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GlobalEconomic
Prospects

Economic Implications ofRemittances and Migration
34320

2006

Global
Economic
Prospects
Economic Implications ofRemittances and Migration2006

© 2006 The International Bank for Reconstruction and Development / The World Bank
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ISBN: 08213-6344-1
E-ISBN: 0-8213-6345-X
13-digit E-ISBN: 978-0-8213-6345-4
DOI: 10.1596/978-0-8213-6344-7
EAN: 978-0-8213-6344-7
ISSN: 1014-8906
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Cover design: Naylor Design
Cover photo: Panos

Contents

Forewordvii

Acknowledgments
Overview

ix

xi

Abbreviations

xvii

Chapter 1 Prospects for the Global Economy
1
Global growth3Long-term prospects and poverty forecast
International finance10
Commodity markets
14
World trade
16
Risks and uncertainties
18
Notes
22
References
23

8

Chapter 2 The Potential Gains from International Migration
International migration trends
26
The demographic challenge
29
Migration and its development impact
31
Returns to households
34
Returns to factors of production
41
Caveats—what the model leaves out
48
Notes
51
References
53

25

Chapter 3 The Policy Challenges of Migration: The Origin Countries’ Perspective
The migration decision and its impact on migrants and their families
59
Low-skilled migration
64
High-skilled emigration
66
Diasporas
70
The return of expatriates can benefit development
70
Temporary migration and international agreements
72
Notes
76
References
78

57

iii

C O N T E N T S

Chapter 4 Trends, Determinants, and Macroeconomic Effects of Remittances
Remittance data and trends
86
Factors affecting remittance flows
92
Macroeconomic effects of remittances
99
Annex 4A.1 World Bank data on remittances
105
Annex 4A.2 A model-based estimation of informal remittance flows
Notes
110
References
112
Chapter 5 Remittances, Households, and Poverty
117
Remittances, poverty, and inequality
118
Remittances and household consumption smoothing
122
Remittances and indirect effects on household income
123
Remittances, savings, and investment
125
Annex 5A.1 Poverty simulation model: description and results
Notes
129
References
131

85

108

127

Chapter 6 Reducing Remittance Fees
135
Remittance fees and costs
136
Factors underpinning high remittance fees
144
Policies to reduce remittance costs
147
Remittances and financial institutions
149
Annex 6A.1 A stylized remittance transaction—structure, players, instruments
Annex 6A.2 Licensing and registration requirements for remittance service
providers152
Annex 6A.3 A brief history of some remittance service providers
153
Notes
154
References
156
Figures
1.1
Industrial production
3
1.2
A sharp slowdown5
1.3
Regional growth6
1.4
Dollar-euro interest rate differentials
10
1.5
Financing of the U.S. current account deficit
11
1.6
Emerging market spreads
11
1.7
Real long-term interest rates in G-7 countries12
1.8World savings rate
12
1.9
Inflation rates
13
1.10
Cumulative real increase in housing prices, 2005
14
1.11
Commodity prices
14
1.12
Levels of spare oil capacity15
1.13World trade volumes
16
1.14
Change in textile exports to the developed world, first half of 2005
17
1.15
Estimated change in textile exports as share of total merchandise exports
18
1.16
Some countries are particularly at risk
20
2.1
International migrants as a share of destination countries’ population
27

iv

151

C O N T E N T S

2.2
2.3
2.4
2.5
2.6
2.7
3.1
3.2
3.3
3.4
3.5
3.6
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
5.1
6.1
6.2
6.3
6.4
6.5
Tables
1.1
1.2
1.3
1.4
1.5
1.6
2.1
2.2
2.3
2.4
2.5
3.1
3.2
4.1

Share of females in international migration
28
Immigration to selected countries, reasons for admittance, 2001
28
Labor force and dependency rates
30
Factor returns and migration
42
Source of gains for native workers
45
Factor returns and migration in high-income countries, 2005
46
Median wage levels for workers in the same occupation, relative to high-income
economies, 1988–92
59
Major developing country diasporas in developed countries
62
Estimates of stock of irregular migration
62
Emigration rates for low-skilled workers
64
Emigration rates for those with a tertiary education, 2000
67
Number of temporary workers admitted under skill-based programs72
Top 20 remittance-recipient countries, 2004
90
Estimated remittance payment, by country group, 2004
91
Remittances as percent of private consumption, two years before and two years after
natural disasters
100
Remittances as a share of personal consumption, two years before and two years after
conflict
100
Remittances as a share of personal consumption, two years before and two years after
financial crises
101
Indebtedness classification including and excluding remittances, 2003
101
Remittance securitization structure
102
Securitization of remittances, 1994–2004
103
Sri Lankan migration
122
Remittance costs are high and regressive
138
Remittance fees in the United States–Mexico corridor
138
Fees and foreign exchange spreads for $200 in Western Union transfers from New
York City
144
Exclusive arrangements with post offices skew competition
145
Barriers perceived by remittance service providers
146

The global outlook in summary
4Long-term prospects
8
Regional breakdown of poverty in developing countries
9
Terms-of-trade impacts of commodity price changes
16
Impact of a 2 million bpd negative supply shock
19
Interest rate scenarios
20
Growth in international migration by destination, 1970–2000
27
Labor force structure in the base case and after increases in migrants
33
Change in real income across households in 2025 relative to baseline
34
Real income impacts across developing regions
38
Impact of different assumptions on the consumption of public goods and services byselected groups in 2025
39
Fees charged by recruitment agencies
60
Emigration rates of skilled workers, 2000
68
Workers’ remittances to developing countries, 1990–2005
88v

C O N T E N T S

4.2
4.3
4.4
4.5
4A.1.14A.2.14A.2.24A.2.3
5.1
5A.1
6.1
6.2
6.3
6.4
6.5

Boxes
2.1
2.2
2.3
2.4
2.5
3.1
3.2
4.1
4.2
4.3
4.4
4.5
5.1
6.1
6.2
6.3
6.4
6.5
6.6

vi

Recorded remittances have grown faster than private capital flows and ODA
88
Choice of remittance channel in selected countries
91
Estimated increase in formal remittances if transaction costs were reduced to
2 to 5 percent and dual exchange rates were eliminated92
Impact of remittances on country credit rating and sovereign spread
102
Countries with alternative estimates in 2004106
Regression results: determinants of worker remittances
109
Regression results: determinants of transaction costs
109
Panel regression results: determinants of remittances
110
Simulated impact of eliminating remittances on poverty rate
120
Effect of removing remittances on the poverty headcount rate
128
Approximate cost of remitting $200
137
Operating profits of major MTOs
140
Estimating the cost of a remittance transaction
140
Remittances are more cost-elastic when costs are higher
143
Policies to reduce costs, regulate informal providers, and provide remittance-linked
financial services
148

The model used in this study
32
Calculating and interpreting global welfare gains from migration
36
The impact of immigrants on fiscal balances
40
Empirical studies of the impact of immigration on wages
43
Increased migration and its impact on wages
47
Internal versus international migration
65
Mode 4 and international migration
75
International working group on improving data on remittances87
The recent surge in remittance flows to India
89
Collective remittances through hometown associations and matching schemes
95
Forced remittances
97
Unlike oil windfalls, remittance inflows do not weaken institutional capacity
105
Estimating a cross-country poverty change model
119
Decline in remittance costs in the United States–Mexico corridor
139
Estimating remittance industry costs
141
Even charitable donations are sensitive to cost
142
United States–Mexico FedACH
148
The World Bank/CPSS task force on general principles for international remittancesystems
149
Smart’s phone-based remittance system in the Philippines
150

ForewordFor millennia people have migrated insearch of economic opportunity. In thenineteenth and early twentieth centuries,
technological advances and untapped natural
resources drove movements of population from
Europe and Asia to the Americas. Internationalmigration generated enormous improvementsin people’s lives. Immigrants enjoyed higher
wages, countries of destination profited fromincreased supply of labor, and countries of origin saw labor market pressures ease.
Current trends indicate that pressures for
migration from the south to the north are set
to rise again. This movement is driven largely
by income gaps and the rising number ofyoung adults in developing countries seeking
better opportunities abroad. The economic,
social, and political implications that comewith the movement of people differ from the
movement of goods or money. As a result, thetopic of international migration has prompted
much political debate in the international
community today.
The prospects for migration flows are critical for development. Developing countries
benefit through the money that migrants sendhome to their families (remittances), throughreduced labor market pressures, and throughcontacts with international markets and access to technology.
But migration is not always beneficial. Migrants can be subject to exploitation andabuse, and the loss of highly skilled personnel
through migration has hindered development
in some countries.

The World Bank’s research department, inpartnership with others, has launched a program to expand knowledge in an area that deserves greater attention. The program addresses the issues surrounding remittances;migration of high-skilled workers; the determinants of migration; temporary movementsof persons; social protection and governance;
and the links among trade, foreign direct investment, and migration.
An integral part of this program, Global
Economic Prospects 2006 focuses on policies
to improve the developmental impact of remittances. It documents the high level of transactions costs facing migrants sending small remittances to their families, and it outlines theregulatory issues and market imperfections
that keep costs high.
Fewer barriers to remittance flows andgreater competition among remittance service
providers could substantially reduce costs andboost remittance flows to developing countries. Global Economic Prospects 2006 shows
how sound domestic policies and an investment-friendly climate can significantly increase
the contribution of remittances and migration
to improved living conditions back home.
Migration remains an important force forfighting poverty, the key mission of the World
Bank, and it is our hope that this report willcontribute to this important debate.
Paul Wolfowitz
President
World Bank
November 2005vii

AcknowledgmentsT

HIS REPORT WAS prepared by the Development Prospects Group (DECPG). The lead authorsof this report were Dilip Ratha and William Shaw, with direction by Uri Dadush. The
principal authors of the chapters were Andrew Burns (chapter 1), Dominique van der
Mensbrugghe (chapter 2), William Shaw (chapter 3), and Dilip Ratha (chapters 4, 5, and 6). The
report was prepared under the general guidance of François Bourguignon, chief economist andsenior vice president of the World Bank.
The main macroeconomic forecasts in chapter 1 were prepared by the Global Trends Team of
DECPG led by Hans Timmer and including John Baffes, Andrew Burns, Maurizio Bussolo,
Annette de Kleine, Betty Dow, Himmat Kalsi, Fernando Martel Garcia, Donald Mitchell, Gauresh
Shailesh Rajadhyaksha, Mick Riordan, Cristina Savescu, Shane Streifel, and Shuo Tan. The outlook for the East Asia and Pacific region was carried out with the cooperation of Milan Brahmbhatt and Louis Kuijs. The team also benefitted from in-depth consultations and comments fromthe regional chief economists and their staff, as well as country economists. The long-term growthand poverty forecasts were prepared by Dominique van der Mensbrugghe, Shaohua Chen, andMartin Ravallion. The companion Prospects for the Global Economy web site was prepared byAndrew Burns, Sarah Crow, and Cristina Savescu, in collaboration with Reza Farivari, Saurabh
Gupta, David Hobbs, Shahin Outadi, Raja Reddy Komati Reddy, Malarvizhi Veerappan, andCherin Verghese.
Maddalena Honorati and Prabal De provided research assistance. Chapter 2 benefitted fromcollaboration with Hans Timmer and from comments received from seminar participants, notably Lindsay Lowell and Susan Martin. Special thanks are due for the background material
provided by Riccardo Faini, Robert Lucas, Julia Nielson, Kathleen Newland, and Irena Omelaniuk for chapter 3; Swaminathan S. Aiyar, Ralph Chami, Neil Fantom, Caroline Freund, Gary
McMahon, Irena Omelaniuk, Serdar Sayan, Nikola Spatafora, and K. M. Vijayalakshmi forchapter 4; John McHale for chapter 5; John Gibson, David McKenzie, George Kalan, Dilek
Aykut, Nikos Passas, and Jan Riedberg for chapter 6. Ole Andreassen, Jose de Luna Martinez,
Raul E. Hernandez-Coss, Massimo Cirasino, and Roger Ballard also contributed backgroundnotes for chapter 6. Thanks also to colleagues in the International Organization for Migration
who helped collect information on remittance-related government policies (for chapter 4) using
their extensive international network, and Bernd Balkenhol of the International Labour Organization for preparing a background paper on forced remittances.

ix

A C K N O W L E D G M E N T S

Many colleagues provided excellent comments at various stages of the report’s preparation.
L. Alan Winters provided comments on the report and guidance throughout its preparation. Luca
Barbone, Kevin Barnes, Augusto de la Torre, Shantayanan Devarajan, Mustapha Nabli, John
Page, Bryan Roberts, John Whalley, and Dean Yang were peer reviewers at the Bankwide review.
Richard Adams, William Easterly, Isaku Endo, Jose Maria Fanelli, Shahrokh Fardoust, Ian
Goldin, Daria Goldstein, Yevgeny Kuznetsov, Ali Mansoor, Phil Martin, Maria Soledad Martinez
Peria, Fernando Montes-Negret, Nayantara Mukerji, Latifah Osman Merican, Christopher Parsons, Guillermo Perry, Sonia Plaza, S. Ramachandran, and Terrie Walmsley also provided usefulcomments. Johan Mistiaen and Romeo Matsas provided excellent help in designing and implementing a survey of migrant remitters from Congo, Nigeria, and Senegal residing in Belgium.
Maria Amparo Gamboa, Araceli Jimeno, Katherine Rollins, Sarah Crow, and Michael Paul provided invaluable administrative support, including the collection of remittance fee data from allover the world.
The report team held consultations in July 2005 in Accra, Brussels, Geneva, London, andParis. Thanks are due to Haleh Bridi, Barbara Genevaz, Carlos Braga, Sonia Plaza, Michelle
Bailly, and other colleagues in these country offices for efficiently and enthusiastically arranging
consultations with several international, academic, financial, and non-governmental institutions.
Thanks are also due to the International Organization for Migration for assistance with organizing consultations in Geneva and to the International Labour Organization, the Global Commission on International Migration, the European Commission, and the Commonwealth Secretariat
for participating in consultations and providing useful feedback.
This report also benefitted from the comments of the Bank’s executive directors made at an
informal board meeting on October 20, 2005.
Marilou Uy, Alan Gelb, Jeff Lewis, Amar Bhattacharya, Shaida Badiee, Robert Keppler, andMisha Belkindas provided guidance and encouragement to the team at various stages. Dorota A.
Nowak managed production and dissemination activities by DECPG. Steven Kennedy’s contribution as an editor is gratefully acknowledged. Book design, editing, and production were coordinated by the World Bank Office of the Publisher.

xOverview

T

HE THEMES OF this year’s Global Eco-nomic Prospects are international remittances and migration, their economic consequences, and how policies canincrease their role in reducing poverty. International migration can generate substantial welfare gains for migrants and their families andfor the countries involved (countries of origin
and destination). The money that migrants
send home—remittances—is an importantsource of extra income for migrants’ families
and for developing countries: in aggregate, remittances are more than twice as the size of international aid flows. However, migration
should not be viewed as a substitute for economic development in the origin country—
development ultimately depends on sounddomestic economic policies.
Over the past two decades, barriers tocross-border trade and financial transactions
have fallen significantly, while barriers to thecross-border movement of people remainhigh. Despite its economic benefits, migration
remains controversial and, for some people,
threatening. In part, this is because migration,
like trade and capital movements, has distributional consequences, whereby net gains forsociety may mask important losses for someindividuals and groups. But migration also
sparks resistance because the movement ofpeople has economic, psychological, social,
and political implications that the movementof goods or money do not.

This publication has two goals. The first is
to explore the gains and losses from international migration from the perspective of developing countries, with special attention to themoney that migrants send home. The second
goal is to consider policy initiatives that could
improve the developmental impact of migration, again with particular attention to remittances. Our focus (for economic purposes) is
on international migration from developing
countries to high-income countries. Despite
their importance, internal migration, migration among developing countries, and the political and social impacts of migration are
beyond the scope of this work.
It is important to keep in mind three basic
principles. First, migration is a diverse phenomenon, and its economic impact in one
location or another depends heavily on the particular circumstances involved. Second, basic
data on migration and remittances are lacking,so predicting the impact of policy changes canbe problematic. This underlines the need forbetter data and more research. Third, migration has social and political implications that
may be just as important as the economic
analysis provided here. These are ably andcomprehensively discussed in the recent reportof the United Nations’ Global Commission on
International Migration. For all of these reasons, the analysis and policy recommendations
for migration must remain qualified. This
report draws conclusions where they can bexiO V E R V I E W

supported by adequate data and points to an
agenda for research where they cannot.

Global economic prospectsT

he slowdown among industrial economies
that began in the second half of 2004 continued in 2005, with GDP growth expected tocome in at 2.5 percent, down from 3.1 percent
the year before. The pace of the expansion in
the high-income countries is forecast to increase slightly over the next two years, with acceleration in Europe offsetting a modest slowing in Japan and stable growth in the UnitedStates. Economic activity also slowed in developing economies during 2005. Higher oil
prices, domestic capacity constraints, andslower demand for their exports brought GDP
growth down from a very strong 6.8 percent in2004 to an estimated 5.9 percent this year.
While GDP growth has remained robust,higher oil prices have sharply slowed real income growth among oil importers from 6.4 to
3.7 percent. Looking forward, continued highoil prices, coupled with inflationary pressures,are expected to restrain growth in most developing countries over the next two years. Nevertheless, GDP in these economies should
expand by around 5.5 percent—much more
quickly than during the past two decades.
This relatively positive outlook is subject toimportant downside risks. The outlook for oil
prices is particularly uncertain. Low excess capacity has introduced a risk premium into oil
prices and will make it more difficult to contain the impact of a future supply shock,should one arise. As a result, a significant supply disruption could slow global growth, withlarge negative consequences for global economic prospects. The future path of interest
rates, which despite recent increases are still
low, is another source of uncertainty. Persistent global imbalances, signs of rising inflation, and concerns about the sustainability of
government finances in industrialized countries are all factors that could push rates
higher and possibly provoke a much more serious slowdown.

xii

The impact of remittancesand migration
The impact on migrants
The bulk of the economic gains from migration accrue to migrants and their families, andthese gains are often large. Wage levels (adjusted for purchasing power) in high-income
countries are approximately five times those of
low-income countries for similar occupations,generating an enormous incentive to emigrate.
Moreover, to the extent that migrants devote
a portion of their income to remittances, thegains are even greater. Essentially migrants canearn salaries that reflect industrial-country
prices and spend the money in developing
countries, where the prices of nontraded goods
are much lower. Migrants, however, incur substantial costs, including psychological costs,
and immigrants (particularly irregular migrants) sometimes run high risks; many sufferfrom exploitation and abuse. The decision to
migrate is often made with inaccurate information. Given the high costs of migration—
including the risks of exploitation and the exorbitant fees paid to traffickers—the net
benefit in some cases may be low or even negative. There are costs, too, for family members
left behind—particularly children—althoughthese costs must be balanced against the benefits of the extra income that migrants sendback home to their families.

The impact on destination countries
Destination countries can enjoy significant economic gains from migration. The increased
availability of labor boosts returns to capitaland reduces the cost of production. A modelbased simulation performed for this study indicates that a rise in migration from developing
countries sufficient to raise the labor force ofhigh-income countries by 3 percent could boost
incomes of natives in high-income countries by
0.4 percent. In addition, high-income countries
may benefit from increased labor-market flexibility, an increased labor force due to lower
prices for services such as child care, and perhaps economies of scale and increased diversity.

O V E R V I E W

Nevertheless, there are losers within destination countries. Some workers may see an erosion of wages or employment, although this effect is found to be small in most empiricalstudies. In the model-based simulation of the
impact of increased migration, earlier migrants
suffer significant income losses, while the impact on natives’ wages is small. (The differential
impact is reduced if foreign-born workers are
viewed as closer substitutes for natives.) Easing
rules that limit labor-market flexibility, andstrengthening institutions that provide education and training, will help workers displacedby immigration (both natives and resident migrants) to find work. Note that the simulation
results are not intended to incorporate all of theeconomic impacts of migration, nor do theycapture important social and political implications. The goal is not to forecast the overall impact of increased migration, but rather to give
us insights into the economic gains that might
be expected from changes in policy or circumstances, as well as insights into the channels
through which migration affects welfare.

The impact on origin countries
Migration also generates economic benefits fororigin countries, the largest being remittances.
International remittances received by developing countries—expected to reach $167 billion
in 2005—have doubled in the past five years as
a result of (a) the increased scrutiny of flows
since the terrorist attacks of September 2001,(b) changes in the industry that support remittances (lower costs, expanding networks), (c)improvements in data recording, (d) the depreciation of the dollar (which raises the dollar
value of remittances denominated in other currencies), and (e) growth in the migrant stock
and incomes. However, records still underestimate the full scale of remittances, because payments made through informal, unrecorded
channels are not captured. Econometric analysis and available household surveys suggest that
unrecorded flows through informal channels
may conservatively add 50 percent (or more) ofrecorded flows. Several countries with significant migrant populations do not report data on

remittances at all, even those sent through formal channels, or they report remittances underother balance of payments entries.
Despite the prominence given to remittances from developed countries, South-South
remittance flows make up between 30 and 45
percent of total remittances received by developing countries, reflecting the fact that overhalf of migrants from developing countries
migrate to other developing countries.
While the impact of remittances on growthis unclear, remittances do play an importantrole in reducing the incidence and severity ofpoverty (with no significant effect on income
inequality). Remittances directly increase theincome of the recipient and can help smoothhousehold consumption, especially in responseto adverse events, such as crop failure or ahealth crisis. In addition to bringing the direct
benefit of higher wages earned abroad, migration helps households diversify their sources ofincome (and thus reduce their vulnerability torisks) while providing a much needed source ofsavings and capital for investment. Remittances appear to be associated with increased
household investments in education, entrepreneurship, and health—all of which have a highsocial return in most circumstances.
Measuring the poverty impact of remittances is difficult: data are scarce, and calculating the income gains from remittances requires assumptions concerning what migrants
would have earned if they had stayed at home.
Careful analyses of the available household
survey data indicate that remittances havebeen associated with declines in the poverty
headcount ratio in several low-income
countries—by 11 percentage points in
Uganda, 6 in Bangladesh, and 5 in Ghana, forexample. In Guatemala, remittances may have
reduced the severity of poverty by 20 percent.
Cross-country regressions and simulations
also indicate that increases in remittances help
to reduce the incidence of poverty.
By generating a steady stream of foreignexchange earnings, remittances can improve a
country's creditworthiness for external borrowing and, through innovative financingxiii

O V E R V I E W

mechanisms (such as securitization of remittance flows), they can expand access to capitaland lower borrowing costs. While large andsustained remittance inflows can contribute tocurrency appreciation, this outcome may beless severe than it is in the case of natural resource earnings, because remittances are distributed more widely and may avoid exacerbating strains on institutional capacity that areoften associated with natural resource booms.
Migration has economic implications for origin countries beyond remittances. The small sizeof migration flows relative to the labor force suggests that the effects of South–North migration
on working conditions for low-skilled workers
in the developing world as a whole must be small
as well. However, in some countries low-skilled
emigration can raise demand for the remaining
low-skilled workers (including poor workers) at
the margin, leading to some combination ofhigher wages, lower unemployment, less underemployment, and greater labor force participation. Thus low-skilled emigration can offer avaluable safety valve for insufficient employment at home. In the long run, however, developing country policies should aim to generateadequate employment and rapid growth, rather
than relying on migration as an alternative to development opportunities.
High-skilled emigration has more complex
implications. Like low-skilled migration, it
can greatly benefit migrants and their families
and help relieve labor market pressures. However, a well-educated diaspora can improve access to capital, technology, information, foreign exchange, and business contacts for firms
in the country of origin. The return of expatriates and the maintenance of close contacts
with high-skilled emigrants have played an
important role in the transfer of knowledge toorigin countries. At the same time, large outflows of high-skilled workers can reduce
growth in the origin country for these reasons:(a) the productivity of colleagues, employees,
and other workers may suffer because theylose the opportunity for training and mutually
beneficial exchanges of ideas; (b) the provisionof key public services with positive externali-

xivties, such as education and health (particularly
for the control of transmissible diseases), may
be impaired; (c) opportunities to achieve
economies of scale in skill-intensive activities
may be reduced; (d) society loses its return on
high-skilled workers trained at public expense; and (e) the price of technical services
may rise. Highly educated citizens, if they
stayed in their countries, could help to improve governance, improve the quality of debate on public issues, encourage education ofchildren, and strengthen the administrative
capacity of the state—contributions thatwould be lost through high-skilled emigration.
It is impossible to reliably estimate the net
benefit, or cost, to origin countries of highskilled emigration because data are limited
and a myriad of individual country circumstances enter into the calculus of that benefit
or loss. We can only offer two rough observations, which reflect the wide variation in highskilled emigration rates among countries:• Very high rates of high-skilled emigration are found in countries that represent
a small share of the population of the developing world. Many of those countries
have poor investment climates that likely
limit the productive employment of highskilled workers. Of course, the loss ofhigh-skilled workers may aggravate thepoor investment climate and limit thepotential benefits of economic reform.
• Some countries find it difficult to provide productive employment for manyhigh-skilled workers because of theirsmall economic scale or because misguided educational policies have resulted
in a large supply of university graduates
for whom no suitable jobs exist.

Policies to improve thedevelopmental impact ofremittances and migration
Migration policies
Greater emigration of low-skilled emigrants
from developing to industrial countries could

O V E R V I E W

make a significant contribution to poverty reduction. The most feasible means of increasing such emigration would be to promotemanaged migration programs between origin
and destination countries that combine temporary migration of low-skilled workers withincentives for return. Temporary programs
have several advantages, and some disadvantages, relative to permanent migration. Fromthe perspective of the destination country,
managed, temporary migration programs easesocial tensions by limiting permanent settlement; they limit the potential burden on public expenditures because immigrants are guaranteed a job and are less likely to bringdependents; and they allow for controlled
variation of the number of immigrants in response to changes in labor-market conditions,thus limiting adverse effects on low-skilled native workers. However, temporary migration
can be less efficient than permanent migration
for firms in destination countries because ofhigh training costs. From the origin-country
perspective, managed, temporary migration
may be the only means of securing deliberateincreases in low-skilled emigration and may
raise remittances and improve the skills of returning workers. On the other hand, managed
migration programs do not guarantee futureaccess to labor markets (and thus to remittances), because it is easier for destination
countries to suspend temporary programs
than to expel immigrants. Overall, however,such programs do represent a feasible approach to capturing the efficiency gains fromlabor migration.
Origin countries that are adversely affectedby high-skilled emigration face challenges inmanaging it better. Service requirements foraccess to publicly financed education can beevaded and are likely to discourage return;and proposals for the taxation of emigrants tothe benefit of the origin country have made little progress. Origin countries can help to retain key workers by improving working conditions in public employment and by investingin research and development. Origin countries
can also take steps to encourage educated em-

igrants to return by identifying job opportunities for them, cooperating with destination
countries that have programs to promote return, permitting dual nationality, and helping
to facilitate the portability of social insurance
benefits.
By providing authoritative information on
migration opportunities and risks, governments could help avoid unfortunate, costly-toreverse migration decisions and limit the abuseof vulnerable migrants. Labor recruiters canplay a valuable role in promoting migration,but emigrants’ lack of information often enables recruiters to capture the lion’s share of therents generated by constraints on immigrationand imperfect information. Origin countries
with effective public sector institutions might
consider the regulation of recruitment agentsto limit rents and improve transparency.

Remittance policies
Governments in destination and origin countries can sharpen the developmental impact ofremittances through the application of appropriate policies. Access of poor migrants andtheir families to formal financial services forsending and receiving remittances could be
improved through public policies that encourage expansion of banking networks, allow
domestic banks from origin countries to operate overseas, provide identification cards tomigrants, and facilitate the participation of
microfinance institutions and credit unions inproviding low-cost remittance services. Remittances, in turn, can be used to support financial products—housing and consumer loans
and insurance—for poor people.
A second set of promising policies could
improve competition in the remittance transfer market and thereby lower fees. The priceof remittance transactions is often unnecessarily high for the small transfers typically madeby poor migrants. The cost of such transactions is often well below the fees paid by customers. Reducing transaction charges increases the disposable income of poor
migrants and increases their incentives toremit, because the net receipts of recipientsxv

O V E R V I E W

increase. The overall result would be stronger
remittance flows to developing countries.
Competition among providers of remittanceservices could be increased by lowering capitalrequirements on remittance services and opening up postal, banking, and retail networks tononexclusive partnerships with remittanceagencies. Disseminating data on remittancefees in important remittance corridors and establishing a voluntary code of conduct for delivering fair-value transfers would improvetransparency and reduce prices for remittancetransactions. Governments could help reduce
costs by supporting the introduction of modern technology in payment systems. Alleviating
liquidity constraints by providing a credit line
either to the sender or the recipient, based on
past remittance activity, would enable senders
to take advantage of the lower fee rates available only for larger remittances. Reducing exchange-rate distortions could also lower thecost of remittance transactions. Finally, regulatory regimes need to strike a better balance between preventing financial abuse and facilitating the flow of funds through formal channels.
Several origin countries have attempted to
improve the developmental impact of remittances by introducing incentives to increaseflows and to channel them to more productive
uses. Such policies are more problematic thanefforts to expand access to financial services
or reduce transaction costs, because they poseclear risks. Tax incentives to attract remittanceinflows, for example, may also encourage tax
evasion, while matching-fund programs to attract remittances from migrant associations
may divert funds from other local funding priorities. Efforts to channel remittances to investment, meanwhile, have met with little success. Fundamentally, remittances are private
funds that should be treated like other sourcesof household income. Efforts to increase sav-

xvi

ings and improve the allocation of expenditures should be accomplished through improvements in the overall investment climate,rather than by targeting remittances. Similarly,
because remittances are private funds, theyshould not be viewed as a substitute for official development aid.

