Do Financial and Institutional Variables Enhance the Impact of Remittances on Economic Growth in Latin America and the Caribbean? A Panel Cointegration Analysis

By Ramirez, Miguel D. | International Advances in Economic Research, August 2013 | Go to article overview

Do Financial and Institutional Variables Enhance the Impact of Remittances on Economic Growth in Latin America and the Caribbean? A Panel Cointegration Analysis


Ramirez, Miguel D., International Advances in Economic Research


Abstract Using recently developed panel unit root and panel cointegration tests and the Fully-Modified OLS methodology (FMOLS), this paper estimates the impact of remittances on the economic growth of selected upper and lower income Latin American & Caribbean (LAC) countries over the 1990-2007 period. Despite the large flow of remittances to the region, there have been relatively few empirical studies assessing the impact of remittances on economic growth in LAC. Panel unit root tests suggest that several of the macro variables included in the model exhibit unit roots, yet, at the same time, Pedroni's panel cointegration test determined that there is a cointegrating relationship among the variables in the estimated model. The FMOLS estimates suggest that remittances have a positive and significant effect on economic growth in both groups of countries. The estimates also indicate that both the degree of economic freedom and credit provided by the banking system have a positive and significant effect on economic growth in upper (middle) income LAC countries. The sign of the interaction term between remittances and the credit (and EFI) variables suggest that remittances act as substitutes for these variables. Finally, the effect of remittances on both sets of countries is stronger in the presence of a financial (credit) variable.

Keywords Credit * Economic freedom index (EFI) * FMOLS * Latin America & Caribbean * Remittances and growth * Panel cointegration * Panel unit roots

JEL C22 * O10 * O40 * O54

Introduction

For the better part of a decade, remittance flows to Latin America and the Caribbean have increased dramatically, even surpassing the region's FDI inflows for selected years. Figure 1 below shows that remittance flows to Latin America and the Caribbean increased steadily from US$21.3 bn in 2001 to US$53 bn in 2005, before jumping to US$61.5 bn in 2006 and almost US$70 bn in 2008. The figure also reveals that the onset of the Great Recession in 2008-09 led, at first, to a significant reduction in these flows before leveling off in 2010 and a slight increase to an estimated $62bn in 2011. It is apparent from the figure that these flows exhibit less variability than other private and official flows such as FDI, portfolio investment, and ODA flows. In Latin America and the Caribbean, Mexico is by far the largest recipient of remittance flows (estimated $24bn in 2011, and the third largest recipient in the world, after India, $58bn, and China, $57bn), followed far behind by Brazil, Colombia, El Salvador, Guatemala, the Dominican Republic, Peru, Honduras, and Jamaica (see ECLAC 2011; World Bank 2011). In relative terms, remittance flows represent at least 2 % of GDP for the larger countries, such as Mexico (3.8 %), Brazil (2.29 %), and Colombia (2.31 %), while for the smaller ones, such as El Salvador, Guatemala, Honduras, and Jamaica, these flows easily surpass double-digits, ranging from 12.7 % of GDP in Guatemala to 21.6 % in Honduras. For many of the smaller countries and some of the larger ones, notably Mexico, remittance flows far exceed FDI inflows and have become an important source of foreign exchange earnings as well as a potential source for the financing of private capital formation. For example, in the case of Mexico, remittance flows ranked third over the first decade of the 2000s, just behind Mexico's earnings from maquiladoras (assembly-line industry) and oil; while over the 2004-10 period, these flows averaged an impressive 15.5 % of gross domestic private (fixed) capital formation (see Canas et. al. 2007; ECLAC 2011).

[FIGURE 1 OMITTED]

In the extant literature, there is considerable controversy and disagreement as to what economic (and social) factors determine remittance flows, as well as what impact, if any, these flows have on economic growth and other variables of interest such as investment (and savings) rates. For example, Chami et al. …

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Do Financial and Institutional Variables Enhance the Impact of Remittances on Economic Growth in Latin America and the Caribbean? A Panel Cointegration Analysis
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