firsts i s the finding that remittances have generally a positive impact in terms of reducing poverty and inequality. Not so good, however, is the news that the above effects are generally modest. For poverty, our cross-country and micro-based estimates indicate that for each percentage point increase in the share o f remittances to GDP, the fraction o f the population living in poverty i s reduced by an average o f about 0.4 percent. However, household survey based estimates suggest that remittances reduce poverty headcounts in only 6 out o f the 11 L A C countries for which data i s available - the exceptions being Mexico, Nicaragua, Paraguay, Peru and the DominicanRepublic - and they reduce poverty gaps inonly 3 cases - Ecuador, Guatemala and Haiti. Intwo cases, the DominicanRepublic and Nicaragua, we evenfind that remittances are linkedto small increases inextreme poverty. Similarly, the differences between observed Gini coefficients and those that would have prevailed inthe absence o f migration and remittances are generally small. The largest reductions attributable to migration and remittances are obtained for Haiti (7.7%), Guatemala (2.9%), El Salvador (2.1%), Nicaragua (1.8%) and Honduras (1.1%). The inequality reducing effects o f 8 remittances are much smaller in the other countries and small increases in the Gini are obtained for Mexico and the DominicanRepublic. A similar story applies to the impact o f remittances on investment and growth. Indeed, while the estimated effects are positive and robust to corrections for the potential endogeneity o f remittances and the use a wide set o f control variables as potential investment and growth determinants, their magnitude i s relatively small in economic terms. As an example, the increase inremittances observed for the average Latin American country in our sample from 0.7 percent o f GDP in 1991-1995 to 2.3 percent o f GDP in2001-2005 i s estimated to have led to an increase o f only 0.27 percent per year in per capita GDP growth, o f which about one half i s estimated to be due to increased rates o f domestic investment. However, on the positive side, we also find that remittances behave counter cyclically in most countries o f the region and they increase sharply after macroeconomic crises. Moreover, after controlling for various sources o f external and policy shocks, we find that remittances significantly reduce growth volatility, both directly and by diminishingthe impact on the economy of external and macroeconomic policy shocks. The report also looks at microeconomic channels through which remittances could affect growth, namely through household savings and expenditure patterns, human capital outcomes, labor supply and entrepreneurship. The results are once again quite mixed, both across countries and between different socio-economic groups within each country. On the positive side, we find evidence that remittances are not entirely consumed - i.e. households save a positive fraction o f remittances income. However, while saving rates increase among poorer recipient households the opposite effect i s obtained for richer ones. In contrast, while the composition o f household expenditures i s altered in the direction o f increasing human capital investments, with the only exception o f Mexico this effect is restricted to households located in the middle to upper segments o f the income distribution. With regard to human capital, there is evidence that for some specific groups - defined by country, gender, and urban status - remittances increase children's educational attainment. However, the impact is often restricted to children with low levels o f parental schooling. In the case o f health outcomes, we are able to analyze only two cases -Nicaragua and Guatemala - and find that in both o f them remittances improve children health, particularly among low income households. A positive link is also found between remittances and entrepreneurship, but the effects once again vary considerably by income quintile. Finally, although the effects are often restricted to individuals with low levels o f schooling, we find that remittances have a negative effect on labor supply, which as mentioned below could contribute to exacerbate potential Dutch Disease effects. A complementary channel through which remittances could promote economic growth is by increasing access to financial services among recipient households and promoting an overall increase in the level o f financial development o f recipient countries. The report shows that this effect is indeed present inLatin America but it i s weaker than inthe rest o f the developing world. Moreover, at the microeconomic level remittances are found to increase access to deposit accounts but the use o f credit by recipient households remains unchanged. Among the implications o f these findings is the need to step up the on-going efforts by financial institutions and regulators inorder to increasingly "bank" migrants and remittance recipients. 9 Another important policy challenge faced by recipient countries i s related to the fact that at least in Latin America remittances are found to be accompanied by real exchange rate appreciation pressures. While this i s consistent with natural adjustments towards new equilibriums following positive shocks (Le. the surge inremittances), the evidence in this report suggests that at least a fraction o f the observed appreciations i s linked to real exchange rate misalignments, which justifies the desire by policy makers to take mitigating actions in order to minimize competitiveness losses due to remittances. While there are no general answers to the question o f how to respond to possible misalignments, the report discusses various possibilities, including the use o f fiscal policy restraint while avoiding the sterilization o f remittances inflows, and microeconomic interventions aimed at reducing rigidities inlabor and product markets. In addition to addressing the above mentioned potential external competitiveness problems, the report shows that policy makers can also take actions in traditional economic reform fronts which are estimated to enhance the development impact o f remittances. Indeed, we show that progress inthe areas o f education, institutional quality, and the macroeconomic policy environment can contribute to increase the positive impact o f remittances on growth. While deepening reforms on these areas would be desirable even in the absence o f remittances, it becomes even more important when those flows are significant. Finally, the report discusses the policy challenges associated with the regulatory environment for remittances services. Recent high-level multilateral initiatives have produced, with the leadership of the World Bank, a set o f "General Principles for International Remittances Services". These principles cover key features and functions that should be satisfied by remittance systems, providers and financial intermediaries, in order to reduce the costs o f sending remittances while avoiding criminal misuse o f remittance channels. In this context, the report's recommendations include actions to ensure contestability in remittances markets, by establishing regulatory requirements that balance the need to maintain security in the system with the goal of eliminating unnecessary hurdles to bona fide entrants. Moreover, it is recommended that unduly regulatory barriers to the direct or indirect use o f payment and settlement systems should be removed, while at the same time regulators and service providers should take a proactive stance to increase market transparency and accessibility to financial services among remittances senders and recipients. Overall, the basic conclusion o f this report i s that remittances are an engine for development but they are neither a "manna from heaven" nor a substitute for sound development policies. First, the migration flows that logically precede surges in remittances are not without costs, both for the households directly affected and their countries. For instance, once reductions inhouseholds' earning generatingpotential are taken into account, net income increases fall well below observed remittances inflows - simply because the migrant was usually economically active. As a result, the poverty and inequality reduction potential o f remittances is in most cases quite modest. Similarly, while there are some positive growth-enhancing effects associated with remittances - e.g. higher savings, human capital investments, increased entrepreneurship, and higher bank deposits -the bottom line effects on investment rates and per capita GDP growth are relatively small. Second, the way countries benefit from remittances appear to be positively related to the own countries institutional and macroeconomic environments, so that countries ranking low on these fronts should expect even more modest impacts. If in addition one 10 considers that remittances may reduce labor supply and leadto real exchange rate over-valuation, it becomes clear that countries experiencing large remittances inflows will also face considerable policy challenges that may require corrective actions. Thus, given the positive effects of remittances, the private nature o f remittances flows and the fact that they may be here to stay, it appears that a healthy stance i s that o f combining measures to minimize negative effects on competitiveness, with a focus on complementary growth-enhancing policies and improvements inthe regulatory environment aimed at promoting secure andlow cost remittances services. 11 The Development ImpactofWorkers' Remittances inLatinAmerica I.INTRODUCTION Over the past two decades remittances to Latin America and the Caribbean have experienced a tenfold increase inreal terms. Not surprisingly, the interest on the potential impact o f those flows on economic development has also grown considerably, both among academics and policy makers. At the academic level, a number o f recent works have explored the impact o f remittances on poverty (Adams and Page, 2005; Page and Plaza, 2005, Acosta et al. 2006a, and Acosta et al. 2006b), inter-temporal consumption smoothing (Yang, 2005), growth (Ruiz Arranz and Giuliano, 2005; Calderon, Fajnzylber and Lopez, 2006), risk management (Amuedo- Dorantes and Pozo, 2004), education (Cox and Ureta, 2003), labor supply (Rodriguez and Tiognson, 200l), and external competitiveness (Amuedo-Dorantes and Pozo, 2004; Rajan and Subramaian, 2005)'. At the policy level, the International Monetary Fund (IMF), the World Bank, and the United Nations Development Program (UNDP) have all addressed the growing importance of migration and remittances and their impact on development efforts in some of their flagship publications. For example, the IMF's World Economic Outlook 2005 devoted significant attention to the determinants and implications o f inflows o f workers' remittances, whereas the World Bank's Global Economic Prospects 2006 had as its central topic the economic implications o f remittances and migration. The World Bank has also edited a number o f volumes on migrations and remittances issues (see Maimbo and Ratha, 2005, and Ozden and Schiff, 2006). Similarly, the UNDP's 2005 Human Development Report for El Salvador focused heavily on the development impact o f remittances and the UNDP i s now organizing a high level meeting on the topic to be heldinNew York inthe fall o f 2006. As mentioned before, this interest is understandablegiventhat workers' remittances have become a major source o f financing in developing countries. According to the World Bank's Global Economic Prospects 2006, in 1990 remittances to middle and low income countries amounted to about US$31billion. Fifteenyears later, they are estimated to have reachedUS$167 billion. Workers' remittances now account for about 30 percent o f total financial flows to development countries (table l), are more than twice as large as official development assistance, and represent the equivalent to 2.5 percento f the gross national income o f the developing world. They are also comparable to FDI flows (about 80 percent of the latter), and in some regions (Middle East andNorth Africa, and SouthAsia) muchlarger than FDI. ' This listo f works on the topic does not intendto be exhaustive;insteaditjust aims at givingan idea of the recent intereston the issue o f remittances. 12 Table 1.Internationalflows to low and middleincomecountries. Region Remittances Remitt.pc FDI Privatenon-FDI ODA US$million US$ US$million US$million US$million EAP 43100 23 64563 26660 6916 ECA 19900 42 62211 69089 11869 LCR 42400 80 60843 -4460 6869 MENA 21300 68 5340 2980 10517 SA 32000 22 7151 12670 6758 SSA 8100 11 11276 8400 26004 Total 166800 31 211384 115339 68933 Last available estimates. Source: GEP and WDI Considering the large amount o f analytical work recently done on the topic, a natural question relates to the motivations for undertaking the present regional study. To answer this question it i s important to consider the fact that, as shown below, there i s a large heterogeneity in migration and remittances patterns across regions and countries. As a result, the nature and impact o f those flows are likely to be different in Latin America and the Caribbean, in comparison to other parts o f the developing world. Moreover, they are likely to also differ from one L A C country to the other. Since the existing evidence on the development impact o f remittances in the L A C context i s restricted to only a few countries - e.g. Mexico and El Salvador - the present study i s expected to provide readers an unprecedented general picture o f how the various economic effects o f remittances vary across the main recipient countries o f the region. That i s not to say that the report is based only on country case studies - performed when possible with a common methodological approach. Indeed, the report also makes use o f cross- country analysis based on large samples o f countries encompassing other regions o f the world. However, whenever possible our approach i s that o f using those cross-country frameworks to investigate potential L A C specificities in terms o f the development impact that remittances may have inthe region. A complementary motivation for undertaking a specific study on this region is that remittances are especially important in Latin America. Thus, with flows estimated in US$42 billion in 2005, L A C i s at the top o f the ranking (together with East Asia and the Pacific) o f remittances receiving regions. Moreover, on a per capita basis Latin America is the region with highest remittances: an average o f US$102 per person per year. Clearly, giventhe magnitude of these flows there are a large number o f questions that arise related to the potential development impact o f remittances: What is the profile o f recipients o f remittances in LAC? How do they affect poverty and inequality? Do remittances contribute to higher investment and faster growth rates or instead they are mainly directed towards consumption? Do countries react differently to a surge in inflows and if so why? I s there any policy challenge associated to remittances that policy makers have to be aware of? Finally, what can policy makers do to enhance the developing impact o f these flows? This report offers a fresh look at these issues in the Latin American context. We have to admit that there are many other issues that while not discussed in this report would also justify a study on the development impact o f remittances in Latin America. For example, even though the remittances associated to migration flows tend to improve the income dimension o f the welfare o f those households at the receiving end, it i s also the case that 13 migration i s likely to impose important costs on family members left behind and especially on children that have to grow without the presence o f one and in some cases o f both parents. Similarly, a number o f development practitioners have noted their concern with the social implications associated to the fact that important groups o f the younger generations are getting used to receiving steady flows o f remittances without any effort, something that may discourage their incentives to participate inthe workforce (Le. a similar concern to the one usually raised for public transfers and the so called asistencialismo social). In fact, an analysis that takes into account the costs associated to those (and other potential) aspects o f migration could significantly enrich the results presentedinthis study. Thus this report should not be understood as an attempt at having the final word on the development impact o f remittances in Latin America. Rather, it should be viewed as a contribution to the existing debate that focuses on a selected number o f relevant issues but leaves many others for future undertakings. The presentVolume summarizes the report's main findings, which are described indetail inthe nine chapters of Volume 11.We start by reviewing the magnitude of remittances flows to the region paying special attention to the different profile o f recipients in 11 Latin American countries for which available household surveys contain information on remittances (Chapter 1). We then exploit the information contained inthe censuses o f the U.S.and other OCDE countries to get a better understanding o f Latin American migration flows towards developed countries (Chapter 2). Chapter 3 directly explores the impact o f remittances2 on poverty, inequality, growth, investment and output volatility. The conclusions o f this chapter are reached on the basis o f cross country econometrics and the results o f 11 country cases that use the same methodology. One point o f interest i s that the report aims at computing a counterfactual scenario without migration, which requires imputingthe income o f migrants had they stayed intheir home countries. Chapter 4 deals with the impact o f remittances on household behavior using, once again, data from household surveys for as many as 11 eleven LAC countries. The chapter addresses the impact of remittances on savings and expenditures, educational attainment, health outcomes, labor supply and entrepreneurship. Chapters 5 to 8 address a number o f questions that may be o f particular interest for policy makers. For example in chapter 5 the report explores whether remittances affect financial sector development. Once again, this chapter reaches its conclusions combining cross country econometrics and country case studies. Chapter 6 discusses one important policy challenge associated to the large magnitude o f remittances flows for some o f the economies, namely the possibility o f Dutch Disease type o f effects. The chapter presents new empirical evidence and discusses policy options. In chapter 7 we explore whether public transfers, such as Conditional Cash Transfers (CCTs) crowd out remittances. The analysis in this chapter exploits the information generated through randomized experiments designed to evaluate the impact o f CCT 'We would like to note that in many cases it is quite difficult to separate the migration effects from the pure remittances effects. In fact, while the increases in household income after remittances will have a positive effect on many dimensions o f household welfare one cannot discount that migration per se (Le. without remittances) can also positively contribute to those dimensions. For example, McKenzie (2006) notes that mothers in migrant families are found to have higher levels o f health knowledge. Thus even though throughout the report we refer to the estimated effects for remittances, it must be understood that these effects will in all likelihood also incorporate the pure migration effect. 