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The economics of remittances
Just how beneficial are remittances? One loyal MR reader writes on his blog:
While undoubtedly a portion of remittances are sent back to the U.S. via purchasing power to buy U.S. goods and services, a portion is also kept in-country and used as an alternative monetary system or held by a foreign government as a source of "hard" currency to prop up its domestic money.
Money that leaves the U.S. and never comes back is great for the U.S. government. Essentially it bought goods and services without ever having to pay up on it's end of the IOU. Therefore, shouldn't Americans support remittances? America doesn't run out of money - we'll just print more.
I am more interested in the effects on the receiving country.
Assume that dollars are sent rather than exchanged for pesos and that the remittance money never returns to the United States. In essence we are inflating the parallel currency in Mexico (or Vietnam, or wherever). This means more wealth for the people who receive the remittances. But who loses?
Some of the new money will just be inflationary. People who compete with remittance receivers in consumer markets will face higher prices.
Output and employment will rise in regions with unemployed or underemployed resources, or simply in monopolized sectors. If a Mexican uses the money to bribe a policeman, or hire a doctor, the quantity effect may outweigh the price effect. This is the main source of net benefits to the receiving country. But in perfectly competitive sectors this is just pure inflation. Note that rural Mexico, where most of the remittances go, is far from perfect competition.
There is also an precautionary insurance gain from having more savings held in dollars, distinct from whatever is finally purchased with those dollars.
Of course, not all of the dollars will stay in Mexico. Mexico, as a nation, gains to the extent those dollars buy goods and services from the United States, assuming of course U.S. markets are large enough that more Mexican buyers won't push up prices for subsequent buying Mexicans. So the best outcome, at least for Mexico, is if the remittances go to people who will carry them back across the border or spend them on imports.
If the dollars are exchanged into pesos, through Western Union, the story differs. The rate for dollar-peso exchanges moves against the dollar. This hurts people who have already accumulated dollar-denominated assets; usually those are previous receivers of remittances and of course American tourists who visit Mexico or who buy amates. It also will hurt Mexican exporters. Mexican importers gain accordingly.
In sum, it is a complicated story. Yes, in many regards remittances are more like inflation -- albeit in a parallel currency -- than like real wealth transfers. But there are also some important efficiency gains.
We also should not assume that distribution and efficiency are fully separate. Perhaps the remittances go to people who know better how to invest the money. Perhaps not.
Comments are open for analysis of remittances, but general talk of Mexican immigration will be deleted...
Posted by Tyler Cowen on November 7, 2006 at 07:22 AM in Economics | Permalink
Comments
Are comments about the impact of emigration in Mexico OK?
Posted by: Peter Schaeffer at Nov 7, 2006 8:32:23 AM
The focus of comments should be remittances...
Posted by: Tyler Cowen at Nov 7, 2006 8:47:11 AM
I would be curious to see the %'s saved of these remittances. I remember reading somewhere that people in poorer countries tended to save quite a bit. And then the next question would be the form of savings. Is a large part of this money stuffed into a mattress? Or are there institutions that they can use?
Posted by: JoshK at Nov 7, 2006 9:09:18 AM
I wonder, though, whether emigration and remittances substitute, or are complimentary. One could imagine that remittances mean that the recipients no longer feel the need to migrate, or that remittances enable the recipients to migrate -- indeed, both effects are likely in play.
Mexico might be a bad example because the ever-changing legal situation of migrants makes the true cost of migration hard to measure. Perhaps the place to look is turn-of-the-century Italy-to-US migration and US-to-Italy remittances or somewhere similar where the legal realities of migration remained mostly fixed over the time period in question. There also you have the effect of remittance money in essence financing Italy's deficit spending.
Posted by: Grant Gould at Nov 7, 2006 9:15:19 AM
As I recall, remittances were a very important element in Italian national accounts in the first decade of the 20th. Century. As a result, Italy was able to stay on gold, and enjoyed significant capital inflows at a crucial point in its industrial development. It could be that remittances to Mexico exchanged into Pesos have a less beneficial effect, contributing to overvaluation (through inflation under a peg) or depreciation. This will make foreign deposits or investments less appealing.
