Migradollars and Economic Development: Characterizing the Impact of Remittances on Latin America

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• Self-Financing: Remittances are Big Business in Latin America

Remittances, the funds sent by foreign-based Latin American workers to their families back home (also called migradollars in Mexico where they constitute the third highest source of income after oil exports and tourism), represent one of the major economic trends shaping Latin America’s recent development. They are considerably more important than official development assistance (ODA) and equal the foreign direct investment (FDI) volume for the region. In some of the poorest countries of the hemisphere (Haiti, Guyana and Honduras, to name a few) they account for more than 10% of the GDP, and, in several Latin American countries, remittances per capita readings are higher than the GDP per capita of the poorest 40% of the population.

Despite their prevalence and assumed transcendent importance, the transfer of these funds back to the motherland have not been extensively studied. Indeed, remittances signify a relatively new economic phenomena; they are hard to track and only have been registered by the Inter-American Development Bank (IADB) for the past 10 years. The current economic and financial crisis has resulted in the first drop in remittances since those transfers were first tracked and gives us further insight into their impact on the region. It is therefore a felicitous occasion to examine remittances and to see what impact they have on economic development in Latin America.

Increasing migration and low transaction costs: the two reasons behind the spectacular rise in remittances sent to Latin America

Remittances sent back to Latin American countries have increased by an average of 15% every year from 1998 to 2008, when they amounted to a total of $70 billion. Effectively, this has made Latin America their top destination in the world (in both absolute and per capita statistics). This dramatic upsurge also may reflect the recent improvements in data collection, but it is first and foremost due to the increase in migration and the reduction of remittance transaction costs over the past 20 years.

Even though remittances come to Latin American from diasporas in various regions of the world (Ecuadorians in Spain, Brazilians in Japan, etc.), and sometimes from within Latin America itself (for instance from the Bolivians in Argentina and the Haitians in the Dominican Republic), 80% of the funds at play are transferred from the United States. The majority of remitters are working class males between the ages of 20 and 50 years old who left their home country in the last fifteen years. They now send approximately 10% of their income every month to their direct family members (wives, parents, siblings and children). Apart from those general characteristics, the social and economic background of remitters strongly depends on their country origin and where they are now located. For example, remitters often are more skilled when they come from South America or the Caribbean, since the costs of moving to the U.S. (with or without proper documents) are higher than they are for Central Americans.

As the number of migrants from Latin America has skyrocketed over recent decades (according to the U.S. census, between 1980 and 2000, 12 million persons born somewhere in Latin America have entered the U.S.), flows of remittances have followed the same upward trend. Similar statistics have attracted the attention of banks and financial transfer companies. Consequently, the number of companies offering to broker the transfer of funds to Latin America has increased, resulting in a higher level of competition and a drop in transaction costs. This has provided even greater incentives to migrants to send even more remittances. Thanks to this cycle, transaction fees are now only between 5% and 10% of the amount sent, compared to a much higher average from Europe to Western Africa.

The 2007-2010 crisis and its consequences

The increase in remittances was halted in the last quarter of 2008 and the amount sent to Latin America started to recede in 2009. This drop surprised several analysts since remittances were supposed to have a counter-cyclical effect. For instance, the late 2001 crisis did not adversely affect remittances at all even though Latino unemployment in the U.S. increased at the time. This was because the increase was only marginal, with the number of remitters still increasing. But the current economic crisis is having a major and direct impact on the sectors featuring heavy concentrations of migrant workers, such as construction, manufacturing and tourism. However, while in 2009 almost 45% of the remitters living in the U.S. sent less money home than they did the year before, remittances are likely to stabilize for 2010.

The current global economic crisis, combined with this drop in remittances, seriously lowered living standards in several parts of Central America as well as in the Caribbean, especially in countries like the Dominican Republic, where 40% of households are dependent on remittances. The crisis also resulted in wide fluctuations of exchange rates and in an overall drop in the value of the dollar. Even if the purchasing power of remittances has risen in some countries where the domestic currency is not pegged to the dollar, such as is the case in Brazil and Mexico, these wide fluctuations increased the instability factor in the region.

Despite this rapid fall, along with the loss of jobs that resulted from the crisis, there was no major change in the flow of migrants returning to their home countries. As observed by Inter-American Development Bank (IADB) president, Luis Alberto Romero, “migrants will exhaust all other options before going back home.”

How are remittances impacting Latin America’s economy?

The negative effect of the recent drop in remittances on Latin American economies confirmed the thesis of several World Bank working papers that established a correlation between remittances as a share of GDP and poverty reduction. Those funds are vital to many people; they mitigate millions from the strains of poverty and reduce economic risk while providing a margin for survival. What’s more, their positive impact is catalyzed by a multiplier effect. In other words, every dollar sent in remittances results in a social benefit of approximately 2 dollars (this figure varies widely among studies), because most of the dollars sent will be spent or invested locally., thus stimulating the surrounding economy.

Furthermore, remittances motivated by family commitments are therefore less risky than FDI, which are fueled by pure financial considerations. For instance, remittances were vital after the January 12th earthquake in Haiti, as they were the first flow of new funds to enter the country, even before ODA and FDI. Thus presented, remittances appear almost as manna, but in actuality, the situation is somewhat more troubled than it may first appear.

First of all, their impact on poverty reduction is rather modest. In other words, remittances lack a truly decisive redistributive effect. The money received by people living in rural areas will be mostly spent in urban economic centers and are mainly likely to increase the consumption of goods and service produced in those areas. Remittances are not necessarily aimed at the poorest citizens, and it is the cities that tend to benefit the most from the aforementioned multiplier effect.

