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…

Comments

Are comments about the impact of emigration in Mexico OK?

I would be curious to see the %'s saved of these remittances. I remember reading somewhere that people in poorer countries tended to save quite a bit. And then the next question would be the form of savings. Is a large part of this money stuffed into a mattress? Or are there institutions that they can use?

As I recall, remittances were a very important element in Italian national accounts in the first decade of the 20th. Century. As a result, Italy was able to stay on gold, and enjoyed significant capital inflows at a crucial point in its industrial development. It could be that remittances to Mexico exchanged into Pesos have a less beneficial effect, contributing to overvaluation (through inflation under a peg) or depreciation. This will make foreign deposits or investments less appealing.

Arrgh! Not depreciation, appreciation (must have more coffee...)and increased probability of fx crisis..

If dollars are really sent abroad and don’t come back, then the US profits from seigniorage. Some people claim the US promotes the use of dollars abroad for precisely this reason. I am not so sure. However, it is true that when the US changed the portraits on our currency, the US government paid for advertising abroad explaining the change (in Russia). No such ads were used in the United States. The foreign ads stressed that existing currency would remain legal tender forever.

It is by no means clear, that the money is inflationary. To the extent that dollars circulate in Mexico as a parallel currency, Mexico must reduce the peso monetary base accordingly. Stated differently, dollar circulation in Mexico transfers seigniorage gains from Mexico to the United States. Indeed, legislation was once introduced in the Senate to share seigniorage gains with countries that dollarised (see http://www.bis.org/publ/bppdf/bispap17s.pdf) . Of course, dollar circulation and dollarisation are not the same thing.

I don’t see how this increases wealth for the recipients. If they got pesos, or converted the dollars to pesos, they could hold peso accounts/assets instead. A quick check shows that Mexico’s rate of inflation has been declining for years (see http://www.latin-focus.com/latinfocus/countries/mexico/mexcpi.htm). Years ago, Mexicans had compelling reasons to hold non-peso financial assets. This is far less true now.

I would expect some prices to rise in rural Mexico from remittances. However, this is a consequence of greater local incomes, not an influx of dollars per se. Converting the dollars to pesos wouldn’t change the outcome, at least in my opinion.

I am concerned by assertions that dollar circulation will raise output/employment in some parts of Mexico. If it were that easy, the Mexican government would have printed money to obtain the same benefits a long time ago. As stated above, I do agree that high local incomes from remittances will have positive local effects†¦ And some negative ones.

Of course, holding dollars in Mexico is also risky. If the US dollar appreciates versus the local currency, the Mexican holder profits. If the dollar devalues, the holder loses. Since the dollar is likely to fall against the peso (baring an upturn in Mexican inflation), this is a material downside.

I agree that Mexican exporters suffer. Remittances can be thought of as an export of labor services. As such, they compete with all other exports and make other exports less profitable. The same is true for the US. The US “exported† $700 billion in IOUs in 2005. Of course, these “exports† competed with US exports of goods and services.

Why aren't remittances equivalent to the purchase of imported goods, without any of the goods showing up in the US? Don't they affect the "balance of payments"? Or is that irrelevant these days?

I'm just a dude who's not as well versed with econ. theory as the vast majority of commentators here. That was my blog post that I sent to Tyler, and I'm glad not to have received a Gary Williams-esque "you're wrong, you're so wrong" response :)

But back to the story. I don't have a well formed opinion as to whether remittances would increase output/employment in areas receiving them, but to say that 'if it were that easy, Mexico would just print money' seems to me to miss a critical factor. We're talking about US dollars. Introducing dollars will likely have deflationary effects on the local currency - by driving up prices and such - but the deflation would be significantly less than if the local government prints more money.

I would reason simply that the effect is positive for both remittance emitting and receiving country provided that wealth creation is always positive. US didnt grow by impoverishing Europe.

