Topic 4


Recently an increasing amount of attention has come to focus on the size and impact of informal remittances.  While formal remittances refer to those remittances which enter a country through official banking channels, informal remittances include those money transfers which occur through private, unrecorded channels.  Such private transfers include remittances brought home by friends, relatives and even the migrant himself/herself.  While formal remittances to developing countries now total over $167 billion (2005) a year, the level of informal remittances is virtually unknown because they tend to flow through unrecorded channels.  Estimates of the size of informal remittances vary widely, ranging from 35 to 250 percent of formal remittances.

In one of the few empirical attempts to estimate the size of informal remittances Freund and Spatafora (2005) use insights from the literature on shadow economies to estimate informal remittances for more than 100 developing countries.  Results suggest that informal remittances amount to 35 to 75 percent of formal remittances to developing countries.  Findings also suggest that the size of informal remittances varies by region:  informal remittances to Eastern Europe and Sub-Saharan Africa are high, while those to East Asia and the Pacific are relatively low.

Other preliminary work suggests that the level of informal remittances also varies by type of migrant, that is, internal or international migrant.  For example, a recent household survey in Ghana (Adams, 2007) found that while only 1 percent of internal migrants remit through formal channels (banks, Western Union, post offices), 43 percent of international migrants remit through formal channels.  These figures are interesting because they reveal that fully one-half of all international migrants in Ghana prefer to remit through informal channels, namely, through friends and relatives.

One important factor causing migrants to remit through informal channels is the high cost of transferring funds through banks and transfer agencies.  In 2000 the average cost of remitting money to 8 Latin American countries was above 10 percent of the amount being sent (Orozco, 2006).  By 2006 the transaction cost of remitting money to these Latin American countries had declined to 5.6 percent, but still this figure is much higher than that charged by informal channels.

From a policy perspective, it is important to reduce money transfer costs in order to increase the amount of remittances returning through formal channels.  Remittances sent through official banking channels can facilitate financial sector development in developing countries in a number of ways:  (1) as bank deposits from remittances increase, banks are able to make more loans; (2) remittance receivers who use banks can gain access to other financial products and services; and (3) banks that provide remittance transfer services are able to “reach out” to unbanked recipients and those with limited financial intermediation (Aggarwal et al, 2006).  Also, in economies where the financial system is underdeveloped, remittances made through official channels can help alleviate credit constraints and promote growth (Giuliano and Ruiz-Arranz, 2006).

 

Topic 4 – Articles

Adams, Jr., Richard. 2007. An Overview of Data Contained in the 2005/06 Ghana Living Standards Survey (Glss 5) on Migration and Remittances: Unpublished.

This short, descriptive paper provides an overview of the main findings of the migration and remittances data contained in the nationally-representative, 2005/06 Ghana GLSS 5 Survey (sub-sample).  It finds that households receiving internal remittances (from Ghana) and international remittances (from African and other countries) tend to be different – in terms of human capital, etc. – than households with no remittances.  It also finds that while only 53 percent of all migrants in Ghana remit, many migrants remit to households other than their nuclear households; that is, they remit to relatives and friends.  It also finds that migrants prefer to remit through informal, private channels:  99 percent of internal migrants remit though informal channels (friends, relatives) and 57 percent of international migrants remit through informal channels.

Aggarwal, Reena, Asli Demirguc-Kunt, and Maria Soledad Martinez Peria. 2006. Do Workers’ Remittances Promote Financial Development? In World Bank Policy Research Working Paper 3957. Washington, DC: World Bank.

This paper uses data on international remittance flows to 99 developing countries to analyze the impact of remittances on financial sector development.  It finds that remittances have a positive effect on bank deposits as well as on bank credit to the private sector.  Controlling for endogeneity, on average, a 1 percentage point increase in international remittances leads to a 0.2-0.5 percentage increase in the ratio of bank deposits to GDP and a 0.1-0.4 percentage rise in bank credit to GDP.  Instrumental variables estimations also show that remittances have a positive and significant effect on bank credit and deposits.

Freund, Caroline, and Nikola Spatafora. 2005. Remittances:  Transaction Costs, Determinants and Informal Flows. In World Bank Policy Research Working Paper 3704. Washington, DC: World Bank.

Using insights from the literature on shadow economies, and historical data on migration, remittances, and transaction costs, this paper empirically estimates the size of informal remittances for more than 100 developing countries.  Results suggest that informal remittances amount to about 35-75 percent of official remittances to developing countries.  Findings also suggest that the size of informal remittances varies by region:  informal remittances to Eastern Europe and Sub-Saharan Africa are high, while those to East Asia and the Pacific are relatively low.  With respect to the determinants of informal remittances, the paper finds that the stock of migrants abroad is the primary determinant, but that the level of money transfer fees also plays a role.

Giuliano, Paola, and Marta Ruiz-Arranz. 2005. Remittances, Financial Development and Growth. In International Monetary Fund Working Paper No. 05/234. Washington, DC: International Monetary Fund.

This paper uses data from 100 developing countries to analyze how local financial sector development affects a country’s ability to use remittances.  Controlling for endogeneity, it finds that remittances promote growth in developing countries by providing an alternative way to finance investment.  By becoming a substitute for inefficient credit markets, remittances improve the allocation of capital by alleviating credit constraints.  With regards to the cyclical nature of remittances, the paper finds that remittances are generally “pro-cyclical,” that is, remittances increase when the economic situation (and investment opportunities) in a country are more favorable.

Orozco, Manuel. 2006. International Flows of Remittances:  Cost, Competition and Financial Access in Latin America and the Caribbean, prepared for the Inter-American Development Bank, May 12, 2006. Washington, DC: Inter-American Dialogue.

This paper analyzes recent trends in the cost of money transfers in Latin America, paying particular attention to the recent decline in these costs.  For example, between 2000 and 2005 the average cost of sending US $200 to 8 Latin American countries declined from 10 to 5.6 percent.  Some of the factors causing this decline in transfer costs include the rapid increase in the number of money transfer companies operating in Latin America, and the increase in both the average amount of remittances sent and total remittance volume.  Regression analysis suggests that when the average size and total volume of remittances increase, transfer costs tend to fall.