14 programs inHonduras and Nicaragua. Chapter 8 analyzes whether policy makers have any tools to enhance the development o f remittances, and more specifically whether there are any complementarities between remittances and other growth enhancing policies. Finally, chapter 9 i s concerned with the regulatory and payment systems issues that need to be tackled in order to facilitate the transfer o f funds across borders. The rest of this chapter presents the main findings o f the report. 11.HOW RELEVANTARE REMITTANCESINLAC? As noted above remittances are particularly important inthe Latin America region. More importantly, they are particularly important for a number o f countries inthe region. For example, in2004 remittances represented 52.7 percent o fHaiti's GDP, whereas inJamaica, Honduras and El Salvador they were about 17, 16 and 15 percent o f GDP (figure 1). These figures are even more dramatic when compared with Foreign Direct Investment (FDI) flows. In Guatemala, Honduras, El Salvador and the Dominican Republic, remittances at the beginning o f the present decade were equivalent to respectively 4, 4, 3 and 2 times FDI flows. Even in Colombia and Ecuador, where in relative terms remittances are lower than in some o f the Central American and Caribbean countries, remittances represented respectively 197 and 112 percent o f FDI. Interms o f volume, the country with the highest absolute remittances flows is Mexico, which i s estimated to have received $21.8 billion in 2005. This would represent 45 percent o f total flows to Latin America in that year ($48.3 billion) and would make Mexico the largest world recipient, followed by India, Philippines, China and Pakistan. Colombia and Brazil were ranked respectively gth and 11' among the top remittance receiving countries in the world, receiving respectively $3.8 and $3.5 billion in2005. On a per capita basis the country with the highest remittances would be Jamaica with approximately $550 per capita, followed by Barbados with about $400 per capita and El Salvador with flows o f approximately $350. The average for the 28 countries here considered would be $128 per capita per year. 111.PROFILE OF REMITTANCES RECIPIENTS The BOP data reviewed in the previous section allows for global cross country comparisons o f the magnitude remittances flows. Yet, it gives no information about those at the receiving end. In order to address these issues, it i s necessary to have household specific information and therefore a natural way forward i s looking at household surveys. Unfortunately, national representative household surveys with specific questions on remittances are only available for eleven Latin American countries: Haiti, El Salvador, Honduras, Nicaragua, Guatemala, the Dominican Republic, Ecuador, Paraguay, Mexico, Bolivia and Peru. On a more positive tone, it is worth noting that in terms o f BOP data these countries would represent more than two-thirds o f the remittances to the Region. 15 Figure 1. Remittancesto LatinAmerica in 2004 PanelA. (YOof GDP) 60 I I PanelB. (US$ millions) 21000 18000 % 15000 3 s 12000 9000 g6OOo 3000 0 PanelC.Per capita Source: Own calculations using BOP data 16 How many households receive remittances? The number of households receiving remittances in the Latin American region varies significantly. For example, in Haiti more than 25 percent o f the households reported having received remittances in 2001. At the other extreme, only 3 percent o f the Peruvian households would benefit from these flows. Inbetween, remittances reach between 10 and 25 percent o f the households inthe DominicanRepublic, El Salvador, Nicaragua, and Honduras; between 5 and 10 percent in Mexico and Guatemala; and between 3 and 5 percent in Bolivia, Ecuador and Paraguay. Thus remittances are quite a popular phenomenon inthese countries. Who receives remittances in Latin America? A natural question that arises from the previous discussion regards the position along the income distribution o f those receiving remittances. Figure 2 plots the percentage o f households receiving remittances by quintile o f the (non-remittances) income distribution. For instance, in the case o f Mexico the recipients of remittances are predominantly poor: 61 percent o f the households that report receiving remittances fall in the first quintile o f non-remittances income whereas only 4 percent o f them are in top quintile. Similarly, in Paraguay 42 percent o f recipients are in the first quintile o f the distribution and only 8 percent are in the top quintile. Other countries where at least 30 percent o f the recipients o f remittances are in the lowest quintile (Le. where these flows tend to be directed towards the lower quintile) are Ecuador, El Salvador, and Guatemala. In contrast, in Peru and Nicaragua the distribution of remittances across households is completely different. For example, in Peru less than 6 percent o f the households that receive remittances belong to the lowest quintile while 40 percent belong to the top quintile. Or take the case o f Nicaragua, where only 12 percent of the recipients are in the first quintile while 33 percent belong to the fifth quintile. Thus in these two countries remittances seem to be flowing towards the richest. In between the groups o f Mexico, Paraguay, Ecuador, El Salvador, and Guatemala, and the group o f Peru and Nicaragua, there are four countries (Bolivia, Honduras, the Dominican Republic and Haiti) where remittances appear to be homogeneously distributed across the distribution of income, or exhibit a U-shaped distribution (Le. remittances flow towards the poorest and the richest in the same proportion and more than towards the three middledeciles). This situation changes dramatically when we analyze the economic status o f recipients on the basis of total income (including the value of remittances). In fact, the analysis in Chapter 1 indicates that (i)the share o f recipients that belong to the lowest quintile falls dramatically in all the countries; and (ii) the exception o f Mexico and to a lesser extent o f Paraguay and of El with Salvador where 50, 40, and 34 percent o f recipients respectively continue to be in the first and second quintiles, in the rest o f the countries more than half o f recipients are now in the two highest quintiles. Not surprisingly, this concentration is particularly marked in those countries where migrants seem to come from richer classes. For example, inPerumore than 75 percent (50 percent) of recipients are now in the two (top) quintile of the income distribution. 17 Figure2. Householdsreceivingremittancesby quintileofthe non-remittancesincome distribution. Bolivia Ecuador 30 30 20 20 10 10 0 0 Q1 Q2 43 4 4 Q5 El Salvador Guatemala :: 30 30 20 10 ~ 0 1 0 Q1 Q2 43 4 4 QS Q1 4 2 Q3 Q4 Q5 Haiti Honduras 30 1 I 30i 20 10 0 0 1 Q2 0 3 Q4 0 5 1 01 Q2 Q3 Q4 Q5 Mexico Nicaragua 80 1 4o 1 60 30 40 20 20 10 0 0 Q1 Q2 43 4 4 Q5 Q1 4 2 Q3 4 4 Q5 Paraguay Peru 50 1 40 40 30 30 20 20 10 10 0 0 Q1 4 2 Q3 4 4 Q5 I 01 0 2 0 3 Q4 0 5 Dominican Republic 30 i I I 20 10 0 Q1 4.7 Q3 4 4 QS 1 e figure reports the percentage o f households receiving remittancesthat fall in each of the five quintiles o f the incomedistribution, when reportedremittancesare excluded from reportedincome. Source: Owncalculationsusingthe last availablehouseholdsurvey. 18 Figure3. Income and RemittancesDistributionby IncomeQuintile Bolivia Ecuador 80 60 40 40 20 20 0 0 1 2 3 4 s I 1 2 3 4 5 1 El Salvador Guatemala 50 40 30 40 20 10 0 ' 0 1 2 3 4 5 1 2 3 4 5 Haiti Honduras 100, I 80 1 80 60 60 40 40 20 20 0 0 1 2 3 4 5 1 1 2 3 4 s Mexico Nicaragua I -- 1 1 40 I 60 - 30 20 40 - I O 0 1 2 3 4 5 ; 1 2 3 4 s Paraguay Peru ' 40 ' 60 40 20 i 20 0 l o 1 2 3 4 5 1 2 3 4 s Dominican Republic 1 I 60 40 20 0 1 2 3 4 S I Source: Own calculations using the last available household survey, and quintiles o f the total income distribution. 19 More direct evidence on the extent to which remittances have a regressive effect on the distribution o f income i s provided in figure 3, which reports each quintile's share o f both total income and total remittances. The results suggest not only that remittances are distributed in a quite unequal fashion, but also that that are generally distributed more unequally than total income. Thus, inthe 11 countries for which we have data the first three quintiles -the poorest 60 percent o f the population - receive only a quarter o f total remittances, while the top quintile receives on average 54 percent of those flows. For comparisons purposes, on average the richest 20 percent responds for 51 percent o f total household income, which suggests that the distribution o f remittances is only slightly more unequal than that o f income. Figure 3, however, reveals that in the cases o f Mexico, El Salvador, Guatemala, and Paraguay remittances are less unequally distributed than total income - e.g. the poorest 60 percent receive 41 percent o f remittances compared to 29 percent o f income. Incontrast, in the other 7 countries the first three quintiles respond for only 16 percent o f total remittances, compared to 26 percent o f total income, thus suggesting that remittances have a regressive effect on the income distribution. While these calculations are subject to a number o f caveats which we address indetail inchapter 3 - e.g. in the absence o f remittances households would probably have generated incomes that are likely to be higher than the observed non-remittances income - the evidence so far does not suggest that remittances could play an important role in reducing the very high levels o f income inequality observed in Latin America. Moreover, this analysis also suggests that one would expect that remittances may have quite different inequality and poverty impacts in the various countries o f the region. IV. WHAT DOWE KNOWABOUT THE MIGRATIONPATTERNSOF LATINAMERICANS? Migration and remittances are two faces o f the same coin, and in fact remittances would not occur if those sending them had not migrated in the first place. Thus in order to understand the volume of remittances that a country may experience it is critical to have some knowledge about its population living in other countries. Chapter 2 addresses this issue and presents a profile o f Latin American migrants living in developed countries. We have to acknowledge that the picture i s undoubtedly biased because due to data limitations we do not take into account South to South migration flows, which in some cases can be important. For example, it i s well known that a large number o f Nicaraguans migrate towards Costa Rica. However, if one i s willing to assume that most o f Latin American migrants take as destination a developed OECD country, then the biases will be relatively small. Ina nutshell, the main stylized facts on Latin American migrationpresentedinchapter 2 are the following. Choice of destinatiolz. While most o f Mexican and Latin American migrants are directed towards the US,for many South American countries, Europe continues to be an important destination. In some cases, migrants to the U S from South America tend to represent less than 50 o f those countries' migrants. These are the cases o f Brazil, Chile, Paraguay and Uruguay. Among European destinations o f Latin American migrants, language seems to play an important role, 20 with the Caribbean migrants' preferring the United Kingdom as a destination and the South Americans choosing Spain. Migration to the US. The total number o f Latin American migrants in the US increased from 8.6 million in 1990 to about 16 million in2000 (an 86 percent increase), o f which close to 10 million had Mexican origin. That same year, according to the US Census figures, the number o f Cubans (870 thousand) or Salvadorans (820 thousand) in the U S (i.e. the countries with the second and third highest number o f migrants, respectively), representedless than 10 percent o f the Mexican figure. In addition to Cuba and El Salvador, there are several other countries with a stock of migrants between half a million and one million inthe US: Dominican Republic (680 thousand), Jamaica (550 thousand), and Colombia (510 thousand). In absolute terms, and apart from the small Caribbean Island o f St. Kitts and Nevis, the country with lowest number o f migrants inthe USis Paraguay with less than 13 thousand. Migrants in relation to home population. As o f 2000, on average, 30 percent o f the labor force o f many Caribbean Islands had migrated. An extreme case i s that o f Grenada, where close to 50 percent o f the population had migrated. For the non Caribbean countries, migrants as a share o f the origin country population would represent on average about 10 percent (6 percent for South America). Thus even if Mexico and the Central American countries tend to top the ranking o f migrants in absolute terms, the small Caribbean Islands clearly dominate the migration charts when we look at migration flows inrelation to each country's population. Schooling levels ofmigrants. The schooling levels o f Latin American migrants in the US are especially low for people who migrqted as adults, after completing their education intheir home countries. This is particularly the case for those migrants from Mexico and Central America, who account for the majority o f Latin American migrants and tend to dominate the overall education profile. Yet, there are significant differences in the education distribution between different countries. In fact, while only 4 percent o f Mexican migrants have tertiary education, the same ratio is 7 percent for Central America, 12 percent for the Caribbean, 24 percent for the Andean region and around 30 percent for other South American countries. If one were to expand the comparison to developing countries from other parts o f the world, the gaps are even bigger. For example, around 70 percent o f migrants from India, China, the Philippines, Egypt, Iran, Indonesia, Pakistan and Malaysiahave tertiary education. Labor market performance. The schooling levels o f migrants is somewhat reflected in their labor market performance. In fact, slightly above 10 percent o f Mexican and Central American migrants who were above 22 years old when they migrated to the US work ended up in high- skilledand medium-skilled jobs. That same ratio is between 40 and 50 percent for Caribbean and South American migrants. The differences between countries o f origin are also evident for migrants that arrived to US before the age o f 17. Over 20 percent o f Mexican migrants and over 30 percent o f Central American migrants would be in highly or medium skilledjobs, but that ratio is between 50 and 60 percent for migrants from the Caribbean and South America. The improvements with respect to the population o f migrants that were aged 22 or older when entering the U S are likely to be due to the higher educational levels, English proficiency and other measures o f social and economic integration exhibited by migrants that entered the country as children. 21 Schooling levels of migrants relative to those in the home country. The comparison o f the schooling levels o f migrants with those who remained at home indicates that Mexican and most o f the Central American migrants are drawn from the lower end o f the education spectrum inthe home country. In contrast, migrants from the Caribbean and South America tend to be proportionally more educated than those who remain behind. For example, even though education levels in Brazil and Mexico are similar, their migrants are starkly different in their education profiles (figure 4). One possible explanation o f this finding is that it i s relatively easy for Mexican and Central Americans to migrate to the U S whether through legal channels using family preferences or without proper documentation. On the other hand, it is more costly for a Brazilian to migrate. As a result, the educated form a higher portion o f the migrants from South American countries since these are the people who can afford to migrate and they benefit more from migrating. Figure4. Educationprofile of nativepopulationversus the Migrantsfor Latin American countries. ~~ 4 Venezuela 4 4 Brazil 4 St KitWNeuis Costa Rica Haiti Dominican Republic Guatemala #Salvador Mexico D 5 tertiaryI school enrollment in origin country D 15 20 25 30 Source: USCensus (2000) andWorld DevelopmentIndicators(2005) Brain drain appears as aproblem to many small Caribbeancountries. Over 80 percent o fpeople born in Haiti, Jamaica, Grenada, or Guyana who have college degrees live abroad, mostly in the US. On the other hand, less than 10 percent of the college graduates from South American countries have migrated even though they form a large portion o f the migrant population. This i s mainly due to the low levels of overall migration for South America. For Mexico and Central America, the migration level o f college graduates is around 15-20 percent which is relatively high in comparison to South America, but not as alarming as the situation found in the Caribbean. 22 The impact of migration on remittances. Econometric analysis relating remittances to the stock o f migrants living abroad also indicates the following: (i)the ratio o f remittance to GDP increases with the stock o f migrants but the latter reduces the amount o f remittances sent per migrant; the impact on remittances received per capita is ambiguous; (ii) increases inthe overall educational levels o f migrants tend to reduce remittances sent. (iii) the share of female migrants does not have a significant effect on remittance flows; (iv) economic growth in the recipient country tends to increase remittance levels; and (iv) remittances sent by migrants increase with the level o f financial development o f their home countries. V. DOREMITTANCESREDUCEINEQUALITY AND POVERTY? Inprinciple, giventhat inmany cases remittances go to poor households and they directly increase their level o f income, an unequivocal positive answer could be expected. Moreover, to the extent that remittances could ease credit constraints and reduce risk and volatility, they could also promote higher levels o f investment in physical and human capital, and have dynamic effects on growth and poverty reduction. There are, however, several reasons that warrant circumspection when answering the above question. First, as shown above, the position o f migrants in the income distribution varies considerably across countries. As a result, the impact o f remittances on poverty reduction should also vary by country and region. Second, as we will show below, remittances could also reduce labor supply and generate real exchange rate appreciations which, in turn, could hurt competitiveness and growth..Third, it is reasonable to believe that inmany cases remittances and migration also entail potential losses o f income, associated with the migrants' absence from their families and communities. Finally, depending on the demographic characteristics o f migrants, "brain drain" effects could have negative effects on productivity and welfare. To test what i s the net effect o f remittances on inequality and poverty, chapter 3 uses both micro and macroeconomic data and techniques. Inthe first case, using household survey data for 11 countries, we first adopt a simple approach - previously used in several poverty assessment reports - o f comparing Gini coefficients and poverty headcounts estimates obtained using observed non-remittances household income and total income. This simple analysis indicates that 9 out o f 11 countries' - the exceptions being Nicaragua and Peru - exhibit higher Gini coefficients for non-remittances income, suggesting that if remittances were exogenously eliminated inequality would increase. Quantitatively, however, the estimatedpotential changes inthe Gini coefficient are small, which can be attributed to the fact that the distribution o f remittances income i s generally very unequal, and that inmost countries remittances also tend to go to relatively well-off households. Onthe other hand, the comparisons o fpoverty headcounts before and after excluding remittances from the total income o f recipients do suggest large reductions in poverty levels, especially in Note that household surveys include remittances received from abroad, and do not differentiate between those comingfrom developedor developingnations.Our resultsthus encompass cases where south-southand south-north migrationare predominant. 