FOCUS ON DEVELOPMENT POLICY

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1 FOCUS ON DEVELOPMENT POLICY Policy Papers of KfW Entwicklungsbank Developmental Potential of Migrant Remittances April 2007 Author : Bettina Zoch Edited by: Frank Weiler Migration is a controversial issue in development policy. For a long time, discussion centred on the adverse effects for the countries of origin, above all the loss of know-how (brain drain) and productive human resources. Development-policy measures had been directed at mitigating these adverse impacts and restricting migration. Recently though, the debate has made a discernible shift in focus towards a new aspect: the enormous development scope remittances may hold for their home countries. Remittances are transfers of money by foreign workers to their home country. These remittances to developing countries have almost doubled in the last six years and were estimated to amount to US$ 167 billion in 2005, at least double official development assistance. This stream of private funds has therefore attracted the attention of the international donor community, the hope being that remittances can effectively contribute to poverty reduction and capacitybuilding in developing countries. If their effect is strong enough, they could do more than just offset the adverse impacts of migration but help give an impetus to sustainable development. Particularly amidst efforts to attain the Millennium Development Goals, with many donor countries short of budget funds, the steady and increasing flow of remittances appears to some like manna from heaven'. 1 In the following, we shall first outline the background of remittances. Then we shall describe the findings to date on the developmental potential and constraints. Based on this information, we shall point out possible ways of maximizing their developmental impacts. Remittances and statistics In 2005, about 200 million migrants worldwide transferred at least US$ 232 billion to their home countries, of which 70% (about US$ 167 billion) went to developing countries. Including informal remittances, private capital transfers exceeded official development assistance amounting to US$ 78 billion for 2005 by a factor of two to three (Chart 1). 2 Remittances are private funds and the decisions on how to use them are equally private, thus, third parties cannot exert any legitimate influence. For the most part, the approximate doubling of statistically recorded migrant remittances since 2000 has been attributed to the increased surveillance of private fund transfers in response to the terrorist attacks of 11 September They are unlikely to have grown more than the rate of mi- 1 Fajnzylber, P., Humberto López, J., Close to Home: The Development Impact of Remittances in Latin America, World Bank, All figures in Charts 1 and 2 and Tables 1 and 2 stem from Global Economic Prospects 2006: Economic Implications of Remittances and Migration, page 88, World Bank 2006 Note: This paper reflects the opinion of the authors, not necessarily KfW policy.

2 2 US$ billions Chart 1: Financial flows to developing countries since 1990 gration. Remittances, then, are not a new phenomenon by any means: It is simply that more of the money is now transferred through formal channels with improving statistical records. 100 Remittances Though impressive, these figures probably 80 Official Development Aid still only account for a part of the actual volume of remittances due to the difficulty of obtaining solid data. On top of this come the unrecorded remittances by way of informal transfer networks; by mail, through acquaintances or in person and as gifts. The World Bank estimates that informal remittances make up 35% - 75% of the statistically recorded amount. This broad range underlines the need for more in-depth research. Who sends the money and why? Most migrants from developing countries work in low-wage sectors of their host countries as kitchen helpers, cleaning personnel or farm hands, for example. The average annual amount remitted per migrant ranges between US$ 2,000 and US$ 5,000 or 20% - 30% of total income. Remittances are usually made regularly in consistent amounts. Altruism motivates supporting the closest family members at home. The support of spouses, children and other dependents by means of remittances replaces the regular income of the emigrant in his native country. Moreover, relatives and friends often club together to enable a migrant to leave the country, so remittances are a kind of participating interest in the welfare gains of migration. The share of remittances used for consumption or invested and saved differs greatly depending on the region and the recipient s level of income. Typically though, a large part is used to satisfy the basic needs of the recipient families. According to World Bank information, in Central America an average 90% of remittances is used for family upkeep, including expenditures on education and health services. As statistics show, the recipient households are better nourished and have greater access to education and health services as a result. Only about 10% of the remittances are saved or invested in entrepreneurial activities. The picture would appear to be different in Vietnam, where a survey by the Agence Française de Dévéloppement (AFD) 3 found that remittances are frequently invested by family members in entrepreneurial activities. Export-import trade transactions in cooperation with the migrants are a popular line of business. Remittances are also commonly used to acquire residential property in the home country. Who are the recipients? Foreign Direct Investments At US$ 43.1 billion and US$ 42.4 billion, respectively, East Asia and the Pacific and Latin America and the Caribbean top the list of recipient regions, with South Asia, the Middle East and North Africa as well as Europe and Central Asia following in midfield. Sub-Saharan Africa takes last place. Only 4.9% of migrant remittances to developing countries went to the poorest region in the world (Chart 2) in This regional distribution is also apparent in the ranking of recipients amongst the developing countries in 2004 (Table 1). Accounting for the size of the national economies and the ratio of return remittances to gross domestic product (GDP), small economies and island states in particular headed the list of recipient 3 Survey by AFD of migrants from Mali, Senegal, the Comoros, Vietnam and Morocco: Migration et phénomènes migratoires: Flux financiers, mobilisation de l'épargne et investissement local, French Development Agency, April 2004