Organization of this studyA

s is customary in this report, chapter 1
reviews recent developments in andprospects for the global economy and theirimplications for developing countries. Chapter
2 uses a model-based simulation to evaluate
the potential global welfare gains and distributional impact from a hypothetical increase of 3
percent in high-income countries’ labor force
caused by migration from developing countries. Chapter 3 surveys the economic literatureon the benefits and costs of migration for migrants and their countries of origin, focusing
on economically motivated migration from developing to high-income countries. We thenturn to remittances, the main theme of the report. Chapter 4 investigates the size of remittance flows to developing countries, the use offormal and informal channels, the role of government policies in improving the development
impact of remittances, and, for certain countries, their macroeconomic impact. Chapter 5
addresses the impact of remittances at thehousehold level, in particular their role in reducing poverty, smoothing consumption, providing working capital for small-scale enterprises, and increasing household expendituresin areas considered to have a high social value.
The last chapter investigates policy measuresthat could lower the cost of remittance transactions for poor households and measures tostrengthen the financial infrastructure supporting remittances.

Abbreviations

ADB

Asian Development Bank

AML

Anti-money laundering

AML/CFT

Anti-money laundering/countering financing of terrorism

ARTEP

Asian Regional Team for Employment Protection (ILO)

ATC

Agreement on Textiles and Clothing

BIS

Bank for International Settlements

BoA

Bank of America

BOP

Balance of payment

CECEI

Comité des établissements de crédit et des enterprises, d’investissement

CEMLA

Center for Latin American Monetary Studies (Centro de Estudios
Monetarios Latino Americanos)

CEPAL

Economic Commission for Latin America and the Caribbean (Comisión
Económico para América Latina y el Caribe)

CES-IFO

Center for Economic Studies at the University of Michigan—Institutefor Economic Research

CGAP

Consultative Group to Assist the Poorest

CPI

Consumer price index

CPSS

Committee on Payment and Settlement Systems

DDP

Development data platform

DFID

Department for International Development

DHS

Department for Homeland Security

DPRs

Diversified payment rights

DPS

Deferred payment scheme

ECA

Europe and Central Asia

ECOSOCUN Economic and Social Council

EU

European Union

EV

Equivalent variation

FATF

Financial Action Task Force against Money Launderingxvii

A B B R E V I A T I O N S

xviii

FDC

First Data Corporation

FDI

Foreign direct investment

FFMC

First Financial Management Corporation

FinCEN

Financial Crimes Enforcement NetworkFISDL

Social Investment Fund for Local Development (Fondo de Inversión
Social para el Desarrollo)

GATS

General Agreement on Trade in Services

GDP

Gross domestic productGE

General equilibrium

GTAP

Global Trade Analysis Project

HIV/AIDS

Human immunodeficiency virus/acquired immune deficiency syndrome

HSBC

Hong Kong Shanghai Bank Corporation

HTAs

Hometown associations

IADB

Inter-American Development BankIBM

International Business Machines

ICICI

Industrial Credit and Investment Corporation of India

ICMCInternational Catholic Migration Commission

IFAD

International Fund for Agriculture and Development

ILO

International Labour Organization

IMF

International Monetary Fund

IOM

International Organization for Migration

IRCA

Immigation Reform and Control Act

IRD

Institut de recherche pour le développement

IRnet

International Remittance Network

LAC

Latin American and the Caribbean

LDCs

Least-developed countries

MCIC

Matricula Consular identification card

MDG

Millennium Development Goal

MIDSA

Migration for Development in Southern Africa

MFIs

Microfinance institutions

MFN

Most-favored nation

MICR

Magnetic ink character recognition

MIDA

Migration for Development in Africa

MIDWA

Migration for Development in Western Africa

MPG

Migration Policy Group

MSB

Money service business

MTOs

Money transfer operators

NAFTA

North American Free Trade Agreement

A B B R E V I A T I O N SNBERNational Bureau of Economic ResearchNGOs

Non-governmental organization

ODA

Official development aid

OECD

Organisation for Economic Co-operation and Development

OFAC

Office of Foreign Assets Control

OPEC

Organization of the Petroleum Exporting Countries

OLS

Ordinary least squares

PADF

Pan-American Development Foundation

PPP

Purchasing power parity

PRIO

International Peace Institute, Oslo

PROFECO

Procuraduría Federal del Consumidor

R&D

Research and development

SADC

Southern African Development Community

SPV

Special purpose vehicle

TDS

Telephone and data systems

TSG

Technical Sub-Group on the Movement of Persons

UAE

United Arab Emirates

UCSD

University of California, San DiegoUN

United Nations

UNDP

United Nations Development Programme

UNESCAP

United Nations Economic and Social Commission for Asia and thePacific

UNESCO–ICSU

United Nations Educational, Scientific and Cultural
Organization–International Council of Scientific Unions

USAID

United States Agency for International Development

USD

US dollar

WEO

World Economic Outlook

WOCCU

World Council of Credit Unions

WTO

World Trade Organization

xix

1
Prospects for the Global Economy

Following very strong growth, the world
economy slowed in late 2004 and into 2005 as
output began to push against capacity constraints. High oil prices cut into the incomes ofoil importers, but the expansion remained
strong, partly because of favorable conditions
in financial markets, including still low inflation, interest rates, and interest-rate spreads.
Tightness in the oil market, the threat of evenhigher fuel prices, and the possibility that interest rates may rise pose major threats to the
expansion.

Slower but still strong growth
World GDP is estimated to have increased by
3.2 percent in 2005, down from 3.8 in 2004.
Growth is projected to be stable in 2006, before strengthening somewhat in 2007. The
slowdown that began in the second half of2004 was experienced throughout the industrialized world, with growth in Europe still
underperforming its potential. In contrast, theeconomies of the United States and Japan, despite having slowed, are expanding at close to
their maximum sustainable rates.
Among large developing economies, GDP
in 2005 continued to expand rapidly in China
and India (in excess of 9 percent and about
7 percent, respectively), but slowed in Russia
as growth in oil production weakened. Highoil prices, in combination with domestic capacity constraints and slower import demand
from high-income countries, are estimated tohave reduced growth among oil-importing developing countries from 6.9 percent to 6.1
percent. In terms of real incomes, the slowdown was much sharper—from 6.4 percent to
3.7 percent. Despite still growing oil revenues,
reduced opportunities to expand productionin the petroleum sector meant that output
growth in oil-exporting developing countries
also eased, from 6.6 percent to 5.6 percent.
During 2006 the expansion among highincome countries is projected to be stable, at
about 2.5 percent, before picking up a bit in2007. This reflects a combination of improved
performance in Europe and stable growth in
the United States and Japan. In the UnitedStates, higher oil prices and tighter monetary
policy are expected to offset the positive stimulus to growth from past depreciations. The
projected pickup in Europe occurs despite asignificant drag on growth from high oil prices
whose effects are expected to be more thanoffset by low interest rates, pent up investment
demand, and a dissipation of most of the negative consequences following the euro’s realeffective appreciation. In Japan, strengthening
domestic demand and supportive macroeconomic policies should enable growth to remain close to potential, despite high oil prices.
Growth in developing economies is projected to slow modestly from an estimated
5.9 percent in 2005 to 5.5 percent by 2007.
In East and South Asia, the expansion is
projected to moderate somewhat but remain

1

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 6very strong, particularly in China and India.
In the Middle East and in both North and
Sub-Saharan Africa, strong oil revenues
should buoy internal demand among oil exporters and partially offset capacity constraints that will slow production growth. The
projected easing of growth in Latin America
and the Caribbean reflects weaker non-oil
commodity prices as well as a return to trend
growth in several countries that reboundedvery strongly in 2004. In Europe and Central
Asia, the waning of the growth bonus following EU accession and capacity constraints in
oil-producing countries are expected to contribute to a modest slowing of the expansion.

Tight commodity markets
Weaker global growth should reduce thestrain in non-oil commodity markets. Alreadythere are signs of stabilization, and even of
decline, in the prices of agricultural products,
where supply has responded to high prices.
Metals and shipping prices also show signs ofeasing, although to a lesser extent.
In oil markets, the projected slowdown is
not expected to be sufficient to generate a substantial easing of prices. While crude oil supply
is growing marginally faster than demand,
supply conditions are expected to remain tight.
As a result, crude oil prices, which currently
embody a large risk premium, are not expected
to fall rapidly. The baseline assumes that no
major supply disruptions occur and that there
will be a gradual decline in oil prices toward$40 per barrel by 2010. This implies an average price of $56 for a barrel of oil in 2006 and$52 in 2007.
Future spikes in oil prices form a potential
risk to global prospects. A price hike generated by a sustained negative supply shock
would be particularly disruptive, because output would be constrained directly by the reduced availability of oil and petroleum-based
inputs. This would be in contrast to the recent
past, when prices rose in the context of rapidly
growing supply. A supply shock that reduced
oil deliveries by 2 million barrels per day

2

could push prices to more than $90 a barrel
for more than a year, resulting in a 1.5 percent
reduction in global growth by the second year
following the shock. The terms-of-trade impact for low-income oil-importing economies
would reduce incomes in these countries bymore than 4 percent of their GDP (much morethan for high-income countries) because theireconomies are relatively oil intensive, and because a supply shock–induced increase in oil
prices is unlikely to be accompanied by higher
non-oil commodity prices.

Global imbalances remain an issue
Global current account imbalances and the
U.S. current account deficit (which is expected to exceed $750 billion in 2005) remain
important medium-term problems. Duringlate 2004 and early 2005 tensions eased
somewhat. Rising interest rate differentials
relative to European short- and long-term assets made private sector purchases of dollar–
denominated assets more attractive. As a result, the dollar appreciated some 2.5 percent
in real-effective terms during the first sevenmonths of 2005, and reserve accumulation byforeign central banks became less important in
the financing of the current account deficit.
This respite appears to have been shortlived. To some extent, the increased private
flows represented a one-off portfolio adjustment toward U.S. assets by investors. Beginning in the second quarter of 2005, the flows
diminished, and the dollar faced renewed
downward pressure. As a result, foreign reserve accumulation once again became a critical component in the financing of the U.S. current account deficit, restoring the risk that achange in behavior on the part of foreign central bankers could prove destabilizing. Recent
decisions by China and Malaysia to widen therange of currencies to which their own currencies are pegged could help ease future pressures, especially if the scope for appreciation
included in the regime is exercised in practice.
Globally, policy should continue to focus on
increasing public and private savings in deficit

P R O S P E C T S

countries and increasing spending (notably on
investment goods) in surplus countries.

F O R

T H E

G L O B A L

E C O N O M Ysame way that other countries have profited
from freer trade in the manufacturing and raw
materials sectors.

Low interest rates are a sourceof uncertainty
The future path of long-term interest rates andspreads, which have been at historically low
levels for an extended period, is an important
uncertainty. A number of factors have helped
maintain interest rates at low levels, including
several years of very loose monetary policy
throughout the developed world; increased
aging-related savings in Europe; balance-sheet
consolidation in the United States andAsia; and a low inflationary environment—
thanks, in part, to increased competition following the entry into global markets of China
and members of the former Soviet bloc. Mostof these factors are temporary and are expected
to gradually abate, resulting in a steady rise inlong-term rates in the baseline. Indeed, yields
on 10-year U.S. Treasuries have risen 50 basis
points since September.
However, these temporary factors could
continue to hold sway, reversing or bringing
to a halt the recent increase in long-term rates(as they have in the past). This would prompt
stronger-than-projected demand, but also exacerbate capacity constraints. As a result, oilprices could get pushed higher, which would
provoke a more brutal inflationary cycle, andultimately, a recession.
Alternatively, these forces could dissipate
more rapidly, causing long-term interest rates
to rise more quickly toward long-term equilibrium levels, which would provoke a more pronounced slowdown. While not the most likely
scenario, the recent rise in long-term yields
and inflation suggest that a higher interestrate scenario is a real possibility.
Finally, this environment of slowing
growth and global imbalances raises the riskof rising protectionism. In this regard, policymakers need to make a concerted effort to ensure that the Doha round reaches a successful
conclusion so that developing countries specializing in the export of agricultural products
can benefit from trade liberalization in the

Global growthThe global economy slowed markedly in
2005, but still continued to expand at an
estimated 3.2 percent pace, compared with
3.8 percent in 2004 (table 1.1). The slowdown
was widespread, reaching virtually every economic region. It was precipitated by higher oil
prices, resource-sector capacity constraints,tightening monetary policy in the UnitedStates, and in some countries, the maturationof the investment cycle following a year ofvery fast growth.

Outturns and prospects inhigh-income countries
Growth among industrialized economies in2005 is estimated at 2.5 percent, substantiallylower than the 3.1 percent recorded the year
before. Industrial production and trade flows
among high-income countries were particularly weak. Growth rates of the former declined from over 5 percent in mid-2004 to lessthan 1.5 percent in the middle of 2005 (figure1.1). High oil prices, rising short-term interest
rates, and an unusually disruptive hurricane
season1 slowed growth in the United States to

Figure 1.1 Industrial production% change, monthly, year over year
15

Developing countries

10
5
0
⫺5

Developing
countries(excluding China)World(excluding China)⫺101997 1998 1999 2000 2001 2002 2003 2004 2005
Source: World Bank.

3

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 6

Table 1.1 The global outlook in summary
Percentage change from previous year, except interest rates and oil price
2003

2004

2005e

2006f

2007f

5.9

10.2

6.2

7.0

7.3

1.5
2.3

1.7
2.7

2.2
3.4

2.0
3.0

1.7
2.4

10.2
28.9
15.9
7.5

17.5
37.7
30.6
6.9

11.9
53.6
42.1
2.4

⫺5.9
56.0
4.5
2.4

⫺6.3
51.5
⫺8.0
2.1

1.2
2.3

1.7
2.1

3.8
2.2

5.0
2.1

5.2
2.8

Real GDP growthe
World
Memo item: world (PPP weights)f
High incomeOECD countries
Euro areaJapan
United States
Non-OECD countries
Developing countries in
East Asia and Pacific
Europe and Central Asia
Latin America and Caribbean
Middle East and N. Africa
South Asia
Sub-Saharan Africa

2.5
3.9
1.8
1.8
0.7
1.4
2.7
3.7
5.5
8.1
6.1
2.1
5.2
7.9
3.6

3.8
5.0
3.1
3.0
1.7
2.6
4.2
6.3
6.8
8.3
7.2
5.8
4.9
6.8
4.5

3.2
4.4
2.5
2.4
1.1
2.3
3.5
4.3
5.9
7.8
5.3
4.5
4.8
6.9
4.6

3.2
4.3
2.5
2.5
1.4
1.8
3.5
4.2
5.7
7.6
5.2
3.9
5.4
6.4
4.7

3.3
4.4
2.7
2.7
2.0
1.7
3.6
4.0
5.5
7.4
5.0
3.6
5.2
6.3
4.5

Memorandum items
Developing countries
excluding transition countries
excluding China and India

5.3
4.1

6.8
6.0

6.1
4.9

5.8
4.7

5.6
4.6

Global Conditions
World trade volume
Consumer prices
G-7 countriesa,bUnited States
Commodity prices (USD terms)
Non-oil commodities
Oil price (US$ per barrel)c
Oil price (percent change)
Manufactures unit export valued
Interest rates$, 6-month (percent)€, 6-month (percent)Note: PPP ⫽ purchasing power parity; e ⫽ estimate; f ⫽ forecast.
a. Canada, France, Germany, Italy, Japan, the UK, and the United States.
b. In local currency, aggregated using 1995 GDP weights.
c. Simple average of Dubai, Brent, and West Texas Intermediate.
d. Unit value index of manufactured exports from major economies, expressed in U.S. dollars.
e. GDP in 1995 constant dollars;1995 prices and market exchange rates.
f. GDP measured at 1995 PPP weights.

an estimated 3.5 percent, compared with
4.2 percent the year before. The slowdown
was not as marked as it could have been,
because low long-term interest rates boosted
domestic demand, and the cumulative effectof past dollar depreciations improved net
exports.
In Europe, the growth slowdown was lesspronounced, but the expansion, at an estimated4

1.2 percent (1.1 percent in the euro zone), wasmuch weaker. The relatively low oil-intensityof European economies and relaxed macroeconomic policy stance help explain why theslowdown in Europe was not more pronounced. In Japan, GDP is estimated to haveincreased 2.3 percent. Rising domestic demand and household incomes, as a result oftighter labor market conditions and reduced

P R O S P E C T S

Developing economy outturns
and prospects
Despite a slowdown of almost a full percentage point, growth in developing economies remained very robust, at an estimated 5.9 percent in 2005 (figure 1.2). In part this reflects
the strong performance of China and India,
where output continued to expand at rapid
rates (in excess of 9 percent and about 7 percent, respectively). The slowdown among theoil-importing countries (excluding China andIndia) was sharper, from 5.6 percent to
4.3 percent.2 At the same time, dwindlingspare capacity in the petroleum sector caused
growth in oil-exporting developing countries
to ease from 6.6 percent to 5.7 percent, eventhough oil revenues continued to rise.
High oil prices, rising interest rates, andbuilding inflationary pressures are expected torestrain growth in most developing regions in2006 and 2007 (figure 1.3). As a group, however, low- and middle-income countries should

T H E

G L O B A L

E C O N O M Y

Figure 1.2 A sharp slowdown% change, GDP

Projection

7
Developing countries
6
5
4
3

World

2

06

07
20

20

04

03

02

01

00

99

05
20

20

20

20

20

20

19

97
19
98

1
19

industrial restructuring, compensated formuch slower Chinese import demand.
Looking forward, the increase in oil prices
observed in 2005 is expected to slow global
growth by about one quarter of a percentage
point in 2006, compared with what it would
have been had prices remained stable. In the
United States, the pace of the expansion is
projected to remain broadly stable, because
the negative effects of further expected increases in interest rates and high oil prices will
be partly offset by a deficit-financed pickup in
post-hurricane investment and additional increases in the contribution of the external sector to growth. In Europe, economic activity is
projected to accelerate despite a significant
drag on growth from high oil prices, becauseof low interest rates, pent up investment
demand, and a dissipation of most of thenegative consequences following the euro’s
real-effective appreciation. Meanwhile, inJapan, the negative consequences of higher oil
prices are expected to be substantially offset
by strengthening domestic demand and continued supportive macroeconomic policies.

F O R

Source: World Bank.

again outperform high-income economies by awide margin through 2007.

Regional outlooks
Detailed descriptions of economic developments in developing regions can be foundin the Regional Outlooks section of http://www.
worldbank.org/globaloutlook.

The economies of the East Asia andPacific region continued to expand rapidly
in 2005. Regional GDP is estimated to haveincreased by 7.8 percent, down from 8.3 percent in 2004. Growth in China remained
very strong—despite a substantial slowing inboth private consumption and investment
demand—because exports continued to
grow rapidly, and import growth declined byhalf. China appears to have been a major
beneficiary of the expiration of quotas on
textiles (see the global trade discussion
below), which contributed to rapid export
growth in the first half of the year. Since
then, the re-imposition of quotas by theUnited States and the European Union (EU)have attenuated this positive force. For othercountries in the region, the slowdown in
Chinese imports, weak global high-tech demand, and elevated oil prices have translated
into reduced export growth, rapidly rising5

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 6

Figure 1.3 Regional growth% change, GDP
9
2006

8

2005
2004

7

2007

2003

6
5
4
3
2
1
East Asia andthe Pacific

Europe andCentral Asia

Latin America
and theCaribbean

Middle Eastand North
AfricaSouth Asia

Sub-SaharanAfricaOil importers

Oil importers,
except China

Source: World Bank.

producer prices, and a deterioration of current account balances.
Even higher oil prices on average in 2006,3
the longer-term implications of reduced investment levels of China, and a tightening ofmonetary policy are expected to slow regional
growth to 7.6 and 7.4 percent in 2006 and2007, respectively. The changes in the currency regimes of China and Malaysia are notexpected to have a major impact on growth.
Nevertheless, as discussed below, theseregimes should improve financial stability
both domestically and internationally.
Economic activity in the Europe and Central Asia region decelerated sharply in 2005,
with GDP growing by an estimated 5.3 percent, down from 7.2 percent in 2004. Slower
increases in oil production, a peaking of theinvestment cycle (especially among economies
that recently joined the EU), and less robust
world demand for the region’s exports contributed to the slowdown, which was particularly intense in a number of the larger
economies of the region. Russia decelerated
from 7.2 percent to 6.0 percent; Ukraine from
12.1 percent to 4.4 percent; Poland
from 5.4 percent to 3.5 percent; and Turkey
from 8.9 percent to 4.8 percent.
Higher oil prices constrained domestic
demand in oil-importing countries, but oil

6revenues in oil-exporting countries helped offset much slower growth in the oil sector itself.
Reflecting these capacity constraints and thevery strong growth recorded last year, inflationary pressures have built up in many countries in the region, notably Russia. Turkey,
where improved macroeconomic policy has
pushed inflation below 10 percent, represents
an important exception. The expected acceleration of demand in Europe, continued high oil
prices—which for many countries in the region are a positive factor—and additional
gains in European market share, suggest thatgrowth for the region as a whole should remain relatively stable—at about 5 percent in2006 and 2007, which is close to the region’s
potential growth rate.
Economic activity in Latin America and the
Caribbean is estimated to have increased bysome 4.5 percent during 2005, substantiallyslower than the 5.8 percent recorded in 2004
but much faster than the region’s 0.4 percent
average growth rate during the preceding
three years. Supply constraints and tight monetary policy are estimated to have slowed GDP
growth in Brazil to some 3.8 percent (downfrom 4.9 percent in 2004), while in Mexico
five fewer working days in 2005 than in 2004
are expected to contribute to a significant
slowing.4 Excluding these countries, regional

P R O S P E C T S

growth in 2005 is estimated at a robust
5.9 percent, boosted by both strong world
demand for the region’s exports (particularly
oil, coffee, and copper, which account for 65
percent of the regions’ commodity exports)
and low interest rates. Domestic factors that
contributed to the strong performance include
past efforts to open the region up to international trade, more responsible budget policy,
the introduction of more flexible exchange
rate regimes, and lower inflation.
Slower global growth is already easing tensions in the non-oil commodity markets thathave driven the recovery in the Latin America
and Caribbean region, and this trend is expected to continue. Moreover, while many
countries in the region benefit from high oil
prices, many others, particularly those in the
Caribbean, are heavily oil dependent and facesubstantial income losses.5 As a result, regional GDP growth is projected to decline to
3.6 percent by 2007.
High oil prices and strong oil demand continue to be key drivers for the economies ofthe Middle East and North Africa, where GDP
is estimated to have increased by 4.8 percent
in 2005. Very high oil revenues generated
double-digit advances in public spending,which have helped to increase GDP in oilproducing economies by an estimated 5.4 percent. Strong demand from these economies
spilled over to the labor-abundant economiesof the region through higher remittances andincreased intraregional tourism flows. However, weak growth in Europe, high oil bills,
and a one-off negative effect from the removalof quotas under the Agreement on Textiles
and Clothing (ATC) reduced growth of regional oil-importing countries from 4.6 percent in 2004 to about 4.0 percent in 2005.
Looking forward, high oil prices are expected to continue feeding demand in oilproducing countries, whose economies should
expand by 5.4 percent in 2006 and 5.1 percent
in 2007. In the oil-importing economies,
growth is expected to accelerate to about thesame level, supported by stronger European
growth and a weaker negative effect from

F O R

T H E

G L O B A L

E C O N O M Y

the ATC. The region’s strong performance reflects, in part, past reforms, such as steps toimprove transparency in the oil sector in
Algeria, as well as banking-sector reform, reductions in customs duties, privatization, andregulatory reform in other Maghreb countries.
These efforts, and in particular, the substantial
reforms underway in Egypt, help to raise theregion’s growth potential by improving bothinfrastructure and the overall investment climate. While heartening, the pace of reform
outside of Egypt appears to have waned, perhaps because high oil prices have reduced
the sense of urgency attached to reform in oilexporting countries.
In contrast to the slowdown elsewhere in
the world economy, growth in South Asia isestimated to have picked up a bit in 2005,
coming in at 6.9 percent, compared with
6.8 percent in 2004. This mainly reflects improved performance in Pakistan, where GDP
is estimated to have increased 8.4 percent (upfrom 6.6 percent in 2004), thanks to a broadbased acceleration in the manufacturing andagricultural sectors. Like Pakistan, othercountries in the region have enjoyed verystrong export performance, in part because of
the recent removal of ATC quotas. However,the sharp rise in oil prices and solid regional
growth over the past several years havecontributed to an acceleration of inflation.
Addressing this issue will require a further
tightening of monetary policy, which, in combination with rising oil bills, is expected toresult in a modest deceleration of economic
activity to about 6.3 percent by 2007.
GDP in Sub-Saharan Africa is estimated tohave increased 4.6 percent in 2005, bolsteredby very strong growth among resource-richcountries. Output in South Africa, the region’slargest economy, is estimated to have accelerated to 4.2 percent, lifted by high metal prices,
strong confidence, low nominal interest
rates and the rand’s recent depreciation.
The economies of oil-exporting countries,
including Nigeria (the region’s second largest
economy), grew an estimated 5.5 percent in2005, reflecting rapid increases in petroleum

7

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 6

production and investment inflows. Growthin some oil-exporting countries may exceed
25 percent in 2006 and 2007, as new oil fields
come on stream. However, the pace of the
expansion will taper off in other countries as
they reach capacity constraints.
In West Africa, strong commodity prices in
2005, improved rainfall, and more vigorous
use of insecticides are expected to lift regional
growth. In East and Southern Africa the expansion is projected to slow somewhat, partly
because the removal of quotas under the ATC
will continue to put textile exports under pressure. Political strife and insecurity in Côte
d’Ivoire and the Great Lakes region are likely
to impact growth there. Countries are increasingly passing higher crude-oil prices throughto consumers with the aim of containing budget deficits but will cut into consumer demand
and add to inflationary pressures.
The balance of payments and economic
consequences of higher oil prices are expected
to intensify over the next year as other commodity prices, which have attenuated theterms-of-trade impact of high oil prices, ease.
Despite higher oil prices and increased passthrough, inflation is expected to remain in the

single digits as a result of lower food prices
and prudent monetary policies. Recent economic reforms, and increased donor support—as more countries reach the Heavily Indebted Poor Country (HIPC) completion
point—will also help support growth, which is
projected to be at or above 4.5 percent overthe medium term.

Long-term prospects and poverty
forecastT

he recent strong economic performance ofdeveloping economies and the relatively
rapid growth projected for these economies
over the medium term owe much to the economic reforms undertaken over the past several years. Improved macroeconomic policies,
reflected in lower inflation, trade liberalization(average tariffs have fallen from 30 percent toless than 10 percent since the 1980s), more
flexible exchange rate regimes, and lower fiscal
deficits have reduced uncertainty and improved the overall investment environment.
More microeconomic structural reforms, suchas privatization and regulatory reform initiatives, have also played a key role.

Table 1.2 Long-term prospects
Real GDP per capita, annual average percentage change
Forecast

1980s

1990s

Medium-term
2001–06

Long-term
2006–15

World Total

1.3

1.2

1.5

2.1

High-income countries
OECD
United States
Japan
European Union
Non-OECD

2.5
2.5
2.3
3.4
2.1
3.5

1.8
1.8
2.0
1.1
1.8
4.0

1.6
1.6
1.8
1.1
1.4
2.0

2.4
2.4
2.5
1.9
2.3
3.5

0.7
5.8
0.9
⫺0.9
⫺1.1
3.3
⫺1.1

1.5
6.3
⫺1.8
1.6
1.0
3.2
⫺0.5

3.7
6.4
5.0
1.2
2.5
4.5
1.8

3.5
5.3
3.5
2.3
2.6
4.2
1.6

Developing economies
East Asia & Pacific
Europe & Central Asia
Latin America & Caribbean
Middle East & North Africa
South Asia
Sub-Saharan Africa
Source: World Bank.

8

P R O S P E C T S

These factors are expected to contributeto better long-term growth performanceas compared with past decades (table 1.2).
Consistent with recent improvements in economic performance, per capita incomes in developing countries are projected to growsome 3.5 percent a year, more than twice as
fast as the 1.5 percent growth rates recorded
during the 1990s. Projected future growth
rates are higher than during the 1980s and1990s in every developing region except East
Asia, where they are expected to decline
somewhat due to an aging population.
Table 1.3 reports poverty projections
based on these real per capita income growth
rates and the (re)distribution of income
within the population. The table indicatesthat over the next 15 years the share of the

F O R

T H E

G L O B A L

E C O N O M Y

population living in extreme poverty is expected to decline in all developing regions.6
With the exception of Sub-Saharan Africa,
all regions are expected to achieve their
Millennium Development Goal of reducing
poverty by 50 percent from its 1990 level. In
East Asia, the target has already beenachieved. Moreover, based on the current
long-term forecast, extreme poverty would bealmost eliminated by 2015 in both the East
Asia and Pacific and the Europe and Central
Asia regions. Overall, the number of people
living on $1 a day or less will fall to around
620 million, from 1.2 billion in 1990 and an
estimated 1.0 billion in 2002.
Despite these heartening prospects, there is
no room for complacency. The percent of the
population in developing economies living at

Table 1.3 Regional breakdown of poverty in developing countries
Millions of people living on
less than $1 per day

less than $2 per day

Region

1990

2002

2015

1990

2002

2015

East Asia and the Pacific
China
Rest of East Asia and the Pacific
Europe and Central Asia
Latin America and the Caribbean
Middle East and North Africa
South Asia
Sub-Saharan Africa

472
375
97
2
49
6
462
227

214
180
34
10
42
5
437
303

14
11
2
4
29
3
232
336

1,116
825
292
23
125
51
958
382

748
533
215
76
119
61
1,091
516

260
181
78
39
106
40
955
592

1,218
844

1,011
831

617
606

2,654
1,829

2,611
2,078

1,993
1,811

Total
Excluding China

Percent of population living on
less than $1 per day

less than $2 per day

Region

1990

2002

2015

1990

2002

2015

East Asia and the Pacific
China
Rest of East Asia and the Pacific
Europe and Central Asia
Latin America and the Caribbean
Middle East and North Africa
South Asia
Sub-Saharan Africa

29.6
33.0
21.1
0.5
11.3
2.3
41.3
44.6

14.9
16.6
10.8
3.6
9.5
2.4
31.3
46.4

0.9
1.2
0.4
0.4
6.9
0.9
12.8
38.4

69.9
72.6
63.2
4.9
28.4
21.4
85.5
75.0

40.7
41.6
38.6
16.1
22.6
19.8
77.8
74.9

12.7
13.1
11.9
8.2
17.2
10.4
56.7
67.1

Total
Excluding China

27.9
26.1

21.1
22.5

10.2
12.9

60.8
56.6

49.9
52.6

32.8
38.6

Source: World Bank.

