Undergraduate Economist

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The Economics of Remittances

Posted by Alex M Thomas on January 6th, 2007

Definition

According to Wikipedia, Remittances are transfers of money by foreign workers to their home countries. Remittances (also known as current transfers) include worker’s remittances and other private transfers on the current account. [Gupta 2006]

 

The Indian scenario

Remittances to India have increased at about 13 per cent a year since 1991, making India one of the largest recipients of remittances in the world. They have been the most stable type of external flows in India. They have been crucial in improving the current account and in the consequent build-up of foreign exchange in the last few years.

 

The effect of remittances on output and employment generation would depend on the end-use of the transfers. The effect would be larger if remittances are geared more toward investment expenditure.

 

In terms of percentage of GDP, remittances equaled about 3 per cent in 2003.

 

[These are excerpts from Poonam Gupta’s ‘Macroeconomic Determinants of Remittances’ which came in the EPW.]

 

The Kerala scene

 

The great exodus of Keralites to the Gulf Countries during the 1970s oil boom was to a large extent possible because of the benefits these workers had gained from growing up in Kerala (better health and education, and more awareness of opportunities beyond their state). The money they send back today makes up 25% of the state budget, and one third of all remittances to India. It has not only helped to stimulate consumption levels in Kerala, which are among the highest in country, but it has also kick-started the boom in the tertiary (or service) sector of industry –IT, tourism, banking, private health care, etc. – that has been the driving force behind Kerala’s economic growth spurt. While neither the manufacturing industry nor agriculture has experienced any significant growth over the past decade, the service sector now makes up something like 65% of the state economy, and has since 1986 until today gone from a growth rate of 3.25% to 7.5%. The remittances also probably served to underestimate Kerala’s economy throughout the financial dark ages, since they do not count directly towards the GDP. [Blomqvist 2006]

 

Reasons

Obviously, the most common motivation to remit is simply that migrants care of those left behind: spouses, children, parents, and members of larger kinship and social circles. First of all, remittances may just “buy” a wide range of services such as taking care of the migrant’s assets and relatives at home, with the likelihood and size of remittances depending on whether and when the migrant intends to return. Secondly, it is clear that migration is primarily (but not only) driven by wage differentials, implying that people are ready to incur substantial moving costs in order to access to international migration. [Rapoport and Docquier 2005]

The main results established in the literature are: remittances are motivated more by an altruistic motive than by an investment motive; remittances are counter-cyclical, i.e., higher under adverse economic outcomes in the native country; they are used more for consumption than for investment; and they do not respond much to relative rates of return on investment in the home country. [Gupta 2006] This result is supported by The Hindu Business Line which says that “Unlike the capital flows, interest rate differentials are not found to be significant in determining the workers remittances, thus underlining the stable nature of these flows.”

 

A trade off?

Migration to other countries take place mainly when there are better employment avenues abroad. This usually takes place after the individual has completed his education. Large scale migration has been criticized by imposing on them the ‘brain drain’ stamp.

 

Thus when migration takes place, the home country is losing a significant chunk of its educated labour force. In developing countries like India, there is much to be done; but since the addition to labour force happens at a faster rate than the increase in employment opportunities, this ‘migration’ tends to become inevitable.

 

A trade off is evident between ‘brain drain’ and ‘remittances’. Though ‘brain drain’ is said to have a considerable pressure on the home economy (By withdrawing educated labour force) remittances tend to improve standard of living in the home country. But usually remittances better the standard of living of the ‘dependent population’. They do not affect or increase the productive capacity of the Indian economy directly, but they affect it indirectly through increased consumption.

 

Illegal flows

Unofficial remittances are sent through friends or migrants themselves or through traditional networks, known in some countries as hawala or chiti, which allow money deposited with a trader in one country to be paid out by a partner in the recipient country. [Mutume 2005]

 

Hawala is an informal banking system in which funds are transferred internationally, without being moved physically. Hawala brokers, whose relationships are based in part on trust, maintain running accounts with one another. Once a sender deposits funds with a hawala broker, the broker contacts another hawala broker in the relevant location and requests the dispersal of funds to the recipient. Hawala brokers employ fast methods of communication, such as phone or fax. The main users of the hawala system reside in the developed world and transfer funds to recipients in the developing world. [Fugfugosh 2006]

 

Conclusion

The increased inflow of remittances is what is fuelling the ‘consumption boom’ in India. The fact that the SENSEX is bullish and the real estate markets are booming are proof to this. (There has not been any proportionate increase in the intrinsic values. They might be a bubble which is financed almost to a large extent by remittances.) Adequate studies should be targeted at such interrelationships between remittances and various markets in the home country, so that the small investors do not incur huge losses.