23 those countries where migrants tend to come from the lower deciles o f the income di~tribution.~ As an example, in Mexico, El Salvador and the Dominican Republic, extreme poverty is estimated to fall by more than 35 percent, and moderate poverty by an average o f 19 percent. The reductions in poverty headcounts that result from taking remittances income into consideration are smaller when using locally defined country-specific national poverty lines (see appendix to chapter 3)' Thus, while Mexico, El Salvador and the Dominican Republic are still the countries where largest reductions are obtained, the corresponding average changes are of 15 percent for extremepoverty and 8 percent for moderate poverty. There is, however, an important concern with the above inequality decompositions and poverty simulations, namely that they implicitly make the unrealistic assumption that remittances can be treated as exogenous transfers by migrants. The problem i s that it i s reasonable to believe that in many cases migration also entails potential losses o f income, associated with the migrants' absence from their families and communities. In other words, remittances are not exogenous transfers but rather they substitute for the home earnings that migrants would have had if they had not decided to leave their countries to work abroad. In order to consider these effects one needs to estimate the value that household income would have taken had migrants stayed in their households. Chapter 3 carefully performs such an imputationand uses to calculate the levels o f inequality and poverty which would have prevailed had migration and remittances not taken place. The results are reported intables 2 and 3. As seen in table 2, the Gini coefficients that would have prevailed in the absence o f migration would have been generally higher, with the largest differences obtained for Haiti (7.7%), followed by Guatemala (2.9%), El Salvador (2.1%), Nicaragua (1.8%) and Honduras (1.1%). The negative effects of remittances on inequality are much smaller inthe other countries and even a positive effect i s obtained for the cases o f Mexico and the Dominican Republic. The results for the countries for which remittances' impact i s minor or even favoring inequality are consistent with the findings o f previous studies that have made attempts to calculate counterfactual pre-remittances income for families with migrants.6 Overall, the estimated inequality reducing effects o f remittances are found to be relatively small - 2.7% on average, when significant - albeit they tend to be comparatively larger in countries where remittances represent a higher share o f income. Two caveats, however, need to be mentioned in this respect: i)the analysis does not take into account general equilibrium effects (i.e., the average and structure o f wages could also be affected ifhad all migrants stayed in their home countries competing for jobs); ii)we look only at the effects on monetary poverty, and thus do not consider possible negative impacts on welfare arising from the fragmentation o f families, which sociological research has found to be important. We emphasize the calculations based on common international poverty lines (US$ 1 and US$2 PPP) because they are better suited for international comparisons. However, the appendix to this chapter reports similar calculations based on locally definedpoverty lines, which may be o f interest for country-specific analysis, It i s worth noting that poverty headcounts are inall cases much higher when using local poverty lines -which are higher than their international counterparts. Rodriguez (1998), for instance, finds that remittances increase inequality in the Philippines, and the effect rises from 1.27 percent to 7.90 percent when usingimputed income instead o f reported non-remittances income. Similarly Barham and Boucher (1998), for the case o f Bluefields (Nicaragua), find that the Gini for household income falls from 0.47 to 0.43 when using reported figures, but inequality actually rises from 0.38 to 0.43 after correcting the pre-remittances distribution using imputed income for migrant families. 24 Table 2. Income Gini CoefficientinCounterfactualScenario of No-Migration. Gini Differencein Gini Differencein Country Di2 Coefficient Gini before/after in Country Coefficient Gini befordafter Diff. in % remitt. remitt. Bolivia (2002) Honduras(2002) Non-RemittancesIncome 0.556 Non-Remittance8Income 0.565 95% Confidencelnferval (0.553; 0.561) 95% Confidencelnferval (0.564; 0.567) Total Income 0.555 -0,001 -0.3% Total Income 0.559 -0.006 -1.1% Ecuador(2004) Mexico (2002) Non-RemittancesIncome 0.501 Non-RemittancesIncome 0.477 95% Confidencelnferval (0.500; 0.503) 95% ConfidenceInferval (0.477; 0.478) Total Income 0.499 -0.002 -0.5% Total Income 0.481 0.004 0.7% El Salvador (2000) Nicaragua(2001) Non-RemittancesIncome 0.497 Non-RemittancesIncome 0.528 95% ConfidenceInterval (0.494; 0.501) 95% ConfidenceInferval (0.519; 0.539) Total Income 0.486 -0.011 -2.1% Total Income 0.518 -0.010 -1.8% Guatemala(2000) Paraguay(2003) Non-RemittancesIncome 0.603 Non-RemittancesIncome 0.515 95% Confidencelnterval (0.596; 0.615) 95% Confidencelnferval (0.514; 0.517) Total Income 0.586 -0.017 -2.9% Total Income 0.516 0.001 0.2% Haiti (2001) Peru(2002) Non-RemittancesIncome 0.725 Non-RemittancesIncome 0.478 95% ConfidenceInterval (0,703; 0.756) 95% Confidencelnferval (0.476; 0.481) Total Income 0.669 -0.056 -7.7% Total Income 0.476 -0.002 -0.3% DominicanRepublic (2004) Non-RemittancesIncome 0.519 95% ConfidenceInterval (0.514; 0.525) Total Income 0.520 0.001 0.3% Source: Acosta et al. (2006). As for the impact o f migration and remittances on poverty, the results in table 3 suggest that the failure to correct for the reduction in income associated with the absence o f migrants from their households may lead to grossly overestimating the poverty reducing effect o f remittances. Inparticular, when usingour preferred methodology we find that remittances reduce poverty headcounts in only 6 out o f the 11 countries for which data i s available - the exceptions being Mexico, Nicaragua, Paraguay, Peru and the Dominican Republic - and they reduce poverty gaps in only 3 cases - Ecuador, Guatemala and Haiti. In two cases, the Dominican Republic and Nicaragua, we even find that remittances are linked to small increases in extreme poverty - respectively o f 7.4 and 0.4 percent. Thus, for very poor households in those countries the income lost due to the absence o fmigrants from their households is less than compensated by the money they send home, possibly because they also under-perform in the job market o f destination countries. Considering all eleven countries and assuming that the remittances share in GDP i s as given by BOP statistics, the average estimated impact of remittances on poverty headcounts is such that a 1 percentage point increase in the remittances to GDP ratio reduces moderate and extreme poverty by respectively -37and 0.29 percent. One complementary approach proposed by Schiff (2006) is to estimate the impact of remittances on poverty focusing exclusively on the population o f households which receiveremittances. Chapter 3 also reports the results of implementingthis approach and shows that while the impact of remittances on national poverty levels may be limited,the effect on the poverty status of the families with migrantsis muchlarger. The largest absolute reductions inpovertyamongrecipientsare found in Haiti, Guatemala, Bolivia, Honduras andEcuador. 25 Table 3. Poverty Headcounts in Counterfactual Scenario of No-Migration. Country US$laday Diff US$2aday Diff. U S $ l aday Diff US62aday Diff (PPP) in % (PPP) i n % Country (PPP) in % (PPP) in % Bolivia (2002) Honduras (2002) Non-Remittances Income 17.999 35.052 Non-RemittancesIncome 16.715 33,155 95% Confidence Interval (17.842; 18.184) (34.824; 35.279) 95% Confidence Interval (16.608; 16.820) (32.993; 33.307) Total Income 17.764 34.674 Total Income 16.155 31.731 Diff.beforeiafter remitt. -0.2 -1.3% -0.4 -1.1% Dif.beforeiafter remitt. -0.6 -3.4% -1.4 -4.3% Ecuador (2004) Mexico (2002) Non-Remittances Income 11.665 28.082 Non-Remittances Income 3.079 12.603 95% Confidence Interval (1 1.594; 11.741) (27.960; 28.221) 95% Confidence Interval (3.019; 3.145) (12.480; 12.731) Total Income 11.198 27.147 Total Income 3.165 12.695 Dif.beforeiafter remitt. -0.5 -4.0% -0.9 -3.3% Dif. before/after remitt. 0.1 2.8% 0.1 0.7% El Salvador (2000) Nicaragua (2001) Non-Remittances Income 8.215 20.055 Non-Remittances Income 8.226 22.848 95% Confidence Interval (8.077; 8.375) (19.824; 20.311) 95% Confidence Interval (8.012; 8.528) (22.427; 23.345) Total Income 7.700 18.607 Total Income 8.260 22.552 Dif.beforeiafter remitt. -0.5 -6.3% -1.4 -7.2% Dif. beforeiafter remitt. 0.0 0.4% -0.3 -1.3% Guatemala (2000) Paraguay(2003) Non-Remittances Income 23.630 41.379 Non-Remittances Income 6.066 15.373 95% Confidence Interval (23.335; 23.931) (41.055; 41.710) 95% Confidence Interval (5.999; 6.145) (15.256; 15.521) Total Income 21.578 39.087 Total Income 6.057 15.333 Dif.beforeiafterremitt. -2.1 -8.7% -2.3 -5.5% Dif.beforeiafter remitt. 0.0 -0.1% 0.0 -0.3% Haiti (2001) Peru (2002) Non-Remittances Income 57.541 74.376 Non-Remittances Income 4.186 15.555 95% Confidence Interval (56.929; 58.138) (73.793; 74.992) 95% Confidence Interval (4.186; 4.192) (15.533; 15.888) Total Income 53.425 71.414 Total Income 4.185 15.539 Dif. beforeiafter remitt. 4.1 -7.2% -3.0 4.0% Dif. beforeiafier remitt. 0.0 0.0% 0.0 -0.1% Dominican Republic (2004) Non-Remittances Income 4.364 13.008 95% Confidence Interval (4.247; 4.488) (12.777; 13.270) Total Income 4.688 12.836 Dit beforeiafter remitt. 0.3 7.4% -0.2 -1.3% Source: Acosta et al. (2006). Interestingly, the countries for which we find the largest inequality and poverty reducing effects are not necessarily those where remittances recipients tend to come from lower income groups. Consider, for instance, the cases o f El Salvador, Guatemala, Mexico and Paraguay, where remittances recipients tend to be relatively less educated than the general population - there i s "negative" selection into migration - and remittances are more progressively distributed than total income. Only intwo o f them (El Salvador and Guatemala) we do find that remittances are associated with significant reductions in both inequality and poverty. Moreover, in the other two countries where remittances do appear to significantly reduce poverty and inequality - Haiti and Honduras - remittances recipients are more likely to be found among highly educated individuals, and remittances income i s distributed more unequally than total income. If anything, what the four countries where remittances have the largest effects on poverty and inequality have incommonis that they are among those inwhich remittances are highest with respect to GDP. An alternative way o f estimating the impact o f remittances on poverty is by means o f cross-country regression analysis. This i s the approach taken by Adams and Page (2005), and the IMF's World Economic Outlook (2005). Both o f them find that countries that receive remittances have lower poverty levels. In particular, Adams and Page find that a 10 percent increase inper capita remittances would lead to a 3.5 percent decline inthe share o f people living inpoverty inthe corresponding country, and the World Economic Outlook concludes that a 2.5 percentage point increase in the remittances to GDP ratio i s associated with a 0.5 percentage point decrease inpoverty. 26 The above studies, however, do not allow the effect o f remittances to vary by country or region. Moreover, as noted in World Economic Outlook (2005), because both studies control separately for the effect o f per capita income and income inequality, they miss the effects o f remittances that operate through changes in those variables. Thus, they are both likely to under- estimate the poverty effects o f remittances. Chapter 3 addresses both issues usingdata for a large panel of countries. The results suggest that remittances tend to reduce poverty and this effect is more marked in Latin America than elsewhere. On the other hand, remittances seem to lead to higher income inequality at the global level but to either reduce or leave inequality unchangedin LatinAmerica (something to be welcomed given the highinequality levels o f the region). These basic messages are robust to the use o f different econometric methodologies. However, we find that there is substantial heterogeneity in the effects o f remittances on poverty depending upon the country's initial conditions, as given by the ratio o f per capita income to the poverty line, and the Gini coefficient. Overall, assuming a common value o f 0.5 for the Gini, and considering that in the average Latin American country remittances are 4.9 percent to GDP, a one percentage point increase inthe remittances to GDP ratio is estimated to lead to reductions in poverty that vary between 0.08 percent for poorer countries to 1.12 percent for richer countries, with an average estimated reduction o f 0.37 percent, which is fully in line with our micro- econometric results for moderate poverty. VI. REMITTANCES,GROWTHAND INVESTMENT Previous studies on the growth-remittances link have generated somewhat ambiguous results.* This is not surprising given the counter-cyclicality o f those flows, which suggests that remittances tend to respond negatively to economic growth. Thus, failure to correct for reverse causality and other sources o f endogeneity in remittances flows may lead to misleading conclusions regarding the causal relationship from remittances to economic growth. From a conceptual point o f view, this relationship could be motivated by the possibility that workers' remittances may help ease credit constraints thus allowing individuals to not only increase their consumption and also augment investments in physical capital, education, health care, and the creation or expansion o f micro-enterprises, all o f which could eventually be reflected in higher aggregate investment and economic growth. As seen in figure 5, even simple scatter plots between remittances, growth and investment using a large cross section o f countries tend to suggest the presence o f positive correlations between remittances, investment and growth. Faini (2002), the IMF's World Economic Outlook (IMF, ZOOS), and Chami, Fullenkampand Jahjah (2005), for instancehave found that remittanceshave respectivelya positive, non-significantandnegativeimpacton economic growth. Giuliano and Ruiz-Arranz (2005) also find that the impact of remittanceson growth is not significant in general but it is positive in countries with shallower financial markets. In the case of Latin America, Solimano (2003) finds that lagged remittances have a positive and significant impact on growth in Colombia, but the relationship is not significant for Ecuador.Mishra (2005) and Mundaca (2005), on the other hand, find positive effects, respectively for a sample of Caribbean countries, and for Central America, Mexico and the Dominican Republic. 27 Figure5. Scatter plotsof Remittances,Growthand Investment. 1.lWorkers' Remittancesvs. Economic Growth CHN nl y = 0 . 3 + 1.'I137 ~ Rz = 0.0641 -4 J Workrm' Rrmlnmn~msIS ~rrcrnt-orof QDP (In loom1 1.2 Workers' Remittancesvs. Domestic investment 4 0 1 KNA LSO CHN GAB y = 0.0423~ 3.0747 + RZ = 0.0595 I -4 -3 -2 1 0 1 2 3 4 6 Work.-' Rmmlnrncrm ms pmrcrntapm of QDP (In Io0m) Source: Own calculations Panel data estimates on the impact o f remittances and growth are presented in Table 4, using a sample of 67 countries, of which 21 from LatinAmerica and the Caribbean. We find that remittances have a positive and significant impact on growth, and that this effect i s robust to the use o f external and time varying instrumental variables to control for the potential endogeneity o f remittance^.^ All control variables are found to be significant and with the sign that would be a priori expected. That is, growth i s found to be higher for countries with lower levels o f income, higher levels o f education, deeper financial markets, more openness to trade and better institutions, and to be discouraged by excessive government burden, higher inflation and real exchange rate overvaluation. These results improve upon previous estimates, which have either overlooked the issue o f the possible endogeneity o f remittances, or have addressed it using time- invariant instrumental variables (e.g. IMF,2005) or internal instruments only (e.g. Giuliano and Ruiz-Arranz, 2005).loMoreover, following Loayza, Fajnzylber and Calder6n (2005), we now 9 The only exception is given by column [4] where we instrument remittances with their own lagged levels and differences. This may be inappropriate if remittances are influenced in an inter-temporal optimizing framework by future shocks to economic growth. lo We use two external instruments constructed by Aggarwal, Demirguc-Kunt and Martinez Peria (2005), based on the real output per capita o f the countries where remittances originate. The first instrumentis the average output per 28 use a wide set o f control variables as potential growth determinants, thus reducing possible omitted variable biases. Table 4. Remittancesand Economic Growth. Grovth R.gn.slons wilhou1Inw~mwnt Q r o W Regreisionsinsludlng IIIV..INIII [I) I21 81 141 [51 [(I PI [(I Eiwnoum Dis1.m. Mlpnlion Lagpd LIV + DR E x w n w Di.1.m. Mlgnlion Lapg.d Lev + Dm Variable R m r n a n w tnstr~rr~nt I n i l r u ~ n l of RamitUnsei Lmltunc.. Inshununl In.Irumnl of RemltUnc.e* InitialGDP per capita -0 354 " -0.281** -0.298.. -0.349*' -0.438' 0.841** 4.848 " -0.524 ** (I"lop81 (0.08) (0.08) (0.09) (0.08) (0.09) * (0.07) (0.06) (0.09) lilwmwJ lnveslmentRate 4.118' 8.845** 5.988 " 4.325 ** (A8 a p r c s n w 01 GDP,in lopa) (0.85) * (0.32) (0.26) (0.19) Education 0.257 " 0256 " 0.217 ** 0.348 ** 0.220 ** 0.303 0.263 ** 0.219 * (SomrulewEnrdlmnl,InIws) (0.08) (0.11) (0.10) (0.06) (0$0) (0.13) (0.13) (0.11) FinancialDeplh 0.820 .. 0.384** 0.499** 0,523.. -0.109 -0.448 ** 4.226 * 0.007 (PHvale Domilk Credit lo GOP, InI-) (0.19) (0.18) (0.19) (0.17) (0.17) (0.13) (0.14) (0.18) lnstltYIins 3.888 1. 4.236 " 4.105 ** 3.678" 2.918" 2.857** 2.339: 2.934 " (ICRGPolllbl RWI Irdex,InIqla) (0.31) (0.27) (0.31) (0.29) (0.41) (0 35) (0.39) (0.41) Trade Opennuss (TO) 0.329*' 0.431 " 0.422 ** 0.503 ** 0.095 0.283 * -0.305 " -0.155 (Red E~wm ImpomIDDDP,rn lops) and (0.11) (0.11) (0.10) (0.12) (0.12) (0.15) (0.13) (0.11) Lack of Pnce Stability 0.007.. -0.006 ** -0.007 ** -0.008" 4.008: -0.005" -0.007** -0.008" pnnatianma. iniog~ioo+inf.~i~~) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) RER OveNaluallon 4.011 " .0012" -0.012** 0010" -0.005 0001 0.000 -0.003* (Pmpomona M * X inIW,0verVal"a~" >O)n (0.00) (D.00) (0.00) (0.00) 10 00) (0.00) (0.00) (000) GovernmentBurdsn -0.862 .