3 3 countries in 2004 (Table 2). Chart 2: Remittances to developing countries by region in US$ billions Latin America and the Caribbean 42,4 Sub-Sahara Africa 8,1 South Asia 32,0 Europe and Central Asia 19,9 Middle East and North Africa 21,3 East Asia and the Pacific 43,1 Altogether, we can see that few people move to industrialized nations from the world's poorest countries, which in turn only receive a small volume of remittances. As a rule, the higher the level of income in the destination country the higher is the cost of migration. As a consequence, most migration to OECD countries flows from developing countries with higher per capita income. Conversely, migrants from developing countries with very low per capita income frequently migrate to economically more attractive developing countries in the region, where the costs of migration are lower as are the welfare gains. Table 1: Remittances to developing countries in absolute figures (2004) 1. India US$ 21.7 Billion 2. China US$ 21.3 Billion 3. Mexico US$ 18.1 Billion 4. Philippines US$ 11.6 Billion 5. Morocco US$ 4.2 Billion 6. Serbia US$ 4.1 Billion 7. Pakistan US$ 3.9 Billion 8. Brazil US$ 3.6 Billion 9. Bangladesh US$ 3.4 Billion 10. Egypt US$ 3.3 Billion 11. Vietnam US$ 3.2 Billion 12. Colombia US$ 3.2 Billion 13. Nigeria US$ 2.8 billion How is the transfer made? Table 2: Remittances in developing countries as a ratio of GDP (2004) 1. Tonga 31.1% 2. Moldavia 27.1% 3. Lesotho 25.8% 4. Haiti 24.8% 5. Bosnia and Herzegovina 22.5% 6. Jordan 20.4% 7. Jamaica 17.4% 8. Serbia and Montenegro 17.2% 9. El Salvador 16.2% 10. Honduras 15.5% 11. Philippines 13.5% 12. Dominican Republic 13.2% 13. Lebanon 12.4% The formal money transfer is effected via regulated institutions, such as banks, post offices and money transfer organizations. Unlike banks and post offices, the latter usually provide a service especially tailored to migrants needs. The largest money transfer organizations frequently open their branch offices via distribution partners and run a closely-knit network worldwide. The market leader, Western Union, with about 245,000 outlets, operates in 200 nations and territories via this kind of system. With 100,000 branch offices in 170 countries, MoneyGram ranks second. Transfer costs differ widely depending on the provider and transfer corridor. As dictated by market mechanisms, costs are much lower for a high volume of transfers, between the USA and Latin America, for example, than for less frequently used facilities. Global average costs are estimated at about 10% - 13% 4 of funds transferred. For many migrants, formal remittances are therefore prohibitively expensive. 4 Freund, C., Spatafora, N., Remittances: Transaction Costs, Determinants, and Informal Flows, Policy Research Working Paper 3704, The World Bank, September 2005

4 4 Informal transfer systems rival the regulated financial sector worldwide, a prominent example being the hawala system. These are effective and low-cost systems, some of which have already been in use for centuries, mainly in South Asia, parts of Africa and in Arab countries. Asian and African migrants in particular appear to use these systems for remittances. The people offering these kinds of transfer service are called hawalada. They are known in diaspora communities or can be found through newspaper advertisements. They often own import-export businesses. Internet cafés, grocer's shops, etc. can also be used as a base for hawala transactions, however. These transactions are based solely on trust and the basic procedure is simple: A foreign worker from Nigeria living in Frankfurt, for example, wants to transfer EUR 200 to his family in Abuja. With this aim he goes to a hawalada, pays the sum to be transferred and agrees to a code. The hawalada in Frankfurt now contacts a business partner by telephone, fax or internet in Abuja and informs him of the amount and the code. The money can be collected immediately by a member of the family in Abuja who knows the code. The costs for such transactions worldwide are estimated at about 1% - 5% of the transfer amount. There is no actual transfer of real funds in this transaction at first. Instead, the balance is paid by over- or under-invoicing a shipment in a future transaction. The hawala system vies with the formal financial sector, but it also poses problems for international security organizations because it largely evades documentation and control. At first sight, it would appear to be ideal for money laundering and financing terrorism. The practice is, however, based on trust and in part on Islamic law. Those infringing the rules forfeit the trust of business partners and are prohibited from carrying on their occupation for life. How far hawala is put to illegal use is hotly disputed amongst experts. As a rule, migrants do not use it for illicit purposes, but simply as an economical and safe way to transfer funds. II. Impacts of return remittances Remittances increase the income of the recipients, directly raising their standard of living, and also enable them to diversify their sources of income. Under certain circumstances, the additional income can also be invested or saved. This generally makes it easier for recipients to cope with income shocks. A sustainable developmental impact is possible if remittances facilitate capacitybuilding so that capital growth benefits society in general, not just the recipients. Microeconomic impacts In a recent study, though, the World Bank comes to an indeterminate assessment of the developmental impacts of remittances in Latin America: The proven beneficial impacts are only moderate. According to the estimates for Latin America, an increase in the ratio of remittances to GDP by 1% results in an average reduction in the share of the poor population by 0.37%. The poverty impact, however, varies between merely 0.08% for poorer and an above-average 1.12% for wealthier Latin American countries. A reduction in the number of people living in poverty due to remittances could only be proved for 6 out of 11 Latin American countries reviewed. In two individual cases, there has even been an increase in extreme poverty (Dominican Republic 7.4% and Nicaragua 0.4%) due to migration and remittances. In these cases, the costs of migration evidently exceed the positive income effects of remittances. The reasons for this wide disparity in impact are the very extremely diverse profiles of migrants and their relatives at home, their respective countries of origin. Remittances also appear to have a larger beneficial impact when the recipient country is more advanced. In addition, transfer payments raise income in the same way as welfare aid. This may create disincentives for recipients to exert their own economic efforts.

