E A Selvanathan and Saroja Selvanathan Griffith Business School
Griffith University Queensland
DISCUSSION PAPER 10.27
REMITTANCES AND ECONOMIC GROWTH:
EMPIRICAL EVIDENCE FROM BANGLADESH
INDIA AND SRI LANKA*
The University of Western Australia
E A Selvanathan and Saroja Selvanathan
Griffith Business School
Griffith University Queensland
Discussion Paper 10.27
In many developing countries, remittance payments from migrant workers are increasingly becoming a significant source of export income. This paper investigates the causal link between remittances and economic growth in three countries, Bangladesh, India and Sri Lanka, by employing the Granger causality test under a VAR framework (Granger 1988). Using time series data over a 25 year period, we found that growth in remittances does lead to economic growth in Bangladesh. In India, there seems to be no causal relationship between growth in remittances and economic growth; but in Sri Lanka, a two-way directional causality is found; namely economic growth influences growth in remittences and vice-versa. The paper also discusses a number of policy issues arising from the results of the analysis in relation to remittances in association with liberalisation of financial institutions, gender issues, regulation and enforcement, investment and savings schemes, and promotion and education.
* The authors would like to thank Professor K W Clements of the University of Western Australia for his comments on an earlier version of the paper.
South Asia has been an important source of migrant workers for countries suffering from labour shortages and migrant workers’ remittances have become an increasingly important source of export income for this region. Within South Asia, Bangladesh, India, Pakistan and Sri Lanka have been the main suppliers of migrant workers who are spread over almost all over the world. Remittances sent by these migrant workers to their home countries have played an important role to promote economic development in these countries. This paper is a modest attempt to examine the impact of remittance income on economic growth in three South Asian countries, namely, Bangladesh, India and Sri Lanka1. Figure 1 indicates that remittance income in Bangladesh, India and Sri Lanka has increased significantly in the last 30 years, with some minor fluctuations. All three countries show three periods where their remittance activities increased substantially, the periods surrounding 1980, post 1993 and 2001. These three trends in remittance, as well as others, such as the period of stagnation visible in remittances to India between 1980 and 1991, are investigated in more depth in Section 4.
Increases in remittance flows have greatly assisted these countries to minimize the problem arising from shortages of foreign exchange reserve which is badly needed to pay the import bills. It is undeniable that during their earlier stage of development, developing countries like Bangladesh, India and Sri Lanka need the scarce foreign exchange to pay for its import requirements. The immense increase in remittance payments over this period may be attributed to two significant factors. First, immigration between developing and developed countries has increased dramatically in the past 20 years (World Bank 2007). Second, transaction costs have declined as technological improvements have allowed for faster, lower cost mechanisms for the international transfer of payments between individuals (Guiliano & Ruiz-Arranz 2006).
Figure 1: Aggregate Remittances to Bangladesh, India and Sri Lanka: 1975-2006
Source: Derived from Table A1, Appendix A.
With the increase in remittance income, practitioners in development economics have shown curiosity in examining its impact on economic growth in both the host and country of origin of the expatriate workers. With regard to its impact on economic growth in the country of origin of the expatriate workers, opposing views have emerged – some argue that remittances have a positive impact on economic growth while others hold the opposite view. The purpose of this paper is to examine the impact of remittances on the economy of Bangladesh, India and Sri Lanka. Together, Bangladesh, India and Sri Lanka have remained an important source of expatriate workers. The number of expatriate workers has increased significantly over the years. In the process, remittance income has emerged as one of dominant sources of foreign exchange earnings for these nations. Thus, these three countries offer a unique opportunity to examine the linkages between remittance income and economic growth. The findings of the study have important policy implications not only for these three countries, but also for other developing countries that depend on remittance income.
The organisation of the paper is as follows. Section 2 gives an overview on the debate surrounding the relationship between remittances and economic growth. Section 3 looks at the motivation behind our paper and introduces our research mechanism while Section 4 of the paper examines the importance of remittances to Bangladesh, India and Sri Lanka. In Section 5 we present a preliminary time-series data analysis of remittances and economic growth data in these three countries, and in Section 6 we investigate the direction of causality under a VAR framework. In the final section we present our concluding statements and provide recommendations according to our findings.