* -0.882" -0.828** -0.942 " -1 019: -1.081 ** -0.929 ** 4.028 " - (GemmiGo*. Co~urnpUmh?lws) (0.18) (0.19) (0.18) (0.16) (0.18) (0.13) (0.11) (0.13) Rmltlances 0.167 " 0.226 0.239 0.025 0.063 * 0.042 0.048 0.038 f m0rk.r. Rrn1tUK.l IO ODP, in -1) (0.041 (0.04) (0.04) (0.07) (0.04) (0.05) (0.04) (0.05) NO.Countries 67 87 67 87 67 87 87 67 NO Observations 273 273 273 273 273 273 273 273 Specification Tests (pvaluer) ..Satgan Test (0.34) (0.28) (0.31) (0.37) (0.84) (0.58) (0.55) (0.53) 2nd. Order Conelation (0.18) (0.19) (0.19) (0.19) (0.20) (0.29) (0 29) (0.21) All m p m ~ 1 hduda a o ~ s t mand Ume dummler. ' denotes staUs1a18ipnflcanss at the 10 (5) pmnt level ~ 8 l r) Source: Own calculations The magnitude o f the estimated effect o f remittances on growth is, however, relatively small in economic terms. For the average Latin American country inthe sample, for instance, the increase in remittances from 0.7 percent o f GDP in 1991-1995 to 2.3 percent o f GDP in 2001- 2005 i s estimated to have led to an increase o f only 0.27 percent per year in per capita GDP growth. Moreover, as seen in the final four columns o f Table 10, when domestic investment i s included as an additional explanatory variable, the effect o f remittances on growth ceases to be significant. This may imply that one of the main channels through which remittances affect growth i s by increasing domestic investment.Direct estimates o f the effect o f remittances on the ratio o f investment to GDP confirm this hypothesis. In particular, the results suggest that from 1991-1995 to 2001-2005, the increase in remittances to L A C was responsible for a 2 percent increase in the share o f domestic investment to GDP, which would in turn correspond to about one half o f the estimated total impact of remittances on growth duringthat period. ~ ~~ ~ capita o f the top country destinations for migrants across the world weighted by the (inverse of the) distance between the remittance-sender and the remittances-recipient country. The second instrument is the average output per capita o f the top five country destinations for migrants in the OECD weighted by the share of migrants o f the recipient country in each of these five destinations. W e refer to these two variables as the "Distance" and the "Migration" instruments, respectively. 29 ibit a counter- I I 30 with incomc, bcing highest among ~ p p c ~ - ~incomc~ c i d ~ Figure 7. Country Estimrt ivity to Own Output. rogcrtciiy, across La olXing for standards d d to c ~ u ~ t ~ i ~ ~ 31 IShocks, fiscaland Source. O-tvncalculations t clfthc six coun icnts s n t : morc cs in saving rates bctwccn r ocks which hav S O ~ Crcmittaacc re iricomc. In almost all 33 with the above findings regarding the positive impact o f remittances on domestic investment and growth. IX. REMITTANCESAND HOUSEHOLDEXPENDITURES A few previous studies have addressed the links between remittances and patterns o f household expenditure, in the assumption that this may shed light on the saving behavior o f recipients. This is indeedthe case if savings are defined in a broader sense, including not only the fraction o f income which i s not spent (as above), but also the one that i s destinedto expenses which probably include important saving components. This is the case, in particular, for the expenditures in consumer durables, education and health.l2Previous evidence on Latin America i s restricted to the cases o f Mexico and Guatemala. Using data on rural Mexico Taylor (1992) has shown that remittances recipient families tend to invest more in farm assets (e.g. livestock). Similarly, Adams (2005) has found that Guatemalan families reportingremittances tend to spend a lower share o f total income in food and other non-durable goods, and more on durable goods, housing, education, and health. Chapter 4 complements the above papers by using household survey data for 7 countries to test whether the share o f different expenditure categories vary across recipients and non- recipients households which share similar demographic characteristics and are located in the same quintile o f the household income distribution (prior to migration). The results are reported in table 5. With the only exception of Jamaica, we find that remittances' recipients direct a smaller share o f their total expenditures towards food, thus suggesting that Adams' (2005) findings for Guatemala also apply to other LAC countries with considerable remittances receipts.l3The complement o f the reduction in food expenditures among remittances recipients i s an increase inexpenses innon-durable goods, durable goods, housing, education and health. The relative importance o f these various increases, however, varies considerably across countries. Thus, changes innon-durable goods consumption (excluding food) are significant only in Peru, El Salvador, and Guatemala. Moreover, only inthe two latter countries and inMexico and Jamaica does the share o f durable goods increase significantly among remittances recipients, and more frequent housing improvements are apparent only El Salvador and Jamaica, with the opposite effect found for Mexico. Increases inhealth expenditures, however, are present in 6 out o f 7 countries (the exception being Nicaragua). Finally, higher educational expenditures are found for 4 out o f 7 countries, with the op osite result found for Jamaica, and non-significant effects obtained for Mexico and Nicaragua.I! To the extent that savings and expenditure patterns vary with income - see previous section - the above estimates o f averages effects on all remittances recipients could mask '* See Attanasio and Szekely (2000). l3 Inthe case ofMexico, food expenses cannot be separatedfrom those inother non-durable goods, which are lower among recipients. l4 Relatively similar results - reductions in food shares compensated by increases in non-durables, durables, health and education - are obtained when the per capita amount o f remittances received by each household is taken into account, and when the possible endogeneity o f remittances is controlled for. 34 possible differences across households located in different parts o f the income distribution. Indeed, allowing the impact o f remittances on expenditures to vary across income quintiles leads to quite different remittances effects across segments o f the income distribution. In the case o f Mexico, for instance, recipients in the lower quintiles exhibit the same pattern observed for the overall recipient population - increased expenditures in durable goods, housing and human capital, at the expense o f non-durables. In contrast, their richer counterparts exhibit higher expenses innon-durable goods and lower expenditures inhousing improvements and education. Ile 5. Acce to Remit nces and rrpenditur Shares. 1 Food Non-Durables Durables Housing Education Health Mexico' -0.031*** NIA 0.014*** -0.006** 0.003 0.021*** (0.006) (0.004) (0.003) (0,004) (0.003) El Salvador -0.038*** 0.008** 0.002' 0.003** 0.019*** 0.006*** (0.004) (0,003) (0.001) (0.001) (0.003) (0.001) Guatemala -0.034*** 0.0101 0.006** 0.000 0.009*** 0.009* (0.006) (0.005) (0,002) (0.002) (0.003) (0.005) Peru2 -0.043*** 0.024*** -0.006 -0.001 0.009** 0.016*** (0.008) (0.007) (0.004) (0.003) (0,004) (0.005) Nicaragua -0.014* -0.002 0.000 0.003 0.008 0.005 (0.007) (0.006) (0.001) (0.003) (0.005) (0.006) -0.002 -0.007 0.004*** 0.003** -0.005' 0.009*** (0.005) (0.005) (0.001) (0.001) (0.003) (0.002) -0.013*** -0.002 0.000 0.000 0.003' 0.012*** (0.004) (0.003) (0.001) (0.001) (0,002) (0.003) I Notes: 'Foodand *** Significant a1 level.** Si@ icant at 5% lev * Significant a 1% level. other non-durable goodstogether *Only urban areas. 'Coefficients for housing inJamaica and Dominican Republic are multiplied by 10. Source: Author's calculations basedon householdsurveys Thus, at least in Mexico, remittances appear to be used in a more productive way by poorer households, arguably because they relax budget constraints that limit housing and human capital investments o f poorer families. For richer households, on the other hand, the results suggest that the above budget constraints are not binding, so that remittances have the effect o f increasing the consumption o f food and non-durable goods. This i s illustrated infigure 10, which shows that in Mexico recipients in the first quintile experience a reduction in food and non- durable goods expenses and an increase in educational expenditures in comparison with non- recipients o f similar characteristics, but both changes tend to become smaller - and even have their signs inverted -as one moves up inthe income distribution. Inthe remaining countries under analysis, however, a quite different pattern is observed across poorer and richer households. Thus, with the only exception o f Jamaica, whenever remittances are found to significantly increase educational and health expenditures o f recipient households, the effects are restricted to those in the upper quintiles o f the income distribution. For those richer families, higher human capital investments are achieved through lower 35 urc in ~ ~ n - ~~ ~~n ~~~ u#food) gI ~Educationby Rem nt Status and co d bn and i ~ ai IncomeQuintilc: ndtture in Non-Dura n ~ I u food) and~E ~ ~ n ecipientStatus and Cou ctual fncornc Quinlil cvicicncc on thc impact of rcmit u' lcvctso f schouling. Si 37 ion models that at nt cfftcr for thosc tt'hosc riiothcr and urban status - c.g. in some I..:In the c w ut'Peruthe andruralchild 38 infant mortality rates. Moreover, Hildebrandt and McKenzie (2006) also find evidence that migration raises maternal health knowledge and the likelihood that the child was delivered by a doctor. On the other hand, preventative health care (such as breastfeeding, visits to doctors, and vaccinations) seem to be less likely for children from migrant households. \ge Group 10-15 Years Old >ependent Variable Accumulated Schooling :ountry Variable Rural Urban Boys Girls Boys Girls dexico Receive Remittances -0.082 0.329** -0.041 -0.573 (0.192) (0.141) (0.329) (0.553) Receive Remittances * -0,144 -0.417** 0.024 0.461 Mother Educ 4 Years or More (0.240) (0.186) (0.378) (0.577) 31 Salvador Receive Remittances 0.511*** 0.251** 0.365** -0.191 (0.129) (0.115) (0.170) (0.186) Receive Remittances * -0.116 0.229 -0.203 0.297 Mother Educ 4 Years or More (0.212) (0.176) (0.197) (0.206) 3uatemala Receive Remittances 0.482** 0.223 0.412 1.109"' (0.200) (0.186) (0.337) (0.231) Receive Remittances* -0.179 0.450 -0.323 -1.336*** Mother Educ 4 Years or More (0.389) (0.3 18) (0.408) (0.315) 3onduras Receive Remittances 0.581*** 0.662*** 0.731*** 0.554*** (0.142) (0.155) (0.178) (0.209) Receive Remittances* -0.3 17' -0.328* -0.564*** -0.247 Mother Educ 4 Years or More (0.193) (0 184) (0.193) (0.220) Zcuador Receive Remittances 0.278 -0.106 0.502 0.805* (0.233) (0.237) (0.331) (0.463) Receive Remittances* -0.138 0.386 -0.239 -0.547 Mother Educ 4 Years or More (0.277) (0.287) (0.344) (0.475) Paraguay Receive Remittances 0.056 0.433* (0.271) (0.235) Receive Remittances* -0.133 -0.476 Mother Educ 4 Years or More (0.3 74) (0.345) Haiti Receive Remittances 0.043 0.273** (0.120) (0.111) Receive Remittances* 0.229 -0.1 11 Mother Educ 4 Years or More (0.237) (0.220) Peru Receive Remittances 0.187 0.393*** (0.296) (0.144) Receive Remittances* -0.362 -0.343* Mother Educ 4 Years or More (0.338) (0.207) Nicaragua ' Receive Remittances 0.577** 0.554** (0.260) (0.221) Receive Remittances* -0.208 -0.296 Mother Educ 4 Years or More (0.310) (0,258) Jamaica ' Receive Remittances 0.510 -0.236 (0.465) (0.435) Receive Remittances* -0.668 0.253 Mother Educ 4 Years or More (0.484) (0.443) Dom. Rep. ' Receive Remittances -0.148 0.301 (0.242) (0.208) I Receive Remittances* 0.282 -0.242 Mother Educ 4 Years or More (0.263) (0.230) 'Rural and Urban areas together. Source: Author's calculations based on household surveys 39 With regard to the health effects o f remittances we focus, in chapter 4, on the links between those flows and anthropometric health indicators for children aged 1 to 5, the incidence o f doctor-assisted births (in a sample o f mothers that gave birth a year prior to the survey), and the probability that children aged 2 to 5 receive complete vaccinations sets. We use data from Guatemala and Nicaragua, as the other household surveys used in this report do not provide information on the above health indicators. Plot densities o f the above anthropometric indicators for children from remittance recipient and non-recipient households show that children from recipient households have both higher weight-for-age and height-for age "z-scores". To test whether these results are drivenby the differential characteristics o f households with and without migrants, we estimate a regression model similar to the one used for educational attainment, allowing the effects o f remittances to vary between the first, second and higher quintiles of the income distribution -usingthe counterfactual income prior to migration. l6 Table 7. Remittancesand Hea h Outcomes. Child Dependent Variable Weight-for- Height-for- Received All 4ge Z-Score Age 2-Score Vaccines Ieliveredby Doctor 2nd Income Quintile 0.117** 0.141** 0.011 0.006 0.154* 0.230" -0.028 0.104* (0.058) (0.060) (0.011) (0.015) (0.085) (0.091) (0.047) (0.060) 3rd Income Quintile 0.233*** 0.385** 0.016 0.054*** 0.077 0.327*** -0.011 0.085 (0.060) (0.067) (0.013) (0.025) (0.099) (0.109) (0.054) (0.070) 4th Income Quintile 0.325*** 0.479** 0.010 0.023 0.263** 0.594*** -0.126 0.168* (0.073) (0.076) (0.016) (0.023) (0.117) (0.113) (0.062) (0.079) 5th Income Quintile 0.594*** 0.686** 0.013 0.352" 0.594*** -0.102 0.263" 7 0.026 (0.091) (0.098) I (0.018) (0.025) (0.138) (0.136) I (0.078) I (0.082) Remittances 0.211** 0.213 0.065** 0.255*** 0.306 0.289 I 0.119 I 0.297** (0.089) (0.228) 1I (0.021) (0,160) -0.327 0.084 I -0.082 -0.034' -0.079 0.034 -0.463' (0.283) (0.264) (0.079) (0.007) (0.457) (0.421) (0,Z75) (0.225) Remittances*Q3-Q4-Q5 -0.423 0.004 -0.041 -0.036*** -0.252 -0.148 (0.272) (0.253) (0.071) (0.006) (0.418) (0.385) I (0.252) (0.114) Notes: *** Significant at 1 /Olevel. **Significant at 5% level. * Si@ icant at 10% Source: Author's calculations based on household surveys Table 7 reports our estimation results, including the coefficients on free-standing dummy variables for the second through fifth income quintiles. As confirmed by our estimates, both weight- and height-for-age indexes tend to increase monotonically and significantly with household income, and so does the likelihood o f doctor-assisted deliveries in the case of Nicaragua. More importantly, controlling for pre-migration income, children from households that report receiving remittances tend to exhibit higher health outcomes than those from non- recipients households with similar demographic and socio-economic characteristics. While the relatively small sample sizes make most o f the estimated interactives between remittances and income quintiles non-significant from a statistical point o f view, in most cases the results clearly indicate that the impact o f remittances on children health is concentrated on low income households located inthe first quintile o f the income distribution. l6 We group the 31dthrough 5Ihquintiles due to the relatively small sample size for some of the estimations, 40 XI. REMITTANCES,LABORSUPPLY AND ENTREPRENEURSHIP The impact o f remittances on labor supply i s in principle ambiguous. For individuals in households with migrants, the net additional income derived from remittances could have the "income effect" o f increasing the demand for leisure and reservation wages, with a consequent reduction in labor force participation. However, out-migration also has the direct effect of reducing the size o f the labor force, and the ensuing upward pressure on local wages could in turncreate a "substitution effect" away from leisure, with a consequent increase inlabor supply for those living in areas with high migration rates. In the case o f Mexico, for instance, Mishra (2004) estimates that emigration raised average wages by 8% between 1970 and 2000. In addition to the above factors, in households with recent migrants the need to replace the income lost due to the migration o f wage earners could reinforce the effect o f higher market wages, resulting inan increase inthe labor participation o f stayers. Previous papers on the subject suggest that remittances tend to reduce labor force participation in rural Mexico (Hanson, 2005) and El Salvador (Acosta, 2006), but they do not have a significant effect in Nicaragua (Funkhouser, 1992). To determine whether previous evidence can be generalized to other LAC countries, chapter 4 first compares labor force participation rates across individuals living inhouseholds with and without access to remittances. As seen in figure 13, with the only exceptions o f females in Haiti and Nicaragua, the rates for recipients are considerably lower than for non-remittances, The largest differences are obtained for Mexico, where nearly 90% o f non-recipient males are working or looking for a job, while only 60% o f their recipient counterparts are doing so -the corresponding rates for females are 45 and 34 percent, respectively. Differences by remittances recipient status in other countries average 8 percent for males and 3 percent for females. While these differences are considerable, they could be driven by individual and household characteristics associated with access to remittances and also with labor force participation decisions. To investigate whether this i s indeed the case, we estimate regression models for hours worked outside the home, as well as for individuals' decisions to participate in the labor market, including access to remittances among other determinants.l7Results are presented intable 8. Confirming previous evidence, our results suggest that in all the 10 countries for which data i s available, remittances have the effect o f reducing the number o f hours worked per week. This negative effect is generally present in both urban and rural areas and for both males and females - even if in a differingdegree depending on the country. Similar results are obtained for the impact o f remittances on labor force participation, with the main exceptions o f Guatemala, and urban areas in Mexico, Honduras, and the Dominican Republic, where that effect becomes non-significant. Moreover, inboth Paraguay and Haiti, females living inurban areas are found to be more likely to participate in the labor force when receiving remittances, suggesting that the latter may be having a social disruption type o f effect that in those cases dominates possible reductions inreservationwages. "Inthecaseofhoursweemploya"tobit" specificationthattakesintoaccountthefactthatmanyindividualsdonot participate inthe labor market and thus report zero worked hours.Inthe case of the labor participation decisionwe employa"probit" modelwhich controlsfor the possibleendogeneityofremittancesusinginstrumentalvariables. 41 and pation, anc could arguc that 42 Table 8. Access to Remittanct HoursWorked and Labor Force Particbation. 