When a remittance creator work in a rich country, he creates more dollar value for his labor than at his home country.This has several consequences. If the quantity of work available is limited in host country, this creates pressure in the blue collar wages. Sadly the negative impact will fall among the most vulnerable sections of the host country. For the foreign laborer, its a very good deal as he can work and earn a decent living for himself and his family. For the home country, in most cases this is positive in that the same worker would most probably be unemployed or perhaps joined some fringe extremist group.

For me, talks about inflation / deflation / foreign exchange rates are just tangential. The net result is the creation of bigger cake for everybody. Whether US prints money or Mexico prints money is less important as the money phenomena is just a measure of stock of wealth created.

Sadly, the capital flows from south to north and not vice versa. Developing countries with their stock of dollar and euro are actually financing some part of consumer folly in the north.

Apparently in some cases, you can have a cake and eat it as well.

Two quick thoughts:
a)Although remittances might cause domestic inflation in the short term, high unemployment and low efficiency in poorer countries should allow expanded production, even for services, so that the economy can grow without long-term inflation.
b) Perhaps remittances to Mexico, by causing the peso to be valued higher relative to the dollar, are one of the big reasons that NAFTA has not helped the Mexican economy as much as predicted.

I guess marginal remittances are spent on imports.

Aren't remittences very similiar to finding oil wealth.

It generates a great deal of wealth and income or consumption
but does very little for production or increasing the ability
of the country or population to be more productive.

One has to take monetary neutrality to extremes to say that remittances would not have a short-run impact on employment and output in Mexico. Price rises take time, during which those with U.S. dollars can cash in their dollars for goods and services. This also has implications for the distribution of real income depending on who the recipients tend to be. However, it is clear that remittances in the long-run should not affect economic growth.

I think Economister is right that we should consider the fact that most people in developing countries are credit constrained. However, this does not imply that remittance recipients will use their additional income mostly for precautionary saving. Another distinct possibility is that they will use it to make "lumpy" purchases such as a new house or car, new or better furniture, plasma TVs, etc. When you add durable goods to these household allocation models, durable goods purchases can take the place of stuffing money in the mattress.

It should go without saying that this kind of spending is certainly welfare improving for remittance-receiving households even if it does nothing to raise the capital stock. Without remittances, households may not have the ability to raise the funds needed to make these purchases.

Couldn't you say most of those things about FDI?

When Exxon buys a company in Mexico for the oil field, he will exchange the profits from the remittance into the us dollars to keep the peso lower. When the peso is lowered, he will exchange the US dollars into Peso again to sustain his remittance profitability change.

If through the whole remittance process, the exchange rate is unchanged, the rate of return from the remittance process (only from investment return, taken no consideration of the production profitability) is decreasing, if the Exxon change back their earnings in Peso. To reach equilibrium, Enxxon would increase its investment scale. So in the end, the peso would be higher, more converted U.S. dollar in Mexico.

Then the mexico government would buy a bit of U.S. dollars, even if it does not plan to interfere the currency exchange market. This perahps is for the need to control inflation brought by the Exxon increasing investment.

Tyler, I have to respectfully disagree with you as to whether or not the method of payment of remittances is important. You are right that remittances converted into Pesos will effect the exchange rate (higher demand for pesos drives down the value of the dollar). But remittances sent as dollars will also effect the exchange rate as they increase the supply of dollars in Mexico and thus drive down the value of the dollar that way.

From an Austrian point of view, the payment method is important for working out who will benefit most and how the "information" about the remittance will flow through the economy. However if the market for foreign exchange in Mexico is efficient (while i haven't been to Mexico, my experience of other third world countries is that they often have much more pervasive foreign exchange market infrastructures than developed nations) then the remittance will have an effect EVEN IF it occurs in the form of dollars sent informally as opposed pesos sent formally.

Before the hyperinflation and depression in Germany, a segment of the population converted their Marks to Dollars and Pounds Sterling. After the Mark became next to worthless that same segment of the population exchanged those Dollars and Pounds Sterling back into Marks. They made thousand of percent of gain, but it was all for nought because it was partially responsible for bringing Hitler to power.

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