9

P R O S P E C T S

2 0 0 6or below $2 per day is projected to remain disturbingly high. Moreover, notwithstandingthat inroads have been made recently, the incidence of extreme poverty in Sub-SaharanAfrica in 2002 was actually higher than in
1990. While current projections suggest 8 percent of the subcontinent’s population will be
lifted above the extreme poverty line by 2015,
some 38 percent of Africans will still be livingin extreme poverty. Worse, the absolute number of Africans living at or below the $1-a-day
level is projected to increase. And, because percapita incomes elsewhere are projected to
grow faster, the continent will continue to fall
farther behind the rest of the world—unlesssteps are taken to greatly improve economic
growth in Africa.

Figure 1.4 Dollar-euro interest rate
differentials
Percentage points
2.0
1.5
1.0

Long-term
difference

0.5
0
⫺0.5
⫺1.0

Short-term
difference

⫺1.5
⫺2.0
.2
Ap 003
r.
20
Ju 03
ly
20
03
O
ct
.2
00
Ja
n. 3
20
Ap 04
r.
20
Ju 04
ly
20
04
O
ct
.2
00
Ja
4
n.
20
Ap 05
r.
20
Ju 05
ly
20
05

E C O N O M I CJan

G L O B A L

Source: World Bank.

International financeT

he significant adjustments of international
exchange rates over the past several years
paused in 2005. In particular, notwithstanding
the persistence of the U.S. current accountdeficit (expected to exceed $750 billion thisyear), the dollar’s trend decline with respect tomajor currencies came to an end. Initially, thecurrency appreciated against its trading partners by some 3.5 percent in real-effective terms
as of July 2005. It then lost value in Augustand September, before showing signs ofstrengthening in October.
The strengthening of the dollar during thefirst seven months of 2005 is partly explainedby rising U.S. short-term interest rates (as theFederal Reserve Bank continued its policy ofgradual tightening) and falling long-term rates
in Europe (possibly in response to the continent’s relatively weaker economic performance). By July, these developments had
generated a 300 basis-point swing in the difference between U.S. and European short
rates, along with a 75 basis-point gap in favorof long-term U.S. bonds (figure 1.4).
These growing interest rate differentials increased the financial incentive to hold dollarversus euro-denominated assets, temporarily
producing stronger net private sector capital

10

inflows in the first quarter of 2005 as investors adjusted their portfolios. Not only didthese inflows help strengthen the dollar, theyalso financed a large share of the U.S. current
account deficit (figure 1.5). As a result, thedollar was much less reliant on the accumulation of reserves by foreign central banks (foreign official asset purchases) than in 2004.
In the second quarter of 2005, however,private inflows eased, and foreign central
banks once again assumed a large role in thefinancing of the dollar. Moreover, toward theend of July the dollar came under renewed
downward pressure and depreciated some
1.7 percent in real-effective terms during
August and September. The dollar began toappreciate again only after the long-term
interest rate started to rise again. By October
2005, the long-term interest rate differential
had widened to about 120 basis points.
The apparent sensitivity of the dollar andthe financing of the U.S. current accountdeficit to interest-rate differentials highlightthe problems posed by the large financing
requirements of the U.S. current accountdeficit.
Until global imbalances are resolved, thedollar is likely to continue to come underP R O S P E C T S

F O R

T H E

G L O B A L

Figure 1.5 Financing of the U.S. current
account deficit

Figure 1.6 Emerging market spreads$ billions, annualized

1,000

E C O N O M Y

Basis points

900
800
EMBI global bond spreads

600
600
300
400
0

Private sector
treasury bills

Official assets(reserves)

Net equity and FDI

Source: U.S. Department of Commerce; BEA; U.S.
Treasury Bulletin.

downward pressure, unless foreign central
banks accumulate substantial quantities ofdollars or interest-rate differentials widen further. In the baseline, interest rate differentials
are projected to widen further, and the dollar
is projected to decline gradually, falling by
about 5 percent per year. Should central banks
cease to be willing to accumulate reserves atcurrent rates, there could be a disruptive hikein interest rates or a more precipitous fall inthe dollar (World Bank 2005).
The recent decision of the Chinese andMalaysian authorities to move from an exchange rate regime linked to the dollar alone
to one focusing on a basket of currencies represents a major and welcome move toward amore flexible currency regime. While it will
not resolve current account imbalances, it
should increase the stability of the renminbi
and ringitt with respect to the currencies of
their trading partners (other than the UnitedStates) and reduce the amount by which thedollar would have to depreciate relative toother currencies to achieve a given level of adjustment.7 How effective the new regimes willbe, depends importantly on how they are

05
20

00

5
y
Ju
l

20

.2
Ja
n

4
Ju
l

y

.2

20

00

03
Ja
n

y
Ju
l

Ja
n

.2

00

3

02

Other private flows

20

2005
Q2

y

2005
Q1

Ju
l

2004

04

200
⫺300

Source: World Bank; Datastream.

managed. While technically the announced
rules could allow the renminbi to depreciate asmuch as 9 percent per month, similar possibilities for flexibility existed under the former
regime but were not exercised.

Interest rates and spreads remain low
The recent period of very low real interest
rates has been particularly beneficial to developing economies. Together with narrowerrisk premia (figure 1.6), low rates have allowed developing countries to reduce theirfinancing costs, restructure their debt, andpursue strong investment growth. Early repayment of Paris Club debt has alreadyreached $22 billion in 2005, and among
emerging-market economies, virtually all
financing requirements for this year had been
met by August.8
Short-term rates have been rising, andthey can be expected to continue to rise as
monetary policy tightens, initially in the
United States, but eventually in Europe as
well. In contrast and notwithstanding recent increases, longer-term interest rates
have remained low longer than expected(figure 1.7), while spreads on more risky
emerging market and corporate assets havefallen even further.

11

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 6

Figure 1.7 Real long-term interest rates in
G-7 countries

Figure 1.8 World savings rate

Percent25

8Periodaverage% of nominal GDP a
Globalsavings rate

24

6

23

4
2

22

0
⫺2
⫺4
⫺6
1970

21

GDP-weighted averageof the 10-yeara government
bond yields
1975

1980

1985

1990

1995

20
1981
2000

2005

Source: World Bank.
Note: For data prior to 1972, exclude Italy, a 10-year ornearest government bond yields.

Many reasons for these low interest rates
have been proposed (see IMF 2005 for a recent overview), including the following:• Excess liquidity stemming from an extended period of very low short-term
interest rates in almost all developed
economies.
• A low inflation environment, thanks to
improved credibility of monetary policy,
and the disinflationary impact of increased competition following the entry
into global markets of China and members of the former Soviet bloc.
• An increase in global savings, due to– increased savings in Europe following
heightened recognition of the need toprepare for the impending retirementof the baby-boom generation; and– increased corporate savings in dynamic East Asia (caused by corporate
restructuring following the currency
crisis) and in the United States (following the stock market decline in 2000).
However, while global savings have increased recently, this follows a period where
they declined substantially, making it difficult
to argue that the world savings rate is currently
too high (figure 1.8). Rather, investment

12

Averagesavings rate
1986

1991

1996

2001

2005

Source: World Bank.
a. Sum of national savings divided by the sum of national
GDP expressed in U.S. dollars at market exchange rates.

activity, principally in the developed world, hasfailed to keep pace with savings as they havereturned to historical levels (see IMF 2005).
Most of these explanations for lower longterm rates involve temporary factors, implying that long-term rates will eventually rise
toward their long-run equilibrium level9 (frequently defined as the long-run potential
growth rate of the economy). In this context,
the question is not so much why long-term
rates are low, but how much longer they willremain so. In the baseline, increased investment in Europe and tighter monetary policy
result in a gradual rise in interest rates, which
will nevertheless remain below recent estimates of the long-term growth potential of the
U.S. economy. The final section of this chapter
explores some of the economic implications
should interest rates stay low for an extended
period of time or, alternatively, should theyrise more quickly than anticipated.

Signs of rising inflation
Low interest rates have contributed directly tothe strong economic performance of recent
years. Growth has, in turn, provoked a pickup
in inflation in many developing countries. The
largest hikes have been in commodity prices(see below). However, producer price inflation

P R O S P E C T S

has jumped by more than 4 percentage points
in some regions and exceeds 5 percent inevery developing region except Sub-SaharanAfrica.10
Consumer price inflation has also been
rising (if less spectacularly). Weighted by
GDP, aggregate inflation among developing
economies increased from 4.0 percent in the
fourth quarter of 2003 to 5.4 percent by Julyof 2005. It has since eased somewhat. Regionally, inflation has picked up strongly in SouthAsia, Sub-Saharan Africa, and East Asia (figure 1.9). Inflation in developing countries
is projected to continue rising in 2005, as
growth remains at or above trend rates, andthe pass-through from high oil prices continues to exert upward pressure on prices.
In high-income countries, there are only
limited signs of rising inflation. In the UnitedStates, where output is close to potential, inflation has been rising steadily. It jumped to
4.7 percent in September 2005, but the increase is not expected to be permanent, because it reflects very high gasoline prices thatmonth, which have since declined. Nevertheless, data pointing to rising wages and lower

F O R

T H E

G L O B A L

E C O N O M Y

productivity growth suggest that core inflation, which has been more stable, may begin
to rise soon. In Europe, high oil prices have
limited disinflation despite significant slack
and the appreciation of the euro.
These same factors should continue to limit
price inflation in Europe. However, in the
United States, high oil prices plus the projected further depreciation of the dollar are
expected to generate additional upward pricepressure.
Low interest rates have resulted in higher
prices of interest-sensitive assets in markets
with strong financial intermediation—notably
in the United States and some European
countries—contributing to strong consumer
demand (World Bank 2005, IMF 2005). As interest rates rise, housing prices are expected toplateau and even decline, which has alreadybegun in the United Kingdom. As they do so,
the rate at which household wealth increases
will moderate and its contribution to consumer demand should abate.11
Data indicate that house prices have also
been rising rapidly in a number of middleincome countries, such as Bulgaria, India,

Figure 1.9 Inflation rates
Annual % change
9
2003

8

2002

7

2004
Most recent available dataa

6
5
4
3
2
1
0
East Asia
and Pacific

Europe andCentral Asia

Latin America
Middle East andand the Caribbean North Africa

South Asia

Sub-SaharanAfricaOECD

Source: World Bank.
a. Data concern August 2005, except for East Asia (September), the Middle East and North Africa (June), and Sub-Saharan Africa(March).

13

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 6

Figure 1.10 Cumulative real increase in
housing prices, 2005

Figure 1.11 Commodity prices

Percent

300

Index, 1990 ⫽ 100

100

Metals andminerals

250
80

200

Agricultural
products

Energy

150

60

100
40
50
2000
20

2001

2002

2003

2004

2005

2006

Source: World Bank.

R
us
si
a
T
(B ha aan ilagk nd
Uni ok)
te
d
St
at
es
Sh
an
gh
ai
C
hi
na a

(M
um IndSo ba ia
ut i)
h
Af
ric
a
Bu
lg
ar
ia

0

Source: World Bank; BIS.
a. Data for Russia and China reflect increases between 2000
and 2004; data for other countries reflect increases between
2000 and 2005.

Indonesia, Malaysia, and South Africa (figure 1.10). While fast economic growth andchanges in the regulatory environment havecertainly played a role in these countries, so
have low interest rates. Unfortunately, data
limitations prevent a thorough analysis of thecauses and consequences of rising housing
prices in low- and middle-income economies.12

Commodity marketsAfter several years of rising commodity
prices, there are indications of a stabilization and even reversal of gains in the markets
for agricultural products and for metals andminerals (figure 1.11).
Agricultural prices have been declining
most of this year and are down 5 percent since
March 2005. However, prices of agricultural
raw materials are rising, partly because ofhigher prices for commodities that are close
substitutes for crude oil-based products (forexample, natural rubber prices are up 41 percent because of increases in synthetic rubber
costs).

14

Although metals and minerals prices rose
during the first months of the year, they havesince stabilized, and in October 2005, they
were at the same level as in March 2005.
Conditions in some metals and minerals markets remain tight, due to low inventories. In
the case of copper and aluminum, prices remain elevated (partly reflecting higher energy
content in the production of these goods).
Demand has weakened markedly for lead, tin,and zinc.
Analysis of past non-oil commodity cycles
suggests that this one may have run its course.
Already it distinguishes itself from previous
episodes by having lasted longer, in part,
because energy prices have also been high,which was not always the case during previous episodes. In so far as high fuel prices increase production costs in both agriculture
and metals and minerals, they may have reduced the supply response, keeping prices
higher longer.
In line with the projected slowdown inglobal growth and increased supply, prices ofagricultural products and metals and minerals
are projected to decline somewhat in 2006.

Limited spare capacity to keep
oil prices highIn contrast with other commodity prices,oil prices continued to strengthen during theP R O S P E C T S

first nine months of 2005. During this period,
they averaged some $52 per barrel, a 38 percent increase compared with the average for2004. These increases occurred despite an easing of conditions in the oil market. Demand
growth slowed from more than 3.5 percent in2004 (the highest growth since the late 1970s)
to a 1.4 percent annualized rate during thefirst three quarters of 2005. As a result, supply
is actually increasing faster than demand,13
and inventories have begun to accumulate,although they remain low.14
Rising prices over the first eight months ofthe year reflected the market’s concern thatexisting spare capacity was insufficient to deal
with a major disruption to supply or an increase in demand (figure 1.12). In some sense,
hurricane Katrina was the kind of serious
shock the market feared. Although oil prices
spiked briefly to more than $70 a barrel, they
are back below $60, following the release ofsome 29 million barrels of crude oil from thestockpiles of the International Energy Agency
and the U.S. government. Moreover, gasoline
prices in the United States have returned to thelevels observed before hurricane Katrina, andmarket concerns have switched from a focus
on inadequate oil supply to insufficient

F O R

T H E

G L O B A L

E C O N O M Y

refining capacity, particularly of lower-quality
crude oil.
Spare production capacity is now about
2 million barrels per day (mbpd), comparedwith almost 6 mbpd three years ago, and capacity will remain tight over the near term.
This reflects long lags in bringing significant
new quantities of oil into production15 andshorter lags before demand substitution canhave an effect.16 Moreover, approximately
half of the expected new capacity is being produced by OPEC, suggesting that the organization will continue to exercise significant market power over the near term.
In this environment, prices are likely to remain volatile, as small events or even minorchanges in expectations may provoke significant price swings. As a result, the World Bank
has adopted a technical assumption for the
future path of oil prices based on a slow decline toward $40 per barrel by 2010. Thisimplies an average price of $56 in 2006 and$52 in 2007, which is somewhat higher thanthe current consensus forecast. The economic
consequences of alternative scenarios, notably
a sharp negative supply shock, are discussed in
the final section of this chapter.

The impact of oil prices ondeveloping economies
Figure 1.12 Levels of spare oil capacity
Million barrels per day
8
7
6
5
4
3
2
1
0
Jan.
2002

July
2002

Jan.
2003

Source: World Bank.

July
2003

Jan.
2004

July
2004

Jan.
2005

July
2005

The world economy in general and developing
countries in particular have shown considerable resilience to higher oil prices. This reflects
increases in non-oil commodity prices and avery robust global economy, which have, until
recently, muted the impact of higher oil prices.
The first round of oil price hikes (1999–
2000) adversely affected low- and middleincome countries. The price increase was verylarge in percentage terms (rising from justunder $12 to almost $30 per barrel between thefirst quarter of 1999 and the end of 2000) but
smaller than the most recent increases in dollar
terms (table 1.4). Current account deficits
among low-income oil-importing Africancountries increased by 0.5 percent of GDP on
average.17 Moreover, government deficits in
those countries that did not pass on the price15

G L O B A L

E C O N O M I C

P R O S P E C T S

2 0 0 6

Table 1.4 Terms-of-trade impacts
of commodity price changes

Cumulative price change
Oil
Agricultural products
Metals and minerals
Manufactures

1999–00

2001–03

2004–05

120.3
0.3
25.0
⫺5.0

18.9
15.7
10.2
3.0

88.0
8.9
47.9
10.4

⫺0.1
⫺0.9
1.4
⫺1.5
1.5

⫺0.9
⫺2.9
⫺1.2
⫺2.7
⫺3.3

Total terms-of-trade effect (% of GDP)Oil Importers
Low and Middle income
Low income
Sub-Saharan Africa
South Asia
Highly indebted
poor countries

⫺1.8
⫺3.8
⫺2.5
⫺3.9
⫺4.3

Source: World Bank.
Note: Periods Jan. 1999–Dec. 2000, Dec. 2000–Dec. 2003,
Dec. 2003–July 2005.

hikes rose by about the same amount.18 Among
those countries with limited access to international finance, non-oil imports fell by 3.8 percent in 2000, partly because insufficient foreignexchange was available to finance imports at
previous levels.
During the second bout of (more gradual)
price increases (2001–3) the same countries
performed much better. Current account positions actually improved as a percent of GDP,and there were no discernible slowdown in
non-oil imports. Part of this improved performance is explained by real exchange rate
movements (which diminished the domestic
currency cost of the oil-price hike) and by anumber of non-oil commodity prices that also
increased rapidly during that time, thus providing the necessary foreign currency to meet
the additional oil burden without cutting into
non-oil imports. On average, high non-oil
commodity prices reduced the negative termsof-trade shock from higher energy costs bymore than half.
Drawing from this experience, the impactof the latest hike in oil prices on poor oil importers is a concern, principally because it has
not been accompanied by as much strength in16

non-oil commodity prices. Indeed, the estimated terms-of-trade shock from price movements since January 2004 is more than threetimes as large for various groups of
low-income countries than the cumulative
shock over the preceding three years. As a result, non-oil imports from poor, current
account–constrained countries are expected tocome under pressure in the coming months.
Moreover, the impact on oil-importing poor
countries could be significantly aggravated if
oil prices remain at or close to current levels
and if non-energy commodity prices return topre-shock levels.

World tradeThe expansion of world trade slowed significantly during 2005 (figure 1.13).
While merchandise exports were growing at a
16 percent or more annualized pace in the
middle of 2004, they subsequently slowed andwere expanding at an 8.5 percent pace during
the third quarter of 2005.

Figure 1.13 World trade volumes
Annual growth rates, 6-month moving average
40
China
36
32
28
World

24

Other developing
countries

20
16
12
8
High-income
countries

4
0
Jan.
2003

July
2003

Source: World Bank.

Jan.
2004

July
2004

Jan.
2005

July
2005

P R O S P E C T S

Most of the deceleration concerned the exports of high-income economies, volumes ofwhich grew by less than 4 percent (annualized)in the first quarter of 2005, before strengthening more recently. Merchandise export volumesof developing countries (excluding China) wererelatively robust, increasing at an estimated
12 percent pace toward the middle of 2005.
Chinese exports, boosted by the removal of
ATC quotas, grew at a 24 percent pace.
Commodity markets have significantly
shaped developments in world trade. The merchandise exports of oil-exporting countries,
which had been rising at some 5.8 percent in
2004, increased by an estimated 5.2 percent
in 2005. The deceleration among developing
oil importers (excluding China) was steeper inpercentage terms (from 15 percent to 11 percent), but growth rates remained much higher.
Growth in the production of non-oil commodities in general is moderating, both because demand is easing and because of supply
constraints.
As a reflection of the slowdown already observed, international trade is forecast to slow
down relative to 2004 as a whole. Merchandise trade volumes are expected to increaseby around 7.7 percent. The goods and service
trade is expected to increase 6.2 percent in2005 before strengthening somewhat in2006–7.
Exports of developing economies continue
to be heavily influenced by developments in thevolatile high-tech market. After falling sharply
in the third quarter of 2004, global sales ofsemiconductors and other high-tech products
picked up before weakening once again in thesecond quarter of 2005. This volatility is apparent in East Asian export volumes (high-tech
products represent as much as two-thirds of theexports of some economies in this region).19
High-frequency data suggest a strengthening of
demand for these products, implying a pick up
in export flows from the region.
Trade growth for some countries washeavily influenced by the removal of quotas
under the ATC of the Multifiber agreement in

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Figure 1.14 Change in textile exports tothe developed world, first half of 2005
Tajikistan
Myanmar
Nepal
KenyaaPhilippines
MexicoMongolia
MauritiusSouth Africa
Vietnam
Tunisia
Lesothoa
Madagascar
Moldova
Albania
Macedonia, FYR
Pakistan
MoroccoThailandSwazilandb
Indonesia
Romania
Bulgaria
Lao PDR
Egypt
Bangladesh
Cambodia
Perua
JordanTurkeySri Lanka
India
Chinab⫺60⫺40 ⫺200
20
40
60% change, year over year, $ values

Source: World Bank, IMF, U.S. Department of Commerce,and EuroStat.
a. Data refer to the first five months of each year only.
b. Data for China include Hong Kong and Macao.

January 2005 (figure 1.14). While the removalof quotas was done in phases, and ten years ofadjustment time provided, backloading of theremoval of quotas meant that they were stillbinding when they were finally removed. As aresult, there were significant changes in patterns of trade among affected goods in 2005,
most notably in the form of increased exports
from China (and other countries, whose market share had been artificially held back under
the old quota scheme) to the detriment of17

G L O B A L

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2 0 0 6

income imports over the same period. The textile sectors in Kenya, Myanmar, Nepal, thePhilippines, and Tajikistan, on the other hand,
saw the dollar value of their exports decline by
4 or more percent.
However, many of these countries are notlarge exporters of textiles. As a result, thesefigures may exaggerate the overall economic
impact of the relaxation of textile quotas.
Expressed as a percent of these countries’
total merchandise exports, the biggest gains
were experienced by Bangladesh, Cambodia,
Jordan, India, Pakistan, Sri Lanka, andTurkey, while the largest losses were those of
Kenya, Nepal, Myanmar, Mongolia, andTajikistan (figure 1.15).

Figure 1.15 Estimated change in textile
exports as share of total merchandise
exports
Bangladesh
Cambodia
Sri Lanka
TurkeyJordanIndia
Lao PDR
Pakistan
Romania
ChinaaBulgaria
MoroccoEgypt, Arab Rep.
Macedonia, FYR
Madagascar
Perub
Tunisia
Albania
Moldova
Indonesia
VietnamThailandSouth Africa
MexicoMauritius
Philippines
KenyabMongolia
Myanmar
Nepal
Tajikistan⫺15

Risks and uncertaintiesL

ow interest rates, moderate inflation, andthe robust growth projected in the baseline
constitute a relatively benign scenario. However,
the outlook is dominated by downside risks.

An oil-market supply shock could cause
serious disruption

⫺10

⫺5

0
Percent

5

10

15

Source: World Bank, IMF, U.S. Department of Commerce,and EuroStat.
Note: Data reflect the change in textile and clothing exports
between 2004 and 2005 as a percent of total merchandise
exports.
a. Data for China include Hong Kong and Macao.
b. Data refer to the first five months of each year only.

those exporters that had benefited most fromthe old quota system.
Using U.S. and European imports of textiles as a proxy for developments in the world
as a whole, China,20 India, Jordan, Peru,
Sri Lanka, and Turkey saw the dollar value of
their exports increase between the first half of2004 and the same period in 2005 by morethan the 20 percent average increase in high-18

The most important potential risk comesfrom the oil market. As global demand andsupply are projected to increase broadly instep, excess capacity (currently estimated at
1.9 million barrels per day) will remain very
constrained. In this context, the market can be
expected to continue reacting to events in a
relatively volatile manner. Rather than gradually declining, as in the baseline scenario,
prices could remain at current levels, rise further, or even fall.
More fundamentally, with spare production capacity so low, the market is particularly
vulnerable to a supply shock. Because nocountry can easily ramp up production, if output in another producing country were to fallsignificantly, world supply would fall, provoking a decline in economic activity to the extent
that the global economy could not quickly
adopt an alternative energy source.21
Table 1.5 presents results from a simulationof the impact of a 2-million-barrels-per-dayP R O S P E C T S

Table 1.5 Impact of a 2 million bpd
negative supply shock
2006

2007

2008

2009

90
34

70
28

44
3

40
0

⫺1.5
⫺1.3
⫺1.6
⫺2.8

⫺1.1
⫺1.3
⫺0.1
⫺1.8

0.2
⫺0.3
1.4
0.7

2.6
1.4
5.8
2.8

0.6
0.0
2.0
0.9

⫺0.9
⫺1.0
⫺0.9
⫺0.7

⫺0.2
⫺0.4
0.5
⫺0.2

Impact on real interest rates (levels)
World
1.0
High income
1.0
Middle income
1.1
Large low income
0.5

0.2
0.1
0.7
0.1

⫺0.1
⫺0.2
0.2
0.1

0.1
0.0
0.2
0.4

Impact on current account balance (% of GDP)
World
⫺1.1
⫺0.5
⫺0.1
High income
⫺1.1
⫺0.7
⫺0.2
Middle income
⫺0.9
⫺0.2
⫺0.5
Large low income
⫺1.9
⫺0.2
1.7

⫺0.1
⫺0.2
⫺0.3
1.0

Price of oil(Change from base line)

Change in GDP % of baseline
World
⫺1.0
High income⫺0.7
Middle income⫺1.6
Large low income⫺1.7
Impact on inflation rate
World
High income
Middle income
Large low income

Impacts on low-income current account–
constrained countries (1)Terms of trade
⫺4.1
..
GDP
⫺0.3
0.1
Domestic demand
⫺2.7
⫺1.1
Current account balance
⫺1.2
0.9

..
0.0
0.0
0

Source: World Bank.
Note: Impacts on low-income, current account–constrained
economies were estimates based on the terms-of-trade impact
using a purpose-built VAR model. Other estimates were
simulated using the World Bank’s macroeconomic simulation
model.

negative supply shock.22 The disruption isassumed to last throughout the projection
period, causing prices to rise to $120 for an
initial period of three months before easing
to $80 for three quarters. Thereafter, supply
and demand adjustments result in a gradualdecline in oil prices toward $40.
Global output responds to the initial shockby contracting, as compared with the baseline,
by 1.5 percent of GDP after two years, while
inflation picks up rapidly. On average, thecurrent account position of oil-importing
countries deteriorates by about 1.1 percent of
GDP. The impact is more severe in large low-

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E C O N O M Y

income and middle-income countries, both because of higher energy intensities and a greater
inflationary impact, which requires a larger
contraction to eliminate.
While the impact in terms of GDP for current account–constrained low-income countries is smaller, it is more severe in terms ofdomestic consumption and investment. Suchcountries have limited access to international
capital markets, and their capacity to pay
higher oil prices is limited by their export revenues. If these revenues are stable, they areforced to reduce domestic demand and nonoil imports in order to pay their higher oil
bill. As a consequence, when oil prices rise,oil consumption remains relatively constantin volume terms (being generally inelastic in
the short run), but the oil bill rises. To compensate, non-oil imports and domestic demand tend to decline in unison—leaving GDP
relatively unchanged. For these countries, theterms-of-trade shock of the initial increase inoil prices is estimated at 4.1 percent of theirGDP, which would translate into a 2.7 percent decline in domestic demand, with potentially serious impacts on poverty.

The future path of interest rates represents
an additional source of uncertainty
Persistent global imbalances continue to be aserious source of uncertainty. The current account deficit of the United States and its financing requirements are very large, and thewillingness of investors to finance it is sensitive to both interest-rate differentials andexchange-rate expectations. As net foreign liabilities accumulate, markets will become increasingly sensitive to adverse shocks orchanges in sentiment, and the dollar is likely
to come under downward pressure once
again, which would put upward pressure on
interest rates.
Table 1.6 explores the possible implicationsof higher interest rates. In this scenario, facedwith sustained downward pressure on the dollar, investors demand higher returns on U.S.denominated assets to offset further expected
depreciations. This, combined with concerns

19

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2 0 0 6

Table 1.6 Interest rate scenarios
2005

2006

2007

2008

2009

A. A 200 basis-point increase in interest rates and in spreads
Interest rates (change of Q4 level from baseline)
World
1.8
1.4 ⫺0.6
0.2High income
1.7
1.1 ⫺1.1 ⫺0.3
Low and middle
income
2.0
2.7
1.9
2.6
GDP (% change from baseline)
World⫺0.1 ⫺1.7
High income
0.0 ⫺1.5
Low and middle
income⫺0.2 ⫺2.4
Inflation (change in inflation rate)World
0.0 ⫺0.3
High income
0.0 ⫺0.3
Low and middle
income0.0 ⫺0.3

1.3
0.9
3.1

⫺2.9
⫺2.7

⫺1.9
⫺2.5

⫺0.6
⫺1.0

⫺3.5

⫺3.0

⫺1.5

⫺1.1
⫺1.5

⫺1.1
⫺1.6

⫺0.3
⫺0.5

0.7

1.2

0.9

B. Persistently low interest rates
Interest rates (change of Q4 level from baseline)
World⫺0.7 ⫺0.5
0.6
0.1
High income⫺0.7 ⫺0.5
0.8
0.1
Low and middle
income⫺0.8 ⫺0.8 ⫺0.1 ⫺0.1
GDP (% change from baseline)
World
0.0
0.8
High income
0.0
0.8
Low and middle
income0.0
1.0
Inflation (change in inflation rate)
World
0.0
0.2
High income
0.0
0.2
Low and middle
income0.0
0.1

prices and consumer wealth. Slower growtheases inflationary pressure and global tensions, including in the oil market. As monetary policy loosens in response to increasing
output gaps, growth starts to pick up again,
bringing output back to the levels in the baseline by the end of the simulation period.
Higher interest rates would also affect financing conditions for developing countries
by increasing future borrowing costs. For
many countries this will not pose a serious
short-term risk, because they have taken advantage of low rates to reduce the share ofshort-term debt relative to their overall debt
and to prefinance some of their future borrowing needs. For others, particularly thosewith large debt-to-GDP ratios or those thathave accumulated large short-term debt positions (figure 1.16), a rapid rise in interest rates

⫺0.6
⫺0.6
⫺0.7

Figure 1.16 Some countries are particularly
at risk

1.4
1.4

0.3
0.4

⫺0.5
⫺0.5

1.4

⫺0.1

⫺0.7

Argentina

0.6
0.8

0.6
0.8

0.1
0.2

Lebanon

⫺0.2

⫺0.5

⫺0.3

Debt/GNI ratio
0

50

100

200

150

BelizeSource: World Bank.

Papua New Guinea
Uruguay
Indonesia
Ecuadorabout rising debt and pension liabilities inindustrialized countries, and a more rapid dissipation of the temporary factors depressing
long-term interest rates, causes them to increase by some 200 basis points in highincome countries. Risk premia in developing
economies increase by an additional 200 basis
points as investors’ appetites for risk decline.
The world economy reacts to the substantial tightening of monetary conditions by reducing global growth by half for a periodof two years, as higher interest rates cut into
investment and consumption demand, boththrough classic transmission mechanisms andvia the impact of interest rates on housing

20

TurkeyPhilippines
Jamaica
BoliviaParaguay
BrazilPakistan
R.B. de Venezuela
UkraineDominican Rep.
Guatemala

0

5

10

15

20

25

30

Short-term debt/Total debt
Source: World Bank.

35

P R O S P E C T S

could pose a real threat—particularly if therise in base interest rates also provokes a return of spreads to more usual levels.
Alternatively, if excess liquidity and global
savings prevent long-term interest rates fromrising as quickly as in the baseline scenario,
the resulting higher levels of demand could increase tensions in commodity markets, including the oil market. In addition, lower interest
rates could cause a number of economies, including the United States, to overheat, generating additional inflation that forces a further
tightening of monetary policy. As a result,while growth would be initially higher, thesubsequent tightening of policy could provoke
a stronger-than-projected slowdown.
The depth of the cycle would depend importantly on the extent of the wealth effectgenerated by low interest rates on housing
prices. The more pronounced, the deeper thecycle. Moreover, because asset prices become
even more out of step with their long-run
levels, an even longer period of slow growth
could be required to re-establish equilibrium.

Policy challenges
Policy can help reduce both the economic
severity of such unfavorable outturns and thelikelihood that they will materialize.
High oil prices will naturally induce substitution toward alternative energy sources andconservation. In the current context, where
the increase in oil prices is expected to endure,
countries that have not passed on recent pricehikes to consumers (and industry) may wish
to revise their policies. Not only are the budgetary costs of such subsidies likely to be difficult to support, but these policies also impede adjustment.
Moreover, countries with restrictive rules
concerning the exploitation of oil reserves
might wish to re-examine them. Such policies
may deny these countries access to technicalexpertise and financial capital, thereby preventing them from investing in new production to the extent that they might otherwise.
This may slow the aggregate supply response
and encourage greater conservation and sub-

F O R

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E C O N O M Y

stitution toward alternative energy sources—
to the ultimate detriment of oil-producing
countries.
In the developed world, efforts to increaseenergy efficiency by developing more fuelefficient technologies, such as hybrid cars,
could well pay important dividends. These
technologies are already economic in somecountries, where gasoline is heavily taxed, andcould generate substantial savings in overall
fuel demand.23 In addition to the ecologicalbenefits, making such technology available indeveloping economies, where the increase intransportation-related energy demand is highest, would be particularly effective in limiting
overall demand.
Finally, efforts to improve cooperation between users and suppliers concerning the quality and transparency of oil market data could
help reduce unwarranted volatility and perhaps contribute to lower prices by reducing
the oil-price risk premia.
To further dissipate the risk from global
imbalances, policies need to promote bothpublic and private savings in countries withlarge current account deficits. Recent measures to tighten fiscal policy in the UnitedStates are headed in this direction, but more
tightening is required. Tighter monetary policy is helping. Higher interest rates in the
United States promote private sector financingof the deficit but also promote private sectorsaving. In Europe, policymakers should seek
to maintain low interest rates in an effort tostimulate demand. As output picks up, fiscal
policy (rather than monetary policy) should be
used to restrict demand, if necessary. Indeed,
given unfunded public pension liabilities inthese countries, such a fiscal tightening is necessary in its own right.
Developing economies should react flexibly,
seeking to maintain real effective exchange
rates in line with their fundamentals, rather
than a particular alignment with any one currency. In this regard, recent steps by somecountries to adopt an exchange rate regime
that reflects their overall trade patterns are
positive and could be emulated by other21

G L O B A L

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2 0 0 6

countries. Petro-dollars could help reduce thelikelihood of a disruptive resolution of global
imbalances if they are recycled into the global
economy in a way that reduces tensions. In
particular, the financing of investment expenditures both domestically and in other developing countries would help stimulate demandoutside of the United States, reducing thatcountry’s current account deficit. To the extent
that these funds are invested in U.S. financial
securities, they could also help finance the U.S.
current account deficit.
Finally, global weakness could trigger increased protectionism or a slowing of tradeliberalization (which has been the basis formuch of developing countries’ recent success).
The supply disruptions in Europe provoked by
the re-imposition of quotas on Chinese imports of textiles, following their liberalization
at the beginning of this year, is a good illustration of how trade restrictions work to thedetriment of both exporting and importing
countries. Not only should countries resist thetemptation to intervene in already liberalized
domains, concerted efforts need to be made toachieve meaningful liberalization in the agricultural and service sectors in the Dohaprocess. To date, liberalization has largely
omitted the politically sensitive agricultural
sector, depriving many developing countriesof the benefits from trade liberalization that
more manufacturing-oriented economies haveenjoyed.

Notes
1. The Congressional Budget Office (2005) estimates that hurricane Katrina reduced growth in the
United States by 0.4 and 0.9 percent (annual rates) inthe third and fourth quarters.
2. The importance of China to aggregate statistics
is also visible in the industrial production data. Growth
rates for all developing countries showed little slowing,
but excluding China, annualized growth rates declined
from about 7.5 percent in mid 2004 to less than 5 percent a year later.
3. Although oil prices are projected to decline during 2006, they will be higher, on average, than in 2005.
4. The number of working days each year varies,
generally because certain holidays do or do not fall on

22weekends. Occasionally, these fluctuations can have an
important impact on annual GDP growth. While fivefewer days corresponds to roughly a 2.5 percent reduction in working time, in general, the actual reduction in production is less pronounced.
5. These losses are estimated at more than 5 percent of GDP for Antigua and Barbuda, Belize, Guyana,
Honduras, Nicaragua, and Jamaica.
6. This year’s projections differ somewhat from2004’s partly because of a shift in the base year for calculations from 2001 to 2002, which reduces thepoverty level of the starting year in all regions thathave experienced positive per capita growth. In addition, new survey data was employed for a large number of countries (more than half in the Europe andCentral Asia region), including important new household surveys in a number of Latin American countries
in the place of labor force survey data used in the past.
Finally, revisions to national income estimates ofGDP, inflation, and consumption play a role. For more
information concerning the changes to the poverty
forecast, please visit the Long-term Prospects andPoverty Forecasts section of http://www.worldbank.
org/globaloutlook.
7. The extent to which the new regime will contribute to increased stability in world markets will also
depend on the extent to which other Asian currencies
follow suit, and how much flexibility is permitted inpractice.
8. As of August 2005, overall financing for emerging market sovereign debt was already 74 percent
funded; this share reached 93 percent for emerging
Europe and Turkey, and 100 percent for Latin America.
9. Long-term interest rates tend to be determinedby the long-term growth potential of the economy andexpected inflation. Historically, temporary factors havecaused them to deviate from this measure, sometimes
for extended periods of time. However, they have always tended to return to this level.
10. In the first half of 2005, producer price inflation exceeded 15 percent in the Europe and Central
Asia region, was more than 9 percent in Latin America
and the Caribbean, about 7 percent in the Middle
East and North Africa, and around 6 percent in both
East and South Asia.
11. The stock of housing in the United States is estimated by the Federal Reserve Bank to be equal to$15.2 trillion, or about 138 percent of GDP. A 10 percent change in the value of that stock would represent
13.8 percent of GDP, or 19 percent of consumption.
Econometric estimates suggest that the long-term marginal propensity to consume from housing wealth is
0.05 (see, for example Catte and others 2004 andBenjamin, Chinloy, and Jud 2004), implying a reduction in consumption of 1.35 percent.

P R O S P E C T S

12. Very few low- and middle-income countries
have housing data similar to the data available in highincome countries; and what does exist tends to belimited to wealthy neighborhoods in single cities.
Moreover, there is little information on home ownership ratios, and mortgage-market completeness—all
critical components in determining housing-market
wealth effects.
13. The U.S. Department of Energy estimates thatboth oil and gasoline consumption fell by 2.5 or more
percent in September 2005.
14. In the second quarter, stocks equaled 54 days
worth of consumption versus an average of more than
58 days during the first half of the 1990s.
15. Some oil fields can be brought into production
within 1 year, but others would take as long as 10 years.
Three to five years would be needed to bring in two million barrels per day over and above expected increases
in demand.
16. Opportunities for demand substitution may beless plentiful than in the 1970s because of the substantial conservation steps undertaken then. Nevertheless,use of fuel-efficient cars and less intensive use ofexisting cars can have substantial impacts on overall
demand.
17. Simple average of 32 oil-importing SubSaharan economies.
18. Among countries that did not pass prices
through fully, fuel subsidy spending rose substantially,
for instance in the Central African Republic, Guinea
Bissau, Malawi, and the Seychelles.
19. In 2003, high-tech products represented 13 percent of Thailand’s exports, but more than 50 percent of
Taiwanese, Malaysian, and Philippine exports.
20. China here is taken as the sum of Hong Kong,
Macao, and China, based on the assumption that prior
to liberalization some of the exports from Hong Kongand Macao had actually originated in China, andtherefore, the changes in their market share reported in
official statistics are exaggerated.
21. During the 1980s (and before), OPEC acted asa swing producer, stepping up production in response
to shortfalls elsewhere. With its spare capacity now
measured at less than 2 million barrels per day, its
capacity to act as a swing producer is limited.

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22. Beccue and Huntington (2005) estimate thatthe probability of such a disruption occurring during
the next 10 years is high (70 percent for one lasting
6 months and 35 percent for one of 18 months).
23. In the United States, for example, hybrid cars
currently offer approximately an 80 percent improvement in fuel efficiency. Were these vehicles to gain a
10 percent share of new car sales, new energy demand
would be reduced by about 12 percent (c. 0.3 percentage points) per year for about seven years.

References
Beccue, Phillip C., and Hillard G. Huntington. 2005.
“An Assessment of Oil Market Disruption
Risks.” In Final Report EMF SR 8. Energy Modeling Forum. October.
Benjamin, J.D., P. Chinloy, and G.D. Jud. 2004. “RealEstate versus Financial Wealth in Consumption.”
Journal of Real Estate Finance and Economics
29(3): 341–54.
Catte, P., N. Girouard, R. Price, and C. André. 2004.
“Housing Markets, Wealth and the Business
Cycle.” Economics Department Working Paper
394. OECD, Paris.
Congressional Budget Office. 2005. “Macroeconomic
and Budgetary Effects of Hurricane Katrina.”
Report. September 6. Washington, DC.
Huntington, Hillard G. 2005. “The Economic Consequences of Higher Crude Oil Prices.” In Final
Report EMF SR 9. Energy Modeling Forum,
October.
International Energy Agency. 2004. World Energy
Outlook. Paris.
IMF (International Monetary Fund). 2005. World
Economic Outlook. Washington, DC.
OECD (Organisation for Economic Co-operation andDevelopment). 2004. Economic Outlook, no. 74.
Paris.
World Bank. 2005. Global Development Finance2005. Washington, DC.

23

2
The Potential Gains fromInternational Migration

International migration can generate substantial welfare gains for migrants, their countriesof origin, and the countries to which they migrate. The main focus of this report is on gains
from the remittances that migrants send home
(discussed in chapters 4–6); chapters 2 and 3
address the economic costs and benefits of
migration and the impact of migration on
poverty. In this chapter, we use an economic
model to estimate the size of the welfare gains
resulting from migration from developing tohigh-income countries.1 It must be recognizedat the outset that the model fails to capturesome known costs and benefits of migration;that the results are dependent on the specification of the model and its key parameters;
and that the model cannot incorporate social
or political considerations.2 The results of thissimulation do not provide a precise forecast of
the likely impact of migration; instead, they
provide a consistent framework that offers insights into (a) the economic gains that can be
expected from changes in policy or circumstances, and (b) the channels through which
migration affects welfare—and both are difficult to measure in reality. The conclusions
drawn from the model are supported by several empirical studies, and they hold up wellunder various alternative assumptions formodel specification and parameters.
In chapter 3, we complement this modelbased approach to measuring the gains from
migration with a review of the economic literature, which covers the implications for

migrants and for their origin countries. Here
we can refer to a broader range of economic
issues than are captured by the model, although without the ability to quantify that themodel-based simulation provides.
Starting from the base-case forecast of economic activity described in chapter 1, we introduce an additional increase in migrationfrom developing to high-income countries sufficient to raise the labor force of high-income
countries by 3 percent over the period
2001–25. The assumed increase, roughly oneeighth of a percentage point a year, is close tothat observed over the 1970–2000 period. We
imply no judgment concerning whether suchan increase is likely or politically feasible, butrather view the rise in migration as an exogenous shock. As discussed in chapter 3, pressures to migrate are likely to rise over the next
few decades, but the actual size of the migrantflows will depend heavily on political decisions in destination countries. This exercise
presents us with the following key findings.
The expected decline in the labor force inhigh-income countries will increase dependency ratios, which could add to the benefits
from migration. However, such increases inmigration are unlikely to be large enough tohave a significant impact on dependency ratios in high-income countries.
Under the assumptions adopted in this modeling exercise, the rise in migration—small

25

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relative to the labor force of high-income countries, but large relative to the existing stock ofmigrants—would generate large increases in
global welfare. Migrants, natives in destination
countries, and households in origin countries
would experience gains in income, although migrants already living in high-income countries
would see a decline in wages relative to the basecase. Estimates of these gains and losses are particularly sensitive to assumptions about the degree of differentiation among workers (between
natives and migrants and between old and new
migrants), the impact of migrants on fiscal balances, and the extent of remittances.
Empirical studies of the impact of migration
on natives’ wages have had mixed results. In
this simulation exercise, the rise in migration
leads to a small decline in average wages inhigh-income countries relative to the baseline,
which one would anticipate from a labor supply shock. But the decline has a barely perceptible impact on the long-term growth rate
for wages.
Native households in high-income countries
enjoy a rise in income, on average, as returns
to capital increase, offsetting the mild decline
in wages. The impact on developing countries
is nearly the reverse, with wage income risingas labor-market conditions for workers improve, while returns on capital decline withthe smaller supply of workers. In developing
countries the gain from increased remittances
greatly exceeds that from changes in factor
returns.
The economic benefits for high-income
economies could be even larger than those predicted by the model, due to several factors: themodel excludes the increased productivity of
migrants (and the benefits to their offspring)over time; investment levels could increase
substantially in response to higher returns tocapital; labor-force participation could riseamong natives with the greater availability of
migrant labor (for household help, for example); the labor market would become more
flexibile, and diversity would increase.

26

The costs of adjusting to increased migrationand the gains from migration depend, in part,on the investment climate. Adjustment costs
as a result of migration will be lower if more
flexible labor markets and more efficient capital markets in high-income economies reducetransitional unemployment and the cost of replacing capital as economies adjust to the risein immigration. Similarly, developing countries with strong investment climates will beable to use increased remittances more efficiently, and enable workers who do not migrate to respond to improved labor market
conditions. The cost of adjustment may also
be lower if migration is spread over timerather than concentrated in spurts.
A principal conclusion from this exercise isthat migration can generate significant economic gains for migrants, origin countries,
and destination countries—but migration also
can have important political and social consequences. For example, natives in destination
countries may become concerned about maintaining cultural identity in the middle of a
growing diversity, which also has implications
relative to minority languages and other issues
surrounding the integration of migrants. To
some extent, opposition to migration is driven
by these concerns, and not by an economic
calculation of the gains and losses.
We begin with a discussion of recent trends
and discuss how migration to high-income
countries has grown over the past 30 years.
We then turn to the prospects for migration,
including the intense pressures generated bydemographic changes. We describe the basecase scenario for migration and the modelbased analysis of the welfare gains from increased migration. We conclude with issues
that the model does not consider.

International migration trends
Migration to high-income countries
has accelerated
The United Nations (UN) estimates that migrants account for some 3 percent of the

T H EP O T E N T I A L

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F R O MI N T E R N A T I O N A L

M I G R A T I O NTable 2.1 Growth in international migration by destination, 1970–2000
Percent change per year in stock of migrants

World
High-income countries
Developing countries
Excluding former USSR
Former USSR

1970–80

1982–90

1990–2000

2.0

4.4

1.3

2.4
1.8
1.9
0.5

2.9
5.5
2.1
25.0

3.1
–0.1
0.0
–0.3

Source: United Nations.

world’s population, or about 175 million
persons.3 The stock of immigrants to highincome countries increased at about 3 percent
per year from 1980 to 2000, up from the
2.4 percent pace in the 1970s (table 2.1). At
that rate of growth, the share of migrants inhigh-income countries’ population almost
doubled over the 30-year period, and population growth (excluding migration) fell from
0.7 percent per year in the 1970s to 0.5 percent in the 1990s. Immigration has had a particular impact on population growth in several
high-income countries. For example, without
immigration Germany, Italy, and Sweden
would have experienced a decline in population in the past few decades (OECD 2005;
IOM 2005). By contrast, migration to developing countries rose by only 1.3 percent per
year from 1970 to 2000. With rapid popula-

Figure 2.1 International migrants as ashare of destination countries’ population
Percentage
9
8
7
6
5
4

1970
2000

3
2
1
0
World

Developed
countries

Developing
countries

Developing
countriesa

Source: United Nations.
Note: a. Excluding countries of the former USSR.

tion growth, the share of migrants in developing countries’ population (excluding the former Soviet Union) fell (figure 2.1).4
Most high-income countries saw immigration rise by at least 2 percent per year from1980 to 2000.5 This increase reflected, inpart, increased demand for services accompanying rising incomes, global competition
for highly educated workers as technologicaladvances boosted the premium for skills, thegrowth of networks of immigrants in highincome countries that facilitated new immigration, and increased refugee movements.
Almost 70 percent of the increase in immigration is accounted for by the United Statesand Germany, which together make up lessthan 40 percent of the population of thehigh-income countries. In the United States,
the Immigration Reform and Control Act(IRCA) of 1986, which provided permanent
status to 2.7 million migrants, facilitated further immigration through rules governing
family reunification and may have encouraged further irregular immigration (Passel
2005) by encouraging expectations of futureamnesties.6 Germany saw a large inflow of
ethnic Germans following the breakup of theSoviet Union (Dustmann and Glitz 2005), as
well as an increase in temporary migration
under bilateral agreements.
Though the stock of migrants has accelerated sharply relative to the population in theindustrial countries, in some respects the composition and patterns of international migration have exhibited continuity over the pastfew decades. The share of female migrants
has remained almost unchanged (47 percent

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Figure 2.2 Share of females ininternational migration

Figure 2.3 Immigration to selected
countries, reasons for admittance, 2001

Percentage

Percent

51

80

50

70

49

2000

48

1970

UnitedStates

50
40

46

30

45

20

44

10

France0
WorldDeveloped
countries

Developing
countries

Workers

Reunitingfamilies

Refugee/asylumSource: United Nations.

Source: United Nations.

Note: Stock data, reported by countries of destination.

Note: Stock data, reported by destination countries.

of global migrant populations in 1970, compared with 49 percent in 2000—figure 2.2),
although women are the great majority of
migrants from some countries. More women
today are migrating as independent wage
earners, rather than to accompany their husbands (IOM 2005). Migration continues to beheavily determined by geographic proximity(from Mexico to the United States, from
North Africa to Southern Europe, and from
Eastern to Western Europe), as well as bycolonial ties (from Latin America to Spain andfrom a number of Sub-Saharan African countries to Belgium, France, Portugal, and theUnited Kingdom—OECD 2005). The majorcountries of destination continue to admit thelargest share of permanent immigrants forfamily reunification (or, in the case of the EU
countries, for humanitarian or refugee resettlement), although some countries are refocusing
their migration policy toward economic(largely skilled) immigration (figure 2.3).7 But
international migration is also changing, particularly in the direction of flows. For example, more Asians are today seeking work inother Asian countries rather than in the Middle East (Wickramasekera 2002; OECD 2005;
IOM 2005), while more Latin Americans areturning to Europe for work opportunities, inaddition to North America.

28

Australia

60

47

43

UnitedKingdom

It should be emphasized that the migration
data on which these judgments are based
tend to be unreliable and incomplete. Many
countries and international agencies do not
distinguish between regular and irregularmigration or among types of temporary migration. Some record migrants’ country of birth;others their nationality (OECD 2005).
National estimates of the number of migrants
can be vastly different depending on whether“migrant” is defined as foreign born or of foreign nationality.

Migration is set to increase
It is likely that the number of people who wish
to migrate from developing to high-income
countries will rise over the next two decades.
About 31 percent of developing countries’
population is below the age of 14, comparedwith 18 percent in high-income countries. We
can thus anticipate a large influx in the age
categories most suitable for emigration, as
lifetime earnings from migration tend to belargest for those emigrating early in theirworking life. The surge in immigration sincethe 1980s has established large diasporas inhigh-income countries, which help to reducethe costs and risks of migration (see chapter 3). The demand for immigrant services inhigh-income countries will also rise as the

T H EP O T E N T I A L

aging of the population shrinks the workforce
and increases demand for services that
immigrants can supply (such as nursing care).
As income standards rise, the demand forother services that employ migrants (such as
household and restaurant help) should growrapidly. The intensifying competition forskilled workers may also draw migrants, especially from countries with strong systems ofhigher education.

Policies in destination countries
can affect migration
Forecasts of migration flows remain problematic. But with the underlying demand for andsupply of migrants likely to increase in coming decades, the number of migrants will depend on policy decisions governing admittance and the effectiveness of efforts to police
borders and enforce workplace rules. Opposition to immigration may grow as the numberof migrants increases, as it did in majorcountries of destination before World War I.
But it is likely that the main policy issue will
be how best to manage and live with increased migration. In the simulations that follow, we explore the impact of an increase inmigration to 2025 in line with recent historical experience.

The demographic challenge
The labor force in the high-income
countries is set to decline
A key driver in the demand for internationalmigrants over the next 20 years will be slowing growth, and then decline, of the labor
force in high-income countries. The age groupthat supplies the bulk of the labor force(15–65 years old) is expected to peak near
500 million in 2010, and then fall to around
475 million by 2025 (figure 2.4). In Japan thisage group has already begun to shrink, while
in Europe the peak will be reached in
2007–08. In the other high-income countries,
the peak will occur later—around 2020 for
the United States and 2015 for the rest. As-

G A I N S

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M I G R A T I O N

suming no change in labor-force participation
rates, the high-income countries may lose
about 20 million workers by 2025, relative to
peak employment.8
The expected decline in the labor force isaccompanied by a rise in the overall dependency ratio, defined as the ratio of nonworkers
to workers. For the high-income countries as agroup, this ratio is forecast to remain at justunder one through 2009. However, by 2025,
100 workers will be supporting 111 dependents, largely reflecting the increased numberof the elderly (also, in most countries the number of children under 15 will fall). The largest
rise in the dependency ratio will be in Europe.
If we focus more narrowly on the number of
elderly per worker, every 100 European workers now support 36 elderly people; by 2025
they will have to support 52. In Japan 100
workers will support 60 elderly in 2025.

In the developing countries the labor
force will expand
Developing countries show considerable diversity in demographic trends, but overall thebulge of youths born over the last two decades
is now entering the labor force, the number of
elderly is as yet still rising slowly, and thenumber of births is falling rapidly. Thus
developing countries are forecast to add
nearly one billion workers to the world’s labor
force by 2025, again assuming no change inthe labor-force participation rate, and dependency ratios are expected to fall.
The expected expansion of the labor force
in developing countries, coupled with large
wage premiums in high-income countries,
means that migration could help reduce dependency ratios in high-income countries.
However, increases in immigration sufficientto have a noticeable impact on dependency ratios would have to be very large. The scenario
discussed below envisions an increase in thelabor force in high-income countries of 3 percent through migration, or a hike of nearly
50 percent in working migrants in high-income
countries. Even if migrants come with noelderly, the dependency ratio in the host coun-

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Figure 2.4 Labor force and dependency rates
EuropeJapan
Dependency rate

Labor force, millions
200

1.3

195

1.2

190

Dependency rate

Labor force, millions

1.3

70
65

1.2

60
1.1

1.1
185

55
1.0

1.0
180

50
0.9

175
170

0.8
1

0
20

4

0
20

7

0
20

0

1
20

3

1
20

6

1
20

9

1
20

2

2
20

0.9

45

0.8

40
1

5

0
20

2
20

4

0
20

United States

7

0
20

0

1
20

3

1
20

6

1
20

9

1
20

2

2
20

5

2
20

Other high-income countries

Labor force, millions

Dependency rate
1.3

170
165

1.2

Labor force, millions

Dependency rate
1.3

80
75

1.2

70

160
1.1

1.1
65

155
1.0

1.0
60

150
0.9

145

0.8

140
1
00

2

4
00

2

7
00

2

0
01

2

3
01

2

6
01

2

9
01

2

2
02

2

0.9

55

0.8

50
1
00

5
02

2

2

4
00

2

Total, High-income countries
Labor force, millions

7
00

2

0
01

2

3
01

2

6
01

2

9
01

2

2
02

2

5
02

2

Total, Developing countries

Dependency rate
1.3

500
495

1.2

Labor force, millions

Dependency rate
1.3

3,600
3,400

1.2

3,200

490

1.1

1.1
3,000

485

1.0

1.0
2,800

480
0.9

475

0.8

470
1

0
20

4

0
20

2

7
00

0

1
20

3

1
20

6

1
20

9

1
20

2

2
20

5
02

2

Labor force

0.9

2,600

0.8

2,400
1

0
20

4

0
20

7
00

2

0

1
20

3

1
20

Dependency rate

Source: World Bank databanks (DDP).
Note: The dependency rate is measured as the ratio of the nonworking population to working population.

30

6

1
20

9

1
20

2

2
20

2

5
02

T H EP O T E N T I A L

tries would fall by only about 3 percent undersuch a scenario. In the case of Japan, it would
lower the number of elderly dependents in
2025 from 60 per 100 workers to 59 per 100
workers—barely a dent. Nevertheless, as
discussed in more detail below, selective
migration—for example, of experienced andskilled workers—can help mitigate the transitional costs of financing pension benefits for
rapidly aging populations in high-income
countries.

Migration and its development
impactTo illustrate the potential gains fromincreased migration, we compare the basecase forecast for output and consumption
in chapter 1 with an alternative scenario, in
which the stock of migrant workers is allowed
to increase in the high-income countries so
as to raise the overall stock of workers by 3 percent (a movement of 14.2 million workers
from developing countries to high-income
countries by the year 2025). A first
approximation of the global gains from such a
scenario is simply to calculate the income gains
accruing to the new migrant workers—thiswill reflect the gains to the global economy,
because it approximates the increase in global
productivity derived from equipping the migrants with more and improved capital andtechnology. This back-of-the-envelope calculation yields an increase in gross wage income of$772 billion in 2025.9 As we will see later,when corrected for differences in prices that
migrants face in high-income versus developing countries, and taking into account otherimpacts of migration (on prices, for example)
as calculated by the model, global gains fall to$356 billion—an 0.6 percent increase in global
income. The scenario is particularly beneficial
to developing countries relative to high-income
countries. The aggregate percentage gain todeveloping countries (including the new migrants) is 1.8 percent, whereas the gains tonatives in high-income countries amount to
0.4 percent relative to baseline income. TheseG A I N S

F R O MI N T E R N A T I O N A L

M I G R A T I O N

numbers hold up well as an approximation of
the gains to global output, regardless of various assumptions made about taxes, non-wage
income distribution, key model parameters,
and other factors.
Our modeling exercise uses a global general equilibrium model to measure the impactof migration (box 2.1).10 One of the purposesof the global model is to verify the basic intuition described above—that migration produces a sizeable global gain. But it also is a
powerful tool to evaluate distributional
impacts—between skilled and unskilled workers, between native- and foreign-born workers,
between capital and labor, and acrossregions—and to show how these distributional impacts vary with policy choices andparameters (for example, the role of fiscal
policies or the propensity to remit).