20-59 ars Old 20-59 irs Old Hours WOI d last week Labor Force articipation Isample Rural Urban Rural Urban Males Females Males Females Males Females Males Females Mexico 15.473*** -13.187** .12.686*** -7.561*** .0.329*** -0.245*** -0.097 0.023 (I,022) (I,979) (1.473) (2,175) (0.048) (0.049) (0.135) (0.146) El Salvador -4.498*** -12.257** -5.546*** -8.580*** -0.087 -0.598*** -0.032 -0.309*** (0.986) (2.089) (0.847) (1.115) (0.070) (0.083) (0.101) (0.100) Guatemala -0.969 -15.253** -6.180*** -7.228*** 0.007 -0.095 -0.228 -0.261 (1.426) (3.418) (1.601) (2.427) (0,170) (0.221) (0.140) (0.206) Honduras -3.052*** -12.813** -6.307 *** -10.067**' -0.006 -0.135** -0.096 -0.095 (0.704) (2.046) (0.816) (1.152) (0.068) (0.067) (0.094) (0.095) Ecuador -2.186* -4.399** -3.391 *** -5.622*** -0.228** -0.154* -0.310** 0.211 (I,264) (I,723) (1.117) (1.621) (0.090) (0.085) (0.134) (0.203) Paraguay -15.395** -5.583 10.865 7.506 -0.009 0.052 -0.530* 0.908** (7.247) (13.027) (11.680) (10.789) (0.092) (0.174) (0,321) (0.380) Haiti -8.410*** -2.925 -1.221 2.308 0.254 0.338** 0.114** 0.263*** (2.831) (3.069) (1.170) (1.412) (0.164) (0.165) (0.051) (0.088) Peru -12.711*** -7.455*** -0.334*** -0.284** (1.870) (2.306) (0.099) (0.123) Nicaragua -3.096 -0.701 -7.216*** -7.776*** -0.181* 0.337 -0.211* -0.008 (I,889) (5.208) (1.643) (2.134) (0.099) (0.208) (0,127) (0.140) Jamaica NIA NIA NIA NIA -0.047 -0.027 -0.128** -0.056 (0.051) (0.051) (0.064) (0.061) Dominican Republic -5.278*** -8.844**' -7.240*** -10.245**' -0.222** -0.010 -0.108 -0.131 1.301 2.828 1.031 1.514 (0.092) (0,126) (0.071) (0.082) Notes: * *** Significant a % level. ** Significar It 5% level. Significant at 10% lev Source: Author's calculations based on household surveys The data for other countries Erom the region, however, does not overwhelmingly support the above finding. Indeed, in 6 out 11 countries self-employment i s more common among non- recipients, and so i s business ownership in 5 out o f 11 countries. Moreover, when comparing the incidence o f self-employment and business ownership in a regression framework that controls for other personal and household characteristics (table 9), we find that remittances are significantly and positively associated with self-employment in only 6 out o f 11 countries (El Salvador, Guatemala, Honduras, Ecuador, Paraguay and the Dominican Republic). Moreover, in the cases o f Jamaica and Haiti a negative relationship is suggested by the data. As for the effects on business ownership, our estimates suggest positive and significant effects in only four cases: Mexico, El Salvador, Honduras and Peru. We also investigate whether the probability that remittance recipient households engage in entrepreneurial activities varies with income. The results, reported in table 9, suggest that remittances tend to have a positive effect on the probability o f individuals from poor households -located inthe first income quintile -beingbusiness owners. However, this effect becomes increasingly smaller as one moves up in the income distribution, a pattern that i s most clear in 43 the cases o f Mexico, El Salvador, Honduras, and Ecuador. In contrast, for the case o f self- employment, the probability that a remittances recipient from the first quintile engages in that activity is actually smaller than for non-recipients in 6 out o f 11 countries - significantly so in 3 -buttheeffectofremittancesincreaseswithincomeandeventuallybecomespositiveforthetop quintiles. Overall, our results tendto confirm that access to remittances may positively affect the incentives for entrepreneurship in most income quintiles, with a larger effect on business ownership among individuals from poorer households, and a larger effect on self-employment in middle to highincome households. Table 9. Remittancesand Entrepreneurship,by Income Quintile. Mexico Remittances 0.088" 0.048** Remittances -0.268 NIA Remittances'Q2 0.088' -0.01I Remittances'Q2 0.291 Remittances'Q3 -0.038 -0.010 Remittances*Q3 0.274 Remittances'Q4 -0.026 -0.0 I9** Remittances'Q4 0,306 Remittances'Q5 0.148'' -0.020' Remittances'Q5 0.368 El Salvador Remittances -0.056*** 0.092'" Paraguay Remittances -0.005 0.071 Remittances'Q2 0.095"' -0.012 Reminances*Q2 -0.012 -0.0I8 Remittances'Q3 0.071*' -0.020 Remittances'Q3 0.063 -0.029" Remittances'Q4 0.081'" -0.041 *** Reminances'Q4 0.121 -0.030" Remittances'QS 0.115*** -0.050"' Remittances'Q5 0.163 -0.020 Guatemala Remittances 0.091 0.034 Nicaragua Remittances 0.121 0.048 Remittances'QZ 0.050 -0.03I Remittances*Q2 -0.092 -0.007 Remittances'Q3 0.007 -0.013 Remittances'Q3 -0.061 -0.017 Remittances'Q4 -0.026 -0.028 RemittanceslQ4 -0.I02 -0.006 Remittances'QS 0.012 -0.039 Remittances'Q5 -0.095 -0.066 Honduras Remittances -0.033 0.119**' Jamaica Remittances -0.081'' NIA Remittances'Q2 0.077 -0.020 Remittances'Q2 0.063 Remittances'Q3 0.058 -0.037" Remittances'Q3 0.028 Remittances'Q4 0.090' -0.05I"' Remittances'Q4 0.057 Remittances'QS 0.054 -0.062"' Reminances'Q5 0.113 Ecuador Remittances -0.064 0.113*'* Dominican Rep Remittances 0.082 0,005 Remittances'QZ 0.142'' -0.046'" Reminances'Q2 -0.018 -0.013 Remittances'Q3 0.139'. -0.042'*' Remittances'Q3 0.009 0.007 Remittances'Q4 0.079 -0.034'* Remittances'Q4 -0.065 -0.001 Remittances'QS 0.110' -0,048'" Remittances'Q5 -0.084 -0,008 Haiti Remittances -0.065' -0,002 Notes:***Significant at I% level Significant at 5% level. Remittances'Q2 0.018 0.023 Remittances'Q3 0.053 -0.007 Remittances'Q4 0.007 -0.006 Remittances'QS 0.047 -0.009 Source: Author's calc ations basedon household surveys XII. REMITTANCES AND FINANCIAL SECTORDEVELOPMENT Whether and how remittances might affect financial development i s a priori unclear. The notion that remittances can lead to financial development in developing countries i s based on the concept that money transferred through financial institutions paves the way for recipients to demand and gain access to other financial products and services, which they might not have otherwise (Orozco, 2005). At the same time, providing remittance transfer services allows banks to "get to know" and reach out to "unbanked" recipients. Moreover, even if higher bank lending to remittance recipients does not materialize, overall credit in the economy might increase if banks' loanabie funds surge as a result o fdeposits linked to remittance flows. 44 On the other hand, because remittances can help relax individuals' financing constraints, they might lead to a lower demand for credit and have a dampening effect on credit market development. Also, a rise inremittances might not translate itself into an increase incredit to the private sector if these flows are instead channeled to finance the government. Finally, remittances might not increase bank deposits if they are immediately consumed or if remittance recipients distrust financial institutions and prefer other ways to save these flows Recent accounts o f financial institutions' attempts to "bank" remittance recipients - by lowering remittance fees and by offering specially designed products - suggest that financial institutions perceive the likely impact o f remittances on financial development to be positive.l8 However, empirical research on the impact o f remittances on financial development i s largely lacking. One exception is a recently completed study by Aggarwal, Demirgiiq-Kunt, and Martinez Peria, (2005), which using aggregate BOP data for a large sample o f developing countries uncovers a positive relationship between remittances and financial development. Chapter 5 complements that study by investigating the association between remittances and financial development inthe specific case o f Latin America, usingboth at macro and micro level data and techniques. Macroeconomic Evidence As a first approximation, Table 10 shows country by country correlations between remittances and two measures o f financial development, namely bank deposits and bank credit to the private sector as a share o f GDP.I9 The results indicate that for 16 countries out o f 25 countries in the region there i s a positive and significant association between financial development and remittances. On the other hand, for Belize, Dominica, St. Kitts, St. Lucia, and St. Vincent we observe a negative correlation between remittances and both measures o f financial development, and no clear macro-level relationship appears to exist between those variables for Argentina, Mexico, Haiti and Panama. While these correlations are helpful in describing the association between remittances and financial development, a more rigorous empirical approach i s required to obtain a more definitive answer regarding the link between these variables. In particular, it is important to control for other factors that might affect both remittances and financial development and to correct for potential endogeneity biases that might arise as a result o f measurement error, reverse causation, and omitted country characteristics. To this end, chapter 5 models the relationship between remittances and financial development using a large panel o f developing countries and allowing for the relationship between remittances and financial development to be different for countries inthe region vis-&vis other developing countries. T ''See Orozco and Fedewa (2005) for a summary of recent efforts by banks in Latin America to convert remittance recipients into bank clients. Bank deposits include all demand, savings, and time deposits held at deposit money banks as reported in the IMF's International Financial Statistics. Bank credit refers to claims on the private sector held by deposit money banks. These numbers also come from the IMF's International Financial Statistics. 45 ant impact on bothhank dcposits and f pcrccntagc point i a 5 ~~~~~~~#~~ pairtt cxpcctcd sigri. Amang LAC GDP. Table 10. 46 F hand, among LACS I. 18 is3 [I<8S]* -I5.428 11.631 -12.S7ft [0.73] -1 5.582 4.6 15 801 -0 001 [0.77] -3.5 [f .O4] -B.QJZ [ 1.?(I]- ;I011 RemittancesLAC16 3.134 1.754 3.456 1.725 HO:Remittancesfor LACl6=O 3.19 1.38 5.21 2.52 P-Value 0.07 0.12 0.02 0.1I Remittances LAC5 -13.531 7.751 -14.826 5.577 HO: Remittancesfor LACS=() I.22 0.31 I.98 0.1 I P-Vaiuc 0.27 0.58 0.16 0.74 RcmittanccsLAC4 2.116 1.507 2.375 2.571 HO:Reinittanccsfor L.4C4=0 3.71 1.6 5.03 3.27 P-Value 0.I 0.21 0.03 0.07 O l x n ~ m i ~ ~ 1 IS(? 910 I l l 5 9 Iv 47 be less likely to use financial institutions because o f greater distrust o f these institutions relative to recipients in other countries, possibly because crises have been more recurrent and severe in Latin America. Second, the impact o f remittances on financial development in Latin America might be smaller if remittance recipients in these countries are less likely to receive remittances via banks -which is indeedthe case inLatinAmerica, as suggestedby surveysofremittances senders performed by the IDB (see chapter 9). Third, remittances might not spur as much deposits or credit growth inLatinAmerica ifaccess to physical banking outlets i s more limited inthis region than inother countries. Data collected by Beck, Demirguc-Kunt, and Martinez Peria (2005) show that the number o f branches per area in Latin America i s the lowest among all regions, suggestingthat perhaps distance to the nearest branch i s an obstacle for remittance recipients to demand and use financial services inLatinAmerica. Fourth, the impact o f remittances on financial development in Latin America might be smaller than that observed for other countries if the costs o f banking are larger in the region. Recently, collected data from Beck, Demirguc-Kunt, and Martinez Peria (2006) suggest that the costs o f maintaining a bank account and the fees associated with loans are higher in Latin America than in most countries with the exception o f some in South East Asia and in Africa. Finally, even if the supply o f loanable funds increases with remittances, credit might not rise in Latin America due to weak creditor protection and poor contract enforcement. Legal rights rankings and statistics on the number o f days to enforce a contract from the World Bank's Doing Business (2005) dataset reveal that Latin America ranks below all other regions along these dimensions. Microeconomic Evidence While it i s useful to investigate the relation between remittances and financial development using macro-level data, as discussed in chapter 3 cross country analysis have important limitations. In what follows we use household-level survey data to investigate the association between remittances and financial development, equating the latter with greater use o f financial services. Thus, we first use data from 19 surveys conducted inthe 11LatinAmerican countries - Bolivia, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Jamaica, Nicaragua, Peru, and Suriname - to investigate whether the use o f financial services differs between households that receive remittances and those that do not. We find that the proportion o f households with bank accounts for remittance recipients exceeds that for non-recipients in 11 out the 13 surveys for which deposit information i s available. However, these differences are statistically significant in only 5 surveys and 4 countries. In the case o f the proportion o f households that receive credit, we find that ratios are higher among remittance recipients in9 out o f 16 surveys. Differences are statistically significant in the right direction in only four cases. Finally, the proportion o f remittance recipient households with credit outstanding from non-bank sources exceeds that for non-recipients in 7 out o f the 12 surveys. However, these differences are only significant inone case. 48 All in all, household level data provides some evidence consistent with the hypothesis that the use o f financial services i s more prevalent among remittance recipient households. This i s particularly the case for deposit holdings and less so for credit. However, this evidence needs to be taken with a grain o f salt for at least two important reasons. First, the tests conducted do not control for other households characteristics that might account for differences in the use of financial services. Second, these simple statistics suggest a correlation between remittances and the use o f financial services, but are inno way proof o f causality. To mitigate at least the first problem, we use household survey data from three countries which have been analyzed elsewhere in the report - Guatemala, Haiti and the Dominican Republic - to estimate simple "probit" models o f the probability o f having deposit accounts, outstanding bank credit and non-bank credit, controlling for household income and other household characteristics - i.e. age o f the household head, educational attainment o f adults, household size and composition, urban status o f the locality and province "dummy" variables. The estimates for the impact o f remittances are shown in table 12, which also reports the coefficients o f variables representing the 2ndthrough 5th quintiles o f the income distribution - using counterfactual pre-migration incomes estimated in chapter 3. In the three countries the results show that, as expected, the probability o f having deposit accounts increases monotonically with income, and so does the likelihood o f having outstanding bank credit - except in the case o f Guatemala. Moreover, within given income quintiles, households with access to remittances are significantly more likely to report deposit accounts. However, at least in Haiti and the Dominican Republic, recipients are also less likely to have bank and non-bank outstanding credit. Table 12. Remittances and Access to FinancialServices in Guatemala, Haiti and the Country Guatemala DominicanRepublic Haiti Dependent Bank Bank Non-Bank Bank Bank Non-Bank Bank Bank Non-Bank Variable Deposits Credit Credit Deposits Credit Credit Deposits Credit Credit Remittances 0.114"' -0.011 0.013 0.078*** -0.022*** -0.012 0.055*** -0.001** -0.022*** (0.020) (0,009) (0.018) (0.01I) (0.007) (0.008) (0.008) (0.000) (0.007) Counterfactual Income Quintiles Q2 -0.016 -0.022*** 0.016 0.084*** 0.017 0.029*** 0.036*** -0.001 0.018* (0.016) (0.007) (0,016) (0.019) (0,012) (0.01I) (0.015) (0.001) (0.012) 4 3 0.033' -0.012 0.022 0.160*** 0.074*** 0.032*** 0.040*** 0.001 0.024" (0.018) (0.008) (0.017) (0.020) (0.015) (0.012) (0.015) (0.001) (0.0 12) Q4 0.116*** -0.014 0.020 0.235*** 0.090*** 0.033*** 0.075"' 0.001 0.047*** (0.021) (0.008) (0,018) (0.022) (0.016) (0.013) (0.019) (0.001) (0.014) Q5 0.238*** 0.018' 0.008 0.378*** 0.142." 0.008 0.194*** 0.005*** 0.040*** (0.028) (0.011) (0.020) (0.024) (0.019) (0.013) (0.030) (0.003) (0.0 16) An additional more detailed analysis of the relationship between remittances and the use o f financial services i s performed usingdatasets from El Salvador and Mexico which allow us to control not only for household and local characteristics that might influence the use o f financial services, but also for the possibility that remittances might be endogenous - through the use of instrumental variables estimation. 49 Inthe case o fElSalvador, we use data from anationally representativeruralpanel survey conducted by the Fundaci6n Salvadoreiia para e l Desarrollo Econ6mico y Social (FUSADES), and the Rural Finance Program at the Ohio State University. Our estimations indicate consistently that households that receive remittances have a higher likelihood (between 0.12 and 0.16 percentage points higher) o f owning a deposit account regardless o f which household characteristics we control for and independently o f whether we focus on households that appear inat least two or inall four ofthe rounds ofthe survey. To investigate whether remittance recipients are more likely to use bank credit we distinguish between the likelihood o f applying for a loan during the survey period and the probability o f having outstanding credit. Consistently across all estimations, we find that the likelihood o f having outstanding bank debt does not seem to be affected by whether households receive remittances. The dummy for whether the household receives remittances i s always insignificant. This i s also true if we focus on non-bank credit instead, or on the likelihood o f applying for a bank loan. What role does the way in which remittances are received play in the results reported so far? The surveys for El Salvador contain information as to whether remittances are received via banks, money transfer operators, relatives, etc for two years: 1999, 2001. We thus estimates the effect o f remittances on the probability o f having bank accounts, having outstanding credit, and soliciting loans allowing for that effect to be different for those who received them through the banking sector. The results show that the likelihood that remittance recipients have bank accounts i s twice as large if remittances are channeled through the banking sector. On the other hand, no such effect i s present on the credit side. A second detailed case study i s performed for Mexico, which i s Latin America's largest recipient o f remittances in dollar terms. The potential for remittances to impact financial development is perhaps largest inthis country. Indeed, though remittances are 2 percent o f GDP, they amount to approximately 10 percent o f banking sector deposits and credit. Also, in recent years both Mexican and foreign banks have taken steps to enter the remittance business and to cross-sell products to remittance senders and recipients, a move that if successful should be reflected ingreater financial development.*' To analyze the relationship between remittances and financial development for the case o f Mexico, we combined information from the 2000 Mexican Census on the share o f households across Mexican municipalities that receive remittances with municipal level information from the Comisi6n Nacional Bancaria y de Valores (CNBV) on the size o f the commercial banking sector, and use o f their services across municipalities. As reported in table 13 after controlling for other municipal level characteristics that might affect financial development - e.g. GDP per capita and the share o fthe populationinrural localities - and controlling for the potential endogeneity o f remittances, we find that municipalities where a larger percentage o f the population receives remittances also tend to have higherratios o f deposit accounts per capita, larger deposit amounts to GDP, and a higher number o f branches per capita. However, contrary to the findings on deposits and branches, there does See Hernandez-Coss (2004) and Orozco (2004) for a description o f efforts by US. banks to penetrate the remittance business to Latin America. 