Do remittances reduce poverty?

August 14, 2019

     By Maria Faciolince     

Vishwesh Sundar has recently graduated with an Advanced Master’s degree in International Relations and Diplomacy from Leiden University, The Hague. He was also a research assistant at the Leiden University Institute for Area Studies where he assisted with a project on South-to-West Asia migration governance.

We live in a globalised world, and my family is an epitome of that phenomenon. I study International Relations and Diplomacy in The Netherlands and my parents live in India. Once I start earning, I will send money regularly back to my family in India.

These intrafamilial financial flows sent by migrants to their home country are referred to as remittances. Just like me, 244 million people around the world live and work in a country that is not their home country. These migrants sent a whopping $689 billion back to their families and friends in 2018 as remittances. If the migrant community around the world were to be considered a country’s population, it would be the fifth-largest in the world- more than the population of Brazil. And if the amount of global remittances were considered as a national economy, it would be the twentieth-largest in the world- about the size of the Swiss economy. In countries such as Nepal and Kyrgyzstan, remittances alone account for a third of their respective country’s GDP (see Figure 1).

Remittances by country

Figure 1: Top recipients of remittances in 2018. Source: Migration and Development Brief 28, World Bank.

The data of the World Bank suggests that remittances have increased five-fold in the past two decades and are likely to emerge as the largest source of external financing for many low- and middle-income countries in the coming years (see Figure 2). The total remittance sent to developing countries in 2018 totalled to $528 Billion, which is nearly four times the OECD- estimated total official donor assistance of $153 Billion for the same year.

Implications of remittances on poverty reduction

Intrigued by these facts, I decided to write my master’s thesis on the effect of remittances on poverty in 25 labour-sending Asian countries. Being a migrant myself, I was personally motivated to understand the economic implications of migration and remittances in our home countries.

Capital flows

Figure 2: Overseas capital flows to low- and middle- income countries, 1990-2019. Source: Migration and Development Brief 28, World Bank.

Using World Bank data, I constructed a poverty dataset using three indicators, namely the poverty headcount ratio, poverty gap and squared poverty gap to measure the width and depth of poverty in the countries. Poverty headcount ratio is used to measure the prevalence of poverty in a country, i.e. the percentage of a population that lives in absolute poverty. The latter two (poverty gap and squared poverty gap) variables help to measure the distance of the individual’s income from the global poverty line, which is set at $1.90 per person per day (in 2011 PPP) by the World Bank. The sum of the poverty gaps can indicate the minimum cost required to pull the entire population out of poverty only if the resources are redistributed perfectly.

After controlling for the Gini index and GDP per capita adjusted for inflation, the results of the regression show that remittances do have a poverty mitigating effect. Notably, a 10% increase in the per capita remittances of a country results in a fall of poverty headcount ratio by 0.4 percentage points in the 25 Asian countries (to read the full thesis click here).

Remittances as tools for development finance

Besides aiding in poverty alleviation, remittances also help to sustain a population above poverty. Most often in the face of economic adversities, such as an economic recession or destruction due to climate-related disasters, the people who live on the margins of the poverty line slip under poverty. In these situations, migrants remit more to their families and friends to aid in the process of recovery and reconstruction, while also providing a cushioning effect on consumption for their families. In other words, remittances increase when the private capital flow decreases in the home country (otherwise referred to as countercyclical financial flows).

For example, during the floods that hit the southern Indian coastal state of Kerala in August 2018, the remittances to India grew by more than 14%. According to the World Bank, this could be one of the major contributing factors towards India retaining its top spot as the highest remittance earner that year. Besides, remittances are also less volatile in comparison to other financial flows. Even during the global financial crisis, when there was a significant reduction in FDIs (Foreign Direct Investments) and ODAs (Official Development Assistance), remittance receipts barely faltered. These properties of remittances make it a unique tool of development finance.

Additionally, many NGOs have implemented programs in labour-sending countries aimed towards encouraging savings and investing remittances, and discouraging conspicuous consumption. For instance, ‘Oxfam’s Food and Economic Justice program’ in Nepal, assists in accumulating the remittance savings and using the capital to give loans to women farmers. Such initiatives are vital as they provide the required capital for setting up small and medium-sized enterprises in areas where getting access to cheap capital is hard. Furthermore, they also indirectly help in generating employment. The multiplier effect of remittances therefore seems to have a positive spillover effect on the entire community.

High transaction costs as barriers to remittances flows

However, to reap the full benefits of remittances, it is important that the migrant households receive all the money sent to them. Sadly, some of the money is creamed off by intermediaries. While remitting money, the sender has to pay a high transaction cost, which includes a commission for the sender and receiver as well as the exchange rate margin. Currently, the average transaction cost for sending $200 is $14 or 7% of the transaction amount.

Money Transfer Operators

Several policies have been discussed and analysed to address this problem, such as increasing competition between MTOs or Money Transfer Operators, abolishing taxes on remittances, etc. One policy recommendation that is worth considering is to encourage MTOs to have a progressive system of transaction costs, something similar to direct taxes calculation. In other words, charging a lesser percentage of remittance as transaction cost for small amounts and increasing the percentage for higher amounts. Presently, as the remitting amount increases to $500, the transaction costs drop to 5%. The current system is similar to heavily taxing even the meagre incomes that many overseas workers make. Making transaction costs progressive can increase the flow and frequency of remittance sent by migrants, who are otherwise forced to depend on unofficial sources to transfer money.

I am not saying that remittances are the panacea to poverty. But I do think that policies aimed at reducing transaction costs in the home and host countries could increase the flow of remittances through formal channels and increase the economic benefits for the migrant families. So far, the discourse on remittances has tended to focus on its economic implications. However, are the economic benefits of migration and remittances worth the social costs of living far away from your families and friends?

Top featured image: Brooke Patterson/USAID, CC license