 

Since, these remittances are relatively stable, this consumption boom will tend to sustain for longer periods. Moreover, these remittances are said to be one of the main reasons for lowering poverty. For example, remittances enhanced the standard of living of the people in Kerala. They also contributed to development in African countries.

 

The government is trying to improve the investment benefits accruing to the expatriates with a hope of increasing the flow of remittances. There is no doubt that remittances are beneficial to the receiving country.

 

Recipients spend these funds (remittances) in various ways: for some, remittances are their lifeline, without which they do not eat, as in Somalia; for others, remittances are transferred home specifically to be invested in savings schemes with attractive incentives, as in India. In Cape Verde, migrant remittances contributed to political change of the oppressive island government while for people from other countries, remittances are directed to community infrastructure development, such as collective projects in Mexico. These illustrations convey the message that in all corners of the globe, remittances are a precious tool for every single recipient and that the secure flow of remittances must be assured. [Fugfugosh 2006]

 

Thus for countries like India where additions to employment opportunities take place at a slow pace, migration will take place. Providing better investment avenues for these expatriates will help, although not significantly in bettering the flow of remittances. Moreover, by making such inflows easy and transparent, the unofficial inflows will reduce. Targeting these remittances and channeling them to socially productive investment avenues such as education and health will improve the condition of the Indian populace.

 

References

1) Steady rise in NRI remittances, The Hindu Business Line, 29th January 2004.

2) The Economics of Migrants’ Remittances, Hillel Rapoport and Frédéric Docquier, March 2005.

3) Welfare and banana leaf thalis – a foreign student’s take on Kerala, Part 1, Olof Blomqvist, 2006.

4) Informal Remittance Flows and Their Implications for Global Security, Miriam Ahmed Fugfugosh, 2006.

5) Workers’ remittances: a boon to development, Gumisai Mutume, 2005.

17 Responses to “The Economics of Remittances”

  1. unnati Says:

    nice post.
    recently there have been a lot of people from other countries who r coming to ndia in top managerial positions in big companies do u think that this will lead o an outflow of remittances from india.
    and of course, being in iit, one hears a lot about the reverse brain drain, indians abroad coming back to india, as exemplified by the movie ‘Swades’.
    ur last statement is indeed quite critical, where u say that ‘Targeting these remittances and channeling them to socially productive investment avenues such as education and health will improve the condition of the Indian populace’. as u say, most of the times they go for consmption purposes of the family or into unproductive speculative activities like the tock markets. targeting them to areas that matter seems a very difficult job.

  2. The economics of remittances at Blogbharti Says:

    [...] M Thomas has a detailed post on the economics of remittances in India and how these remittances are fuelling consumption. The [...]

  3. Jason Says:

    Good article Alex…..especially since i was an NRI till a few years back.

    its a good point that was raised regarding how the money is used for consumption and investment. what i have noticed especially in places like bangalore, cochin and kottayam (kerela)…. the prices of properties are sky rocketing purely because of investments by NRIs in apartments and land which they have no intention of living in. i think there will be a correction very soon or it is already under way.
    However i think many NRIs do contribute to development activities like the construction of the Kochi airport, hospitals, educational institutions and driving the exports of kerala and other states

  4. Debi Prasad Says:

    nice post..
    well,I had some queries about DSE entrance.In fact I had one doubt.I would like to ask you the same.
    Questions are actually from 2004 entrance exam..

    consider a competitive exchange economy with agents 1 & 2 and two goods X & Y.Agent 1′s endowment of X,Y is (999,0) and agent 2′s endowment of (X,Y) is (0,1000).An allocation for agent i is denoted (x i yi) where xi is his allocation of X and yi is his allocation of Y .Agent i’s objective is to choose allocations to maximise his utility min(x,y).

    1.Consider the allocation (1) in which (x1,y1)=(0,1) and (x2,y2)=(999,999), and allocation (2) in which (x1,y1)=(500,500) and (x2,y2)=(499,500).
    (a) 1 is pareto efficient but 2 is not
    (b) 2 is pareto efficient but 1 is not
    (c) Neither 1, nor 2 is pareto efficient.
    (d) Both 1 and 2 are pareto efficient.
    I have tried it and I think the answer is (d).

    2.The set of all competitive equilibrium allocations for this economy consists of allocations of the form (x1,y1) and (x2,y2) where (x2,y2)=(999-x1,1000-y1) and
    (a) x1=0 and y1 belongs to [0,1]
    (b) x1=999 and y1 belongs to [999,1000]
    (c) x1belongs to[0,999] and y1belongs to [0,1000]
    (d) x1=499 and y1=500

    3.Assuming the sum of the prices is 1, the competitive equilibrium prices (p1,p2) are
    (a) (1,0)
    (b) (0,1)
    (c) (1/2,1/2)
    (d) (500/499,499/499)

    please send the answers and please guide me.

