Growth and crisis
The amount of money sent by emigrants to their countries of origin often exceeds that of international development aid programs. But what impact do these huge remittances have on the economies of countries? The observations are often contradictory. To understand them, economists Nicolas Destrée, Karine Gente, and Carine Nourry propose a model that links remittances, growth and education.
Western Union, World Remit, Remit Ly... You have probably already come across or used one of these organizations offering to transfer money abroad. In 2020, with 281 million immigrants, these operations, called remittances, represented 540 billion dollars, or the equivalent of Belgium's annual GDP1.In Tajikistan and Kyrgyzstan, they represent more than 30% of national GDP .
These remittances constitute considerable financial resources for the economies of these countries, and they are probably underestimated. Transfers are very expensive (private organizations take between 6 and 20% of the sums sent, plus exchange rates), it is possible that part of the sums are sent informally. But what is the impact of these money transfers? This is a question that many economists have studied, with sometimes contradictory answers.
- 1World Bank Open Data, Personal remittances, received (% of GDP). https://data.worldbank.org
Positive and negative outcomes
The positive or negative effect on the country's economy depends on how the money is used. For example, at individual level, a remittance enables a familly to favor school over labor for their child. On a national scale, the proportion of educated people will rise accordingly. Remittances generate human capital. In 2006, economist Lopez Cordovas showed that a 1% increase in remittances in Mexico led to an 11% increase in kindergarten attendance2. Similarly, if the money received is used to create or develop a productive activity, it will have positive effects on the country's growth. As remittances are not affected by internal crises in the country, they substitute for savings for individuals, allowing them to get through difficult times.
Conversely, the effects of remittances can also be negative. By promoting the education of children, their employment opportunities outside the country increase, and some of them may choose to work abroad. This will reduce the human ressources available in the country and the incentive for people to work or save. Without savings, banks have fewer funds to invest.
Despite numerous empirical studies, few models allow us to conclude about these contradictory effects. Economists Nicolas Destrée, Karine Gente, and Carine Nourry therefore propose an innovative theoretical model that looks at the effects of remittances on education and savings.
- 2Guo Q., Sun W., Wang Y, 2017. « Effect of Parental Migration on Children’s Health in Rural China », Review of Development Economics, 21(4), 1132‑1157.
Money, loans and education
Economists are interested in one specific point: what is the effect of diaspora remittances on the education of families left behind? Since education is linked to growth, this allows us to study the impact of remittances on the latter. Let's take the case of Ali who, in order to get an education, takes out a loan at the bank. By choosing to get an education, he accumulates human capital, which he will one day pass on to his children. Some of his children will be able to go abroad and send him back money.
In the model developed, Ali will have a choice between repaying the bank credit used to train himself or defaulting. If he chooses to repay his credit, he will have lifelong access to banking services and the opportunity to save. If he chooses not to repay his loan, he will not have the opportunity to save, as he will have been reported as a defaulter to the banking department. Saving is necessary for Ali in anticipation of his period of inactivity at the end of his life. If he knows that he will receive remittances from his educated children to sustain himself during his period of inactivity, his incentive to save, as well as his incentive to repay his loan, is greatly reduced. Indeed, the bank will assess Ali's propensity to repay his credit to determine how much it wants to lend him.
Remittances therefore have several consequences: if they are too high, they will tend to reduce the incentive to repay loans and thus reduce borrowing capacity. At the country level, this affects both education and growth rates.
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Growth and remittance
When banks anticipate potential defaults, they tend to lend less and thus tighten the credit constraints on the economy. Nicolas Destrée, Karine Gente, and Carine Nourry show how remittances have different effects on growth depending on the initial economic situation of the country receiving the funds. Indeed, if it is an economy in which the amounts borrowed are already insufficient to finance the educational needs of the population, we will say that this economy is constrained even without remittances. In this case, remittances, by inducing banks to lend less, weigh on growth by reducing the educated population proportion, and therefore the human capital available.
In the case where Ali's economy is not constrained, i.e., where the credits offered by the banks more than cover the demands of education, things are more ambivalent. Remittances can, again by reducing the incentive to repay loans, make the economy constrained. But the effect can also be beneficial. Indeed, an increase in remittances represents an increase in the returns to education. When Ali educates himself, his children will have a higher level of education and, if they go abroad, will send him more remittances, which can induce more investment in education and human capital, thus stimulating growth.
By testing it with empirical data, the economists confirm that their model can explain these different effects of remittances on countries' economies, whether positive or negative. But whether Ali uses this money to repay his loan or not, it is probably necessary for him. Behind the billions sent home each year by emigrants is the improvement of their families' living conditions, if not an economic growth.