The assumption is that migrants as ashare of population remain constantin the baseline scenario
We begin with a base case for global economic activity (outlined in chapter 1), demographic trends (described at the outset of thischapter), and for migration. For the base case,the proportion of migrants in each region remains the same over time—somewhat contrary to the trends of the last two decades.
This does not imply that gross migration isstagnant, or even declining. The stock of migrants in any year will equal the previous
stock of migrants, plus new migrants, less theattrition through death and return migration.
We chose a relatively neutral assumption because of the difficulty in forecasting thesecomplex processes. For some countries—for
example Japan and those in Europe—the assumption results in an absolute decline in thestock of migrant workers. This decline parallels the overall decline in the European andJapanese labor forces.11 For the high-income
countries as a group, the stock of migrant
workers would increase by some 760,000
between 2001 and 2025, just a small incrementfrom the estimated 27.8 million in 2001. The
main issue, however, is not the base case,31

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Box 2.1 The model used in this studyT

he underlying analytical framework used in thischapter is the World Bank’s standard global
general equilibrium model—LINKAGE—which has
been used in previous reports for trade policy analysis. It has been modified to differentiate between migrant and native workers and to incorporate remittances. The model is based on release 6.0 of the
GTAP database (base year 2001), developed by the
Global Trade Analysis Project (www.gtap.org), a
global network of researchers and policymakers engaged in the quantitative analysis of international
policy issues. It is supplemented for use in ourmodel with a new database developed jointly by
GTAP and the University of Sussex (Parsons andothers 2005). That database contains a comprehensive estimate of bilateral stocks of migrants for 226
countries and territories.
While the new migration database is undergoing
constant improvements as new data become available and obvious errors are corrected, its developers
have done a remarkable amount of detective work,largely in national data sources. The GTAP centerhas used this underlying migration database to build
a bilateral migration database for the 87-region levelof aggregation of the main GTAP database—including estimates of population and the stock ofworkers, both skilled and unskilled (Walmsley,
Ahmed, and Parsons 2005).a World Bank data (described in more detail in chapter 4 of this report)
was used to provide the total level of remittances,and the bilateral stock of migrants was used to estimate the bilateral remittance flows subject to theoverall total flows.
The standard horizon for the LINKAGE model has
been 2015. For the work described here, the model
horizon has been extended to 2025, in part because
demographic dynamics play a more important roleover the longer-term horizon, and in part to allow
for more time to phase in the increase in migration.

aThe 87 regions of GTAP have been aggregated into 21 regions for the purposes of this study. Six of these are high-income regions using World Bank definitions—the European
Union and the European Free Trade Area, Canada, the UnitedStates, Japan, Australia/New Zealand, and the newly-industrializing economies. The fifteen developing countries/regions include China, the Philippines, India, Russia, Turkey, South
Africa, and Mexico as individual countries, plus 6 regions that
represent the remaining countries in each geographical area.

but rather the impact of deviations fromit—although significantly different base assumptions could affect the deviations aswell.
According to the base-case scenario, migrant workers would make up about 6 percentof the labor force of high-income countries in
2025, though with sharp differences acrossregions and skills (table 2.2). The vast majority of migrant workers are unskilled—some25.3 million migrant workers out of a projected total of 28.5 million, or 7.8 percent ofhigh-income countries’ labor force. Skilled migrants, on the other hand, represent just 2.2 percent of the total skilled workforce on average.

There are welfare implications if
migration rises significantly
The alternative scenario involves a rise inmigration sufficient to increase the labor force32

of high-income countries by 3 percent, phasedin from 2010 through 2020.12 As migrants
make up about 6 percent of high-income
countries’ labor force, a 3 percent rise in thelabor force (through migration) implies a
50 percent increase in the number of migrant
workers. This may seem like a large change,
but the resulting stock of migrants in Europe,
Japan, and the United States would remain a
far smaller share of population than current
levels in some high-migration countries. (InAustralia, for example, about a quarter of the
population are migrants, in Canada 19 percent, in Kuwait 50 percent). The percentage
increase in migrants is large in Japan (as thebaseline share of migrants is relatively low),
and lower in the United States. The increase
corresponds to an annual growth rate ofabout 1.9 percent, somewhat slower than the

T H EP O T E N T I A L

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F R O MI N T E R N A T I O N A L

M I G R A T I O NTable 2.2 Labor force structure in the base case and after increases in migrants
In millions except where noted
Baseline

High-income countries
Total labor force
Developing-country migrant workers
Unskilled
SkilledDeveloping-country migrant workers
as share of total labor force, percenta
Unskilled, percent
Skilled, percent
Developing countries
Total labor force
Unskilled
SkilledMigration shock

2001

2025

Change in millions 2001–25

Change in percent 2001–25

480.8
27.8
24.6
3.1

474.0
28.5
25.3
3.2

14.2
14.2
9.8
4.5

3.0
49.9
38.6
137.9

5.8
7.4
2.1

6.0
7.8
2.2

2,596.2
2,395.9200.4

3,561.0
3,294.3
266.7

8.8
10.5
5.0
–14.2
–9.8
–4.5

–0.4
–0.3
–1.7

Source: Initial 2001 data from migration database under development by GTAP/University of Sussex (Parsons and others 2005
and Walmsley, Ahmed, and Parsons 2005). Scenarios based on World Bank assumptions.
Note: a. The percentage of migrant workers as a share of the total labor force is assumed to be the same for each individual
region of the model throughout 2001–25, but the share averaged across all developed regions will change through aggregation
effects.

average increase over the period 1980–2000.
Moreover, the growth rate is unbalanced, withan annual increase of only 1.5 percent in unskilled workers, but 3.8 percent in skilledworkers. A number of additional assumptions
are critical to the results.
First, the high-income countries’ labor
force of both skilled and unskilled workers
increases by 3 percent.13 As the share of skilledworkers among migrants is much smaller than
the share of skilled workers among highincome country natives, the shock results in amuch larger percentage increase for skilledmigrants. The number of unskilled migrant
workers increases by 39 percent, while thenumber of skilled migrant workers rises by
138 percent.14
Second, the share of migrants by region oforigin remains constant; in other words, the
new migrants reflect the same allocation byregion of origin as existing ones. Thus if
Mexicans constitute 30 percent of foreign migrants in the United States in the base case,they maintain the same share after the increasein migration. This assumption is made to simplify the analysis, although it does fail toreflect the likely migration pressures impliedby large differences in demographic trends insending regions (for example, Sub-SaharanAfrica versus Latin America).
Third, foreign workers are assumed tobring family members in proportion to thedependency ratio in their home country. As aresult, the total number of migrants in highincome countries increases from 65 million(6.5 percent of high-income countries’ population) in the baseline for 2025, to 93 million(9 percent of population) after the shock. This
assumption can change the average dependency ratio of the host country. It canalso have other implications not modeled
explicitly—including fiscal impacts, because
the families of new migrants may require additional public services (such as schooling),
not fully compensated by the taxes paid by the
new migrants.
Fourth, remittances are assumed to be a
fixed proportion of migrants’ labor income,equal to the level in the base year. The averagefor developing countries is 17 percent, although
the level varies with the migrant’s origin anddestination countries. New migrants are

33

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assumed to send remittances to their homecountry at the same rate (relative to income)as existing migrants.15

nearly 0.9 percent from baseline levels.18 A
significant portion of the increase is due to theremittances from the new migrants, with some
improvement in labor-market conditions forremaining workers. Those who are likely tolose—in the absence of any compensatory
mechanism—are the existing migrants inhigh-income countries, who are relatively
close substitutes for the new migrants. Their
private consumption would decline by over
9 percent and overall consumption (including
public services) by 6 percent compared tobaseline levels.

Returns to households
The gains from increased migration
are large
With the labor force moving, it is best toassess the effects on real income in terms ofhouseholds as opposed to the national level(as is typically done in analyses of trade reform). Households are broken down into fourgroups. First are the native households inhigh-income countries.16 Second are previous
migrants from developing countries now living in high-income countries, that is, those
who were in place in the baseline scenario.
Third are native households in developing
countries—households that do not migrate.17
And finally, we have the households of the
new migrants. Each household’s welfare isbroken down between the change in private
consumption and the change in the consumption of public services.
Natives in high-income countries gain$139 billion in real income, or 0.4 percent of
the baseline, as a result of the rise in migration(table 2.3). Nonmigrating households in developing countries see a rise in real income of

New migrants and their countriesof origin reap benefits(through remittances)
The main gains come from the higher incomesthe new migrant workers can earn in the destination country relative to what they would
have earned in their country of origin. New
migrants earn $481 billion in real (after-tax)
income in 2025 over the base case. However,the dollar increase in income overestimates thewelfare gains for migrants. Essentially, an
additional $1 spent in the high-income countries does not provide the same amount ofwelfare as an additional $1 spent in the homecountry, because prices are higher in highincome countries. Whereas the prices ofTable 2.3 Change in real income across households in 2025 relative to baseline
Real income adjusted forcost of living

Real income
PrivatePublicTotal

PrivateChange, $ billions

Total

Change, $ billions

Natives in high-income countries
Old migrants in high-income countries
Natives in developing countries
New migrants
World total

139
–88
131
372
554

–1
0
12
109
120

139
–88
143
481
674

139
–88
131
126
308

–1
0
12
36
48

139
–88
143
162
356

Natives in high-income countries
Old migrants in high-income countries
Natives in developing countries
New migrants
World total

0.44
–9.41
0.94
584
1.20

Change, %
–0.01
–0.02
0.44
607
1.15

0.36
–6.02
0.86
589
1.19

0.44
–9.41
0.94
198
0.67

Change, %
–0.01
–0.02
0.44
203
0.45

0.36
–6.02
0.86
199
0.63

Source: World Bank model simulations.

34

PublicT H EP O T E N T I A L

traded goods (for example, cars and electronics) are the same worldwide, at least in principle, the prices of nontraded goods and services(for example, housing and haircuts) are muchhigher in high-income countries.
A simple example may clarify the idea.
Take a household of two persons living intheir home country. One works and earns$200. The other does not work. Each spends$100, half on tradable goods (each priced at$1) and half on nontradable goods (likewise
priced at $1). Now the worker moves to ahigh-income country and earns $700. Assume
that spending patterns do not change. The
worker remits $200 back to the home country,
so the income (and welfare, in money terms)of the other doubles. The new migrant buys
the same goods—50 units of tradable goods
and 50 units of nontradable,19 but the price ofthe latter is now $9 and not $1. The migrant
thus spends $500, but welfare is unchanged,
because the basket of purchased goods is
identical.
Welfare evaluations are of course more
complex than this simple example illustrates.
For one thing, new migrants will have to adjust
their spending patterns to deal with their new
environment. Heating oil and warm clothes
are necessities that will not boost a migrant’s
welfare above what it was in the home country. For another, the decision to migrate is nottaken for simply static reasons; there are significant dynamic reasons for migrating—for
example, better opportunities for one’s children that are not captured in this simple framework. Nonetheless, the difference in purchasing power illustrated in the example is a strong
motivation for migrating, even on a temporary
basis. The more wage income earned in highincome countries that can be spent in lowerincome countries, the greater will be the welfare benefits. Box 2.2 provides additional
detail on the computation and interpretationof global welfare gains from migration.
To account for the change in prices facedby the new migrants, their “new” consumption in the destination country is adjusted toaccount for differences in the cost of living,G A I N S

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using purchasing power parity (PPP) exchange
rates from the World Bank’s database.20 Thus
instead of an increase of $481 billion, the rise
in welfare for new migrants is $162 billion.21
Table 2.3 shows the change in these components for the four household groups and theworld. Measured in national accounting
terms, that is, with no adjustments for the difference in the cost of living for the new migrants, global real income rises under themodel by 1.2 percent relative to the baseline,
or 0.6 percent with the cost-of-living adjustment. Global private consumption increases inreal terms by $308 billion in 2025 (with thecost-of-living adjustment), with real government expenditures increasing by an additional$48 billion. The total real gain—with equal
weight for high-income—and developingcountry gains—is $356 billion, with justunder half accruing to the new migrants,though natives in both high-income and developing countries also are better off. In percentage terms—where relative weights between
high-income and developing countries areirrelevant—the scenario clearly indicates thatthe relative gains are much higher for
developing-country households than highincome country households, rivaling gains
from global reform of merchandise trade.
Obviously, global income and global gains
would also be larger if expressed in PPP terms.
As the percentage increase in welfare for migrants living (originally) in developing countries is larger than the percentage increase forthose living in high-income countries, a switch
to PPP measures would also increase theglobal gains as a percentage of global income.
If in the migration scenario presented here thegains are PPP-adjusted, the global gains would
amount to 0.9 percent of global income in thebaseline, instead of 0.6 percent using the EV
aggregation. This scenario illustrates that migrants living (originally) in developing countries gain the most from migration in percentage terms.
The impact of higher migration on prices ismild in aggregate in high-income countries,
with a small decline in the average price of35

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Box 2.2 Calculating and interpreting global welfare
gains from migrationT

wo sets of issues arise with respect to the socalled global gains from a policy shock. First,
how should the gains of specific groups be evaluatedand how do the gains compare with traditional measures, such as GDP or national accounting standards? Second, how should the gains be aggregatedover groups and countries, and how should theaggregated gains be interpreted?
Evaluation of the welfare gains of specificgroups. In standard applications of general equilibrium (GE) models, the welfare impacts of specificgroups are evaluated using a concept from welfare
theory called equivalent variation (EV). The concept is relatively straightforward. Welfare changes
as a result of changes in nominal income andchanges in prices. EV calculations summarize thiswelfare change in terms of an equivalent change
in income alone, showing by how much income
at original prices would have to change toachieve the same change in welfare as observed ina simulation.a
For most households, the standard notion of thechange in real income, that is, the difference in nominal income adjusted by the change in the CPI, is agood approximation of EV.b
This is not the case for new migrants, however.
There is no standard price index that can be used asa deflator for the change in the nominal gains for the
new migrants, since the prices they face in their new
host country have no linkages to the prices they paidin their home countries. GE and macro models typically calibrate base-year prices in each region to one(or unit value) by choosing corresponding volume
units.c
This approach does not allow one to take into account the price increases that new migrants face asa result of their migration. In the simulations, themacro PPP exchange rate (as an approximation of
the rise in prices faced by migrants from developing
to high-income countries) has been used to adjust thegains to the migrants—although this is just an approximation of the true welfare gains.d
Because of the cost-of-living adjustment to thewelfare gain of new migrants, the real gain reported
is no longer equal to real income gains ofcountries—and real output gains—measured using36

national accounting standards. However, the standard real income measure is still a good approximation of the welfare gains for the other households inthe model.
To the extent that new migrants remit part oftheir income to their country of origin and that
income is spent in that country of origin, the increasein the cost of living that new migrants face is not
relevant. Therefore, the EV measure of remittances islarger than the same nominal income spent by the
new migrant in the host country. This difference
illustrates the incentive for new migrants to remit
income home.
Aggregation. The second issue relates to the interpretation of the “global” gains. Typically, to derive
aggregate or global gains, EV (expressed in a common currency, typically the U.S. dollar) is summed
across all households. For individual persons or homogeneous groups this EV aggregation, expressed asa percentage of original income, is a good approximation of the change in welfare (or more precisely, it
is a good indication of the change in welfare).e
However, no clear link exists between global welfare and the aggregation of EV across heterogeneousgroups, because we do not know how to weigh individual welfare across heterogeneous groups (a particularly difficult issue in aggregating across countries
at very different stages of development, as is donehere). For example, while most groups gain from migration in the scenario discussed in the text, somelose. The fact that the change in global welfare (expressed as the aggregation of EV across groups) is
positive does not mean that the welfare gains of thewinners are considered more important than the welfare losses of the losers. Thus, global gains as expressed in aggregate EV should not be interpreted asa value judgment on how to weigh individual or
local welfare gains.
The aggregation of EV across groups does,
however, have a useful interpretation, which is
linked to the notion of compensation and Pareto
optimality. As long as the global gains are positive—
using the standard practice of adding up EVs acrosshouseholds—then it is possible through redistribution to compensate households that lose (so that noone is worse off relative to the baseline scenario),T H EP O T E N T I A L

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Box 2.2 (continued)
when some households are better off. In that sense
the global gain can be compared with an equal risein global output plus redistribution.
In this report we maintain this standard practiceof reporting EV aggregates, making the gains comparable to global gains in many other studies.
An alternative approach to calculating global
gains would be to add up changes in income measured in PPP terms. The rationale for that alternative is that because prices of nontraded goods arelower in developing countries, the addition of a dollar to a developing country would enable the purchase of a larger amount of goods and services thanin an high-income country. In that case, both baseincome and gains for new migrants and for those
who remain in developing countries would beroughly three times as large as reported here. Thisis true for all gains, whether they come from migration itself, from remittances, or from changes inwages and prices in developing countries. As a result, the share of those who live (originally) inabsorption (private consumption, private investment, and government spending) of 0.1
percent. However, prices of some key nontradables decline by larger amounts—0.8 percent
on average for public services (including
health-related services) and 0.2 percent for construction and recreational services. These pricedeclines will be even sharper for specific subsectors where migrant workers are concentrated (for example, household help), for which
we currently have no comprehensive data.
The allocation of the gains across developing countries depends on various factors, including the skill loss and the resulting impact
on production, the locations to which migrants move and the relative wage differential,
and the propensity to remit. By developing region, the gains to households under the model
vary from 0.6 percent for Europe and Central
Asia to 1.1 percent for South Asia and Latin
America and the Caribbean (table 2.4).

developing countries in global aggregates would increase in the measurement of both global income
levels and global welfare gains. However, the percentage increase in income for developing countries
would not be affected.
aOne of the advantages of the EV measure is that it transforms the ordinal concept of welfare into a cardinal concept ofincome. While it is impossible to measure how much one welfare
level differs from another (one can only conclude that one level ispreferred to another), the corresponding increase in income canbe measured, and the size of the increase has a clear meaning.
bFor example, in trade-reform scenarios, the change in theprice index is a relatively good approximation of the welfare
impact, since the new price is approximately the old price lessthe tariff.
cThere are exceptions. For example, in the case of climatechange models, it is necessary to know the relative prices of thedifferent fuels to accurately determine the carbon tax.
dSee Timmer and van der Mensbrugghe (2005) for moredetails.
eThe size of the change in individual welfare is undetermined, since welfare is an ordinal concept.

For the new migrants, the real income
gains—cost-of-living adjusted—increase bynearly 200 percent. There are large differences
across regions, with the highest gains (in percentage terms) accruing to migrants from SubSaharan Africa (619 percent) and the lowest
to migrants from the Middle East and North
Africa and Europe and Central Asia. The main
reason for the disparity is the relative differential between wages in origin and destination
countries. Variations in wages paid to migrants from different regions in destination
countries are minor, whereas there are very
wide variations in wages in countries of origin. For example, the average wage for a migrant in Europe in the base year is about$16,500—with only minor variation acrossmigrants. However, the average wage in SubSaharan Africa is only $470, whereas in the
Middle East and North Africa it is $2,700.
Thus, the migrant from Sub-Saharan Africa

37

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Table 2.4 Real income impacts across developing regions
Change in 2025 relative to the baseline, adjusted for differences in cost of living
Natives in region

Total developing
East Asia and PacificSouth Asia
Europe and Central Asia
Middle East and North Africa
Sub-Saharan Africa
Latin America and the Caribbean

New migrants from region$ billions

Percent$ billions

Percent

143
37
21
14
18
7
47

0.9
0.7
1.1
0.6
0.9
0.9
1.1

162
32
2
25
11
7
85

199
215
175
138
134
619
224

Source: World Bank model simulations.

will gain much more in both absolute and percentage terms than one from the Middle Eastand North Africa.

The impact of migration on trade
would be mild
Whether migration and trade are substitutes
for each other is an old debate. For example, in the discussions leading up to the signing of NAFTA—the free trade agreement
among the United States, Canada, andMexico—one of the key arguments was that
trade would replace migration and reduce
the pressure for Mexicans to migrate to theNorth. Likewise, allowing for increased
migration—for example of unskilledworkers—could reduce trade, because it
would enable the high-income countries tocontinue producing low-skill-intensive products at competitive cost.
Evidence of the link between trade andchanging the comparative advantage emerges
in the migration scenario described here. For
example, the largest gains in export revenue
for high-income countries come in agriculture,
clothing, other manufacturing, recreational
services, and public services—all laborintensive sectors, the first four being relatively
intensive in unskilled workers and the last in
skilled workers.
Change in comparative advantage has only
a mild impact on trade flows in this scenario,
however, as migration affects trade through38

several channels, some of which increase, andothers that decrease, trade flows:• First, the rise in incomes due to migration produces a small rise in global tradeflows, with regional differentiation (because income gains differ considerably
among regions). In addition to higher incomes, the rise in migration changes thesize of regional economies, with implications for their demand for imports andability to export.
• Second, the nature of the shock assumed
in our model differs from the standard
debate over trade and migration. The
share of skilled workers in total migrants
is larger in the shock than in actual migration over the recent past. A large
proportion of skilled workers will findemployment in nontraded sectors—for
example, as doctors and nurses—rather
than in producing traded goods. This
will have general equilibrium effects tothe extent that the price of nontraded
goods will decline by more than the priceof traded goods. Thus there will be a relative shift to nontraded goods and apotential reduction in demand for imports of traded goods. Overall, the larger
share of skilled versus unskilled workers
does tend to reduce trade flows.
• Third, the increase in remittances provides an opportunity for developing

T H EP O T E N T I A L

countries to import more and export less,as their current-account balance will increase by the size of the remittances ($98billion in net terms). The model results
show that total imports into developing
countries would increase by $58 billion
in 2025 (1.1 percent relative to the baseline), as aggregate exports decline by$40 billion (0.7 percent).22 The change
in remittances leads to an appreciation of
the real exchange rate and therefore aloss in relative export competitiveness.23
For instance, the output price index indeveloping countries rises by 0.6 percent
on average, whereas it declines by 0.1 percent for high-income countries.

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Migrants’ impact on government fiscal
accounts is broadly neutral
The assumption concerning the level ofconsumption of public goods and services by
new migrants has important implications forindividual gains, and global gains, under themodeled scenario. We assume that the new
migrants’ level of consumption of public
goods and services equals the amount they pay
in taxes, that is, their impact on the publicbudget is revenue-neutral. This is broadly consistent with the available evidence (box 2.3).
To provide some sense of how different approaches would affect the scenario results, we
present two alternative assumptions regarding
the distribution of public goods and services
to the new migrants (table 2.5). The default
assumption had a largely neutral impact forexisting residents in the host country. Under
another assumption—new migrants pay taxes
but receive no benefits from public goods andservices—existing residents, native and migrant, enjoy a rise in real incomes of $126 billion ($117 billion for natives and $9 billion
for existing migrant households). Note thatthe global welfare gains increase as well, since
the income accruing to natives (and existing
migrants) is not adjusted for the differences in
the cost of living between developing andhigh-income countries.25 A second extreme

In summary, the scenario provides evidence
that changes in comparative advantage due tomigration do influence trade flows. However,overall migration and trade are not substitutes
for each other, because migration has manyother economic effects that have more power
to stimulate or reduce trade. One implicationof this finding is that migration policies should
not be pursued because of their specific impact
on trade flows. Likewise, in trade policies theimpact on migration should not be a main
focus.24 Trade and migration policies shouldbe evaluated on their own merits.

Table 2.5 Impact of different assumptions on the consumption of public goods
and services by selected groups in 2025
Change in cost-of-living-adjusted real income in 2025; billions of dollars
Default
assumption—“New” migrants
receive benefits
equal to theirtaxes

Natives in high-income countries
Old migrants in high-income countries
Natives in developing countries
New migrants
World total“New” migrants
receive no publicbenefits but pay
taxes“New” migrants
receive per capita
average benefit

PrivatePublic

Total

Public

Total

Public

Total

139
88
131
126
308

1
0
12
36
48

139
88
143
162
356

117
9
12
18
120

256
79
143
108
428

85
6
12
75
4

54
94
143
201
304

Source: World Bank model simulations.

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Box 2.3 The impact of immigrants on fiscal balancesI

mmigrants’ net contribution to fiscal revenues isusually considered to be small. The net fiscal impact of immigration on the United States has beenminimal (Coppel, Dumont, and Visco 2001;
Auerbach and Oreopoulos 1999). The U.S.
Binational Study on Migration (1997) found that irregular migrants did impose a significant fiscal burden on state and local government. However, school
expenses accounted for the bulk of these costs, and(as the authors note) education is an investmentthat may readily be recovered in greater future productivity. Moreover, Lee and Miller (2000) foundthat the overall fiscal consequences of altering thevolume of immigration to the United States would
be quite small. Gott and Johnston (2002) andSriskandarajah, Cooley, and Reed (2005) estimatedthat immigrants made a positive contribution to
public finances in the United Kingdom. Gustafsson
and Osterberg (2001) found that new immigrants toSweden generated a net fiscal cost, but this turned
into a positive contribution after a few years. Nanaand Williams (1999) found that immigrants to New
Zealand had a positive fiscal impact. Bonin,
Raffelhuschen, and Walliser (2000) found that the
net fiscal contribution of immigrants to Germany
could be significant if the government selects forskills.
Calculations of the net fiscal cost of immigration
are fraught with difficulties, for several reasons.
First, the computation at any point in timedepends heavily on the methodology used, what
expenditures and revenues are included, which public
services should be regarded as pure public goods (andthe extent of economies of scale in expenditures), andwhether households or individuals are considered.
Second, static calculations of the current net fiscal
impact fail to take into account the age structure of
the immigrant population. Smith and Edmonston(1997) found that immigrants arriving between theages of 10 and 25 years produced fiscal benefits undermost scenarios, while immigrants arriving in their late

60s generally imposed a long-term burden. Studies
that follow immigrants over time generally conclude
that in net-present-value terms, immigrants and theirdescendants tend to contribute more in terms of tax
revenues than they absorb in expenditures, but the orders of magnitude are typically small (OECD 1997).
Intergenerational models are sensitive to the discountrate used and assumptions concerning the allocationof the fiscal burden over future generations.
Third, the computation will depend on the levelof skills, experience, education, and fertility of immigrants. Rowthorn (2004) calculates that skilled migrants to the United States typically make a large
positive contribution to the fiscal balance, whereas
unskilled immigrants cost more on average than thetaxes they pay. Storesletten (2000) calculates that the
net-present-value contribution of the average highskilled immigrant to the U.S. budget is $96,000; themedium-skilled immigrant’s contribution is $2,000;
and low-skilled immigrant’s contribution is$36,000.
The results may change over time, as migrant
characteristics and government policies change. The
probability that an immigrant to the United States
will receive public benefits has risen since the 1970s,
probably due to an increasing share of immigrants
from poorer countries (Gustmann and Steinmeier1998).
An issue of particular concern has been the impact of migration on government-financed pensions.
Likely increases in immigration can make only asmall net contribution to strengthening the financingof pensions in the United States (Fehr, Jokisch, andKotlikoff 2004), although selecting immigrants forworking age and high skill levels could improve thepicture (Storesletten 2000). By contrast, increases inimmigration could make a significant contribution
to financing pensions in Germany (Bonin, Raffelhuschen, and Walliser 2000) and Spain (Collado,
Iturbe-Ormaetxe, and Valera 2004).

assumption is that new migrants receive thesame amount in public benefits as the average
household in the destination country. This
would imply a net positive transfer to the new
migrant households, since they would receive
more in public benefits than they paid in

40

taxes.26 In this case natives in high-income
countries would lose $85 billion in aggregate
public goods and services, although thisamount would not translate one-for-one into abenefit for new migrants due to the cost-ofliving adjustment. These simulations underline

T H EP O T E N T I A L

the effect of public policy on the distributionof gains from migration.

Additional gains from migration
can be substantial
The gains for migrants from this scenario
essentially provide the same message as earlier estimates. In their seminal paper, Walmsley
and Winters (2003) estimate that a relaxation on the movement of temporary workers on the same order as that modeled
here—that is, 3 percent of the labor force ofthe high-income countries—would yield
global income gains of $150 billion (using a
1997-based comparative static model). The
result from our scenario that is roughly
comparable to their figures (that is, global
gains before adjustment for cost of living
and measured relative to 2001, rather than2025) are more than double their results.27
However, our figures are comparable withthe more recent work done by Walmsley
and her colleagues.28 One of the key reasonsfor the increase in the global welfare impact
is a reevaluation of the assumed wage differential between the home and host country. In their initial work, Walmsley andWinters had assumed that new migrants
made up 50 percent of the difference between the home and host country’s wages.
Their new assumption (used in our model aswell) is 75 percent, based in part on the factthat the migrants are permanent rather than
temporary. Hamilton and Whalley (1984)
and Moses and Letnes (2004) have shownthat removing all restrictions on labor
movement, admittedly not a realistic scenario, would yield a huge increase in world
output. Overall, these papers suggest thatlabor-market restrictions are imposing amuch larger burden on the global economy
than are trade restrictions. The World Bank’s
trade model suggests that removing all remaining merchandise trade barriers would
yield $287 billion in global real income gains
in 2015. For the purpose of comparison, when
the gains from the two different scenarios—

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those from an increase in migration, and thosefrom global trade reform—are scaled to thesame reference year, 2001, the gains fromtrade reforms are $155 billion versus $175 billion from the migration scenario.29 This
leaves little doubt that easing restrictions on
the movement of labor could provide a significant boost to the global economy. Moreover, in comparison with the most recent
work on global merchandise trade reform,
the gains from an increase in migration are
more balanced toward income increases fordeveloping countries relative to developed
countries. In a study by Anderson, Martin,and van der Mensbrugghe (2005), the gains
to high-income and developing countries are
0.6 and 0.8 percent, respectively, relative tobaseline income. In the scenario modeledhere, the income increases are 0.4 percent
for native households in high-income countries and 1.8 percent for developing countries (including the new migrants).

Returns to factors of productionF

our critical factors determine the distribution of gains from migration among skilledworkers, unskilled workers, and owners ofcapital: (a) the size of the increase in migration; (b) the distribution of nonwage income(profits); (c) the degree of substitution between
workers by region of origin; and (d) the degreeof substitution or complementarity between
workers and capital. We have already positedthat the increase in migration is large, with anaverage increase in the migrant labor force ofaround 50 percent over a 20-year period, andcomparable (if somewhat less) to the rise in theshare of migrants in high-income country population over 1970–2000. In the absence of any
specific data on the source of migrant income,we assume that migrants—both existing andnew—receive no nonwage income. In essence,
their real income will be driven by changes inwages. The effects of this simple assumption
on the distribution of gains are significant, andthe implications of relaxing it are discussed
below.

