Remittances, Dutch Disease, and Competitiveness: A Bayesian Analysis

By Makhlouf, Farid; Mughal, Mazhar | Journal of Economic Development, June 2013 | Go to article overview

Remittances, Dutch Disease, and Competitiveness: A Bayesian Analysis


Makhlouf, Farid, Mughal, Mazhar, Journal of Economic Development


The paper studies symptoms of Dutch disease in the Pakistani economy arising from international remittances. An IV Bayesian analysis is carried out to take care of the endogeneity and uncertainty due to the managed float of Pakistani Rupee. We find evidence for both spending and resource movement effects in both the short and the long-run. These impacts are stronger and different from those the Official Development Assistance and the FDI exert. We find that while aggregate remittances and the remittances from Persian Gulf contribute to the Dutch disease in Pakistan, those from North America and Europe do not.

Keywords: Remittance, Real Exchange Rate, Dutch Disease, Competitiveness, Bayesian Analysis, Pakistan

JEL classification: F40, F41, O10

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

Remittances are an important source of foreign exchange for developing countries. The volume of remittance transfers to many developing countries, including Pakistan, exceeds that of foreign private capital and official development assistance. Remittances to Pakistan have seen a sharp and sustained rise in the recent years, increasing from under $1 billion in 1999 to over $12 billion today (State Bank of Pakistan, 2012). This has not gone without leaving its macroeconomic impact. Anecdotal evidence points to links with higher price levels and added reliance on imports (State Bank of Pakistan, 2007).

Remittances are found to promote economic growth (Stark and Lucas, 1988; Faini, 2002). Rise in remittances has also made the developing countries governments like Pakistan's less reliant on other financial inflows for their foreign exchange requirements. Remittances are also purported to be a relatively stable source of foreign exchange (Mughal and Makhlouf, 2011), more so than FDI and portfolio inflows, and help countries cope up with difficult economic conditions.

Remittances to Pakistan are found to be sent primarily for altruistic motives (Anwar and Mughal, 2012), and therefore help the migrant households survive in times of crisis. Remittance inflows, for instance, rose substantially in the aftermath of the October 2005 earthquake and the country's worst floods in July 2010. These inflows have also led to lower poverty and economic disparity in the country (Mughal and Anwar, 2012).

Remittances, however, can lead to the overshooting of a country's exchange rate and hurt its competitiveness, a phenomenon known as the Dutch disease. The overvaluated exchange rate makes the country's exports relatively expensive, imports cheaper, and thus puts pressure on the country's current account. The additional demand arising from remitted money raises prices in the non-tradable sector while the prices can not move much in the tradable sector in a small open economy. This shifts resources from industry and agriculture (tradable sectors) to services (non-tradable sector), making the country's tradable sector less competitive. Why does this matter? In the words of Rajan and Subramanian (2010): "a number of studies (Jones and Olken, 2005; and Rodrik, 2007) have argued that the traded goods sector is the channel through which an economy absorbs best practices from abroad. The absence of these learning-by-doing spillovers, which may be critical to long run productivity growth, could be one constraint on growth".

The aforementioned spending and resource shifting effects of the Dutch disease which lead to lower competitiveness have been examined for various developing countries. For example, in their study of 13 Latin American and Caribbean countries, Amuedo-Dorantes and Pozo (2004) find that a 100 percent rise of remittances cause the real exchange rate (REER) to appreciate by 22 percent. Similarly, Bourdet and Falck (2006), in their empirical analysis of the Cape Verdean economy, find evidence of adverse effects of remittances and official development assistance on the country's competitiveness. Acosta et al. …

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