Although remittances are definitely a stimulus for development, they are far from being an unqualified bonanza, especially when one takes into account the harsh, profound effects of migration on individuals and communities. In addition to the emotional pain, migration is combined with the curse of a brain drain, which has proven catastrophic on some Caribbean islands, such as Haiti, Jamaica, Grenada, as well as in Guyana on the mainland. Astoundingly, these island nations have lost on average more than 80% of their college graduates. Furthermore, those trends can even accelerate the “Dutch disease effect” in the long term, as this outflow in labor supply combined with real exchange rate appreciation pressures due to the exportation of natural resources, can lead to competitiveness issues.

Finally, the effects of remittances on poverty reduction and economic development are more efficient in countries that benefit from stable institutions. But most of the time, remittances only have a temporary impact, as they are spent on basic needs and do not contribute to the formation of human capital, thus relieving the plight of poverty only for a relative brief respite, while not providing long term development or infrastructural improvement for the affected individual. As Guillermo Perry, former Chief Economist of the Latin American and Caribbean Bureau at the World Bank, has noted: “In other words, remittances are a complement to, rather than a substitute for, good economic policies.”

The necessity to improve financial literacy

One of the major issues with remittances is the missing link between families benefiting from them and banking institutions. At the moment, more than half of the people receiving remittances do not have bank accounts and less than 20% of Mexican adults have access to credit. Banks are reluctant in many cases to have poor customers, due to the association of high-risk that they evoke, small margin perspectives and also because of the financial instability and the inflationary risk that exists in most Latin American countries. Creating access to banking institutions is vital and incentives need to be created for people to open bank accounts and for banks to facilitate this process. Banks also need to offer various financial services to the receivers of remittances so that they can make use of this money in a productive and lasting way.

The federal Community Reinvestment Act and other measures aimed at spreading “financial literacy” to senders and receivers of money (such as Spanish-language programs dollars and cent, partnerships with immigrant associations, and more comprehensive disclosure) are having a positive influence on the volume of funds being sent. Some remittance specialists maintain that since it is the U.S. that preeminently benefits from the resulting immigrant workforce, that gathers here, it is appropriate to insist that it subscribes to a reasonable list of economic rights. Finally, the flow of remittances must be tracked and controlled to avoid the misuse of the channels being utilized. There are, according to a number of sources, few of such misuses now occurring. However, if desired, they would remain relatively easy to carry out, given the lack of regulation of these funds.

Hometown Associations: an Important Link

Hometown associations (HTAs or clubes de oriundos) are structured groups of immigrants coming from the same, nearby community or region who are eager to maintain ties with the places from where they originate. An average of 9% of remitters in the U.S. are members of HTAs; these are mainly the ones that have established themselves, through the accumulation of wealth. Currently there are about 3,000 Mexican HTAs in the U.S. These associations usually affect a precise structure and are governed by a board of directors and elected officers. The benefit of HTAs, despite traditionally their limited resources (mainly coming from fundraising operations – raffles, cultural events – corporate sponsorship, as well as from savings), is impressive since they often finance projects that in turn generate income (such as agricultural activities or the creation of microenterprises).

Their beneficial work is furthered through their partnership with other like-minded organizations. The work of Manuel Orozco, the author of Global Opportunities for International Person-to-Person Money Transfers (Lafferty Group, 2005), is edifying when it comes to regarding these agreements. Hometown associations work with NGOs and local municipalities in Latin America. In fact, some of those associations of Mexican, Haitian and Honduran immigrants have even created partnerships with the IADB and the United National International Fund for Agricultural Development (UNIFAD). Cooperation with local government admittedly has been rare, but one should take note of the success of the dos por uno (or “two for one”) program introduced in the state Zacatecas in Mexico.

Through the above framework, the government has matched two U.S. dollars for each dollar raised by the HTAs for approved public infrastructure projects. In 1999, local government joined up with this project, changing its name to tres por uno, now increasing the matched amount to three U.S. dollars per every dollar sent. Tres por uno has since expanded to other Mexican states: Guerrero, Jalisco, Guanajuato, San Luis Potosí and Michoacán. A partnership of the same order was also created in El Salvador with the Banco Agricola, which temporarily subsidized the remittances sent by hometown associations through the bank. By encouraging the use of remittances as an investment in projects, such as infrastructure creation or various education projects, hometown associations play an extremely valuable role in helping migrants to maintain the relationship with the country that they left behind, and can have a constructive long-term impact on development.

A potentially Marvelous Tool to Halt Underdevelopment

Remittances have been subject to numerous debates and contradictory forecasts due to the strong political message they often carry. On one hand, they reflect the shifting mood of most Latin American governments in promoting different types of economic development as well as the relative vigor used in in tackling inequalities in the region. On the other hand, they show the region’s ability to support itself by revealing the relative strength of different country’s diasporas by transferring funds equivalent to the FDIs. Remittances should not be considered as only a political tool; they are just one of the numerous consequences of migration and globalization on Latin America’s economy, such as the success of Pan-American telecommunication services or some aspects of the nostalgia trade; the fact that immigrants continue to buy products from their home country once they live abroad, therefore enhancing Latin America’s export capacity. Remittances’ impact on development may prove timorous given the relatively small amount of money being repatriated, but it could become a major tool to fight poverty, if the funds sent home are pooled together and spent on useful infrastructure.