Posted by: Roland at Nov 7, 2006 9:32:57 AM
I don't really believe that remittances "never come back to the United States". If they were not a legal claim on assets in the United States, then they just wouldn't have any value abroad. They may be gone from the US for a long time, and you could probably find specific hundred dollar bills that actually never do make it back, but on net, eventually the dollars will find their way back to someone who will buy something inside the US.
Posted by: Foolish Jordan at Nov 7, 2006 9:40:03 AM
Arrgh! Not depreciation, appreciation (must have more coffee...)and increased probability of fx crisis..
Posted by: Roland at Nov 7, 2006 9:50:20 AM
Suppose the person who sends remittances and a representative foreign investor are assymetric for whatever reason, i.e the "sender" who is a receiving country national has more information, a reasonable assumption. Now suppose that the mexican marginal productivity of capital is very high vis a vis the U.S, and no "foreign" investment is forthcoming anyhow, a Lucas Paradox type of
environment. In that context, I think remittances unquestionably increase aggregate welfare, because they solve an important capital market problem. This holds true for both the recipient (which is now able to fund more aggregate investment and build a marginally efficient capital base) and the source country (now able to export what would otherwise become marginally inefficient capital).
Posted by: ac at Nov 7, 2006 9:51:50 AM
If dollars are really sent abroad and don’t come back, then the US profits from seigniorage. Some people claim the US promotes the use of dollars abroad for precisely this reason. I am not so sure. However, it is true that when the US changed the portraits on our currency, the US government paid for advertising abroad explaining the change (in Russia). No such ads were used in the United States. The foreign ads stressed that existing currency would remain legal tender forever.
It is by no means clear, that the money is inflationary. To the extent that dollars circulate in Mexico as a parallel currency, Mexico must reduce the peso monetary base accordingly. Stated differently, dollar circulation in Mexico transfers seigniorage gains from Mexico to the United States. Indeed, legislation was once introduced in the Senate to share seigniorage gains with countries that dollarised (see http://www.bis.org/publ/bppdf/bispap17s.pdf) . Of course, dollar circulation and dollarisation are not the same thing.
I don’t see how this increases wealth for the recipients. If they got pesos, or converted the dollars to pesos, they could hold peso accounts/assets instead. A quick check shows that Mexico’s rate of inflation has been declining for years (see http://www.latin-focus.com/latinfocus/countries/mexico/mexcpi.htm). Years ago, Mexicans had compelling reasons to hold non-peso financial assets. This is far less true now.
I would expect some prices to rise in rural Mexico from remittances. However, this is a consequence of greater local incomes, not an influx of dollars per se. Converting the dollars to pesos wouldn’t change the outcome, at least in my opinion.
I am concerned by assertions that dollar circulation will raise output/employment in some parts of Mexico. If it were that easy, the Mexican government would have printed money to obtain the same benefits a long time ago. As stated above, I do agree that high local incomes from remittances will have positive local effects… And some negative ones.
Of course, holding dollars in Mexico is also risky. If the US dollar appreciates versus the local currency, the Mexican holder profits. If the dollar devalues, the holder loses. Since the dollar is likely to fall against the peso (baring an upturn in Mexican inflation), this is a material downside.
I agree that Mexican exporters suffer. Remittances can be thought of as an export of labor services. As such, they compete with all other exports and make other exports less profitable. The same is true for the US. The US “exported” $700 billion in IOUs in 2005. Of course, these “exports” competed with US exports of goods and services.
Posted by: Peter Schaeffer at Nov 7, 2006 9:53:36 AM
Remittances are equivalent to foreign aid without the potential incentives effects. It is a transfer of US income to another country. What happens just depends on whether Mexicans prefer to spend only on traded goods, in which case there is no real exchange rate effect, or some on traded goods in which case there is. It does not matter what currency the remittance takes place in, only on what goods recipients choose to spend it on. Mexico gets the same share of value added that it would if those workers produced equivalently at home, minus what goes to capital. But presumably those workers could not produce as much at home, so Mexico is better off.