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Substituting between migrant and native
workers determines who gains
The key issue of who reaps the benefits involves the degree of substitution among different workers. The allocation of demand forworkers assumes differentiation among workers from different regions. This is done in two
steps. First, “similar” workers are bundled together into “native” workers and “foreignborn” workers.30 In the second step, these
two bundles are decomposed into labor demand by region of origin. We assume that
there is more differentiation between a native
and a foreign-born worker (that is, a lower
substitution elasticity) than between two
workers from different countries of origin
within each of the two aggregate bundles. For
example, in the case of the United States, employers see a greater difference between a U.S.
worker and a generic immigrant from a developing country than between a Mexican and a
Salvadoran worker. The implication is that arise in the supply of migrants has a greater impact on old migrants than on native workers,
which plays a key role in the distributional
outcomes of the increase in migration. The
assumption of labor demand differentiation
operates for both skilled and unskilled laborin the model.
In the default case, we assume that wages
are flexible, with a substitution elasticity between unskilled migrants and natives that isroughly comparable to that implied in the
conclusions of the meta analysis in Longhi,
Nijkamp, and Poot (2004); they conclude
that a “one percentage point increase in the
proportion of immigrants in the labor force
lowers wages across the investigated studies
by only 0.119 percent.” (See box 2.4 for a review of empirical studies of the impact of migration on wages.) In the scenario described
here, the 50 percent increase in the stock ofmigrants raises their proportion of the labor
force by about 3 percentage points, producing a 0.5 percent decline in the wages of natives.31 We also assume perfect substitution
between new and old migrants (the large majority of both categories being unskilled). The

42

empirical evidence of the extent to which migrants are substitutes for natives or for existing migrants is sparse. Thus in addition to
exploring the implications of the assumptions
made, we also devote attention to alternative
assumptions.
Finally, in a departure from previous
work but in line with a developing consensus, we assume that skilled workers are nearcomplements with capital (meaning that they
are more productive, and thus earn higher
returns, when used together with capital),
whereas unskilled workers are substitutes
for capital and skilled labor.32 This specification has important consequences for the
distributional impacts of increased migration. Whereas investment rises with increased income, the overall increase in thestock of capital is modest, so that the rise in
the supply of skilled workers is not matchedby an equivalent increase in capital. Thus themarginal productivity of additional skilledworkers declines, provoking a decline in thewage of skilled workers (by more than thefall in the wages of unskilled workers).

Increased migration can generate
substantial changes in income distribution
among workers and owners of capital
The change in factor returns is depicted infigure 2.5. In the high-income countries only
Figure 2.5 Factor returns and migration% change in factor returns, 2025, relative to baseline
10
Developing countries

5
0
5
10
15
High-income
countries

20
25
Capital

Unskilled Unskilled
nativeforeignworkers
bornworkers

Source: World Bank simulations.

Skillednativeworkers

Skilledforeignborn
workers

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Box 2.4 Empirical studies of the impactof immigration on wagesM

ost cross-sectional studies find that immigrants
have no impact, or a very limited impact, on
the wages or employment of natives (LaLonde andTopel 1997 and Borjas, Freeman, and Katz 1997 for
the United States; Pischke and Velling 1994 forGermany). However, cross-sectional approaches relate wage differences across local labor markets tothe share of immigrants in each market. If immigrants are attracted to high-wage areas, which islikely, it is difficult to identify the exogenous impactof immigrants on wages.a Studies of sudden, politically driven inflows of immigrants likewise fail to detect a significant impact on natives’ wages or employment in affected areas.b However, native workers
may adjust to large, sudden inflows of immigrants bymoving to other areas (or through reduced inflows
from other areas), again obscuring the relationshipbetween immigration and labor-market outcomes.c
This problem has encouraged the use of panel
techniques that can discern the combined effects oftime and cross-sectional effects. Some panel studies
have found a significant impact on the wages of unskilled natives, who in addition have suffered declines in wages due to skill-biased technical change
and increased trade. Borjas (2003a), analyzed the impact of immigration in the United States across different levels of skills and experience and estimatesthat immigration reduced the wages of native highschool dropouts in the United States by 8.9 percent
from 1980 to 2000. Jaeger (1996) finds that immigration lowered the real wage of U.S. high-school
dropouts by as much as 3.6 percent in the 1980s.
DeNew and Zimmermann (1994) find that a one
percentage point rise in the share of migrants in thelabor force reduces the wages of blue-collar workers
by almost 6 percent. By contrast, Dustmann and others (2003) find that immigration has little impact onnative wages (or employment) in the United
Kingdom, including for the low-skilled.
Where wages are relatively inflexible, an inflow of
migrants may affect employment levels rather thanwages. Angrist and Kugler (2002) find that increased
immigration in Europe is associated with a significant decline in native employment, particularly forthe low-skilled. Hunt (1992) finds that a one percentage point rise in the share of immigrants in the
French labor force (following Algerian independence)increased the unemployment rate by 0.2 percentage
points. This shows more adjustment through employment than through earnings compared to U.S.
studies, which may be due to French rules governing
wages (Dustmann and Glitz 2005). The comparison
underlines the importance of the investment climate,and in particular, labor-market flexibility, in the efficient absorption of migrants. Some studies show that
immigration reduces native unemployment in thelong term (Poot and Cochrane 2004), presumably
because increased consumption demand from immigrants raises the demand for labor.dThus some articles support the view that unskilled
immigrants are relatively close substitutes for native
workers (without attempting to distinguish between
the effects on native workers and old migrants). However, the share of low-skilled native workers in destination countries is falling. The share of U.S. adults
with less than a high-school education declined from47 percent in 1970 to 22 percent in 1998 (Massey
2000). About 90 percent of new native entrants to the
U.S. labor force in 2004 had completed high school(U.S. Labor Survey 2005). By contrast, the average
migrant from rural Mexico has six years of educationand does not speak English (Mora and Taylor 2005).
Many low-skill immigrants may have such limited education and language skills that they do not competewith native low-skilled workers at all, but instead
take jobs that natives are unwilling to do. In this view,the rise in immigration in high-income economies
since 1980 has been accompanied by increases in native educational levels; essentially natives moved outof certain kinds of jobs, creating a demand for immigrant labor.

aThe researchers do attempt to correct for endogeneity byusing instrumental variables.
bExamples include the Mariel boatlift from Cuba (Card1989), the repatriation of Algerians of European origin to France(Hunt 1992), the inflow of workers to Austria after the breakdown of the communist regimes (Winter-Ebmer and Zweimuller
1999), and the return of Portuguese from Africa in the 1970s(Carrington and de Lima 1996).
cStill, Card (2001) finds no evidence that immigration into
an area leads to offsetting net outflows of workers.
dSee Gross (1999) for this result for France.

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capital enjoys an increase in returns under themodel—with wages declining for all labor
categories, skilled and unskilled, native andforeign-born. With essentially only a labor
shock, the scarcity value of capital increases.
The negative impact on unskilled native wages
is small, at around 0.3 percent, depending on
the assumed elasticity of substitution between
migrant and native workers.33 The greater
impact is felt by existing, unskilled migrants,
whose wages decline by more than 10 percent.34 At least two factors mitigate thatdecline. First, labor markets are not completely segmented, so that part of the adjustment falls on native workers. Second, othergeneral equilibrium effects are at work, suchas a relative shift in the demand for unskilledworkers as the price of capital (combined withskilled labor) rises and a relative shift in demand toward goods that use unskilled labor
intensively, raising the relative demand for unskilled workers.
The impact of the shock on the wages ofskilled workers is greater than for unskilled.
Wages decline by 1.1 percent on average forskilled natives, significantly more than forunskilled natives. Old skilled migrants suffer awage decline of 20 percent, which is doublethat of old unskilled migrants. The impact onskilled workers is larger than for unskilled
because skilled workers are assumed to be nearcomplements with capital; with capital increasing only slightly, this would tend to drive
down skilled wages. And the impact is largest
on old skilled migrants because the rise inmigration of skilled workers is large relative tothe stock of old skilled migrants, and the new
migrants are assumed to be closer substitutes
for skilled migrants than are native workers.
The greater impact of migration on skilledthan unskilled wages is not at first sight consistent with the limited evidence available. In
those studies that find any significant impactof migration on native wages, the largest impact tends to be on unskilled wages (seeabove). Our seemingly contrary result arises
for three reasons. First, unskilled immigration
to high-income countries has been much

44

larger than skilled migration, so that the wage
impact of unskilled migration is easier to detect in empirical work. Second, the shockmodeled here represents a one-time increase inskilled migration that is larger than the existing stock, which has built up over time. And
third, the model assumes little change in thecapital stock, while increased investment in response to migration would dampen the fall inskilled wages, a point to which we return inthe conclusion to this chapter.
The impact in developing countries isnearly the reverse. Capital returns suffer andlabor returns improve, with larger improvements for skilled workers than for unskilledworkers. The magnitudes differ because therelative size of the shock differs. For example,
the decline in unskilled workers in developing
countries is only 0.3 percent, versus 1.7 percent for skilled workers.
Assuming that all capital income accrues
to native households, native households inhigh-income countries are on aggregate better
off after the shock, with real incomes increasing by 0.4 percent. That is, the increase incapital income more than offsets the loss inwage income. Part of the old migrants’ 6 percent decline in real income is due to the assumption that they own no capital, so enjoy
no nonwage income.35 An alternative, extreme assumption is that on a per capita basis,
old migrants receive the same amount of nonwage income as natives. This alternative
would reduce old migrants’ loss to 3.4 percent
of base real income.
To summarize, the new migrants areclearly the large winners, particularly in percentage terms. Under the assumptions of themodel, existing migrants are likely to belosers—though the extent of their loss will
depend on their degree of substitutability with native workers and their share of
nonwage income. Native households in both
high-income and developing countries are
better off. The sources of their gains, though,are very different (figure 2.6). In the highincome countries the gains are generated byhigher returns to capital—somewhat offset by

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Figure 2.6 Source of gains for native workers
Native workers in developing regions

Native workers in high-income regions
Change in real income in 2025, $ billions

Change in real income in 2025, $ billions

350

200

300
150

250
200

100

150
100

50
50
0

0

50
100

50

150

an
R

em

itt

To
ta
l

s
ce

bl
ic
Pu

La

bo

l
ita
ap
C

an
R

em

itt

To
ta
l

s
ce

bl
ic
Pu

r
La

bo

l
ita
ap
C

r

100

200

Source: World Bank simulations.

lower wages. The gains for natives in highincome countries would be lower if we assumed a more even distribution of capital (toward migrants) and a greater degree of labor
substitutability. In developing countries, thegains to natives essentially are generated byhigher wage income and higher remittances—
somewhat offset by lower returns to capital.
These gains would be lower should thepropensity of the new migrants to remit belower than average.

If migrants are viewed the same as
natives, then increased migration
reduces natives’ wages
The degree of labor-market differentiation
plays a critical role in determining the effect of
the increase in migration on native and foreign households. An alternative scenario—
maintaining the same increase in migration—
assumes that employers are perfectly
indifferent to hiring native workers versus foreign-born workers.36 This empirical issue islinked to real-world dynamics since, over thelong run, differences in labor characteristics
could fade as migrants adjust to their new
environment and as employers cease to seethem as different.37
The impacts of the alternative scenario on
factor returns are shown in figure 2.7. The
most notable impact is that native wages (forskilled and unskilled workers) decline by morewhen natives and migrants are viewed as perfect substitutes for each other, while the wagesof the foreign-born decline by significantly
less.38 For skilled workers, the average decline
becomes negligible; the burden of adjustment
is spread out more evenly between native andforeign-born workers. For the given shock,and depending on the assumed elasticity of
substitution between foreign and native workers, the impact on native wages ranges froma slight increase to a decline of 1 percent(box 2.5).
Because increasing migration constitutes aclear labor-supply shock, one would expect it

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Figure 2.7 Factor returns and migrationin high-income countries, 2005
% change relative to baseline
505Perfect
substitution

10
15

Standard

20
25
Capital

Unskilled Unskilled
nativeforeignworkers
bornworkers

Skillednativeworkers

Skilledforeignborn
workers

Source: World Bank simulations.

to affect wages (or employment, where movement in wages is constrained). But it is important to view these changes in dynamic terms.
First, assuming differentiation between nativeand foreign-born workers, the impact on native workers’ wages in high-income countries
is slight even in absolute terms (–0.04 percent
for unskilled workers and –0.4 percent forskilled workers). More important, in dynamic
terms, these changes alter the rate of growthof wages over the next two decades only
slightly. In the base case, nominal wages will
increase by 3.6 and 4.7 percent, respectively(average annual growth between 2001 and2025), for unskilled and skilled workers inhigh-income countries. With an increase in migration, the growth rate is unchanged for unskilled workers and drops to 4.6 percent forskilled workers. Even in the worst-case scenario for native workers, where foreign-bornworkers are assumed to be perfect substitutes
for natives, the dynamic trends are almost exactly the same as in the baseline scenario.
The effects of the modeled shock are obviously larger for existing migrants. With labor
differentiation, their long-term wage growthtrend drops to 3.1 percent for unskilled workers and 3.9 percent for skilled workers fromtheir baseline trend of 3.6 and 4.9 percent—46

still positive but significantly lower. In the
more optimistic scenario for existing migrants, where native workers bear a larger
part of the burden, the trend growth in wages
is virtually identical to the baseline, declining
to 3.4 and 4.8 percent, respectively, for unskilled and skilled workers.
The assumption of perfect substitutabilityof native and migrant labor has a small impact
on the global income gain ($379 billion insteadof $356 billion), but significant distributional
effects. First, in high-income countries perfect
substitution implies a more pronounced procapital bias, as native labor suffers a larger
loss. However, the negative impact on existing
migrant households is much smaller: less than
1 percent, compared with the 6 percent suffered with labor differentiation. This has apositive impact for developing countries, because their loss in remittances from existing
migrants drops dramatically. Second, with perfect substitution the new migrants benefit froma larger wage differential and thus a higher income gain. And again, for developing countries, this translates into higher remittances.
Overall, the change in real net remittances is$129 billion under perfect substitutability, as
opposed to $88 billion. The bottom-line is thatthe real income of new migrants increases by
250 percent, as opposed to 200 percent, andthe gains for natives in developing countries
rise to 1.2 percent, instead of 0.9 percent.
Several other parameters affect the relative
impact of increased migration on wages andreturns to capital. For example, as shown inbox 2.5, the relative impact will depend on thesubstitution between capital and labor. The
lesser the degree of substitution (or the lessflexible the economy), the greater will be thenegative impact on wages. Most econometric
evidence suggests a capital–labor substitution
elasticity of around 1, somewhat higher thanthat used in the model.39 Another crucial assumption in the standard model is that skilledworkers and capital are near complements. An
alternative would be to assume that unskilled
and skilled workers were both substitutes
with capital. This would moderate the decline

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Box 2.5 Increased migration and its impact on wages

T

he impact of increased migration on wages canbe summarized by a few simple formulas. The
key parameters are the share of foreign workers in
the economy, the capital-labor elasticity of substitution, and the substitution between native and foreign
workers. These relations are summarized in the tablebelow.a The values refer to an economy where foreign labor is 5 percent of the labor force (sfl). The
capital-labor substitution elasticity (␴v) is 0.9; andthe substitution (␴l) between native and foreign
workers is 4.b The point elasticity is given in thethird column of the table. The estimated impact of a
50 percent increase in the stock of foreign workers is
simply the point elasticity multiplied by 50. The
actual impact comes from a calibrated numericalmodel. The two are relatively close, despite the sizeof the shock. This is because the results are largely
driven by the low share of foreign workers in theeconomy; therefore most of the economy stays nearits initial equilibrium. The aggregate wage falls by
only 1 percent. This is allocated across the different
workers depending on their substitutability. With anelasticity of 4 (used in the default scenario), migrant
workers see a 10 percent decline in wages; domestic
workers see only a 0.5 percent decline. If migrants

Wage impact from a 50 percent increase inforeign workers, under various substitution
assumptions% change in wages
505Nativeworkers’
wages

10

Foreignworkers’
wages

15
20
25
30
35
1.5

2.5

3

3.5

4

8

16

32

64

Substitution elasticity between native and foreign workers

Source: World Bank staff calculation.

Summary of elasticities with respect to an increase in foreign workers
ExpressionlW, F   sf sk
␴v
snl
sfl skFW, F   l  v␴␴NW, F slf

sfl sk␴␴vlDescription

Point
elasticity

Estimated
impactActualimpactAggregate wage

0.0222

1.1

1.0

Wage of foreign workers

0.2597

13.0

10.1

Wage of native workers

0.0097

0.5

0.5

and native workers are perfect substitutes, thenwages of native workers would decline by 1 percent,that is, by the same amount as the aggregate wage.
The figure shows the impact on wages—of bothforeign and native workers—using different assumptions about their substitutability. The shock is
a 50 percent increase in the stock of foreign workers with the same assumptions used for the numerical example in the table. The impacts on wages
converge only at very high levels of substitutability.
In actual econometric work, it might be hard to es-

timate the substitution elasticity with great precision, particularly since the shocks are unlikely
to be as considerable as those modeled here.
aThese relations are for a small single-sector closed economy but line up relatively well with the impacts from theglobal model. Because it is closed and single-sector, the relations may not hold exactly because of other general equilibrium effects. See van der Mensbrugghe 2005b.
bThe other parameters are the capital share (s ), the sharekof foreign labor in output (sf  sl.sfl), and the share of native
workers in the labor force (snl).

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2 0 0 6of skilled wages and the rise in the returns tocapital, essentially because there would be
more (assumed) flexibility in the economy.
When capital and skilled workers are complements, a sharp increase in skilled workers,
without a concomitant increase in capital,
raises the scarcity value of capital. If we makecapital and skilled labor more substitutable,
the decline in the wages of skilled workers will
create more demand for them and dampen thenegative impact on their wages.

Caveats—what the model
leaves out

While the scenarios discussed here provide
a wealth of insights, they do not address
many important aspects of the impact of
migration. Using side calculations, it is possible
to get a sense of two such aspects.

The model does not account for changes
in migrant characteristics over time
The model assumes that migrant characteristics do not change over time. This is useful inhighlighting the immediate impact of migration, but less realistic over the medium term.
As migrants remain in the destination country, they tend to take on the characteristics ofnative workers. For example, they learn or
improve their fluency in the language, they
better understand (and may tend to adopt)the social mores of the destination country,
and they may become more educated. Employers are likely to view a migrant that has
lived in the country for 20 years as being
more similar to a native worker than a migrant who arrived yesterday. This issue has
several implications for the calculation of thegains from migration. Migrants who havespent a longer time in the destination country
will be less perfect substitutes for new migrants, mitigating the drop in their wages
predicted by the model. Similarly, as thedegree of labor differentiation declines, theimpact on native wages will rise, thus reduc-48

ing native households’ gains. On the other
hand, increased productivity as migrants improve their education may generate larger
gains to owners of capital and could benefit
native workers through spillover effects suchas training. Remittances may decline as migrants become more removed from the origin
country.
The process of catch-up in productivity is
not captured in our current model, but wehave done some side calculations to see how
the results could be affected. The catch-up rate
and workers’ length of stay are two factorsthat affect catch-up. How long does it take theaverage migrant to achieve the level of productivity of native workers? Borjas (2003b)
provides mixed evidence on this point for
migrants in the United States. First, he showsthat the catch-up rate depends very much on
when the migrants arrived, with earlier migrants doing better than later migrants. Second, he finds no absolute convergence, with
migrants’ wages remaining below those of native workers.
The second factor relates to workers’
length of stay. The longer workers stay, thebetter placed they are to improve their skills
and adapt to local work practices, including
language skills (if necessary). At one extreme,
all migrants may be assumed to be temporary
workers staying for a short period to returnhome permanently. Or they may be assumed
to be permanent workers arriving young andwith high educational attainment or acquired
skills.
Under the most optimistic scenario, wherecatch-up occurs within a year, our simple,
calibrated model predicts gains in the output
of high-income countries that are about
25 percent higher than in the case of no catchup.40 Under a more plausible scenario, where
the process of catch-up takes 10 years andannual attrition41 is around 10 percent, theoutput gain in high-income countries is about
12 percent higher than with no catch-up. It
appears, therefore, that the catch-up phenomenon could boost the gains from migration
substantially.

T H EP O T E N T I A L

The model does not account for the
potential of migration to spur higher
investment
The model generates only a modest rise in thecapital stock as a result of the increase in migration. Increased returns to capital, and thusinterest rates, do increase savings. However,this effect is marginal, in keeping with empirical estimates of the responsiveness of savings
to changes in interest rates. In reality, higher
investment in response to the higher returns tocapital may be financed by capital inflows,which do not change in the model. There issome evidence, however, that large immigration can attract capital flows. For example,
Davis and Weinstein (2002) argue that skilledlabor, unskilled labor, and capital are all attracted to the United States, owing to U.S.
technological superiority. The mass migrationfrom Europe to the new world before WorldWar I encouraged large inflows of capital.
Higher investment would lessen the decline
in wages suffered by skilled workers, dampen
the rise in the return to capital, and increase
the demand for unskilled workers in the highincome countries—but it could have the opposite effects in developing countries. To verify
this intuition, we simulated the same migration shock and added to the shock a 0.4 percent decline in the level of investment indeveloping countries, with a concomitanttransfer of these resources to high-income
countries.42 Those assumptions indeed have apositive impact for the high-income countries
and dampen the capital-income gains andlabor-income losses. Overall, the gain for
native households in high-income countries
improves by 4.5 percent (from $139 billion to$145 billion). But it comes at the expense ofnatives in developing countries, whose income
gain drops from $143 billion to $125 billion,a drop of 12.5 percent. The global gains fall to$345 billion, a 3 percent fall. This suggests—
in the absence of an increase in savings—that
the potential reallocation of global savings
toward high-income countries is negative at
the global level and that capital is moreproductive in developing countries.

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Other factors not covered by the model
are more difficult to quantify
There are various costs associated with migration that the model does not take into
account. One issue concerns adjustment costs,
as changes in the technology of production
and in the mix of goods imply transitional unemployment and changes in the pattern ofinvestment. The magnitude of these costs depends in part on the structure of labor-market
institutions (such as constraints on hiring andfiring and minimum-wage legislation) and on
the efficiency of capital markets. Countries
with more flexible labor markets and soundbanking, stock, and bond markets are likely toexperience lower adjustment costs, underlining the importance of the investment climate
for realizing the potential gains from migration. The size of adjustment costs will also
depend on whether migration is concentrated
or spread over time. This point also has policy
implications. If a country anticipates needing
migrants in the future or recognizes that migration pressures are bound to rise due to demographic changes, it would be better toloosen constraints on migration earlier andmore gradually than to be confronted with asharp rise later on. Migration also involves
direct costs, including transportation andtransitional expenses, as well as the noneconomic costs suffered by migrants separated
from their families (for example, the impact
on children raised without one or both parents—see chapter 3). In general these are either short-term costs that should not greatlychange the calculation of benefits from permanent migration or problems that decline
over time as migrants and families adjust to
permanent changes or take steps to reunite.
Several other issues that may affect thegains from migration are impossible to quantify. First, our model does not distinguish between irregular and regular migrants. If migrants are irregular, they may be paid lower
wages (see chapter 3), which would reduce
their welfare gains (and remittances) relative
to the model results, while it increases thegains of natives. However, irregular migrants49

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2 0 0 6also may impose costs on destination
countries—among them the costs of enforcement (as governments seek to limit what some
may view as undesirable changes in the country’s culture and demographic characteristics);
a possible burden on public spending, which
may be higher for irregular migrants (see box2.3); and the potential for other forms ofillegality generated by the presence of a large,
undocumented group of foreign workers.
Second, immigrants may improve the efficiency of employment from the perspective offirms by providing a source of labor that caneasily be employed in new geographic locations, and hired or fired in response to changes
in cyclical conditions. Piore (1986) describes
how many migrants (at least initially) tend toview their stay as temporary, filling jobs withlower salaries and less stability than those ofnatives.43 Large numbers of immigrants workin construction, which facilitates new developments in areas that require a mobile labor
force. However, over time, migrants will become more permanent and demand jobs similar to those held by natives.
Third, our model does not reflect the social
or economic implications of increasing diversity in the destination country. The social impact lies outside our present scope, but diversity has potential economic costs and benefits
that should be considered. Some writers argue
that increased diversity has an economic
value. Glasser, Kolko, and Saiz (2001) emphasize the role of a rich variety of services andconsumer goods in enhancing the attractiveness of cities. Florida (2002) relates an index
of diversity to a concentration on high-technology industries. Ottaviano and Peri (2004)
find that cultural diversity has a net positiveeffect on the productivity of U.S.-born citizens. By contrast, Schiff (1998) uses a theoretical model to underline how a society’s sharedvalues can reduce the cost of transacting business, owing to higher trust and easier enforceability of sanctions. Thus immigration, which
increases diversity, may lower productivity byraising transaction costs. Finally, Alesina andFerrara (2004) find that increases in ethnic

50

diversity are associated with lower growth
rates, holding all else equal. However, diversity
may be more beneficial to growth at higher income levels.44 Clearly much will depend on
the kinds of diversity involved: immigrants
who rely on national affinities to cement loyalty to violent gangs presumably have a very
different impact on growth and welfare than
immigrants who open ethnic restaurants.
Fourth, the model may not fully capture
the beneficial effect of immigration on increasing the supply of labor in the service sector. Although reductions in the prices of services are captured, the resulting expansion in
the supply of native labor (as more parents
can afford child care and workers have moretime to devote to their jobs) is not.
Fifth, the model does not reflect the possibility that skilled migration may lower
growth in origin countries, for example, because of positive externalities from the presence of skilled workers or increases in theprice of services that require technical skills(see chapter 3).
Finally, the model assumes constant returns to scale, while immigration may be
more beneficial if significant sectors enjoy
increasing returns to scale. Increasing returns
may be derived, for example, from fixed production costs, network effects (the unit priceof providing telephone service falls as the customer base grows), reduced transport andcommunications costs (as the local market expands), or increased productivity due to interactions among highly skilled workers. In theirrole as consumers and workers, immigrants
may facilitate an expansion of the market,
thereby raising productivity by increasing returns. On the other hand, large inflows of immigrants may induce congestion, straining
public transportation systems, for example, or
bidding up the price of land. Such effects are
particular to the sector and geographic area
involved, so it is difficult to draw broad conclusions. However, skilled immigrants havemade significant contributions to high-technology sectors that are subject to increasing
returns to scale.

T H EP O T E N T I A L

These qualifications to the scenario results
illustrate how model exercises must abstractfrom reality to provide quantitative measuresof the impact of migration. Some of the issues that the model does not consider would
likely be small in the medium term (adjustment costs, transportation costs) or would
tend to increase the economic benefits of migration (improved productivity of migrants
over time, greater labor-market flexibility andsupply of labor). Other issues would increase
benefits to destination countries, while potentially harming origin countries (higher investment, economies of scale). Still others may
have both economic and social effects, without lending themselves to determinations of
their direction and size (diversity, irregularmigration).

Notes
1. In keeping with the overall thrust of this report,
we focus here on South-North migration, although it isimportant to recognize that a large portion of migrants
from developing countries move to other developing
countries.
2. Some readers may also find the chapter too technical, as it necessarily deals with detailed specification
issues—for example, the degree of differentiation between native and migrant workers, the fiscal impact of
migrants, and how to take into account the change inprices between developed and developing countries
when evaluating gains to migrants.
3. Data on the stocks of migrants are generally
taken from census reports in countries of destination andthus include both regular and irregular migrants. However, irregular migrants tend to be less likely to reporttheir immigrant status, so the estimate of total migrants is probably low.
4. The breakup of the Soviet Union and emergenceof 15 new independent countries in 1991 created new
populations of “international” migrants without migration having taken place.
5. The exceptions were Belgium, France, Ireland,
Portugal, and the United Kingdom.
6. In their regression equation explaining immigration to the United States, Hatton and Williamson (2002)
calculate that IRCA doubled the Mexican immigration
rate from 1989 to 1991.
7. Germany, Ireland, and the Czech Republic are in
the process of establishing new immigration regimes,
with a major focus on economic migration. The EU is

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also discussing the Green Paper on an EU Approach toManaging Economic Migration (EU 2005).
8. These numbers will be moderated to the extent
that labor-force participation rates in the 65 cohort
are positive, if small. Moreover, labor-force participation rates for the elderly are likely to increase as pensions and benefits stagnate or decline with fiscal pressures and as life expectancy rates continue to increase.
We may also witness an increase in labor-force participation rates among people of working age.
9. These global gains are comparable to the recent
findings by Walmsley and Winters (2003), when adjusted for the size of the economy in 2001 relative tothe projected size of 2025.
10. The model’s specification is described in vander Mensbrugghe (2005a).
11. “Migrants” refers to migrants from developing
countries unless otherwise stated.
12. The phase-in period is somewhat arbitrary.
Because of its 10-year implementation, it minimizes
adjustment costs to some extent. The five-year period
between 2020 and 2025 enables an assessment of longrun steady-state impacts.
13. This is by design. An alternative would be toincrease the stock of migrants in proportion to theircurrent structure—by host region and skill level. In thiscase, the largest proportional increase would be for unskilled workers in the United States.
14. A switch of 14 million workers from developing to high-income countries has only a small impact(a decline of 0.4 percent) on aggregate employment indeveloping countries, albeit with potentially greater
consequences among the relatively more scarce skilledworkers.
15. Many factors determine the level of remittances.
For example, new migrants may leave many dependents
in their home countries, which would tend to raise remittances. On the other hand, at least in the short-term,
moving and start-up costs could lower remittances.
16. For simplicity, migrants from other highincome countries are added to the true natives.
17. Again, for simplicity, all migrants in developing
countries—both from rich and developing countries—
are lumped together for the purposes of the aggregate
analysis.
18. The impact on households other than the“new” migrants is not affected by cost-of-living adjustments. Since these households do not move, they face thesame system of prices, and thus their change in real
income simply depends on the standard real income
measure.
19. This assumes a perhaps implausible Leontief
utility function but the purpose is simply to illustrate
the point that corrections need to be made for differences in the cost of living.

