Remittances and competitiveness: Evidence for Latin America Migration and Development Thematic Group Seminar Humberto Lopez November 26, 2006 Presentation based on

Close to Home: The development impact of remittances in Latin America Pablo Fajnzylber and Humberto Lopez

Main messages of the report Remittances have positive effects… …but their impact is quantitatively modest… …in part because they also have costs… …pose important policy challenges… …and their development impact is very heterogeneous across countries.

Outline Stylized Facts of Remittances to LAC The development impact of remittances in LAC Challenges related to competitiveness –labor supply, –real exchange rate Conclusions

Remittances to LAC have increased dramatically over the past 25 years

And now LAC is the top recipient region of remittances (*) 2004 data.

Remittances flows to LAC are large no matter how we measure them (*) 2004 data.

Remittances volumes: above $1.5 billion in 10 LAC countries

Remittances per capita: highest in LAC, >$200 p/c in 11 countries

Remittances as a % of GDP: above 10% in 8 countries

Remittances tend to reduce poverty… Typical LAC country: 0.4% poverty decline for each 1% of GDP. These results are robust to the use of country case studies or cross country analysis. Reductions in 6/11 countries: 5.2% in poverty Examples: – Ecuador: 3.3% – El Salvador: 7.2% – Haiti: 4%

…accelerate growth

Approach: cross country panel regression with remittances, instrumental variables Robust but small effect of remittances Additional 0.27% in p/c GDP growth in 1991/2005 Increased investment is one half of growth effect

…raise school enrollment rates

…and improve health indicators. Nicaragua (weight and height for age)

Two potential challenges that affect competitiveness i) Reductions in labor supply –Remittances affect the income of recipient households and if individuals value leisure… ii) Real exchange rate appreciation –To the extent that remittances positively affect consumption and that part of the consumption is directed to non tradable sector…

(i) reductions in labor supply

(ii) real exchange rate appreciation

Beyond correlations… Labor markets Estimate L i =  + β X i +  H i +δ R i +ε i L is hours worked/labor market participation X is a vector of personal characteristics H is a vector of household characteristics R is a dummy variable for remittances IV estimation (Hanson and Woodruff, 2003) Parameter of interest is δ

Main results… Hours worked: Significant effects in 11/11 countries Fewer hours worked by active individuals in recipient households Lower probability of labor force participation Effects on males, females, urban and rural areas Larger impact on unskilled workers

Remittances and hours worked

Remittances and participation

Remittances and participation (cont.)

Beyond correlations… Exchange rate Estimate  q t =  + β X t +δ  R t +ε t q is the real exchange rate X is a vector of controls (tot, ir, gov, growth) R is remittances as % of GDP IV estimation (Aggarwal, Dermirguc-Kunt, Martinez Peria, 2005) Parameter of interest is δ

Three variations i) Is LAC different?  q t =  + β X t +δ  R t + λ * lac*  R t +ε t ii) Is there a difference between countries with fix and flexible exchange rates?  q t =  +β X t +δ  R t + θ * FE*  R t + ε t iii) Is the observed change consistent with changes in the fundamentals? q t =qd t +qe t  qd t =  +β X t +δ  R t +ε t

Main results More than just correlations: remittances appear to cause exchange rate appreciations LAC does not appear to be different. Countries with fixed exchange rates do not appear to experience significant overvaluations. About half of the effect is consistent with the evolution of fundamentals: the rest is temporary

Base model

LAC…

Exchange Rates…

Misalignment

How to respond? –Do nothing Particularly if one believes that remittances are permanent and that observed changes in labor and exchange rate markets are consistent with changes in economic fundamentals. –Otherwise… Fiscal restraint, but probably not enough Explore micro interventions: –increased flexibility, –competitiveness Consider shift from payroll to sales taxes

Concluding Remarks Remittances have a positive effect on the development indicators of recipient countries. Yet, the overall impact is modest because of the associated costs to migration/remittances, and there is substantial hetereogeneity (not all countries benefit in the same fashion!!!). And remittances come with a number of policy challenges that may require government reaction. On the whole, remittances are opportunities, not substitutes for sound development policies.

Close to Home: The development impact of remittances in Latin America Pablo Fajnzylber and Humberto Lopez