2. Remittances and Economic Growth: An Overview As mentioned above, whether remittances promote economic growth is an important issue of debate amongst economists. Those that believe remittances do not contribute to economic growth point to their expenditure on conspicuous consumption (Rahman et al. 2006) and that any savings are being spent on consumption rather than for the accumulation of productive assets (Stahl and Arnold 1986), and the theoretically low marginal propensity to consume out of transitory income. Those that argue for the positive developmental effects of remittances focus on the multiplier effects of consumption (Stahl and Arnold 1986), development of the financial institutions that handle remittance payments (Aggarwal et al. 2006), use of remittances as foreign exchange (Ratha 2005), and the role of remittances as an alternative to debt that helps alleviate individuals’ credit constraints in countries where micro-financing is not widely available (Guilamo and Ruiz-Arranz 2006). These arguments may be separated into the classical opposing camps of development economists; those who believe in a top-down approach to poverty alleviation placing primary focus on the development of institutions, and those who argue for a bottom-up approach in which the individual is first lifted out of the poverty trap from which point society follows.
Many studies have attempted to address the impact of remittances on economic growth and poverty alleviation. Pradhan et al. (2008) find that remittances have a small, positive impact on growth in a 36 country cross-sectional study using a linear regression model in which remittances form one of five variables. Aggarwal et al. (2006) conducted a study of 99 countries over the period 1975-2003 and find that remittances have a positive effect on bank deposits and credit to GDP. The authors then interpolate the positive effect on development by invoking existing studies showing the positive impact of these two variables on economic growth. Taylor (1992) and Faini (2001) also find a positive association between remittances and economic growth. Taylor (1999) find that every dollar Mexican migrants send back home or bring back home with them increases Mexico’s GNP from anywhere between US$2.69 and US$3.17. In contrast, Spatafora (2005) finds that there is no direct link between per capita output growth and remittances. Meanwhile, in one of the larger cross country surveys, Chami et al. (2003) conclude that remittances have a negative effect on economic growth across a sample of 113 countries. Several other published studies in relation to remittances have focused specifically on the alleviation of poverty rather than overall economic growth (for example, see Adams & Page 2003).
3. Motivation for the Current Study In the above studies, the null hypothesis has been a statement of correlation and not causation. The question itself is framed around whether remittances are a statistically significant factor in determining economic growth. Another important question in relation to remittances and economic growth should be that of causation. Such a question asks whether economic growth causes remittances or visa-versa. In addition, the results from the above studies are also based on panel-data consisting of a number of countries. This may be suitable for answering greater questions on average, but is of little consequence to individual countries seeking to manage domestic policy. Such policy questions include the opportunity cost attributable to the emigration of skilled workers, the financial treatment of recipients of remittances, the composition of domestic institutions for the transmission of remittances and the style and placement of investment incentives targeting remittance recipients. Furthermore, most of the other studies have qualitatively considered the impact of remittances on an economy in terms of social measures such as education, health and democratization (Rahman et al. 2006), and development budget increases. Nor has any quantitative analysis on the causality between remittances and economic growth been conducted. We believe this study will help to fill such a gap.
With this aim in mind, the main objective of this paper is to employ the Granger Causality Framework (Granger 1988) in order to investigate the directional linkage between economic growth and remittances in the context of Bangladesh, India and Sri Lanka. The benefit of the use of such an approach lies in its ease of application for policy makers in developing countries and the demonstration of (non-) causality for an individual country given time series of only two variables; remittances and economic growth.
4. Importance of Remittance in the Economies of Bangladesh, India and Sri Lanka In this section we examine the importance of remittances in the three economies under our investigation. For the sake of brevity we discuss the importance of three areas: trends in remittances, the link between remittances and economic growth, and the importance of remittances as a source of foreign exchange in these economies.