Posted by: Barry Ickes at Nov 7, 2006 10:01:45 AM
Why aren't remittances equivalent to the purchase of imported goods, without any of the goods showing up in the US? Don't they affect the "balance of payments"? Or is that irrelevant these days?
Posted by: Robert Speirs at Nov 7, 2006 10:05:43 AM
Tyler, I think I have an interesting take on this based on two visits this spring. I have worked with the governors of a couple of states in Mexico. This spring I was in the central part of the country where the Governor said to me that a third of the population of the state was in the US and that while they wanted to get those people back they were concerned about the potential transitional effects which bringing back large numbers would have on remittances which are the second largest source of income in the state. The next day I was in a neighboring state, and the Governor's staff used the same words, almost exactly, to describe their dilemma. These are two very good governors who are trying to grapple with a transition problem that is huge but with a genuine desire to get a large percentage of the productive citizens who migrated back and working in their state.
Posted by: drtaxsacto at Nov 7, 2006 10:14:28 AM
I'm just a dude who's not as well versed with econ. theory as the vast majority of commentators here. That was my blog post that I sent to Tyler, and I'm glad not to have received a Gary Williams-esque "you're wrong, you're so wrong" response :)
But back to the story. I don't have a well formed opinion as to whether remittances would increase output/employment in areas receiving them, but to say that 'if it were that easy, Mexico would just print money' seems to me to miss a critical factor. We're talking about US dollars. Introducing dollars will likely have deflationary effects on the local currency - by driving up prices and such - but the deflation would be significantly less than if the local government prints more money.
Posted by: D. at Nov 7, 2006 10:20:13 AM
Does it matter that the transfers are targeted? A migrant does not remit randomly. A migrant remits to people the migrant knows and cares about. If migrants could not remit because of some barrier, would that lead migrants to bring the people they care about along with them during migration or would people reduce migration, attempt to earn where they were, and tranfer a (presumably) smaller amount to the people they care about? Do people willing to migrate generate enough positive externalities to justify reducing migration? No answers here.
Posted by: evm at Nov 7, 2006 10:48:01 AM
I would reason simply that the effect is positive for both remittance emitting and receiving country provided that wealth creation is always positive. US didnt grow by impoverishing Europe.
When a remittance creator work in a rich country, he creates more dollar value for his labor than at his home country.This has several consequences. If the quantity of work available is limited in host country, this creates pressure in the blue collar wages. Sadly the negative impact will fall among the most vulnerable sections of the host country. For the foreign laborer, its a very good deal as he can work and earn a decent living for himself and his family. For the home country, in most cases this is positive in that the same worker would most probably be unemployed or perhaps joined some fringe extremist group.
For me, talks about inflation / deflation / foreign exchange rates are just tangential. The net result is the creation of bigger cake for everybody. Whether US prints money or Mexico prints money is less important as the money phenomena is just a measure of stock of wealth created.
Sadly, the capital flows from south to north and not vice versa. Developing countries with their stock of dollar and euro are actually financing some part of consumer folly in the north.
Apparently in some cases, you can have a cake and eat it as well.
Posted by: artha at Nov 7, 2006 11:15:05 AM
El Salvador dollarized, so remittances there are macroeconomically no different than remittances from Virginia to California.
I believe that a lot of the remittances to El Salvador are then spent on imported finished consumer goods produced elsewhere. It will be quite a while before Central American economies step up to producing large amounts of finished consumer goods, but they are on their way.
Posted by: Mr. Econotarian at Nov 7, 2006 11:59:50 AM
Two quick thoughts:
a)Although remittances might cause domestic inflation in the short term, high unemployment and low efficiency in poorer countries should allow expanded production, even for services, so that the economy can grow without long-term inflation.
b) Perhaps remittances to Mexico, by causing the peso to be valued higher relative to the dollar, are one of the big reasons that NAFTA has not helped the Mexican economy as much as predicted.