5 5 Macroeconomic impacts Large flows of outside capital afford opportunities and pose risks for the recipient economy. The possible benefits include the anti-cyclical effects of return remittances in the recipient country, which can have a stabilizing economic effect. In Botswana, for example, considerably higher remittances to migrant households were recorded during the drought period. Remittances also exert a favourable influence on refinance facilities in a country. On the one hand, they have a direct beneficial effect on the balance of payments and credit standing of the recipient country and on the other hand, they also provide a suitable means of securitization. One risk, however, is the possible heavy economic dependence on remittances. If a shock triggers a sharp drop in remittances, this can throw the economy off balance. This kind of plunge happened in the Philippines after 11 September 2001, where remittances temporarily declined by 17.6%. Another risk is the so-called Dutch disease effect. The local currency appreciates due to a massive influx of outside capital. As the prices for export goods rise, this works to the detriment of the recipient country s international competitiveness. What are the development constraints? The literature frequently cites high costs, poor service and transfer insecurity as the main development constraints, with most discussion focusing on transfer corridors between industrialized and developing countries. Little attention has been paid to another constraint on transfer payments; remittances from one developing country to another. As the amounts are even smaller and regional banking networks are generally underdeveloped, this type frequently costs twice as much as the North-South transfer. The World Bank estimates that about 30% of remittances are so-called South-South transfers, i.e. where both senders and recipients are located in developing countries. This kind of migration is particularly widespread in sub-saharan Africa (69%) and Europe and Central Asia (64%). A reason given by migrants in the AFD survey as to why remittances are not invested is the lack of access to financial services geared to needs in the home countries. This applies to finance for building schemes as well as for entrepreneurial activities and investments by diaspora communities. Additional factors are a lack of business knowledge amongst migrants and recipients and the considerable bureaucratic hurdles in business registration or the acquisition of land titles. Conclusion Due to their mainly consumptive use, remittances raise living standards directly for recipient households. Based on findings so far, the capacity-building impact is only moderate from a macroeconomic viewpoint. Nevertheless, the moderate average benefits at micro and macro level warrant development assistance. It is imperative that policy measures to maximize the prospective development benefit of migrant remittances cater to the completely private status of these funds. As restrictive measures such as taxation or overly strict regulations are burdensome to migrants and induce them to seek informal channels, they detract from developmental efficacy. In contrast, we strongly recommend measures to support the personal decisions of migrants and their families and to enlarge their scope for development. These must be geared closely to the country setting and target group. Otherwise they can have an adverse developmental influence on incentives for senders and recipients alike. There is also a need to avoid preferential treatment for recipients at the expense of others.

6 6 Suitable measures include facilitating investments in education and health. Crucial also for maximum impact are financial system development and in particular access for poorer sections of the population to appropriate financial services. This also entails promoting financial system networking to make national, regional and international transfers cheaper, safer and closer in line with demand. At the same time, there is a need to develop special financial services to cater for the special requirements of migrants and recipients, including, for example, innovative savings products, insurance, medium-term and long-term loans as well as mortgages to create positive savings or investment incentives. KfW Entwicklungsbank projects have already contributed to financial system development and the promotion of payments transaction systems in many countries. Cases in point are support to the micro bank network of the ProCredit banks in Eastern Europe and the ProPay payments transaction product as well as the modernization and expansion of the payments transaction system in Uganda in cooperation with GTZ. Another project is the First Microfinance Bank of Afghanistan, founded together with other donors. Today, it performs a key function in the country as the major hub for payments transactions. Remittances also play an increasing role in the development of capital markets by way of securitization, an area where KfW has gained broad experience. The international community has placed very high developmental hopes in remittances. Findings to date, however, indicate that these have been overoptimistic: Migrant remittances alone will not suffice to set sustainable development in motion. A generally conducive economic and social climate, however, can ensure that migrant remittances bear fruit and bring maximum benefit both to recipient households and the economy as a whole. KfW Entwicklungsbank Palmengartenstraße Frankfurt Postfach Tel Fax: FZ-Büro Berlin Charlottenstraße 33/33a Tel Fax: Pressestelle Tel info@kfw-entwicklungsbank.de Redaktionsschluss: