Are Bilateral Remittances Countercyclical? Implications for Dutch Disease and Currency Unions

1. Are Bilateral Remittances Countercyclical? Implications for Dutch Disease and Currency Unions Jeffrey Frankel Harpel Professor, Harvard Kennedy School, and CID Presented May 26, 2009, at a panel on “Macroeconomic Impacts of Migration and Remittances,”at conference on Immigration and Global Development: Research Lessons on How Immigration and Remittances Affect Prosperity Around the World, co-hosted by Center for International Development at Harvard University and the Center for Global Development in Washington DC.

2. Importance of remittances • Total recorded workers’ remittances received by developing countries increased 73% between 2001 and 2005, reaching a total of $167 billion. • They have grown more rapidly than private capital flows, or official development statistics. • They constitute more than 15% of GDP in Tonga, Moldova, Lesotho, Haiti, Bosnia, Jordan, Jamaica, Serbia, El Salvador and Honduras. • Until recently, macroeconomic aspects of remittances have been even more neglected than the economic study of migration in general.

3. Hypothesis: Remittances can play the stabilizing role that capital flowsare in theory supposed to play • In theory, capital flows should bring a variety of benefits: • smoothing short-term income disturbances, • financing high-return investment opportunities in low K/L countries • and so substituting for labor flows to high K/L countries or factor-based trade, • and disciplining policies and institutions in the recipient country.

4. In practice, however, capital flows fail to deliver on this promise: • Rather, private capital flows are often procyclical: • pouring in during boom times and disappearing in recessions. • Commodity-producer procyclicality: part of the Dutch Disease. • Rather than flowing on average from high K/L countries to low, capital often “flows uphill.” • Rather than rewarding countries that follow sound economic policies, financial markets often abet irresponsible budget deficits, • including among autocratic and kleptocratic rulers.

5. 3 cycles of net private capital flowsto emerging markets, by regionpeaking in 1982, 1997 and 2008 Source:Capital Flows to Emerging Market Economies, IIF, 1/27/09.

6. Brief summaryof remittances literature • (1) Theory • Rapoport & Docquier (2005) review the New Economics of Labor Migration. • In theory, emigrants’ decisions to send remittances should be based on intertemporal optimization, usually with a household utility function.

7. (2) Bilateral Data • Ratha & Shaw (2005), in the absence of hard bilateral data, allocate the totals across partners. • Schiopu & Siegfried (2006) create bilateral data set between some EU countries & neighbors. • Jiménez-Martin, Jorgensen, and Labeaga (2007) estimate bilateral workers’ remittance flows from all 27 members of the EU, to recipient countries. • Lueth & Ruiz-Arranz of IMF (2006, 2008) the largest known bilateral data set to date. • IDB has data on bilateral remittances from US to countries, esp., in the Central American region.

8. (3) Evidence on cyclicality • World Bank (2006): p.c. remittances respond significantly to p.c. income in the home country. • Clarke & Wallstein (2004) and Yang (2007):remittance receipts rise in response to natural disaster. • Kapur (2003): they rise in response to economic downturn. • Lake (2006): remittances into Jamaica respond to the difference between US and Jamaican income. • Yang & Choi (2007): they respond to rainfall-induced economic fluctuations. • IMF finds less countercyclicality. • Sayan(2006) : 12-developing-country study finds none. • Lueth & Ruiz-Arranz(2006, 2008): similarly, procyclical.

9. (4) Why does the question of remittance cyclicality matter? • (i) It is especially important because governments in remittance-receiving countries often reflexively treat them as a source of foreign exchange to be “harnessed” for national development, • rather than letting recipients spend it on “unproductive” uses such as imports of consumer goods. • This thinking is common even among benevolent governments, let alone the rhetoric of kleptocracies.

10. Applicability, continued • (ii) The Dutch Disease. • On the one hand, Martin (1990): steady flow of remittances can undermine the incentive for governments to create a sound institutional framework,– a sort of natural resource curse for remittances. • Amuendo-Dorantes & Pozo (2004): a rise in remittances to LACA countries leads to real appreciation, a prime symptom of Dutch Disease. • On the other hand, Rajan & Subramanian (2005): although the Dutch Disease analogy does extend to foreign aid (leading to real appreciation & slow growth), it does not extend to remittances.

11. Applicability, concluded • (iii) Optimum Currency Area criterion • The OCA question: • For what countries do the benefits of adopting a common currency outweigh the costs? • e.g., facilitating trade & other international transactions • Vs. losing the freedom to run one’s own monetary policy. • The textbook answer: • A country with few asymmetric shocks, so it seldom needs a monetary policy different from that of the anchor country; or • A country that has cushions against asymmetric shocks: labor mobility, fiscal transfers, capital flows... • My claim: remittances belong on the list • assuming countercyclicality. • Singer (2008): remittances are, and should be, a determinant of the currency decision.

12. Not all senders are industrialized countries • Roughly 10 per cent come from developing countries. • South Africa, for example, receives many immigrants from neighbors to work in its mines, farms, & factories, and sends remittances back to the countries of origin. • In many Gulf countries, immigrants (called ex-patriate workers) > than ½ of the private-sector labor force. • For example, outward remittances from Saudi Arabia are about 7% of all remittances globally . • (not included in the developing country statistic) .