Posted by: Scoop at Nov 7, 2006 12:18:04 PM
Remittances represent work that immigrants have performed in the U.S., expanding total output. Instead of spending that money in the U.S., the money is spend by those receiving the remittances. Ultimately, all dollars send abroad must be spent in the U.S. on goods, services, or financial assets. So remittances are most definitely not a drain on our economy. The important thing is that our economy grew in the process. Where the money is initially spent is not very important.
Posted by: Scott Grannis at Nov 7, 2006 1:01:46 PM
I guess marginal remittances are spent on imports.
Posted by: Doop at Nov 7, 2006 1:53:43 PM
Imagine a rural world affected by poverty-traps, with credit market constrains/imperfections, underdeveloped (or inexistent) capital markets and weak institutions (i.e. corrupt, ineffective and understaffed police and judicial systems, etc.). Indeed, this might seem a very familiar picture to anyone who has been to the rural parts of many developing countries.
In this scenario, remittances act as private aid. The key is whether this form of private aid can be channeled effectively and can help overcome some of the structural problems that affect poor rural areas in developing countries. It does not seem hard to imagine how remittances can help families escape from poverty traps. Whether they can be a good (substitute) source of capital for saving/investment is a more difficult question.
If remittances increase household savings, without sound credit markets or solid financial institutions those savings will mostly serve as insurance against income volatility for households. They won't be channeled as investment and put to more productive uses. If remittances are used directly for investment, will the most efficient investment alternatives find a way to be funded? Or will a lot of money be thrown to below average investment ventures? It is hard to see how in this setting remittances would overcome some of the structural problems that keep poor rural areas poor and underdeveloped.
Posted by: Economister at Nov 7, 2006 2:35:45 PM
Aren't remittences very similiar to finding oil wealth.
It generates a great deal of wealth and income or consumption
but does very little for production or increasing the ability
of the country or population to be more productive.
Posted by: spencer at Nov 7, 2006 5:20:59 PM
Y'all didn't see the article on this topic on the front page of the WSJ, middle of last week? Gist of it was that remittances aren't all to the good, do some demonstrable harm, that Mexicans in Mexico don't invest, and that the whole "remittances will help development" refrain may well turn out to be a fad.
Couldn't find the article online. Here's a blog posting reprinting a small bit of it, though.
Posted by: Michael Blowhard at Nov 7, 2006 6:23:47 PM
One has to take monetary neutrality to extremes to say that remittances would not have a short-run impact on employment and output in Mexico. Price rises take time, during which those with U.S. dollars can cash in their dollars for goods and services. This also has implications for the distribution of real income depending on who the recipients tend to be. However, it is clear that remittances in the long-run should not affect economic growth.
I think Economister is right that we should consider the fact that most people in developing countries are credit constrained. However, this does not imply that remittance recipients will use their additional income mostly for precautionary saving. Another distinct possibility is that they will use it to make "lumpy" purchases such as a new house or car, new or better furniture, plasma TVs, etc. When you add durable goods to these household allocation models, durable goods purchases can take the place of stuffing money in the mattress.
It should go without saying that this kind of spending is certainly welfare improving for remittance-receiving households even if it does nothing to raise the capital stock. Without remittances, households may not have the ability to raise the funds needed to make these purchases.
Posted by: Mark at Nov 7, 2006 8:46:32 PM
I read a book earlier this year on international migration written by Robert E.B. Lucas – not the Nobelist Robert E. Lucas, Jr. – R.E.B. Lucas is a Professor of Economics at Boston University. The focus of the book is how migration affects economic development, and he has an entire chapter on the subject of remittances (“Who sends? How much? Who benefits?), and that chapter alone has over 140 notes and references. He takes a deep look at both economic theory and worldwide empirical evidence over the past thirty years across multiple regions and migration regimes.
If you are interested in a thickly referenced, multi-region, long-term summary of the remittances subject, this chapter should definitely be included. The citation is: Lucas, Robert E. B. 2005. International migration and economic development : lessons from low-income countries. Cheltenham, UK ; Northampton, MA: Edward Elgar.
Posted by: Kirk from Colorado at Nov 7, 2006 10:54:58 PM
Couldn't you say most of those things about FDI?
Posted by: Anonymouse at Nov 8, 2006 12:24:57 AM
