The economics of remittances

Just how beneficial are remittances?  One loyal MR reader writes on his blog:

While undoubtedly a portion of remittances are sent back to the U.S. via purchasing power to buy U.S. goods and services, a portion is also kept in-country and used as an alternative monetary system or held by a foreign government as a source of "hard" currency to prop up its domestic money.

Money that leaves the U.S. and never comes back is great for the U.S. government.  Essentially it bought goods and services without ever having to pay up on it’s end of the IOU.  Therefore, shouldn’t Americans support remittances?  America doesn’t run out of money – we’ll just print more.

I am more interested in the effects on the receiving country.

Assume that dollars are sent rather than exchanged for pesos and that the remittance money never returns to the United States.  In essence we are inflating the parallel currency in Mexico (or Vietnam, or wherever).  This means more wealth for the people who receive the remittances.  But who loses? 

Some of the new money will just be inflationary.  People who compete with remittance receivers in consumer markets will face higher prices.

Output and employment will rise in regions with unemployed or underemployed resources, or simply in monopolized sectors.  If a Mexican uses the money to bribe a policeman, or hire a doctor, the quantity effect may outweigh the price effect.  This is the main source of net benefits to the receiving country.  But in perfectly competitive sectors this is just pure inflation.  Note that rural Mexico, where most of the remittances go, is far from perfect competition.

There is also an precautionary insurance gain from having more savings held in dollars, distinct from whatever is finally purchased with those dollars.

Of course, not all of the dollars will stay in Mexico.  Mexico, as a nation, gains to the extent those dollars buy goods and services from the United States, assuming of course U.S. markets are large enough that more Mexican buyers won’t push up prices for subsequent buying Mexicans.  So the best outcome, at least for Mexico, is if the remittances go to people who will carry them back across the border or spend them on imports.

If the dollars are exchanged into pesos, through Western Union, the story differs.  The rate for dollar-peso exchanges moves against the dollar.  This hurts people who have already accumulated dollar-denominated assets; usually those are previous receivers of remittances and of course American tourists who visit Mexico or who buy amates.  It also will hurt Mexican exporters.  Mexican importers gain accordingly.

In sum, it is a complicated story.  Yes, in many regards remittances are more like inflation — albeit in a parallel currency — than like real wealth transfers.  But there are also some important efficiency gains.

We also should not assume that distribution and efficiency are fully separate.  Perhaps the remittances go to people who know better how to invest the money.  Perhaps not.

Comments are open for analysis of remittances, but general talk of Mexican immigration will be deleted…


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