13. The hypothesis is that remittances respond not just inversely to income in the receiving country, but also positively to sending-country income. • One would need to control for sender-country income even if only the coefficient of recipient-country income were of interest. • It should be in the equation in theory. • Omitting it in practice often produces the wrong sign. • But cyclicality with respect to sender-country income is also of interest in its own right:

14. South Africa and the Gulf are two places where the Dutch Disease and OCA motivations are particularly relevant. • When mineral proces are low, it is useful to South Africa to have the “unilateral transfers” deficit in the balance of payments automatically moderate. • When mineral prices are high (e.g. 2003-2008), outward remittances provide a brake on reserve inflows and inflation – a particularly important point in these two regions debating regional monetary unions.

15. My estimation of remittance cyclicality i) Table 1: The Lueth & Ruiz-Arranz (IMF) bilateral data set, which includes 64 pairs of countries. Cross-section covering 2005. ii) Table 2: LRA bilateral data set, Panel study, covering 1979 to 2005 . iii) Table 3: Splicing of LRA data set with the EU and Central American (IDB) data sets.

16. Country-pairs with high bilateral migration also, of course, tend to show high bilateral remittances. Remittances between included country pairs are around US$113.6 billion. Total of 540 observations: 266 for 2003 and 274 for 2004.

17. Remittances per lagged migrant are positively correlated with cyclical differential Sources: Western Hemisphere data: FOMIN & the Central Banks, data from 2003-2004; Jiménez-Martín, Jorgensen & Labeaga (2007). Data from 2003-2004; Lueth & Ruiz-Arranz, IMF(2006); data from 2003-2004.

18. Table 1: Cross-section, with LRA bilateral data set • Cross-section includes 64 pairs of countries, 2005. • Lagged stock of migrants (in 2000) has highly significant effect on remittances, as in Freund & Spatafora(2005). • We also control for sender-country income per cap. • The variable of interest is the difference in cyclical position between the sender country and the recipient country. • In this table, cyclical position is computed as the (log) difference between GDP in 2005 and the long run trend value of GDP. • The estimated coefficient is positive and highly significant. • The t-statistic is almost 4. • Use of gravity IV for migrant stock makes little difference.

20. Table 2: panel study with the LRA data • 64 pairs of countries, 2005. 1979-2005 panel. • => 1200 or more observations • Lagged stock of migrants replaced by its determinants: • geographical, historical, & cultural. • Cyclical difference now captured by unemployment. • 2(a) The estimated coefficient on us-ur is negative, as now hypothesized, and highly significant. • The t-statistic is now 9. • 2(b) The same when applying fixed effects for countries or country-pairs.

23. Table 3: cross-section study (2003-04) with extended composite data set Sources: Western Hemisphere data: FOMIN & the Central Banks; EU data: Jiménez-Martín, Jorgensen & Labeaga, EC (2007); Lueth & Ruiz-Arranz, IMF(2006). • Approximately 330 bilateral observations. • Lagged stock of migrants (2000) . • Cyclical difference again captured by GDP/trend. • The estimated coefficient >0 & highly significant. • So is the coefficient on currency union dummy. • under OLS, but not under IV. • Causality is unclear

25. To summarize the findings, • splicing together a larger bilateral data set from three data sets used by others, • has allowed a moderately strong verdict on the question of cyclicality. • It runs contrary to the analogy with capital flows /the Dutch Disease: • Remittances respond positively to the cyclical position in the sending country and negatively to the cyclical position in the receiving country.

26. Policy implications • This counter-cyclical pattern is precisely what one wants. • It suggests that emigrants’ remittances can play some of the stabilizing role that capital flows often promise but seldom deliver. • If the finding holds up under further investigation, it carries at least two specific policy implications. • First, it suggests governments should not try to harness remittances in the name of national development, but rather should allow emigrants to transact freely. • Second, it suggests that remittances belong on the list of Optimum Currency Area criteria, • along with trade, labor mobility, & transfers.

27. Acknowledgements I wish to thank Olga Romero for dedicated research assistance; Erik Lueth and Marta Ruiz-Arranz for generously making data available, Maurice Kugler & Hillel Rapoport for comments; and Robert Hildreth, the Center for International Development, and the MacArthur Foundation for support.

28. Jeffrey FrankelJames W. Harpel Professor of Capital Formation & GrowthHarvard Kennedy School http://ksghome.harvard.edu/~jfrankel/index.htm Blog: http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/

29. Appendix Figure 1a :Bilateral stock of migrants (normalized by populations), versus remittances (normalized by GDPs) Sources: Central America data: FOMIN & the Central Banks. data from 2000-2007; Jiménez-Martín, Jorgensen, & Labeaga, (2007), data from 2000-2005; Lueth. & Ruiz-Arranz (2006). Data from 1979-2005.

30. Appendix Figure 1b :Bilateral stock of migrants (normalized by populations), versus remittances (normalized by GDPs) Sources: Central America data: FOMIN & the Central Banks. data from 2000-2007; Jiménez-Martín, Jorgensen, & Labeaga, (2007), data from 2000-2005; Lueth & Ruiz-Arranz (2006). Data from 1979-2005.

31. Appendix Table 2: IMF data set