50 not appear to be a significant association between remittances and credit to GDP across municipalities. Table 13. Remittances and FinancialDevelopmenta ross MexicanMunicipalities. Distanceand rainfalldeviation usedas I V s Distance and rainfall deviation usedas I V s (municipalities where distance >40 miles) (municipalities where distance >50 miles) Bank Bank Bank Deposits Accounts Branches Credit D:;:jts Accounts Branches Credit HouseholdsReceiving Remittances 3.0034 2.2426 0.0146 0.0003 0.0032 2.2702 0.0143 0.0003 :2.74]*** [1.91]* [2.57]** [0.79] [2.50]** [1.72]* [2.42]** [0.78] GDP Per Capita D.0064 10.1437 0.0545 0.0024 0.0069 9.3608 0.0526 0.0026 [3.61]*** [6.41]*** [6.12]*** [5.28]*** [4.08]*** [6.26]*** [6.55]*** [5.43]*** Rural Localities -0.0007 -0.5913 -0.0025 -0.0001 -0.0006 -0.5575 -0.0023 - 0.0001 [4.15]*** [3.44]*** [3.50]*** [2.62]*** [4.17]*** [3.38]*** [3.59]*** [2.441** Constant 0.0408 26.8182 0.0609 0.0021 0.0362 24.652 0.0459 0.0005 [2.09]** [1.61] [0.78] tO.621 [1.96]** [1.59] [0.66] [0.16] Observations 1772 1873 1765 1862 1656 1746 1648 1738 Adj. R-squared 0.16 0.2 0.24 0.1 1 0.15 0.19 0.21 0.12 First Stage F-Statistic 52.07 57.32 51.23 57.07 46.45 48.91 45.32 49.82 Test of Overidentifying Restrictions 0.06 0.95 0.95 0.00 0.22 1.12 1.33 0.00 P-Value 0.81 0.33 0.33 0.99 0.64 0.29 0.25 0.99 IV estimates of the impact of the percentage of households receiving remittances on financial development in Mexico. Robust t-statistics are shown from estimations where standard errors are clustered by Mexican state. *, **, *** denotes significance at 10, 5, and 1 percent. Source: Author's calculations. XIII. REMITTANCESAND THE REALEXCHANGERATE: ARE THERE DUTCHDISEASEEFFECTS? So far we have been arguing that the more remittances a country receives, the higher its welfare level. Yet, Chapter 6 notes that flows that are too large relative to the size o f the receiving economies may also bring a number o f undesiredproblems. Among those probably the most feared inthis context is the Dutch Disease and its rational would be as follows. Given that remittances have a positive impact on the incomes o f receiving households, they will also tend to positively affect consumption. To the extent that some o f this consumption i s directed towards the non tradable sector where competition i s likely to be somewhat limited, remittances will tend to drive up the price o f non tradable goods relative to that o f tradables and therefore contribute to a real exchange rate appreciation. Inturn, there are a number o f additional macroeconomic effects that can result from a real exchange rate appreciation associated to remittances flows. They include the following: (i)adverse effects on the tradable sector o f the economy; (ii)widening of the current account deficit; And (iii)weaker monetary control, inflationary pressures, and sectoral misallocation o f investment. That is, there are a number o f potential challenges that inprinciple may be associated to a surge inworkers' remittances. So, how does the data look and what does the empirical literature 51 has to say about the evolution o f the exchange rate in countries that have experienced important increases o f remittances? Figure 14 compares the evolution o f the real exchange rate to the evolution o f remittances (as a share o f GDP) over the 2000-2003 period for the 8 Latin American countries with the largest remittances to GDP ratio. Inspection o f this figure indicates that in most o f the countries underanalysis it is possible to observe a real exchange rate appreciation inparallel to an increase inthe remittances to GDP ratio. The only apparent exception to this rule would be Nicaragua where the evolutiono f the real exchange rate over the early 1990s and 2000s appears to move in the opposite direction to what one could expect. Figure 14. Remittances and the real exchange rate. Dominican Republic Ecuador 14 12 1.6 10 4.8 8 4.7 1 5 6 t:4'a@ 1 5 4 4.4 1.5 2 t:3 w 0 1.5 4 1 n B H E I E f & f B W W W W w A II B 6 g P I E! f & f !! 84 Remittances/GDP --CREER I I1 ElSalvador Guatemala 17 A 0 10 8 : I: 0 1 d R e m i t t a n c e s / G D P --CREER I I Haiti Honduras 1 50 7 I5.2 1 14 I I 5.1 I I--CRcmittances/GDP --CREER --CRemittanceslGDP +REER Jamaica Nicaragua 20 5 B ::lj 4.8 4 8 4 7 ' 8 1:P: 12 I I 4.7 @ 4.6 3 4.7'a 4 5 2 n A A 3 0 4 6 4 6 # P E E ! I & f B W B W W 1--CRemittancedGDP -CRFER 1 1 --CRemittances/GDP --CREER I 52 D o these tendencies in the evolution o f the exchange have affected the external competitiveness o f the countries? Apparently they have. In fact, chapter 6 also presents comparisons o f the evolution o f exports and imports o f good and services and the real exchange rate for those countries. They indicates that the only countries where export volumes have significantly increased over the 1990-2003 period are El Salvador, a country where exports increased from about 19 percent o f GDP in 1990 to close to 30 percent in 2003, and Ecuador where exports increased by almost 20 percentage points to close to 55 percent of GDP. In Honduras, and Nicaragua export volumes would have been more or less stable over this period oscillating between 30 and 40 percent o f GDP in the case o f Honduras and hovering around 25 percent in the case o f Nicaragua (although with a large variance). In the rest o f the countries under analysis, we observe declines in export volumes which in some cases have been quite dramatic. For example, in Guatemala and Jamaica export volumes have fallen over the period under analysis by about 10 percentage points o f GDP. Instead, on the imports front, there is only 1 country where the imports to GDP ratio fell over the period under analysis: Ecuador. Inthe remaining 7 countries imports increased. True in some countries like Guatemala, Jamaica and Nicaragua only slightly (by less than 10 percentage points o f GDP), but in the cases o f Honduras and Haiti the increase has been quite marked 15 percentage points o f GDP inHonduras and close to 30 percentage points o f GDP in Haiti. More importantly, chapter 6 presents econometric evidence that would support the idea that the relationship between higher remittances and the evolution o f the real exchange rate may be in addition to casual also causal. That is, the empirical evidence presented in the report indicates that, at least in the Latin American context, remittances may indeed lead to real exchange rate appreciations: depending on the specification o f the model and the estimation method, a doubling o f remittances would lead on average to a real exchange rate appreciation o f between3 and 24 percent. Ofthis impact, it is estimated that between 1and 12 percent (or about half o f the estimated appreciation associated to a surge in remittances) would be consistent with the evolution o f economic hndamentals while the rest would be related to transitory factors or temporary overvaluations. This i s important because as the estimates presented in Chapter 3 indicate, an overvalued real exchange rate tends to reduce growth prospects so that to the extent that this overvaluation can be reduced policy makers can enhance the development impact o f remittances. Against this background a natural question that arises i s what Latin American policy makers can do about that real appreciation and therefore about the potential loses in international competitiveness that may come with large remittance flows to the region. We now discuss these issues. 0 Rein in fiscal policy. Fiscal restraint is probably one o f the only tools that governments have to prevent an overheating o f the economy, and avoid a real exchange rate appreciation inthe context o f a surge in international workers' remittances. Beyond the theoretical reasoning in support o f this tool, the estimates presented in Chapter 6 indicate that increases in the government consumption to GDP ratio would be associated with real appreciations. Yet, those estimates also indicate that the impact o f that variable on the real exchange rate tends to be much lower than the impact o f remittances. In other words, the adjustment needed to 53 stabilize the real exchange rate may be quite large and therefore constrained by political economy considerations. 0 Avoid sterilization. One natural question in this context i s the extent to which countries should try to sterilize the remittances inflows, Yet, sterilizing operations but may prove infeasible if needed on a sustained basis for two main reasons. First, the magnitude o f the remittances would make the quasi-fiscal costs o f sterilizing these flows untenable. Large remittances inflows coupled with Latin American spreads that for the ten top receiving countries range from 141 bp in Mexico to almost 300 bp in Jamaica would in fact make this alternative extremely expensive (to the point that even assuming no pressure on the domestic interest rate, in a number o f countries the cost o f sterilizing the inflows in full would be measured intenths o f percentage points). Second, sterilization would possible put pressure on the domestic interest rates something that may attract other type o f inflows in search o f high returns and this in turn would put more pressure on the exchange rate. In this regard, if sterilization i s implemented without fiscal adjustment, (i.e. tight money plus loose fiscal) it would not be unlikely to observe a further appreciation. 0 Explore microeconomic interventions. Although the thrust o f responses to surges on capital inflows o f any type (including remittances) may be expected to be inthe macro policy arena, there are a number o f microeconomic interventions that governments can implemented. The discussions in Chapter 6 suggest that rigidities in labor and product markets could contribute to a real appreciation on the basis o f Balassa-Samuelson arguments. Thus efforts aimed at making domestic markets more efficient and more flexible could also ease exchange rate pressures. More generally, microeconomic interventions that make the economy more competitive could somewhat offset the real exchange rate pressures. 0 Finallv, accept some appreciation. Taking together all the elements and to the extent that fiscal adjustment and microeconomic interventions may not be enough to correct the upward pressures inthe real exchange rate, it i s possible that Latin American policy makers will have to accept some real appreciation, especially inthose countries with substantial flows. XIV. CAN FISCAL POLICY HELP TO MITIGATE SOME OF THE POTENTIAL NEGATIVE IMPACTS OF REMITTANCES? Inthe previous section we have argued that policy makers concerned with the potential negative impact that a surge o f remittances may have on the real exchange rate could, as a first step, rein in fiscal policy. Similarly, we have also argued for additional microeconomic interventions aimed at increasing the competitiveness o f the economy. Clearly, fulfilling both o f these objectives may be difficult if policy makers rely just on the spending side o f the budget to raise public savings. In fact, it might appear somewhat inconsistent to argue on the one hand for less spending to improve the fiscal stance and on the other hand, for more spending to finance the advocatedmicroeconomic interventions. Several considerations have to be taken into account in this context. First, for a given taxation structure the increase in national income associated to a surge in remittances would 54 ceteris paribus result in higher tax collection. Thus, it is possible that even without altering tax rates there would be some extra fiscal space to address, at least in part, new investment needs. However, to the extent that as national income increases countries wish to also increase spending in other priority areas, finding the required space to finance competitiveness enhancing interventions i s likely to require additional tax effort.21 Second, countries should try to avoid taxes on incoming remittances22for at least two main reasons: (i) this type of actions would likely discourage the formalization o f remittances flows; and (ii)directly taxing remittances would conflict with one o f the general recommendations o f chapter 9, namely making efforts aimed at reducing the costs o f sending remittances. Third, even in those cases where policy makers facing a surge in remittances do not consider raisingfiscal revenue a priority, it i s possible that they experience some competitiveness gains by shifting from payroll taxes to VAT or sales taxes. Infact, as documented inChapter 4 o f the report (see also section XI above) remittances appear to have a negative impact on labor supply, something that inturn may exacerbate the real exchange rate appreciation and the loss in competitiveness o f the economy (Chapter 8). Thus one way to mitigate this effect would be through a reduction o f payroll taxes23that increase the demand for labor. Evidence in Bussolo and Medvedev (2006) for Jamaica, indicates that such a policy, accompanied by a compensatory increase in VAT rates, can maintain the government balance unchanged and sterilize most o f the negative labor supply effect o f risingremittances. XV. PRIVATEAND PUBLIC TRANSFERS: I S THERE CROWDINGOUT? Conditional Cash Transfer (CCT) programs have become an important anti poverty tool in many Latin American countries. They currently reach 60 million people representing approximately 60 percent o f the extremely poor in Latin America (Lindert, Skoufias and Shapiro, 2005). In Mexico and Brazil alone, OPORTUNIDADES and Bolsa Familia take approximately 0.4 percent o f these countries' GDP. To some extent, the popularity o f these programs is well justified. As argued by Lindert, Skoufias and Shapiro (2005) cash transfer programs tend to be well targeted and have strong performance in terms o f their marginal contribution to social welfare outranking not only social insurance schemes but also social assistance programs, Olinto (2004), on the other hand, reports that impact evaluations o f conditional cash transfers in Mexico, Brazil, Honduras, and Colombia indicate that these programs have had large impacts on transition rates and secondary enrollment (specially for girls) and indelaying dropout. However, could it be the case that CCTs crowd out private transfers, particularly remittances, which in addition to representing an important source o f foreign exchange for most countries in Latin America have also a significant effect on poverty (Chapter 3)? Inother words, 2'This would be particularlyimportant insome of the CentralAmerican countries, like El Salvadorand Guatemala, where fiscal revenues are very low and where some entities have a legal right to receive a fixed proportion of the budget. 22Today, most remittance-receivingcountries do not impose explicit taxes on incomingremittances, althoughthere are some cases of implicit taxation inthe form of financial services taxes. 23Notehowever, that this is not the only way of increasinglabor market flexibility andultimatelyhelpboost labor demand. 55 could it be that what is gained from an expansion o f CCTs is lost from a contraction in remittances? The idea that public spending may crowd out private spending i s not new in the economics literature. Martin Bailey (1971) first proposed that a unit o f public consumption would likely be valued as much as q units o f private consumption. That is, public and private consumption are imperfect substitutes, so that increases in the former will be accompanied by declines, at least partial, in the latter. Similarly, there is also ample literature analyzing both theoretically and empirically whether public investment substitutes or complements for private investment. Note also that these issues are o f more than an academic interest. In fact, the following paragraph, taken from a recent paper by Attanasio and Rios-Rull (2001) suggests that it i s also concern to policy makers, at least to some policy makers dealing with World Bank operational staff: "In a recent meeting between a World Bank oflcial and a finance minister from a developing country in which theprovision of an income support scheme or safety net was being discussed the minister opposed strongly such scheme. When questioned by the World Bank oflcial about the reason for his opposition, the minister's reply indicated the worry that such schemes couldjeopardize the existence of the support network provided by extendedfamilies. In thispaper, we consider a model thatjustiJies these worries". Theoretical concern has been compounded by the results o f a number o f recent studies that somewhat suggest some degree o f substation between public and private transfers. For example, Schoeni (1996) finds that private assistance in the form o f both cash and time-help were crowded out by Aid to Families with Dependent Children (AFDC) benefits in the United States. Also, Schoeni (2002) concludes that unemployment insurance crowds out interfamilial transfers. Likewise, Cutler and Gruber (1996) find that the extension o f Medicaid to pregnant women and children in the US crowds out private insurance coverage. Cox, Eser, and Jimenez (1998) also find that social security benefits 'crowd out' the incidence o f private transfers in Peru. More recently, evidence specific for CCT from studies utilizing experimental data provides more mixed results. Attanasio and Rios-Rull (2001) find some weak evidence supporting the crowing out hypothesis for PROGRESA which was implemented in randomly selected communities. Yet, on the other hand, ina more thorough analysis employing two rounds o f the PROGRESA evaluation data, Teruel and Davis (2000) more convincingly reject the crowding out impact o f PROGRESA on private transfers. Chapter 7 o f the report adds to this literature by exploiting experimental data from the evaluations o f two CCTs in Central America, the Red de Proteccion Social in Nicaragua, and PRAF-I1 in Honduras, to assess the link between the access to Conditional Cash Transfers and the incidence and volume o f private transfers. That is, Chapter 7 questions the extent to which CCTs crowd out private transfers, at least in the Honduran and Nicaraguan context. The findings o f the chapter are inline with those o f Teruel and Davis (2000) for PROGRESA. That is, we find no evidence that CCTs crowd out private inter-household transfers in either Nicaragua or Honduras. These results should help dispel concerns that CCTs could be displacing private 56 networks and informal insurance schemes and therefore add little to the utility o f the recipient parties. There are a number o f potential reasons for this finding, which we have to admit somewhat contradicts previous findings in the literature. One i s the typical good targeting o f CCTs. As noted above, CCTs tend to be usually well targeted towards the most vulnerable and those are less likely to be receiving private transfers in the first place. This is confirmed by the low incidence o f transfers in Nicaragua, but not in Honduras. In the case o f Honduras, nevertheless, it i s possible that the amounts given out by PRAF are too low to actually have any crowding out effects on private transfers. As discussed in Glewwe and Olinto (2004) PRAF transfers amount on average to only 4 percent o f household annual expenditures, while other CCTs like Progresa, or Bolsa Familia range from 15 to 20 percent o f household expenditures (Lindert, Skoufias and Shapiro, 2006). Thus, as long as transferred amounts continue to be small, and programs are be well targeted to those who are more likely to be poor (and therefore less likely to receive remittances), CCTs are unlikely to crowd out private remittances and other forms o f private insurance. XVI. POLICY COMPLEMENTARITIES: WHAT CAN POLICY MAKERS DO TO ENHANCE THE DEVELOPMENT IMPACT OF REMITTANCES? One typical concern that development practitioners have with studies on the topic o f workers' remittances i s that while these type studies tend to typically present very good descriptions o f the nature (Le. magnitude, origin, profile o f recipients, etc) and impact (i.e. poverty, growth, financial sector, etc) o f these inflows, inmany cases they are not very