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20. Were the true prices available, one could do astandard equivalent variation calculation that would
take into consideration the change in prices.
21. In the high-income countries, new migrants’total real consumption is $562 billion, compared with$80 billion in the baseline, hence the real increase of$481 billion. When the $562 billion is adjusted for thedifference in the cost of living, real consumption, as
perceived from the point of view of the new migrant, isonly $244 billion, taking the change in real income
down to $162 billion. The cost-of-living adjustment
averages 2.3, lower than the 3.1 GDP-weighted average PPP of developing countries. This occurs because
middle-income countries (with a relatively low PPP adjustment) have a higher weight in migration than in developing countries’ GDP.
22. High-income countries, on the other hand, see
a substantial rise in exports, $211 billion (2.2 percent),
and a more modest $113 billion rise in net imports(1.2 percent), with imports from developing countries
declining by $23 billion. This implies that although alarge part of the increase in high-income exports can be
attributed to the increase in remittances, a significant
portion is also coming through intraregional trade
among high-income countries driven in part by changing comparative advantage.
23. A standard “Dutch disease” effect of foreign
inflows.
24. Studies of the impact of trade reform indeveloping and industrial countries tend to show thatwages in developing countries rise relatively more—particularly for unskilled workers—than in industrial
countries, but those changes are relatively minor compared to the initial gap in wages. For example, unreported results from Anderson, Martin, and van der
Mensbrugghe (2005) show that full merchandise tradereform would increase unskilled real wages in developing countries by 3.7 percent (unweighted average), but
by only 0.7 percent in industrial countries. This could
induce a small reduction in the incentive to migrate,
but it would not substantially alter the significant wage
multiple of 4 to 5 (taking into account cost-of-living
differentials).
25. The cost-of-living adjustment for the new migrants treats their consumption of public goods andservices the same as their private consumption—that is,
it is adjusted by the same PPP factor.
26. The assumption is that the new migrant households come with the dependency ratio of their homecountry.
27. There will be compositional impacts in translating gains from 2025 to 2001, since developing countries are growing on average more rapidly than highincome countries.

52

28. Results presented at the eighth annual conference on Global Economic Analysis held in Lübeck,Germany. See http://www.gtap.agecon.purdue.edu/
events/conferences/2005/program_day3.htm.
29. The full merchandise trade reform scenario iswith a standard model and ignores any beneficial impact through higher trade-induced productivity or
scale economy effects. Note that the gains from reformof services trade could be multiples of merchandise
trade reform. See Anderson, Martin, and van der
Mensbrugghe (2005).
30. In the case of high-income countries, ‘similar’
workers would be migrant workers from other highincome countries. Other migrant workers are bundled
together in a so-called ‘foreign-born’ aggregate.
31. One would expect the elasticity to increase as
the proportion of migrants in the population increases(box 2.5).
32. See, for example, Bchir and others (2002).
33. Box 2.5 shows how wages—native andforeign—are related to an increase in the stock of migrants. Two parameters are crucial—the substitution
between native and foreign workers and the share offoreign workers in the labor force.
34. The general equilibrium elasticity is only 0.27
for unskilled workers; for roughly a 40 percent increasein supply, wages decline by around 10 percent.
35. Migrants from other high-income countries(also assumed to have no nonwage income) see only asmall change in their real incomes, as their wages areclosely linked to the wages of native workers.
36. Observed wage differentials can arise from a
combination of two effects—differences in productivity and differentiated labor demand. If labor isperfectly substitutable, then the equilibrating condition is the equality of efficiency wages, that is,
productivity-adjusted nominal wages. If labor is differentiated, efficiency wages are no longer necessarilyequalized, and the equilibrium wage will be determinedby supply and demand conditions for the differentiatedlabor.
37. The empirical evidence on “catch-up” is limited. In the case of migrants to the United States, Borjas (2003b) shows that migrants who arrived in the
1960s almost caught up with natives within a 10–15
year period. Those who arrived in the 1970s made lessprogress in closing the gap with natives. However, thewages of migrants arriving in the 1980s actually fell
further behind those of natives after a 10-year period.
The scenarios described in this chapter assume nochange in the relative productivity of migrants. Such anassumption would require a more elaborate specification of migrants to capture their changing composition
over time, similar to modeling capital vintages. By

T H EP O T E N T I A L

ignoring the catch-up process, our results may underestimate the longer-term gains from migration.
38. The changes in wages by region of origin are
identical for all workers in each high-income region,
but due to aggregation effects, this will not necessarily
be true when averaging across regions.
39. The model has a vintage structure with a lower
substitution elasticity for “old” or installed capital anda higher substitution elasticity for “new” capital. The
actual substitution will be a weighted average of theold and the new vintages, with a higher average forcountries with relatively high rates of investment.
40. This follows directly from the assumption thatthe productivity level of migrants is initially 75 percent
that of natives.
41. The attrition rate will be a combination offactors—return migration, retirement, and death. The
first factor is probably most important the first year,
whereas the other two factors will depend on the ageof the migrant.
42. The value of 0.4 percent was chosen because itcorresponds to the change in the number of workers indeveloping countries—though it should be noted thatthe change in workers represents a change in the stocklevel, whereas the change in investment is a change inflows.
43. He notes that this trend may be changing, as
technology and globalization encourages smaller-scale
production and more permanent immigration.
44. This may occur because “the productivity benefits of skill complementarities are realized only when
the production process is sufficiently diversified,” or
because high-income economies are able to develop institutions that help them cope better with the potential
for conflict inherent in ethnic diversity (Alesina andFerrara 2004).

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3
The Policy Challengesof Migration: The Origin
Countries’ Perspective
In evaluating the impact of remittances, themain subject of this report, it is important totake into account the implications of theinitial decision to emigrate. This chapter will
analyze the implications for migrants and origin countries of migration for economic gainfrom developing to high-income countries.1
Focusing on this form of migration canhighlight some key policy dilemmas that governments face in improving the developmental
impact of migration.
Migration is an extremely diverse phenomenon. Its economic impact on each origin
country, and the impact of policy, will dependon many circumstances—among them theskills and former employment of migrants, thehistory of migration (the existence and location of a large diaspora), the sectors affected,
patterns of trade and production, the investment climate, and the size and geographicallocation of the country. For example, migration policies appropriate for a large developing country with substantial low-skilled emigration and effective institutions will differ
from the policies for a small island economy
with substantial high-skilled emigration andweak institutions.
Migration is as complex as it is diverse, so
predicting the impact of policy changes will be
problematic until more research is done andbetter data obtained. In particular, the gender
implications of migration are poorly understood and require more research. Migration
also has important social and political impli-

cations, that may be as important as the economic analysis provided here. For all of thesereasons, the analysis and policy recommendations in this chapter must remain heavily qualified. Our purpose is to signal to policymakers
in developing countries, and to the development community in general, the elements thatshould be considered in formulating migration
policy.
International migration often generates great
benefits for migrants and their families,
although at some risk. Migration can greatly
increase incomes of both migrants and theirfamilies and has helped countless households
escape poverty. While most workers gain greatly
from migration, the decision to migrate issometimes made with inadequate information
and at high risk and cost, particularly if the
migration is irregular. By providing information
on migration opportunities and risks,
governments could help avoid unfortunate,costly migration decisions. Governments should
also consider means to prevent and prosecute
trafficking and other abuse of migrants, and tostrengthen migration-related partnerships
between origin and destination countries.
Increasing the emigration of low-skilledworkers would significantly reduce poverty indeveloping countries. In addition to enabling
emigrants to escape poverty and to reducing
poverty in the country of origin throughremittances (discussed in chapter 5),
low-skilled emigration can increase wages and57

G L O B A L

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2 0 0 6

reduce unemployment and underemploymentof poor workers in the country of origin.
Many of the poorest lack the financial
resources or the skills required for successful
emigration to high-income countries, butavailable data indicate that a significant
number of them do emigrate, although at
lower rates than the non-poor. Reducing the
restrictions on low-skill emigration, whileremaining sensitive to concerns in destination countries over social tensions, job
opportunities for low-skilled natives and thepotential burden on public expenditures, may
best be achieved through managed migration
programs designed jointly by origin anddestination countries. Such programs
should provide for temporary, low-skilledmigration—with incentives for return.
Emigration of high-skilled workers may
reduce living standards of those left behind andimpair growth, but can also be beneficial. Like
low-skilled migration, high-skilled migration
can greatly benefit migrants and their families
and can help relieve labor market pressures.
In addition, a well-educated diaspora can
improve access to capital, technology,
information, foreign exchange, and businesscontacts for firms in the country of origin. At
the same time, high-skilled emigration may
reduce growth in the origin country because(a) other workers lose the opportunity fortraining and mutually beneficial exchanges ofideas; (b) opportunities to achieve economies
of scale in skill-intensive activities may be
reduced; (c) society loses its return on highskilled workers trained at public expense; (d)the price of technical services (where thepotential for substitution of low-skill workers
is limited) may rise. Highly educated citizens
may also help to improve governance, improve
the quality of debate on public issues,encourage the education of children, andstrengthen the administrative capacity of thestate—all of which may be reduced throughemigration of the highly skilled.
Because of the lack of data and the myriadof individual country circumstances that can

58

influence the impact, it is impossible to reliably estimate the net benefit, or cost, to origin
countries of high-skilled emigration. We canonly offer some rough observations that reflect
the wide variation in high-skilled emigration
rates among countries:• Very high rates of high-skilled emigration affect a small share of developing
countries’ population, and many countries with high rates of high-skilled emigration have poor investment climatesthat likely limit the productive employment of high-skilled workers. On theother hand, the lack of high-skilledworkers may contribute to the poor
investment climate and limit the supply
response to economic reform.
• Some countries also find it difficult to
productively employ all high-skilledworkers because of small economic scaleor misguided educational policies that result in a large supply of college graduates
for whom no suitable jobs exist.
• High-skilled emigration has had a severe
impact on public services with positive
externalities. The loss of skills throughhigh-skilled emigration has particularly
impaired health services in several developing countries.
Origin countries harmed by high-skilled
emigration face difficulties in managing the
problem. Service requirements for access topublicly financed education can be evaded andare likely to discourage return, and proposals
for the taxation of emigrants to the benefit of
the origin country have made little progress.
Improved working conditions in public employment and investments in the infrastructure for research and development may beeffective in retaining key workers. Working
conditions can also be improved by strengthening governance, which may require political
will rather than money. Origin countries canalso encourage educated emigrants to returnby identifying job opportunities, cooperatingwith destination countries that have programs
to promote return, permitting dual nationality,

T H Eand helping to facilitate the portability of social insurance benefits.

The migration decision and its
impact on migrants and theirfamiliesM

aking the costly and sometimes risky
decision to move to another country
generally involves the expectation of large
increases (or lower variability) in income,described by economists as the net present
value of lifetime earnings.2 The migrant’s expected income gain from emigration also reflects his or her employment prospects at home
and the likelihood of employment overseas.

Better economic prospects drive migration
Migrants from developing to high-income
countries generally enjoy large increases inearnings.3 A dataset compiled by the International Labour Organization (ILO) shows thatworkers in high-income countries earn a median wage that is almost five times the levelof that of workers in low-income countries,
Figure 3.1 Median wage levels for workers
in the same occupation, relative to highincome economies, 1988–92aPercent
45
40
35
30
25
20
15
10
5
0
Upper-middleLower-middleincome countries income countries

Low-income
countries

Source: Freeman and Oostendorp (2000).
Note: Chart reports the median wage in each country/skill
group relative to the highest wage for that skill group, withthe ratio in high-income economies as the numeraire. Thus
the median wage in low-income countries (averaged acrossskill groups) is 20 percent of the median wage in high-income
economies.
a. Adjusted for purchasing power parity.

P O L I C Y

C H A L L E N G E S

O F

M I G R A T I O N

adjusted for differences in purchasing power(Freeman and Oostendorp 2000) (figure 3.1).
These data may overstate the wages that
migrants expect, because their earnings, at least
initially, tend to be lower than those of natives(Lucas 2004a). Moreover, many poor workers
who lack local language skills and have minimal education may find limited employment
prospects in high-income country job markets.
On the other hand, these data may understate
the benefit of migration from the perspectiveof the household. In measuring differences in
welfare between migrants and those who do
not migrate, migrants’ earnings in highincome countries are reduced to reflect thehigher cost of living in high-income countries—
or purchasing power parity (PPP). To the extent that migrants send earnings back home in
the form of remittances, however, this adjustment is not relevant, so household gains may
exceed the PPP-adjusted rise in earnings.4 Furthermore, the data on income differences may
influence expectations of future earnings for
migrants and their children, and would undoubtedly generate much larger migration, in
the absence of controls. Evidence of substantial migration pressure includes long queues ofapplicants for immigration to high-income
countries, the rise in irregular immigration,
the increase in asylum seekers (Hatton andWilliamson 2002), and the high fees paid tosmugglers who help migrants cross borders
illegally (Cornelius 2001).
The expectation of higher earnings is not
the only economic incentive for migration.
Households may decide to send some members abroad to diversify the family’s source ofincome and thus reduce risk, as shocks affecting the level of wages and the probability of
employment in the destination country may
not be correlated with the shocks affecting
domestic workers (Daveri and Faini 1999).5

Migration involves considerable costs
Despite clear gains for many, migration involves
costs and risks that, together with restrictions
on migration, help explain why most people
prefer to stay at home. Migration can entail

59

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P R O S P E C T S

2 0 0 6substantial up-front costs—transportation, fees
charged by recruitment agencies, fees to obtaina visa and work permit, maintenance while
searching for work, forgone earnings (if the
migrant was or could be employed at home),
the reduction in value of location-specific skills(for example, knowing one’s native language),and the pain of being separated from family andfamiliar surroundings. Obviously these costs
will vary enormously among migrants.
Lack of data makes it difficult to directly
test the relationship between costs and the decision to migrate. However, distance can beused as a proxy for costs, representing not
only transport costs, but also migrants’ limited familiarity with countries of destination.
Adams and Page (2003) find that distance isa significant determinant of the directionof migration from developing countries tothe United States, European members of theOrganisation for Economic Co-operation andDevelopment (OECD), and the Arab Gulf.
Long, Tucker, and Urton (1988) found that
distance was an important constraint on internal migration in the United States and theUnited Kingdom; what holds for internal migration (without political barriers or language
differences, and with limited cultural differences) probably holds even more strongly forinternational migration. Household surveys
also provide indirect evidence that distancehas an important impact on migration: whilesome of the poorest do migrate internationally, they are more likely to remain at home or
to migrate internally (see below).
Among the largest quantifiable costs tomigrants are fees paid to private recruitment
agencies, whose role in the international labormarket has increased substantially, in part because of the rise of temporary labor migration
programs.6 A major conduit of job opportunities for migrant workers, private recruitment
agencies often are instrumental in seeking out
new markets for job opportunities abroad.
They also provide services such as language
training and assistance with settlement (seeXiang 2003 in the case of China). However,they also can be a source of abuse (ILO

60

Table 3.1 Fees charged by recruitment
agencies
Country

US$

Year

Migration to the Middle East
Bangladesh
India
Pakistan
Sri Lanka
Sri Lanka

1,727
900
768
689
893

1995
1995
1995
1995
1986

Migration to Japan
Thailand⬎8,0001996

Migration to Malaysia
Thailand

666–1,000

1991

Sources: Abella 2004; Lucas 2004a; Eelens and Speckmann
1990; Spaan 1994.

2003b). Because many migrants lack information on foreign job markets, and some agencies may have considerable market power,
recruitment agencies have captured a substantial share of the rents generated by limits on
immigration (Lucas 2004a). Available data
(mostly from past years) indicate that recruitment charges range from $689 (in 1995) for
Sri Lankan immigrants to the Middle East to$8,000 (in 1996) for Thais seeking work inJapan (table 3.1).
Recruitment agencies’ potential for earning
rents raises the issue of whether governments
should regulate their fees. As constraints on
migration generate significant excess profits,
efforts to regulate recruitment fees would
appear to have merit. However, limitations on
the terms of mutually agreed contracts can bedifficult to enforce, and excessive regulation
can drive recruiters underground or lead themto switch to other countries. A few governments have attempted to regulate fees paid torecruiters, and require registration and minimum capital requirements or financial guarantees to limit abuses (ILO 2003a). In general,
successful regulation of recruitment agencies
involves a large pool of potential migrants (toreduce the likelihood of recruitment agencies
switching to alternative sources), effective
government institutions, and regulations that
focus on the most egregious abuses (insteadof just reducing the market rate). Even thePhilippines, considered to have a modelT H E

program, experiences difficulties in enforcing
fee limits, while most recruiters, including theUnion of Filipino Overseas Contract Workers,
argue that stringent regulation of recruiters
impairs the competitive position of Philippine
migrants relative to workers from other countries (Martin 2005). Destination countries
are probably in a stronger position to regulate
recruitment agencies effectively.

Decisions to migrate are often madewith inadequate information
The distance and differences in language andculture between countries of origin and destination imply that migration is particularly
affected by inadequate information. Migrants
may have a distorted notion of the possibilities
of employment and the likely wage in countries of destination, as well as insufficient information on the costs and potential risks ofthe trip. Smugglers, recruitment agencies, andothers with a financial stake in encouraging
migration may present a biased picture of the
migration experience, and poor information
increases the potential for migrants to sufferfrom fraud and abuse.7
Some origin-country governments haveattempted to protect their emigrant workers
by regulating the terms of labor contracts. For
example, Indonesia, the Philippines, and Sri
Lanka have drafted model contracts for various occupations and host countries that detailworking terms and conditions to be specified
in advance (Abella 1997). Such efforts can be
useful in articulating standards and informing
migrants of their rights. However, enforcementof such contracts in destination countries canbe problematic (IOM 2003). The Philippines,
India, and Bangladesh review contracts prior
to migrants’ departure, and Bangladesh verifies the genuineness of overseas work visas.
Some countries have entered into bilateralagreements that require destination countries
to issue visas only if the contract is approvedby the origin country. Restrictive policies ofthis kind run the risk of encouraging irregularmigration if workers cannot secure approvalof contracts in advance. Some countries use fi-

P O L I C Y

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O F

M I G R A T I O Nnancial incentives, such as special exemptions
from travel taxes for those who clear contracts
with government agencies, to facilitate government review of contracts. Some countries withlarge numbers of emigrants offer a comprehensive set of services, including predeparture
training, information on labor markets in destination countries, legal services,8 reintegration support, and welfare funds financed fromfees paid to origin-country governments bydeparting workers.9

A diaspora can reduce the costs
facing migrants
The stock of emigrants in countries of destination can reduce the costs facing new migrants
from the same origin country. The majorcountries of origin with significant diasporasin high-income countries (figure 3.2) are for
the United States: China, Cuba, El Salvador,
India, Mexico, Philippines, and Vietnam; andin other countries: Turkey (for Germany);
Serbia and Montenegro, Morocco, and Algeria(for France); and China (for Japan andCanada). As migrant networks spread, private
institutions and voluntary associations emerge
to provide a range of services, including counseling, social services, and legal advice; lodging, credit and job search assistance; and themeans to reduce the cost of undocumented migration, including smuggling and transport,
counterfeit documents, and arranged marriages (Massey and others 1993). The migrantdiaspora can also reduce the likelihood of, andfears concerning, abuse (see Gunatilleke 1998
for the example of Sri Lanka).
Evidence of how the diaspora encourages
migration can be seen in the grouping of
immigrants from the same country or local
region in countries of destination. Bartel(1989) and Jaeger (2000) find that U.S. immigrants tend to move near former immigrants ofthe same ethnicity. Munshi (2003) finds that anindividual is more likely to be employed and to
hold a higher paying nonagricultural job whena large number of migrants from his homecommunity are in the United States.10 Studiesof the Asia Pacific region have shown that61

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2 0 0 6

Figure 3.2 Major developing country diasporas in developed countries
Major diasporas in the United States

Other major diasporas

Millions of people

Millions of people

12

2

10
1.5
8
6

1

4
0.5
2

G Tur
er ks
m in
an
y
Se
in rb
Fr ia
an ns
ce
M
o
in roc
Fr ca
an ns
ce
A
in lgeFr ria
an ns
ce
C
hi
ne
Ja se
pa in
n
C
hi
ne
C se
an
ad in
a

m
na

ub

a
et
Vi

lv
Sa

C

ad

or

na
hi
C
El

In

ilip

pi

di

s
ne

ic
ex
Ph

M

a

0
o

0

Source: OECD 2004.
Note: Data from the United States are based on country of birth, while most European migration data are based on nationality.

networks raise migration rates once a few initial migrants are established in destination
countries (Massey and others 1998).

Figure 3.3 Estimates of stock of irregularmigration% of reported migrant stock

62

60
50
40
30
20
10

er
itz

K i Un
ng it
do ed
m

la
nd

ly
Ita
Sw

re
ec
e

y
m
an
er
G

G

e

0
an
c

Irregular migration appears to have increased
significantly in major countries of destination,although the estimates are unreliable. The
estimates are based typically on the differences
between census reports and other immigrantregistries, arrests at the border or internally,
and regularization programs (Jandl 2004).11
Irregular migration may have doubled in the
United States between 1990 and 2000, andmay now account for some nine million people (Passel, Capps, and Fix 2004)—about
25 percent of the total stock of migrants. The
scale of irregular migration in Europe may
also be high. Just under 700,000 irregular migrants applied for regularization under the recent amnesty drive in Spain. Mid-range estimates provided by Jandl (2003) indicate that
irregular migrants range from less than 10
percent of the total reported stock of migrants
in France to 60 percent in Greece (figure 3.3).
Most irregular migrants are low-skilled
because (a) immigration laws in high-income

70

Fr

Irregular migration is often subject
to substantial costs and risks

Source: Medium estimates from Jandl 2003.
Note: See note 11 at the end of this chapter for a definition of“irregular” in this context.

countries provide high-skilled workers withgreater opportunities for legal entry andresidence, and (b) it is more difficult for highskilled workers to practice their professions
without adequate documentation, such as educational credentials (Chiswick 2000). Also,
skilled migrants often have more to lose athome and may be less inclined to run the risks
involved in irregular migration. IrregularT H E

migrants also tend to be temporary, rather thanpermanent, immigrants (Carter 1999).12
Irregular migration imposes substantial
costs on migrants, compared with permanent
migration. It can be more expensive: the average price in 1991 for smuggling an illegal
migrant from China to the United States wasestimated at $30,000 and from $3,750 to$12,000 for migrants smuggled to Lithuania(Salt and Stein 1997). Irregular migrants canalso be paid low wages, have poor working
conditions, and be subject to violations of theprotections afforded under industrial-country
labor laws (Vayrynen 2003). Employers may
be able to pay irregular migrants less thanlegal migrants and natives because only certain employers will hire irregular migrants, or
because the migrants are reluctant to moveaway from support networks. Lower pay andhigher costs of migration also make irregularmigration less desirable for the origin country,
because they cut into remittances. Remittances
can be reduced by the relatively expensive
money transfer operations used by irregularmigrants who lack access to bank accounts(see chapter 6).
Irregular migrants can also be exposed
to physical danger. Since 1994 an estimated2,600 undocumented migrants have diedcrossing the United States–Mexico border(Meek 2003). Entrapment into prostitution
is a danger for women and children (Wickramasekera 2002). Trafficking in persons isestimated globally to involve some 600,000 to
800,000 men, women, and children each year
(U.S. Department of State 2004). Different
national policies toward migration control
make it difficult to combat trafficking andsmuggling, although the international protocols against these activities provide a common
instrument to criminalize them.13 Several
governments, notably in Southeast Asia, haveinstituted restrictions on the emigration of
women, fearing their exploitation. Unskilled
and semi-skilled women are allowed to emigrate from Bangladesh only when accompanied by a male partner (Siddiqui 2003). Suchoutright bans, in addition to being limitations

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on what is generally viewed as a basic right toemigrate, are likely to be counterproductive:
they may compel many women to move as
undocumented migrants, thus increasing theirvulnerability (Misra and Rosenberg 2003).
More comprehensive, cooperative policies bygovernments are likely to have a more positiveeffect, including the dissemination of information on the risks of migration, strengthened
protection for women in destination countries, and stepped-up identification and prosecution of traffickers. Migration agreements
between countries of origin, transit, and destination can help achieve such policy coherence(as in the bilateral agreements between some
EU states and Morocco and Tunisia, forexample).

There are costs for those left behind
Finally, migration may impose costs on family
members left behind, particularly children.
For example, Battistella and Conaco (1996)
find that the children of migrant parents from
Luzon, Philippines, performed worse in school
and tended to be less socially adjusted (particularly if the mother had emigrated) than children with both parents at home. On the other
hand, Bryant (2005) found that the improvement in the children’s health and schooling (financed by remittances), coupled with strong
involvement of the extended family, tended tomitigate the social costs of a parent’s migration. In general, emigration does impose hardships on family members left behind, but it
also improves household income and improves families’ ability to make compensating
adjustments that mitigate those hardships.14

The impact of international migrationon countries of origin varies
The impact of migration on countries of origin
varies greatly, depending on the size of emigrant flows, the kinds of migrants, and laborand product market conditions in the country.
In describing these effects, it is useful to distinguish between skill levels, given the differences in the labor markets for low- and highskilled workers.

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Low-skilled migration
Low-skilled migration can improve labormarket conditions for other poor workers
The stock of low-skilled emigrants who moved
from developing to industrial countries in 2000
averaged about 0.8 percent of developing
countries’ low-skilled, working-age residents—
about the same as in 1990. The regions withcountries close to the major destination countries had relatively high rates of low-skilled
emigration (figure 3.4).15
The effects of South–North migration on
working conditions for low-skilled workers in
the developing world as a whole must be
small. In individual countries, however, largescale emigration can place increased pressure
on wages or reduce unemployment of lowskilled workers at the margin. For example,
real wages in Pakistan’s construction sector
and the Philippines’ manufacturing sector
closely trace the deployment of overseas
workers (Majid 2000; Gazdar 2003).16 Lowskill emigration also may reduce underemployment or raise labor-market participation
without significant wage increases. Wagetrends in Albania, Bangladesh, and Sri Lanka,
for example, display no obvious signs ofimprovement, despite massive emigration(Lucas 2004a). The wage response to emigration depends on the institutional setting in
the labor market in the home country (such as
the role of unions, public sector employment,
and minimum wage laws); the extent of emigration relative to the domestic labor force;and the degree to which emigrants were productively employed before migrating.
The impact of international migration may
differ considerably among regions withincountries of origin, depending on the degree ofgeographic concentration of emigration andthe links with other regions through internalmigration. People in regions lying close to acommon border with the destination country
or with easier access to overseas markets (suchas metropolitan centers or coastal areas) havea tendency to migrate (Long, Tucker, andUrton 1988; Malmberg 1997). These effects
can be greatly magnified through the influenceof migrant networks, once initiated from a
specific location (Gunatilleke 1998; Shah1998). Internal migration to areas of high departure can be quite important to the trickledown benefits of international migration, andinternal migration also can have an important
poverty-reducing impact (box 3.1).

Migration of low-skilled workers
is usually beneficial
Figure 3.4 Emigration rates for low-skilledworkers% of low-skilled workers in home region
4
3.5
3
2.5
2
1.5
1
0.5
E
C uro
en p
tra e
l A andLan ati sia
d nA
C m
ar e
ib ri
M
be ca
id
an
dl
e
N E
or as
th t
A an
Ea fric d
a
st
As
ia
Pa an
ci d
f
So ic
ut
h
As
ia
Su
bSa
h
Af araric na0

Source: Docquier and Marfouk 2004.

64

Whether emigration results in reduced underemployment, increased labor-market participation, or higher wages, low-skilled workers
in the home labor market gain, either directly
or indirectly, from additional remittancespending. Emigration of low-skilled workers
thus can act as a safety valve for the failure tocreate appropriate employment at home.
There have been cases, however, usually in thecontext of South–South migration, wherelarge outflows of temporary or irregular workers have resulted in massive return flows due
to economic or political shocks in destination
countries.17 Also, reliance on large-scale emigration may retard efforts to address the issueof employment expansion over the longterm, as a result of either the remittance-driven

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Box 3.1 Internal versus international migration

Although internal migration is much larger thaninternational migration, they are in some respects similar phenomena. Both are largely driven by
economic disparities among regions, although conflict and natural disasters (not discussed here) can
also catalyze large movements of people. Both internal and international migration can be permanent or
temporary, voluntary or forced. Both can subject migrants to substantial risks. Both can result in improved labor conditions in the regions of origin.
Internal migration in Bangladesh, for example,
makes more rural land available for tenancy(Afsar 2003). While the risks are often higher
with international migration (particularly forirregular migrants), internal migration can also beplagued by trafficking of persons, particularly of
women and children, as evident in parts of SubSaharan Africa (Black 2004) and in India and China(Lee 2005).
Internal and international migration also havetheir differences. Wage differentials are often lower
within countries than between countries, reflecting
smaller differences in economic conditions withincountries than between countries.
Internal migration may have a larger role in
reducing poverty than does international migration.
While the expected wage gain is lower in internalmigration, poor workers may have a better chanceof finding work domestically than in economies withhigher wages, where workers’ lack of skills and language ability restrict job opportunities. Moreover,international migration tends to be more costly, so
the poorest workers may not be able to afford it.
While data are sparse, household surveys in a few
countries indicate the important impact that internalmigration has on poverty. In Sierra Leone, internal
remittances helped reduce income inequality in poor
areas in the 1980s (Black and others 2004). In the
Asia Pacific region, international remittances accrue
disproportionately to richer regions, while domestictransfers are directed mostly to poorer regions (UN-ESCAP 2003). In Ghana, internal remittances are estimated to reduce the level of poverty by 14 percent,compared with only 5 percent for international
remittances (Adams 2005).
Internal migration can have large costs on receiving
areas. The proliferation of HIV/AIDs in Ghana has
been linked to the movement of women from rural tourban areas, where unemployment and poverty often
force them into the unprotected sex trade (Black2004b). In some countries, internal migration to thecities has been so massive as to increase crowding andplace inordinate burdens on public services, which
lowers the quality of urban life.a
Internal migration often responds to substantial
emigration abroad. In the Philippines, there are indications of large movements from rural areas of thePhilippines into the Manila region from which mostoverseas workers are drawn, although this movement
appears to have done little to help sustain wages inrural areas (Saith 1997). Bangladesh has seen rapid responses of intra-village migration to replace departing
workers (Mahmud 1989). At the same time, as internal migrants gain skills, resources, information, andnetwork contacts, they often emigrate internationally.
For example, workers displaced by falling agricultural
prices in southern Mexico often moved to northerntowns to work in maquiladoras, later moving to theUnited States.
The links between internal and international migration are inadequately understood, in part because
basic data are lacking. To gather more data, it has
been recommended that a migration module in demographic and health surveys, censuses, household income and expenditure surveys, and labor force surveys
be included (Afsar 2005).

aIn China, for example, rapid urbanization has been accompanied by the emergence of urban enclaves of landless, unemployed migrants from rural areas (Pan 2004).