Figure 2 presents the growth in remittances for Bangladesh, India and Sri Lanka during 1977-2006 and Table 1 presents the average growth rates for various sub-sample periods. As can be seen, the growth rate fluctuates from time to time but is almost a constant during some periods. Growth in remittances across these countries appears to have stabilized somewhat over the last two decades with the variance of fluctuations reducing dramatically relative to the period 1976 – 1985. This reduction in the variance of remittance growth could be related to the stabilization of government policy and currencies over time. An example of such instability affecting remittance flows is the Sri Lankan case where in 1977, the election of the United National Democratic Party led to a change in migration policy, causing a surge in labour exports and thus remittances (Eelens & Speckmann 1990). This, combined with government reforms of the Sri Lankan exchange rate system during the same period resulting in a currency devaluation (Balakrishnan 1980), an economic boom in the labour-scarce oil producing economies of the middle east, and the push factors of prolonged ethnic conflict and slow growth in the rural economy (World Bank 2004), explains the spiking nature of remittances in the late 1970’s and growth thereafter.
Figure 2: Growth in Remittances (in percentages), 1976-2006
Source: Derived from Table A1.
Table 1: Average growth rates in remittances, 1976 - 2006
Source: Derived from Table A1.
Formal and informal remittance transfer channels could help explain why between 1980 and 1991 there is a relative stagnation in remittance growth. Informal remittance channels can involve money carried place to place by individuals or couriers, or, it could involve a hawala service network which is informal and provides cash payouts across borders at a fraction of the cost of formal methods. Formal networks such as banks and foreign exchange bureaus are more popular in robust and liberalised economies with strong financial sectors (Sander and Maimbo 2005, p.65). As India was not financially liberalised until the 1990’s when multiple exchange rate controls were lifted, there would have been an incentive to use informal means of remittance transfer up to this point (Jha et al. 2009, p.9). Using informal transfer methods would cause an under reporting of remittances in India up to the 1990’s.
With nearly one half of Bangladesh’s offshore labour employed in Saudi Arabia (Siddique 2004), Bangladesh too experienced the benefit from growth in West Asia during the 1970’s. This explains their large growth in remittances during the late 1970’s in line with the rising oil prices of the time. There was a significant plateau in remittance growth in the period leading up to and during the Gulf war from 1988-1991. This was remedied however with Bangladesh workers involvement in post-war reconstruction (Siddique 2004) which is reflected by steady remittance growth from 1992-94.
With Saudi Arabia as a majority employer, availability and quantity of work for Bangladeshi migrant workers is at the mercy of pricing fluctuations in the oil industry. When compared to crude oil prices, increases and decreases in remittance growth is correlated to increases and decreases in oil prices. The periods 1977-81 and 1988-1991, as previously mentioned, are good indicators of this, as well as the strong growth in remittances from 2002 which is in line with a sharp rise in oil prices in the same period.
Figure 3 highlights the sheer size of the proportion remittances occupy in the export earnings of Bangladesh, India and Sri Lanka, and Table 2 presents these values at sample means at various sub-periods. Bangladesh shows the greatest reliance on remittances as a form of income growing from approximately 6% of export income in 1976 to more recent times where remittances have hovered close to 50% of export income since 2003. India and Sri Lanka likewise have grown in their dependence on remittance income from humble beginnings in 1975 with both countries attributing approximately on third of their export earnings to remittances in the years surrounding 2006.
For all three countries, the period up to and including 1979 shows steady growth in remittances as a percentage of exports before a major jump in 1980, with Sri Lanka more than doubling remittances while Bangladesh and India came close to doubling over the course of one year. The rising oil price in the mid 1970’s is a contributing factor to this growth, bringing increased wealth into exporting countries in West Asia and the Gulf region. As a result of this increased wealth, development programs including construction of roads, schools, hospitals, houses and other commercial complexes were undertaken (Kuthiala 1986). Increased wealth also meant many households in oil rich areas were less willing to participate in more medial tasks such as cleaning, cooking and household maintenance and could now afford fulltime maids and grounds keepers. This resulted in a spurt in demand for semi-skilled and unskilled workers for which India, Sri Lanka and Bangladesh were well placed to meet.
Figure 3. Remittances as a Proportion of Export Income (%): 1976-2006
Source: Derived from Table A1.
Table 2. Average Remittances as a Proportion of Export Income (%):1977-81-2002-06
Source: Estimated from Table A1.