useful to articulate clear policy recommendations beyond suggesting (either implicitly or explicitly) that countries should try to implement policies that reduce the actual cost o f transferring international funds or improve the payments system. That is, inmany cases the mainrecommendation o f these studies i s that policy makers should aim at facilitating and increasing those flows. And infact we have to admit that the concernmentioned inthe previous paragraph is to a large extent understandable because being remittances a transfer between private parties it i s difficult to imagine which type o f policies governments should follow to enhance their positive impact. For example, if recipients and senders jointly decide that given the country's existing economic environment and their specific personal situation, remittances should be directed towards consumption rather than towards saving or investment (a typical concern o f policy makers in recipient countries), then it i s difficult to imagine which type o f direct policy interventions may induce these individuals to do otherwise other than forcing recipients to save, as a number o f African countries (such as Lesotho or Mozambique) and Latin American (Mexico in the 1940s) have done in the past. And indeed this is probably the type of policy recommendation to avoid because as argued by Maimbo and Ratha (2005) forcing remittance recipients to save more and consume less tends to reduce consumer welfare. Yet, this i s not to say that governments cannot do anything to increase the development impact o f remittances especially if we open the door to consider indirect policy interventions; that is, policies that try to change the incentives o f remittances recipients to use their resources in 57 one or another way. For example, as noted by Burnside and Dollar (2002) the impact o f aid flows on the growth rate o f the recipient economy will depend on whether that particular transfer i s invested or consumed. Whenever the income transfer i s invested it will positively affect growth whereas if consumed it will have no impact. Inturn, the incentive to invest and its subsequent productivity will depend on the policy environment. Good policy environments will increase the return o f investment and hence will raise the opportunity cost o f consumption. On the contrary, a bad policy environment will drive down the return o f investment (or increase the risk associated to a given return) and lower the opportunity cost o f consumption. Put in other words, in the context o f this simple model the impact o f the international transfer on the growth rate will depend on the policies being implementedby the country. Policy makers therefore can potentially affect the impact that an international income transfer has on growth by introducing appropriate changes to the policy environment. Chapter 8 explores these issues from an empirical point o f view following a similar approach to the one in Burnside and Dollar (2000) but focusing on whether there may be complementarities between a surge o f remittances (rather than aid), which are treated as an exogenous factor for policy makers, and the implementation o f policies in a number o f areas. That is, unlike in chapter 3 where the report explores whether in general remittances tend to accelerate growth rates, the concern o f Chapter 8 is whether developing countries could benefit from an "extra bonus" in terms o f growth when remittances are accompanied by progress on a number o f policy areas. Inother words, the concern is whether remittances together with good policies are likely to result inmore growth than remittances and good policies by themselves. And indeed the results presented in the report indicate that policy makers have room to maneuver. More specifically, it i s found that remittances are more effective in both raising investment and enhancing growth in countries with higher levels o f human capital, strong institutions and good policy environments. In other words, countries that while experiencing a surge in remittances flows also promote sound economic policies and human capital development; and make progress in strengthening the institutional framework will likely benefit beyond. Thus the evidence in the report i s consistent with a view o f the development process where the whole can be more than the sum ofthe parts. For example, Panel A o f Figure 15 plots the growth response o f higher remittances as a function o f the level o f secondary schooling across developing regions and across regions. It shows that, ceteris paribus, regions with higher rates o f enrollment in secondary education display the largest potential growth benefits associated to surge in remittances. A one standard deviation increase in the ratio of remittances to GDP would raise the growth rate o f Eastern Europe by 33 basis points per year while, on average, annual growth in East Asia and Latin America would be higherby .26 and .25 percent per year, respectively. 58 Figure 15. The impactof remittanceson growth. PanelA. Regionsof the world 0.35 11 1 0.33 0.25 0.26 0.25 0.20 -I I 1 0.14 0.15 0.14 0.05 4 .-2 u 2 3 v) 4 ,r -0.05 , a 2 5 - 0 3 a, PanelB. Latin American Countries 0.40 1 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 Source: Author's calculations. Inpanel Boffigure 15, we repeat the same exercise butnow focusing on Latin American countries. This panel indicates that there i s substantial variation in the growth benefits o f remittances across countries, a reflection o f the significant differences in human capital within the region. For instance, 9 out o f 19 countries with data on secondary enrollment rate for 2000 have a growth response to higher remittances below the average response for Latin America. Guatemala i s the country with the smallest potential response -an increase inthe growth rate o f 0.08 percent per year. On the other hand, Brazil and Argentina would have the largest potential 59 growth benefits due to higher remittances (between 0.34 and 0.37 percent per year), with growth effects slightly larger than the ones observedby the average inEastern Europe. This finding is particularly important for the Latin American region because in the three areas that seem complement the impact o f remittances on growth the Latin American region has significant progress to make. For example, as noted in Closing the Gap in Education and Technology, even if the Latin American picture regarding net primary enrollment rates i s quite encouraging, most Latin American countries have massive deficits in net enrollments in secondary education, even after controlling for income levels. In fact, the secondary enrolment deficit would be estimated at about 19 percent. On the institutionalfront, Poverty Reduction and Growth: Virtuous and Vicious Circles, notes that a majority o f Latin American countries (the exceptions being Brazil, Chile, Costa Rica, Mexico, Nicaragua, Panama, Trinidad and Tobago and Uruguay) score below what it would be expected in a combined index o f the six institutional measures o f the Kaufman, Kraay and Mastruzzi (2005) database. ' Finally, on the macro front, Chapter 8 also indicates that the region can improve, at least comparatively to the other developing regions. In fact, on the basis o f a macro policy index constructed along the lines o f Burnside and Dollar (2000) and comprising measures o f inflation, trade openness, and excessive government burden, one could conclude that in the first half o f the 2000s Latin America would be, together with the Middle East and Sub-Saharan Africa, the region at the bottom o f the ranking. In contrast South Asia, East Asia, and Eastern Europe all would presentbetter macroeconomic policy indicator^.'^ Chapter 8 also explores whether a more developed financial sector may also complement remittances, but the results in this case are more suggestive o f substitution than o f complementary effects. In other words, increases in remittances apparently have more o f an investment and o f a growth impact in countries with less developed financial sectors. One possible reason put forward i s that as noted by Giuliano and Ruiz Arranz (2005) remittances can be seen as relaxing the budget constraint faced by the poor and this constraint would be more relevant incountries with less developed financial sectors. XVII. THE REGULATORYFRAMEWORK:HOW TO FACILITATE REMITTANCESFLOWS? For migrants sending money home, remittance services have been traditionally expensive, with fees o f up to 20% o f the principal sent, depending o f the size and type o f the transfer and destination". Fees structures themselves have been opaque (with hidden charges and poor exchange rates), and have penalized transfers o f small amounts o f the type commonly made by migrants. Moreover, cost savings achieved through technological advances inpayment 24 Note that this should not be a surprise even when one takes into account the dramatic improvements in macroeconomic management that the region has experienced in recent years. The fact is that Latin America has relatively closed markets, and openness to international trade is one element that, in this index, is associated with a "ood policy environment. Frias (2005). 60 systems have not necessarily translated into lower prices for remittance services.26 Not surprisingly, reducing the price o f remittances services has been a major target for many multilateral initiatives and regulatory efforts. However, authorities have shied away from imposing direct price controls, favoring mechanisms aimed at enhancing competition in the system, increasing transparency, and reducing barriers for users to access a wider range o f service providers. Together with costs reductions, an important concern o f regulators and multilaterals has been the risk o f remittance channels beingused for illegal purposes, including money laundering (ML) and financing of terrorism (FT). Regulation aimed at avoiding misuse of the system commonly requires service providers to positively identify their clients and assess the legality o f their transactions. Compliance with these regulations i s costly, increasing the price o f the service for users, and posing barriers to entry or formalization o f new Remittance Service Providers (RSPs). Similarly, these regulations have made many financial institutions reluctant to service sectors o f the population that cannot demonstrate lawful residency in host countries. In this respect, the main challenge for authorities i s to ensure the integrity o f the system by restricting the opportunities for misuse while minimizing the disruption and cost o f the service for bona fide participants. Multilateral Initiatives InJanuary 2004, the Presidents of the Americas expressed a commitment to take actions that would reduce by at least half the average cost o f remittances services by no later than 2008. A similar pledge "to reduce the impediments that raise the cost o f sending remittances" was expressed at a meeting o f G-7 Finance Ministers and Central Bank Governors in February 2004. These commitments were ratified at the G8 Summit in June 2004, where those countries stated their intent to work with the World Bank and the IMF, to improve data on remittance flows, lead efforts to reduce the remittances costs, and enhance their developmental impact by increasing financial options for recipients. Against this background, the World Bank and the Committee on Payments and Settlement Systems (CPSS) convened, inNovember 2004, a Task Force to address the needs o f international policy coordination for remittance systems. The output from this Task Force forms a basis for the development, regulation and oversight o f remittance systems in the future. Following its mandate, in March 2006 the Task Force produced a report on "General Principles for International Remittances Services"27, describing key features and functions that should be satisfied by remittance systems, providers and financial intermediaries (Box 1). In parallel with the finalization o f the General Principles, the Bank i s developing, together with other international financial institutions (IFIs), a Guidance Note with detailed guidelines and actions for the implementation o f the General Principles. Remittance systems in sending and receiving countries will then be assessedagainst this framework. The Bank, in cooperation with other International Financial Institutions, will also support the implementation o f policy recommendations and action points that stem from these assessments. In this regard, any 26See Global Economic Prospects2006. 27Henceforth referred to as "the General Principles." 61 necessary actions will be integrated in the context o f the reform o f national payment systems, a process inwhich the Bank has been involvedinmore than 70 countries over the past 12years. Box 1:the GeneralPrinciplesand relatedroles The general principles are aimed at achieving safe and efficient international remittance services. To this end, the markets for remittances services should be contestable, transparent, accessible and sound. Transparencyand consumerprotection General Principle 1. The market for remittance services should be transparent and have adequate consumer protection. Paymentsystem infrastructure General Principle 2. Improvements to payment system infrastructure that have the potentialto increasethe efficiency of remittanceservices should be encouraged. Legal and regulatory environment GeneralPrinciple3. Remittanceservices should be supported by a sound, predictable,non- discriminatoryand proportionatelegalandregulatoryframeworkinrelevantjurisdictions. Market structure and competition General Principle 4. Competitive market conditions, including appropriate access to domestic paymentsinfrastructures,should be fosteredinthe remittanceindustry. Governanceand risk management GeneralPrinciple 5. Remittanceservices should be supported by appropriate governance and riskmanagementpractices. Rolesof remittanceservice providersandpublicauthorities A. The role of remittance serviceproviders. Remittanceservice providersshould participate actively inthe implementationof the GeneralPrinciples. B. The role ofpublic authorities. Public authoritiesshould evaluate what action to take to achievethe publicpolicy objectivesthroughimplementationofthe GeneralPrinciples. Enhancing Competition One o f the main challenges faced by policy makers is reducing the high fees charged by Remittances Service Providers (RSPs). Prices for remittances have decreased in the last few years in some Latin American corridors served by multiple RSPs - e.g. the U.S.-Mexico corridor -but they have remained stable or even increasedinless competitive corridors - e.g. those between the U.S.and Colombia, Honduras and Guatemala2'. *'Orozco(2004). 62 While the incentives for incumbent RSPs to realize cost savings and reduce prices may be naturally limited in smaller corridors where the limited volume o f operations represents a natural barrier to entry to new operators, many o f the benefits o f competition can be realized through increased market contestability. In this respect, the role o f the authorities encompasses, first, eliminating unnecessary regulatory entry requirements to new operators, and second ensuring appropriate access to domestic payments infrastructures in fair conditions. The most common re latory barriers to entry refer to the process for authorization for new RSPs to set up business2$1 These barriers are higherincountries where remittances originate . than in recipient countries, and have helped to enhance and maintain the market position o f incumbent RSPs. According to the Financial Action Task Force on money laundering (FATF)30, the main objective o f the formalization o f RSPs activities through either licensing or registration i s to enhance the security in the system, impose anti-money laundering and combating the financing o f terrorism (AMLKFT) requirements and, in some cases, enable the monitoring o f money transfer activities. However, the FATF also advocates flexibility and consistency in formalization requirements in order to avoid creating excessive hurdles to the flow o f remittances and uneven entry conditions to different operators. In turn, adequate and efficient rules are expected to encourage entities currently in the informal sector to come under the regulatory regime. Unfortunately, in practice formalization requirements are far from being consistent, even within the same country, which demonstrates that they are still not based on objective security considerations, and do not create adequate incentives for the formalization o f operators. According to the FATF, countries should define the adequacy o f licensing or registration requirements based on their specific circumstances. Licensing provides the authorities with the power to perform a pre-qualification due diligence - as well as periodic reviews - on the RSPs' operational and basic security systems. Registration, on the other hand, poses significantly lower entry barriers to new RSPs and its main objective i s to encourage all RSPs to identify themselves and commit to comply with AMLKFT requirements. However, since registered RSPs are not required upfront to have systems or procedures in place for basic security, authorities are required to set up monitoring mechanisms to ensure compliance throughout RSPs' on-going operations3'. Regulatory requirements should thus be set up in a realistic way considering not only the benefits o f increased security but also the consequent costs for the authorities. Inany case, as argued by the General Principles, regulatory requirements to set up a new RSP should be clear, non-discriminatory and commensurate with the type and size o f the operations o f the RSP. The issue o f proportionality o f regulation i s essential to ensure a fair and competitive market. Over-regulation or unduly high requirements to entry in the remittance *'World Bank (2006) 30 IMF (2005). 3' It is important to consider that regulatory activities such as surveillance and enforcement o f regulation poses significant resource requirements for authorities, given the number o f RSPs that can operate at any given time. Regulatory requirements should then be set up in a realistic way considering the costs and benefits for the authorities. 