  5. alexmthomas Says:

    Aashish,

    An outflow of remittances from India is inevitable as it is globalised economy. The nature of those employed in the country pertain to that of the highly skilled (like you mentioned top managerial positions).

    The inflow of remittances to India consists of income from both skilled and semi-skilled labourers. Remittances have a considerable positive impact on the poor families.

    I do not know on what basis is Indians returning to India can be termed as ‘reverse brain drain’.

    Targeting and channeling remittances is difficult. It can be achieved by providing conducive investment climate in essential sectors.

  6. alexmthomas Says:

    Jason,

    You are right. A correction in real estate prices is impending.

    Yes, the contribution of NRIs to developmental activities is certainly noteworthy. But, i do not know if the activities have been started in rural areas.

    Debu Prasad,

    I too have not yet solved this question. I will try again.

  7. Dweep Says:

    Alex,
    Great post. The result that remittances are fairly stable is quite interesting, and one I agree with based on my prior behavior.

    One thing – don’t you contradict yourself when you say the Sensex’s rise may be due to remittances, when you suggest previously that remittances are not directed towards investment but consumption? Anyway, I think its safe to assume FII and other investments are the cause of the Sensex’s rise, given the total amount of remmitance we receive.

    Finally, re. development, I believe NYTimes had an article previously on remittances and microfinance. Genevieve also wrote a paper (unpublished?) on the link between the two.

  8. alexmthomas Says:

    Dweep,

    There are theories which conclude that remittances are erratic too.

    Thank you for pointing the ‘contradiction’ out. Do you think that the money going into the SENSEX is getting translated into more jobs or more salaries for all the employees?

    Thanks for the pointer.

  9. Nariyal Chutney Says:

    Excellent Post Alex . Have you ever thought what would have happened if Keralites would have started factories and entrepreneurship with the remittances that they were getting from Abroad. Lot of Gujaratis did this in Gujarat and Gujarat is one of the leading states in India in terms of SME Enterprises. Keralites were more interested in making bigger houses and investing in land and gold which are good investments from a socialistic perspective but very bad from an economic perspective since nothing productive is being generated (in terms of Jobs etcc) through these investments.This is the anomaly and irony in the remittance support system that is being served as oxygen to our state.

    P S: If you are preparing for DSE :) and need any help , you can count me in :D

  10. alexmthomas Says:

    Nariyal Chutney,

    You are cent percent right! Money from remittances are fuelling only the consumption boom mainly in gold and real estate.

  11. Dweep Says:

    Alex,
    Sorry for late reply. I don’t think stock market growth results in job creation. If I’m not mistaken, the rise of the Sensex is simple ‘asset creation’, not GDP growth. So comparing the two is like comparing apples to oranges. I think I’ve heard it argued before that stock market investing is, therefore, inherently unproductive.

    However, stock market growth does benefit overall economy by improving liquidity, providing finance to growing companies, etc. So it does have ‘knock on’ effects. This is to say nothing of other ‘information’ benefits. Perhaps you’ve read the book ‘Saving Capitalism from the Capitalists’. It may have some related answers, and I hope to read it soon.

  12. Dweep Says:

    Here’s an interesting article on the link between remittances and microfinance: Microcapital.org

    The original article in BusinessWeek

  13. alexmthomas Says:

    Dweep,

    I agree with you. The stock market boom is an ‘asset creation’ process rather than a growth in GDP. You are right; it improves liquidity in an economy.

    Thanks for BOTH the pointers. :)

    I am wrong when i say, investment in the Stock Markets is an unproductive investment. [It contributes indirectly, but the share of contribution might be debatable.]

  14. jalmohd Says:

    the idea alex, is to enhance wealth creation among the common man, such that common man has better resources, financially, that is, at his disposal. this could solve a lot of problems at the micro level. it is more important because benefits have to tricle down to the masses.. that is, common man should also made inclusive in the growth story…

    Jaleel Jalaludeen
    http://iindia.wordpress.com

  15. India leads in remittances « Lagged Says:

    [...] country, but in terms of remittances they beat em all. Alex has an interesting and comprehensive analysis of the same. This entry was written by BD and posted on February 11, 2007 at 2:59 pm and filed [...]

  16. How bad is brain drain? Edition 2 « The Great Indian Mutiny Says:

    [...] diaspora also brings a huge amount of monetary flow in to India; for example, take a look at this blog post by Alex Thomas, which explains the trade-off between brain drain and remittances wonderfully (with data, [...]

  17. Sam Says:

    hi! i was wondering if i can get answers to previous years DSE entrance exam question papers…
    do let me know
    thnx.

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