It has been found that remittances help promote growth in less financially developed countries by providing a substitute for inefficient or non existent credit markets, thus allowing consumers to reduce credit constraints and find an alternative way to finance investment (Giuliano & Ruiz-Arranz 2006). Having access to credit can help increase investment opportunities in areas of developing countries that previously produced little, leading to growth and a positive trend relationship between GDP and remittances as shown in Figure 4 [Source: World Bank World Development Indicators (2007)].
Remittances also encourage economic growth when they are used for financing children’s education and welfare expenses such as health care (Chimhowu et al. 2005). Investing in child education and welfare will increase labour productivity in the long term which in turn impacts positively on growth. This longer term approach could also help explain why the GDP appears somewhat insulated from the short term fluctuations in remittances in Figure 4. Even if the remittances are spent on consumption or real estate, there are still multiplier effects and increases in demand for goods stimulated by these activities (Chimhowu et al. 2005), once again showing the positive link between remittances and GDP.
In Figure 4, India requires some further explanation as its remittances do not trend as smoothly as Bangladesh and Sri Lanka. As discussed earlier in Section 4.1, there is a period from 1980 to 1993 where remittances in India stagnate. Apart from this anomaly there is a clear positive trend relationship between Remittances and GDP with the final exception to this being a spike in remittances per capita in 2003. An explanation for this positive spike in 2003 is Resurgent India Bonds, which were launched in 1998 and matured in 2003. A large portion of these bonds were redeemed and retained in India, instead of being repatriated abroad in foreign currency. That amount retained was thus recognized as remittances, resulting in the 2003 spike (Chishi 2007).
A Preliminary Data Analysis of Remittance and Economic Growth
We use annual time series data for the period 1976 to 2006 for the two variables, per capita remittances and economic growth in Bangladesh, India and Sri Lanka. The data is collected from various issues of the World Bank (2007a). Figure 4 plots the two original series for the three countries.
As can be seen from Figure 4, there is an upward trend in both series and therefore, the means of the time series are changing over time indicating that both series in their original form may not be stationary. The plots of the first-differenced series of per capita remittances and economic growth (in logarithmic form) suggest no evidence of changing means, indicating that the per capita remittances and economic growth series may be integrated of order one, that is, both time
Figure 4: Remittance per capita and GDP per capita: Bangladesh, India and Sri Lanka,
Source: Derived from Table A1.
series are I(1). To statistically validate these findings, we formally test the stationarity properties of these two series using the Augmented Dickey-Fuller (ADF) unit-root test.
We apply the ADF test to the per capita remittances and economic growth series separately. We carry out the estimation of the models using the econometric software SHAZAM and test the presence of unit roots using the systematic procedure described in Enders (1995). The results of the Augmented Dickey-Fuller (ADF) test for the stationarity of the two original series are presented in Table 3. As can be seen, both time series have at least one unit root and hence are non-stationary in their original form, except for the remittance series in Sri Lanka.
We now test the stationarity of the first difference of both series by applying the ADF test on the first difference series. The results are presented in Table 4. As can be seen, the results show that both series are stationary in their first difference form. This means both series are I(1).
Even if the two variables, per capita remittances and economic growth series, individually are I(1), it may be possible that a linear combination of the two variables may be stationary. If we are modelling a linear relationship between per capita remittances and economic growth series, even if each of them individually are non-stationary (i.e. I(1)), as long as they are co-integrated, the regression involving the two series may not be spurious. Thus, we now investigate whether the two series are co-integrated and have a long run equilibrium relationship.
We now employ the Engle and Granger (1987) procedure, which is based on testing for a unit root in the residual series of the estimated equilibrium relationship by employing the Dickey-Fuller test. Therefore, the null and alternative hypotheses are:
H0: The residual series has a unit root (or per capita remittances and economic growth series are not co-integrated)
HA: The residual series has no unit root (or per capita remittances and economic growth series are co-integrated)
The results are presented in Table 5 and clearly show that both the least square residual series are non-stationary and hence the series per capita remittances and economic growth series are not co-integrated, indicating that there is no long-run equilibrium relationship between per capita remittances and economic growth series in all three countries.