63 market increases costs which are passed over to users through price increases and may indirectly promote the growth o f informal RSPs. Improving Payment Systems A complementary crucial component o f efforts directed at reducing remittances costs by increasing market contestability i s the improvement o f payment and settlement systems. The degree o f development o f those systems and the extent to which new RSPs can access them largely determines the potential for competition in the market. In this respect, technological barriers for the access o f new RSPs to existing payment systems are less important than formal restrictions. Indeed, direct access to national payment systems i s normally granted only to well capitalized and established banking institutions. Inthis context, regulation of payment and settlement systems should ensure that indirect access to RSPs- e.g. through banks - i s provided infair conditions. However, there are concerns that indirect access could be unduly constrained due to competition (when both the stand-alone RSPs and banks provide remittance services), or regulatory concerns. For non-bank RSPs operating in the U.S.,for instance, accounts with commercial banks are their only way to access the official payment and settlement systems and hence an essential component in their operations. However, RSPs frequently report limited access to banks' settlement systems and problems opening and maintaining accounts with U.S.banks. This may be linked to the fact that many banks are concerned that participation in remittance activities could make them subject to heightened regulatory oversight and costs, even though authorities have expressed that this i s not the case. An additional challenge is that o f building cross-border payment systems. Indeed, in addition to improvements in the domestic payment infrastructure, the safety and efficiency o f cross-border remittances may be further improved by the coordination andor adoption across the relevant payment systems of, for example, communications standards and payment message formats that facilitate greater interoperability as well as rules, procedures and operating hours that support straight-through processing. Moreover, given, first, the diverse nature o f the institutions involved and thus the potential for conflicting interests and, second, the uncertainty about the scale o f future flows, cross-border initiatives may require a high level o f bilateral (or possibly multilateral) cooperation on technical, regulatory and oversight matters. InLatin America, efforts to develop cross-border payment and settlement systems have been conducted through private or public initiatives with different degrees o f success. For example official efforts to link US payments and settlement systems to Mexican banks (FEDAc~~~) to eliminate costly wire-transfers have failed to raise significant interest from commercial banks largely due to revenue expectation^^^. Conversely, private efforts to link ~~ 32The Federal Reserve Bank's Automated Clearing House system for Mexico. 33Exchange rate differentials in operations through the FEDAch facility are kept by the Central Bank. At the same time, many large commercial banks in Mexico can achieve higher profitability inremittances transactions when they use their own internal cross-border systems (as many are subsidiaries o f foreign banks) or closed agreements with capturing agents inthe US. 64 networks o f Credit Unions appear to be successful at attracting new entrants and providing remittances services at a significantly lower cost. However, these arrangements can create barriers to new competitors if they require exclusivity. This i s especially the case when the disbursing RSP has a large network such as those o f the post office, telecom companies or large store chains. While exclusivity agreements between private businesses are difficult to prevent, local governments should ensure that public networks are open to different RSPs rather than beinglimited by exclusivity agreements. A sound and appropriate legal framework is also generally considered crucial for a sound and efficient system o f payments, including remittance services. However, while laws are normally the appropriate means to enforce a general objective in the payments field, in some cases regulation by the overseers or specific agreements among participants might be efficient ways to react to a rapidly changing environment. In May 2005 the CPSS published a report totally devoted to payment system oversight in G10 countries. Among its main conclusions, this report stated that effective cooperation among market participants, between regulators and market participants and among regulators is essential for the development o f a sound and efficient payments system. Transparency Inorder to ensure that users can make informed decisions and have the ability to choose their best service option, the elimination o f unnecessary barriers to entry for RSPs, and the development o f an efficient and fair payment system, must be complemented by measures directed at guaranteeing transparency and accessibility in the remittances market. As discussed below, this is a responsibility for both the authorities and service providers. Eveninamong the most competitive corridors, there is still a wide divergence inpricing o f services, which can largely be attributed to lack o f transparency. In particular, remittance senders are often unaware o f the different direct and indirect costs and fees charged by RSPs and therefore ignore the total price o f their remittance transaction untilthe money i s delivered to their relatives. Direct fees are the most explicit component o f the price and frequently do not vary with the amount o f the transaction, which works in detriment o f smaller remittances. Exchange rate differentials represent a second important component o f remittances costs. It is often the case that the RSP with the lowest fees charges a high exchange rate differential (see figure 16). Given the fact that many users are not aware o f this additional cost, advertisement o f fees by RSPs provides incomplete information and can be misleading. RSPs can also make revenues by holding the remittance funds for a period longer than needed and investing them in overnight transactions. Accordingly, the speed o f the service i s also a factor determiningthe overall cost o f the remittance. Additional fees may be charged by at disbursement, especially when this i s done by agents rather than through branches o f the capturing RSP. According to the General Principles, RSPs should disclose the total price o f their remittance services, the conditions and the characteristics o f the service in a way that i s clear and easy to understandby their common users. However, the General Principles do not call for direct regulation o f providers regarding disclosure o f price information. Rather they suggest that other 65 mechanisms such as self-regulatory efforts or definition o f best practices at an industry level may prove more efficient as ways to enhance transparency. The authorities, on the other hand, should actively facilitate transparency through the collection and publication o f comparative prices and conditions o f service among different RSPs. These efforts can be complemented by the provision o f basic financial literacy to users. Figure 16. Fees and exchange rate 20 1 I Western Union Delgado Citibank MoneyGram OrderExpress Ria Enua i w Fees w Exchange rate rewnue ISource: Author's calculations basedon data from PROFECO and Oanda Currency Exchange. Accessibility toformal remittance services As mentioned above, the existence o f numerous providers o f remittance services in a given corridor does not ensure market efficiency This i s illustrated by the wide divergences in prices still observed among RSPs, even in quite competitive corridors - e.g. U.S.-Mexico. While this can be partially explained by lack o f transparency, price divergences can also be caused by differentiated access to specific service providers, inboth countries o f origin and destination. Over the past two decades, remittances transactions have evolved from labor-intensive physical transmission and courier services to a market dominated by cash-to-cash wire transfers through Money Transfer Operators (MTOs). As seen in figure 17, MTOs currently dominate the Latin American remittances market. However, the recent entrance o f financial institutions has made available more cost-efficient transactions such as account-to-cash and account-to-account remittances, which are slowly gaining market share but are constrained by the fact that a large percentage o f migrants do not have access to banking f a ~ i l i t i e s . ~ ~ At least in the case o f the US., migrants' limited access to bank accounts has both is constrained by both regulatory and non-regulatory constrains. Indeed, U.S. regulations require financial institutions to verify the identity of applicants when opening up new bank accounts. While federal regulation does not expressly forbid the provision o f financial services to ~~~~ 34 Based on a US$300remittance from New York to Mexico calculated with data as o f March 6 2006. The exchange rate cost was calculated using the differential between the exchange rate applied by each RSP and the average interbank exchange rate o f the same date (MXP 10,5958 per USD$I). 35 A survey o f remittance senders in 2002 showed that only in 26% of the cases both sender and recipient of the remittance had a bank account. 66 undocumented applicants, this issue is far from being clear, creating concerns among both financial institutions and a large segment o f prospective clients.36 Figure17. Channelsfor SendingRemittancesto LAC (20t14).~~ MTOs People Bank Mail Credit Union travsling Source: Multilateral Investment Fund, IDB There have been significant efforts both from the private and the public sector to reduce accessibility constraints to migrants. In 2002, the Treasury Department advised Congress that, under the terms o f the regulation to ensure security in the system (U.S. Patriot Act), an official identification issued by the Mexican government (consular identity card) can be used as a valid form o f identification to open an account with a financial institution. There are also, however, non-regulatory constraints to accessibility, including for instance illegal migrants' perception that banks might share their information with immigration authorities, which would expose them to deportation. Another factor is the cost o f financial services, which can be significant given the relatively low income o f many migrants. Accessibility issues and the quality o f the financial services infrastructure in recipient countries are also critical to ensure security and efficiency o f remittances services. Accessibility can be improved by enabling more financial institutions to participate inthe remittances market. In particular, savings and loans, credit unions and microfinance companies may be well positioned to act as disbursing agents, as their networks may be closer to the usual recipients o f remittances than that o f large commercial banks. In this sense, authorities at recipient countries should ensure that there are no unduly regulatory constraints to the participation o f these entities. Security Issues Remittance channels can and have been used for illicit purposes, which include money laundering, as well as fraud and financing o f terrorism activities. The risk o f misuse o f remittance channels is highest among informal remittance providers that are completely unknown to the regulatory or supervisory bodies. Accordingly, the FATF considers that security inthe systemcanbe enhanced through efforts by national authorities to encourage and enable the use o f formal systems (such as banks) by lowering the costs and increasing access to these 36 According to some estimates (Lowell and Suro, 2002), at least two-fifths o fthe adult Latino immigrant population i s made up of individuals not authorized to be in the country. 37 Basedon a survey of 3,802 remittance senders in 37 states of the US.andthe District of Columbia in 2004. 67 systems to all users, as well as by putting in place a regulatory framework which includes licensing or registration together with AML/CFT requirements for money transfer providers.38 An additional challenge is that o f ensuring that security regulations are adequately enforced, especially at the local level. This may be a challenging task, requiring a balance between strict enforcement, proportionality to the risk o f misuse and avoidance o f disruption caused by unduly burdensome requirements. According to the General Principles, AML and CFT regulations should be equally applicable to all RSPs irrespectively o f their legal form (Le. financial institutions or commercial companies) in order to avoid creating loopholes that could be used for illicit purposes, and could signify competitive disadvantages for regulated entities. However, countries should ensure that oversight i s commensurate with the risk o f misuse to avoid unnecessary costs and inefficiency. As put by the General Principles, any regulation o f remittances should balance the benefits o f increased safety o f the system with the potential costs and inefficiencies created. XVIII. OVERALL CONCLUSION: THE DEVELOPMENT IMPACT OF REMITTANCES INLATINAMERICA. Onthe whole, what have we learned from this Regional Study? There are seven mainpoints which we would like to highlight. First, workers' remittances have an overall positive impact on recipient economies. Remittances seem to accelerate growth rates and reduce poverty levels. One potential channel that has been highlightedin this report i s the impact o f these flows on financial sector development, savings and investment. Beyond a pure income dimension o f welfare, however, remittances also reduce risk as evidenced by lower output volatility, and they increase educational attainment and contribute to improvements in health indicators. It i s thus understandable that policy makers are increasingly interested in seeing an increase inthe amount o f remittances flowing to their countries. 0 Yet, it must be highlighted that the impact o f remittances on poverty and growth is in many cases modest. Although in the Latin American sample there i s significant heterogeneity, both our cross-country and micro-based estimates indicate that, on average, an increase in the remittances to GDP ratio by 1 percentage point would be associated with a decline in poverty o f about .4 percent. On the growth front, we have presented estimates indicating that the increase inremittances from .7 percent o f GDP in 1991-1995 to 2.3 percent o f GDP in 2001-2005 experienced by the typical Latin American country may have contributed to a growth acceleration o f a mere .27 percent. Moreover, the impact o f remittances on household welfare - e.g. through higher savings, educational outcomes and increases in entrepreneurship - is often limited to specific socio-economic groups and varies considerably across countries. 38 The main AML / CFT regulations are the Bank Secrecy Act, the Patriot Act and directives from the Office of ForeignAssets Control (OFAC) inthe US. 68 0The report has also shown that the impact o f remittances on financial development is weaker inLatin America than in the rest o f the developing world. Though more research i s required to better understand what drives this finding, our results suggest some tentative conclusions and policy implications, First, hrther efforts to continue to "bank" migrants are important, since they will increase the likelihood that migrants send their remittances through bank accounts. This involves efforts by US.banks and credit unions, in order to continue to facilitate access to their services by lowering costs and tailoring products to meet migrants' needs. At the same time, governments in migrant recipient countries in partnership with those in Latin America need to continue to work on programs to foster financial access for migrants, and link them with financial institutions from their home countries. Similarly, the incipient actions taken by banks in Latin America to "bank" remittance recipients need to be stepped up. Governments can contribute to this process by minimizing regulatory obstacles for opening branches and other outlets to serve recipients, as well as by allowing non-traditional methods o f delivering banking services - e.g. through arrangements with post offices, retailers, or cooperatives. Finally, issues such as weak creditor rights, inefficient contract enforcement mechanisms, lack o f collateral and crowding out as a result o f the government demand for credit might all be factors that will have to be considered and tackled by governments seeking to leverage the impact o f remittances on financial development. 0 Surges in remittances may also have negative effects and thus be accompanied by a number o f policy challenges. Two have been highlighted in this report. On the internal front, remittances seem to negatively affect the supply for labor (number o f hours worked per week and in a number o f countries also labor force participation). On the external front, remittances seem to be accompanied by real exchange rate appreciation pressures. While these effects are consistent with adjustments towards new equilibriums following positive shock (i.e. the surge in remittances), the evidence in this report suggests that some o f the observed appreciations are linkedto real exchange rate misalignments, which justifies the desire by policy makers to take mitigating actions in order to minimize competitiveness losses due to remittances. 0 In addition to addressing the above mentioned potential external competitiveness problems, policy makers can also take actions to enhance the development impact o f remittances. The report has shown that progress in a number o f fronts, namely education, institutional quality, and the policy environment can contribute to increase the positive impact o f remittances. While deepening reforms on these areas would be desirable even in the absence of remittances, it becomes even more important when those flows are significant. 0 With regard to the regulatory environment for remittances services, in consonance with recent high-level multilateral initiatives promoted by Latin American Presidents and the G8, the regulation o f RSPs should be primarily aimed at reducing the costs o f sending remittances while avoiding criminal misuse o f remittance channels. In this context, authorities in low volume corridors should ensure contestability in their local markets by establishing regulatory requirements that balance the need to maintain security in the 69 system with the goal o f eliminating unnecessary hurdles to bona fide entrants, as well as by removing unduly regulatory barriers to the use o f payment and settlement systems (either directly or indirectly). However, since increased market contestatibility by itself may not necessarily lead to lower transaction costs, authorities should take an active role in the collection and dissemination of information on comparative prices of different RSPs, and in increasing accessibility to financial services among remittances senders and recipients. This, in turn, requires reviewing the merit and need for existing regulatory constraints, eliminating artificial constraints to accessibility linked to the misinterpretation o f regulations, and reducing under-utilization o f financial services by immigrants. Finally, accessibility to financial services in recipient countries could be improved by permitting access to remittance services to smaller financial institutions such as credit unions, savings and loans and microfinance companies. 0 Overall, the basic conclusion o f this report i s that remittances are an engine for development but they are neither a "manna from heaven" nor a substitute for sound development policies. First, the migration flows that logically precede surges in remittances are not without costs, both for the households directly affected and their countries. For instance, once reductions in households' earning generating potential are taken into account, net income increases fall well below observed remittances inflows - simply because the migrant was usually economically active. As a result, the poverty and inequality reduction potential o f remittances is in most cases quite modest. Similarly, while there are some positive growth-enhancing effects associated with remittances -e.g. higher savings, human capital investments, increased entrepreneurship, and higher bank deposits - the bottom line effects on investment rates and per capita GDP growth are relatively small. Second, the way countries benefit from remittances appear to be positively related to the own countries institutional and macroeconomic environments, so that countries ranking low on these fronts should expect even more modest impacts. Ifin addition one considers that remittances may reduce labor supply and lead to real exchange rate over-valuation, it becomes clear that countries experiencing large remittances inflows will also face considerable policy challenges that may require corrective actions. 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