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2 0 0 6exchange-rate appreciation or the reducedpressure for policy reform. In general, however, the opportunity to send low-skilledworkers abroad provides substantial benefits
to origin countries because of the impact onlabor markets and remittances.

Low-skilled migration has contributed
to poverty alleviation
The reduced supply of low-skilled workers
may help to alleviate poverty, if as a result of
emigration, poor people receive higher wages
or find new opportunities to work or receive
remittances (see chapter 5). Low-skilled emigration also alleviates poverty to the extent
that the people emigrating are poor.18 It is
unlikely, however, that a large proportion of
migrants to industrial countries are pooraccording to the World Bank’s definitionof poverty as living on less than $2 a day—although certainly a very large share is poor
compared to even the poorest in high-income
countries. Most migrants from Mexico to theUnited States come from households located at
the middle and upper-middle levels of the income distribution (Rivera 2005). Individuals
with very low incomes are unlikely to be able
to obtain the financial resources necessary for
migration (see, for example, Mahmud 1989
for Bangladesh). Most of the world’s poor people live in countries that are far away from industrial countries (Bangladesh, Brazil, China,
India, Indonesia, and most of the countries of
Sub-Saharan Africa), so transportation is expensive. Moreover, many poor people lack the
rudimentary skills required to obtain a job inindustrial countries, as well as the social networks that would facilitate migration and provide assistance once in the destination country.
Nevertheless, the limited data indicate thatthe very poor do move abroad to some extent.
In Sri Lanka, returns from household surveys
show that the share of households with a family member abroad is approximately equal
across income groups.19 Adams (2004) provides model-based estimates implying thatabout 5 percent of Guatemalan householdswith incomes of less than $2 a day received

66

remittances from abroad (used here as a proxyfor having a household member who emigrated). Adams (2005) shows that less than
8 percent of Ghanaian households that received international remittances had estimatedincomes (excluding remittances) that fellwithin the first to fourth deciles of householdsby per capita expenditures; 55 percent had expenditures in the top three deciles. Lucas(2004a) quotes studies of Kerala (India), Pakistan, the Philippines, and Thailand to support
a conclusion that most emigrants were notfrom the lowest income levels, although thepoorest did participate to some extent.

High-skilled emigration
There is a sharp increase in high-skilledmigration
The emigration of high-skilled workers fromdeveloping countries has increased since the1970s.20 By 1990, the stock of high-skilled
South–North migrants in the United Statesalone was more than eight times the total
number of high-skilled migrants from developing to industrial countries over the 1961–72
period, not counting foreign students(Docquier and Rapoport 2004). The numberof highly educated emigrants from developing
countries residing in OECD countries doubled
from 1990 to 2000, compared to an approximate 50 percent rise in the number of developing-country emigrants with only a primaryeducation (Docquier and Marfouk 2004).
Rates of high-skill emigration vary enormously among developing countries, from lessthan 1 percent (Turkmenistan) to almost
90 percent (Suriname) and by region, from15 percent for Sub-Saharan Africa to 5 percent for Europe and Central Asia (figure 3.5).
It is important to keep in mind this degree ofdiversity, as high-skill emigration can havevery different effects, depending on the sizeand economic conditions in origin countries.
The increase in high-skilled migration ispartly due to the growing importance of
selective immigration policies first introduced

T H E

Figure 3.5 Emigration rates for those witha tertiary education, 2000
% of total tertiary-educated population
16
14
12
10
8
6
4
2
an Ea
d st APa s
c ia
Eu ific
C ro
en p
tra e
l A andLan ati sia
n
d
A
C m
ar e
ib ri
M
be ca
id
an
dl
e
N E
or as
th t
Af an
ric d
So a
ut
h
As
ia
Su
bSa
h
Af araric na0

Source: Docquier and Marfouk 2004.

in Australia and Canada in the 1980s andlater in other OECD countries.21 Major recruiting countries have increased their intake
of skilled migrants and relaxed their criteria
relating to labor-market testing and job offers.
Some countries (for example, Germany,
Norway, and the United Kingdom) have introduced new programs; others (such as Austria,
Republic of Korea, the Netherlands, andSweden) offer fiscal incentives to attract talent
to specific sectors (OECD 2005). These programs, and the migrants themselves, are responding to rising skill premiums in industrial
countries that have tightened global competition for skilled workers.

In some instances, high-skilled emigration
has a negative impact on living standardsof those left behind and on growth
There are several reasons that migration ofhigh-skilled workers may decrease living standards and growth. First, the total return toeducation may be greater than the private
return, because highly educated workers may
be more productive when interacting withsimilar workers, and they may help train otherworkers. One statistical measure of the beneficial impact of high-skilled immigrants isthat in the United States, both international

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graduate students and skilled immigrants were
found to be positively correlated with patentapplications (Chellaraj, Maskus, and Mattoo
2005). Highly educated citizens may also
make contributions to public goods—for example, in improving governance and strengthening the administrative capacity of thestate—which may be lost through high-skilled
emigration (McMahon 1999).
Second, the productivity of firms may
increase with size. If large firms require networks of professionals with specialized skills,
then overall productivity will be higher withmany professionals. For example, the value of
telephone networks increases with the numberof people connected. Expanding networks
efficiently may require highly technical skills.
Third, emigration of high-skilled workers
may impose a fiscal cost. In most developing
countries education is heavily subsidized by
the state, so that the permanent emigration of
educated workers represents a loss of fiscal
revenues.22
Finally, emigration of high-skilled workers
will increase the price of services that require
technical skills. It is difficult to provide comparable levels of service with low-skilled workers, and greater resources devoted to training
may be lost through further emigration.

But high-skilled migration is often
beneficial for origin countries
The costs of high-skilled emigration shouldbe evaluated against the beneficial effects of
migration, skilled and unskilled: increased remittances, higher wages (for migrants andworkers who stay home), and benefits to destination countries (see chapter 2). Moreover,high-skilled emigration will have a limited impact if it is difficult for high-skilled workers tofind productive employment in the country oforigin. This may be the case for three reasons.
First, the investment climate may be so poor,
because of political instability or other reasons, that many high-skilled workers cannot
pursue their professions. Even under such conditions, however, high-skilled emigration may
be harmful if it deprives the government of67

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2 0 0 6competent administrators and limits theprospects for growth once the investment
climate improves. Second, a significant proportion of high-skilled workers may not be
trained in professions required by the economy, perhaps because of government subsidy
policies. And third, some of the smallest developing countries lack the economic scale toproductively employ a large number of specialized professionals.23 These issues serve tounderscore concerns over the appropriatenessof state subsidization of university educationin many countries.24
Some recent articles have claimed thathigh-skilled emigration, even of productively
employed workers, may benefit development.
The opportunity to emigrate increases the returns to education, leading more individuals toinvest in education with a view to emigrating.
However, only some of the educated people
will actually emigrate. If the increase in humancapital of those unable to emigrate exceeds theloss from those who do emigrate, then society’s human capital rises following the openingof emigration opportunities (a phenomenon
known as the “brain gain”).25 The effect will
be largest in countries with large stocks ofemigrants (so that the probability of emigration is high). These models have beenquestioned, however, because they assume that
foreign firms are not able to discriminate
among educated workers (otherwise theywould take the best qualified, and so destroy
incentives for education by marginal candidates), and because these models do not apply
where family reunification programs, unrelated to the skills, predominate (Schiff 2005).

Findings on the impact of high-skilled
emigration are mixed
It is difficult to generalize about the impact ofskilled migration. The dispute over gains andlosses has remained largely conjectural andhas not been settled by the available empiricalstudies. On balance, it is not possible at present to provide an aggregate, reliable estimateof the true impact of high-skilled emigration.
Some partial conclusions follow.

68

Table 3.2 Emigration rates of skilledworkers, 2000
Percentage of workers with tertiary education living abroadLess than 10% to 20% to More than
10%
20%
30%
30%

Number of countries
Share of developing
country population (%)

62
75

33
19

16
3

28
3

Source: Docquier and Marfouk 2004.

The available data indicate that high rates
of high-skill emigration affect only a small
share of developing countries’ population. A
data set developed by Docquier and Marfouk(2004) indicates that the 77 countries withhigh-skilled emigration rates (to industrial
countries) in excess of 10 percent account for
only one-quarter of developing-country population (table 3.2).26 Moreover, about half ofthese people live in countries with very poor
investment climates (included in the bottom
25 percent of developing countries, as measured by the United Nations’ Human Development Index), which may indicate that manyhigh-skilled workers face limited opportunities
to practice their professions. It is important tonote that these data do not distinguish by profession (even though high emigration rates forliterature professors and physicians would
have different economic impacts) or by quality(the emigration of a Nobel laureate physicist
would represent a greater loss than the emigration of an average university graduate).
Some countries encourage skilled migration. China, Cuba, India, the Philippines, Sri
Lanka, and Vietnam all have programs tofacilitate training for migration, suggestingthat some policymakers see the benefits ofskilled migration—among them remittances,
relieving job market pressures, developmentof an extensive diaspora, and expectations
that many migrants will eventually returnwith improved skills (as discussed below).
Direct, cross-country tests of the relationship between high-skilled emigration andgrowth have been mixed. The preponderanceof evidence supports the view that education

T H E

makes an important contribution to growth.27
Beine, Docquier, and Rapoport (2001) detected a positive and significant impact onhuman capital formation from the opportunity for emigration, whereas Faini (2003)
found that a higher probability of migration
for workers with secondary education had no
visible impact on secondary educational
achievement in the home country.

High-skilled emigration has had enormous
impact on some sectors, especially health
The sectoral distribution of high-skilled emigrants is important for assessing the implications for countries of origin. Meyer and
Brown (1999) estimate that about 12 percent
of developing-country nationals trained in science and technology live in the United States.
If accurate, these estimates suggest that highskilled emigration may be much more serious
for production than shown by the data from
Docquier and Marfouk (2004) given above,
where total high-skilled emigration to industrial countries was estimated at about 8 percent of the stock of high-skilled developingcountry nationals.
High-skilled emigration may have a particularly severe impact on the health sector, andthe emigration of doctors and nurses may reduce the likelihood of some countries meeting
the Millennium Development Goals for reducing child mortality, improving maternal
health, and combating HIV/AIDS and tuberculosis. Chanda (2001) estimates that at least 12
percent of the doctors trained in India live in
the United Kingdom, that Ethiopia lost half of
its pathology graduates from 1984 to 1996,
that Pakistan loses half of its medical school
graduates every year; and that in Ghana only
about one-third of medical school graduatesremain in the country. Perhaps one-half of thegraduates of South African medical schools
emigrate to high-income countries (Pang,
Lansang, and Haines 2002), and Jamaica
had to train five doctors, and Grenada 22, to
keep just one (Stalker 1994).28 Of course, theincentive for migration is often conditioned
not only by the opportunity for higher earnings

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abroad, but also by poor working conditions
and public sector services in origin countries.

Origin countries face considerable
difficulties in limiting high-skilled
emigration
Even if high-skilled emigration were found to
be detrimental to living standards and growth,countries of origin would face serious obstacles in reducing it. Some countries haverequired that graduates of publicly fundededucation work for a period of time in public
sector jobs. But such requirements can beevaded, and their existence is likely to discourage return of migrants to the country of origin.
Several proposals have been made for international schemes to tax high-skilled emigrants,
with the funds earmarked for developing countries. Such schemes have made no progress, as
they would be hard to enforce. Calculating thewelfare loss from high-skilled emigration andthus setting an appropriate level of tax would
be difficult. Moreover, the schemes would
require the cooperation of migrants and countries of destination—something not likely to beachieved. Bhaghwati (1976) advocates thatdeveloping countries should subject their nationals working abroad to local taxes, as does
the United States. However, many developing
countries would find such a system of taxationdifficult to administer.
Some governments encourage skilled workers to stay by improving working conditions,providing research facilities, and giving incentives for research (see the discussion of incentives for return, below). China has reported
a nine-fold increase from 1995 to 2003 inforeign programs offered in cooperation withlocal institutions, which has resulted in lower
numbers of students going abroad (VincentLancrin 2004). Such programs may require
substantial resources, and poorer countries
will face difficulties in creating the conditions
required to retain their most-skilled workers.
In some cases improvements in governance,
which may require political determination
rather than large expenditures, may help toretain workers.

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Cooperation from destination countries
may help
Effective means of limiting high-skilled emigration, or increasing its benefits, will require
the cooperation of countries of destination.
One example has been the United Kingdom’s
code of practice for the international recruitment of health-care workers, which restricts
the active solicitation of health care professionals from developing countries. However,
implementation has been difficult because thecode does not apply to private sector recruiters(House of Commons 2004). A recent proposal
to require countries of destination to provide
Caribbean countries with subsidies for training health professionals could increase thesupply of health workers in both origin anddestination countries (Commonwealth Secretariat 2005).29 More broadly, contributions bydestination countries to education in origin
countries could both compensate origincountry governments for their training of emigrants and improve the qualifications of workers coming to destination countries. Anotherapproach, which would improve the coherenceof development policies, would be for destination countries to increase their investment insectors in which they lack skills, rather than“raiding” those skills from poor countries.

Diasporas
A large diaspora can expand market
access for origin countries
A potent benefit of high-skilled emigration isthe creation of a large, well-educated diaspora,
which improves access to capital, information,and contacts for firms in countries of origin. Immigrants play a role in facilitating trade by providing information and helping to enforce contracts (Rauch and Trindade 1999) and by acting
as intermediaries that can match buyers with reliable local suppliers (Yusuf 2001). Johnson andSedaca (2004) emphasize that diasporas can act
as “first movers” who catalyze growth opportunities and make connections between markets
that otherwise would not exist. Barré and others (2003) cite the importance of diasporas in70

generating possibilities for codevelopment between firms in the countries of origin and destination, and expanding technical cooperation.
With the growth of outsourcing of manufacturing components and telecommunications andother services, diaspora networks may be of increasing importance. However, despite thebroad agreement on the importance of diasporas and the many anecdotal comments on how
they have assisted development, it is difficult toquantify these benefits.
The diaspora can be a significant source of
foreign-exchange earnings (beyond remittances) for countries with sizeable emigration.
Orozco (2003) documents diaspora-related
increases in exports and tourism receipts forCentral America. Gould (1994) and Headand Ries (1998) found that increased emigration to the United States and Canada raised
exports from countries of origin.
There is some evidence that the diaspora
plays an important role in the transfer ofknowledge between destination and origin
countries. Agrawal, Cockburn, and McHale(2003) find that patent applications are likely
to be filed in both the country of residence andthe country of origin. Meyer and Brown (1999)
and Brown (2000) identify Internet-based expatriate networks of skilled professionals andstudents that facilitate the transfer of knowledge. However, the effectiveness of these networks is open to question: less than half of the
61 Internet-based networks examined in 2004
were updated regularly, and only 56 percent
were updated within the past year.30 Origincountry governments can help maintain ties tothe diaspora by supporting professional networks, promoting dialogue with government,
and funding educational, linguistic, and cultural programs.

The return of expatriates canbenefit development

T

he return of expatriates to their homecountry is widely perceived as benefitting
development (Ellerman 2003). Expatriates may

T H Ebe more effective than foreigners in transferring knowledge back home because of theirunderstanding of local culture. However, returnees may also represent retirees, or the lessskilled of the skilled cohort of emigrants(Borjas and Bratsberg 1994; Lowell andFindlay 2001), or may have difficulties inreadapting to the home country (Faini 2003),
or their skills may have deteriorated whileabroad (Ghosh 1996). Returnees may be thosedisappointed by the wages or working conditions or may have more difficulty in finding or
retaining jobs.31
A range of programs have been establishedto encourage return of highly educated nationals living abroad, with mixed results.
Among developing-country governments, forexample, China, the Philippines, Taiwan(China), Thailand, and Tunisia have offered awide range of incentives, including researchfunding, access to foreign exchange, expanded
real estate investment options, and study
opportunities.32
The domestic policy environment is criticalto productive return. Cervantes and Guellec(2002) cite the favorable impact of returning
expatriates in the Republic of Korea, attracted
by strong research and development (R&D)
environments and infrastructure investments.
Industrial parks helped to lure entrepreneurs
back to China. In Taiwan (China), the Hsinchu
Industrial Park attracted more than 5,000
returning scientists in 2000 alone (Saxenian2002). Conversely, a poor investment climate
will inhibit return. In Armenia, barriers toforeign direct investment (FDI) and inadequate enforcement of contracts have prevented
a more active involvement of the Armenian diaspora in local development (Gevorkyan and
Grigorian 2003). Saxenian (2000) cites the reluctance of Indian entrepreneurs to return because of government regulations that increase
the administrative cost of operating abusiness—although the Indian diaspora hascontributed to the development of information
technology in Bangalore.33
Both origin and destination countries canhelp facilitate return, on both a temporary andP O L I C Y

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permanent basis, through changes in regulaion. Both can allow dual citizenship, anincreasingly common practice (Aleinikoff andKlusmeyer 2002). Origin countries can eliminate rules that prevent emigrants from owning
or investing in property back home. Permanent
residents can be protected from losing theirstatus if they leave for a relatively limited period of time, as this discourages productive
temporary returns to the origin country.
Destination countries can also allow returning
migrants to benefit from the rights they acquire
during their work abroad, such as pensions,health insurance, and disability programs(Holzmann, Koettl, and Chernetsky 2005).34
Such arrangements, however, require effective
institutions in the origin country to provide
such services and are best achieved through negotiations between origin and destination
countries.
Destination countries have provided various
incentives for the return of migrants. For example, France has provided loans and technicalassistance to migrants from Mali and Senegal
to establish businesses in their home countries.
However, few of the businesses appear to havebeen successful, either because of the inadequate investment climate in the recipient communities (Gubert 2005) or because participants
had worked in low-level jobs in France andlacked entrepreneurial skills (Magoni 2004).
Many of these programs are quite small.35
International organizations, too, have managed programs to promote return, although
they tend to cover few emigrants. The IOM’s
Return of Qualified African Nationals program successfully attracted more than 2,000
highly skilled persons back to 41 Africancountries from 1974 to 1990, and the program was later expanded to the Migration for
Development in Africa program (MIDA).36
Similar programs have been run for Latin
American countries, Afghanistan, andBosnia and Herzegovina.37 The United Nations Development Programme’s TOKTEN
project promotes temporary return (threeweek to three-month development assignments), which is often easier to achieve.

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Temporary migration andinternational agreementsT

he number of temporary workers admitted to high-income countries under skillbased programs rose substantially in the
1990s, doubling in the United Kingdom andalmost quadrupling in the United States (figure 3.6). Foreign student programs are also
proliferating, in part due to competitive marketing and entry policies by Australia,
Canada, Germany, and the United Kingdom.
Inflows of unskilled, seasonal workers also
have increased since the early 1990s in mosthigh-income countries that have such programs (UN 2004). Greater emphasis on temporary migration may reflect opposition to
expanding permanent migration.
Temporary labor migration schemes vary
greatly from country to country. Skilled migrants tend to have more opportunities underunilateral visa programs (such as the U.S.
H-1B visa and the temporary skilled migration
programs of Australia and Canada), while
unskilled migrants often must rely on bilateralor regional agreements, such as the seasonal
work programs between Germany and countries in central and eastern Europe.

Figure 3.6 Number of temporary workers
admitted under skill-based programs
Thousands
600
500
400
300

Australia
CanadaUnited Statesa
France200

United Kingdom

100
0
1992

2000

Source: United Nations.
Note: Double counting occurs if a person enters the UnitedStates more than once during the year.
a. Reflects the number of admissions under H-1B visas,
not the number of persons.

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Temporary migration may facilitate
greater migration flows
While temporary migration programs can generate benefits similar to those of permanent migration (such as higher incomes for migrants,
improved efficiency in destination countries,
remittances for origin countries), in some respects those benefits differ between permanentand temporary migration. For the legal migrant, being admitted on a temporary basis
may be less desirable than permanent
residence, which provides for free movement
between destination and origin countries.
However, the existence of temporary migration
programs (reflecting resistance to permanent
migration) may facilitate larger legal flows.
From the point of view of the destination
country, temporary migration offers the flexibility to target required skills and to adjust
entry in response to changes in labor demand.
Temporary migration can reduce fiscal pressures that may be associated with low-skilled
immigration, in that temporary migrants tend
not to bring their dependents (who may require public services). At the same time, programs can be made conditional on employment, thereby limiting social tensions from
immigration. Provisions for temporary migration also can be viewed as offering an alternative to irregular migration.
The record of destination governments inensuring that temporary migration programs
are indeed temporary has been mixed. For
example, over 22 years, most workers in the
Mexico–U.S. guest workers program returnedat the end of their seasonal jobs, although somefound ways to obtain permanent status (Martin
2003). Similarly, from 1960 to 1973, threequarters of the 18.5 million foreigners whocame to work in Germany left. But 25 percent
remained. Coupled with rules that allowed
many to eventually bring their dependents, thisresulted in significant permanent settlement.
There is some evidence that the recent guest
worker programs in Europe, particularly those
involving subcontracting for short-term projects and some return incentives, have managed
higher return rates (Lucas 2004a).

T H E

There are advantages and disadvantages
to temporary migration
Reliance on repeated, temporary migration
for workers also has some economic drawbacks. Hiring a temporary immigrant may
mean a shorter duration of employment compared with hiring a permanent immigrant, andthus higher costs for training. Temporary migrants are also less likely than permanent ones
to invest in skills specific to the destination
country (such as language proficiency andlicensing requirements), because the returns
are enjoyed over a shorter period of time
(Chiswick 2000). Nevertheless, for emigrants
from developing countries, the wage differentials are so large that they may justify substantial investments in acquiring such skills,
even for temporary stays.
For the origin country, remittances (andrepatriation of assets) may be higher withtemporary migration, because temporary migrants are less likely to bring their dependents
and more likely to maintain close ties withthe home country. Perhaps most importantly,
temporary migration programs can provide an
opening to increase legal, unskilled migration,
which generates the greatest developmental
impact for origin countries, as already noted.
On the other hand, temporary migration may
provide a less reliable means of exporting
large labor surpluses, as cancellation of futureaccess is easier for destination countries than
expelling existing migrants. However, it is thisflexibility (coupled with less long-run population pressure, fewer concerns over integration,and fewer pension commitments) that makes
temporary migration desirable for destination
countries, thus facilitating agreements forlarger unskilled migration (Winters 2005).

Bilateral agreements can play animportant role in low-skilled, temporary
migration
Bilateral labor agreements have become amajor vehicle for low-skilled, seasonal workers
in agriculture, tourism, and construction, as
evidenced by agreements between the UnitedStates and Mexico, Germany and central andP O L I C Y

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eastern European states, and Saudi Arabia andEgypt and Libya. There are several hundred
such agreements worldwide, including some
168 signed in the last 50 years in Latin America
alone, half in the past 10 years (IOM 2005a).38
Bilateral agreements could improve the benefits of temporary migration for origin countries
through greater certainty of access and conditions. This may be particularly important inmarkets where increased competition fromother suppliers might lead to a reduction in access (as occurred in Saudi Arabia and the Middle East in the 1990s). Bilateral agreements canhelp build the confidence in both origin anddestination countries that a particular channelof migration will generate real benefits andminimize costs—for example, that migrants
will be treated well and will return at the end of
their contract.
Several factors impede the maximizationof gains from bilateral agreements, however.
Some origin countries may lack sufficiently
reliable information on demand for theirworkers in destination countries, and in which
sectors, to negotiate appropriate agreements.
Destination countries may likewise have difficulty reliably estimating labor shortages inparticular sectors. And origin countries may
face resource constraints in implementing
obligations with regard to prescreening of migrants or monitoring of their return, althoughthese may be covered by the destination
country (as in a nurses program between
Romania and Italy). Origin countries may alsolack bargaining power to conclude terms
favorable to them or to conclude agreements
at all. For example, of 18 bilateral agreements
proposed by the Philippines with countries
in Africa, Asia, Europe, and the Middle
East, five countries refused to enter into
agreements, and others have remained inactive (Go 2004).
Nevertheless, there is scattered evidence
that countries like the Philippines have beenable to use bilateral agreements to gain
favorable employment conditions for theirmigrants—and in some cases to support theirreturn and reintegration (Lucas 2004b).

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Bilateral agreements can help ensure thatorigin-country credentials are accepted in
destination countries, for example.39 They canhelp ensure that temporary migration is indeed
temporary, and that returning migrants arereintegrated, by supporting the transfer oftechnology and human resource developmentin the origin country, as under Spain’s agreements with Colombia and Ecuador (IOM
2005a). Bilateral agreements can also ensurethat the origin country cooperates in monitoring and managing migration, for example, byincorporating a readmission provision (as in the1997 agreement between Italy and Albania).
They also can limit the effects of brain
drain. For example, a pilot scheme between
the Dutch and Polish ministries of healthprepared Polish nurses for employment in the
Dutch health care system for a maximum
period of two years and to facilitate theirsubsequent return and reintegration into thePolish health care system.40 Other proposals
take a development-cooperation approach,under which destination countries fund thetraining (to their standards) of a given numberof nurses in excess of origin country demand,with the surplus nurses granted temporary
visas to work in destination countries for a
specified period, with guaranteed return.

Except in the EU, regional andinternational agreements have had
little impact on migration
At the regional level, there has been some
progress on removing technical and administrative barriers to the cross-border exchangeof skilled personnel for business purposes inAfrica, Europe, Latin America, and parts ofAsia. Also, several consultative processes on
migration have emerged at the regional andglobal levels.41 However, with the major exception of the EU, most regional arrangements
have had little impact on the free movement ofless-skilled foreign workers or on permanent
migration (World Bank 2005).
International treaties have had only limited
impact on migration. Mode 4 of the General

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Agreement on Trade in Services (GATS) has
the potential to improve cooperation on labor
services between countries of origin and destination, but so far it has not facilitated a significant rise in cross-border labor movements(box 3.2). The ILO has pioneered the development of international instruments for protecting the rights of migrant workers, and the UN
General Assembly adopted the International
Convention on the Protection of the Rights of
All Migrant Workers and Members of Their
Families, which clearly defines the rights of
migrant workers, including irregular workers(Wickramasekera 2002). The convention entered into force in 2004. However, none of the
major destination countries have ratified it yet,and its means of enforcement are limited.

International agreements governing
migration contrast sharply with thosefor trade
A major impulse behind the General Agreement on Tariffs and Trade and its successor,
the World Trade Organization, was that multilateral agreements that provide for nondiscrimination among countries would maximize
the gains from trade. By contrast, there is little support for multilateral, nondiscriminatory
approaches to migration, at least in destination countries. In part this is because theeconomic implications of nondiscriminationdiffer between trade and migration. In trade,nondiscrimination maximizes economic efficiency by allowing the lowest-cost supplier tocompete, thus reducing prices and forcing
high-cost producers to improve efficiency orexit the market. But labor markets in highincome countries are generally not permitted(through minimum-wage laws and socialinsurance schemes) to adjust fully to thelowest-cost supplier. Thus the benefits of
nondiscrimination are weaker in migration
than in trade. U.S. consumers benefit if Indian
shirts are cheaper than Mexican shirts, but
U.S. employers benefit little if Indians are willing to work for less than Mexicans—thedecline in wages is limited.

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Box 3.2 Mode 4 and international migrationT

he WTO General Agreement on Trade in Services (GATS) does not cover labor migration perse, but rather the narrower concept of movement ofpeople across borders as one of four modes of delivering services. Mode 4 covers the temporary movement of persons across borders for the purpose of
supplying a service. “Temporary” movement is notdefined, but permanent migration is explicitly
excluded, as are workers in most nonservice sectors,
such as agriculture or manufacturing.
Mode 4 service suppliers can be viewed in termsof both duration and purpose of stay: they enter acountry for a specific purpose (to fulfill a service
contract), for a limited and (generally) specified period of time, and are usually confined to one sector
or one job (they do not enter the labor market andare not free to search for employment). Mode 4 isnormally understood to include business visitors(persons who come for three months or less to negotiate a contract), intracorporate transferees (persons
transferred within a company from one country toanother), and suppliers of contractual services (individuals or employees of foreign companies with acontract to supply a service to a client in the receiving country). While Mode 4 includes persons at all
skill levels, to date market-opening commitments by
WTO members have been limited to the highly
skilled.
Relatively few market-opening commitments on
Mode 4 have been made by both developed and developing countries. Those that have been made tend
to be subject to restrictions on number, type, and duration of stay of service suppliers. Countries’ actual
regimes for temporary entry of workers tend to be
more liberal than their GATS commitments, however, and considerable movement on service issues is
occurring in a range of sectors (such as health),
notwithstanding the near-absence of relevant GATS
commitments.
Five issues arise regarding GATS Mode 4 as an
instrument to manage labor mobility. First, GATS
commitments are fixed commitments of guaranteed

treatment, while migration regimes seek to retain
flexibility to make adjustments in line with labormarket conditions. Second, GATS commitments
follow the most-favored-nation (MFN) principle—
that is, treatment offered to one country must be
extended to all WTO members—whereas migration
regimes can offer special treatment to countries withwhich regulatory trust or other special relationships
have been built (through visa waiver programs, forexample). Third, GATS Mode 4 covers only a relatively limited subset of the workers moving aroundthe globe. Agricultural workers, for example, are notgenerally viewed as falling under the GATS. Fourth,multilateral trade negotiations have a 50-year history,
while migration has largely remained a national policy prerogative characterized by limited international
dialogue. Finally, movement of people, especially thelower-skilled, raises a raft of issues related to socialand cultural integration, exploitation, impact on
local labor markets, and, more recently, security that
trade agreements are ill-equipped to address.
Against this background, what role might the
GATS play in managing labor mobility? The GATS
is a narrow, but sharp, instrument that can deliver a
powerful guarantee of access, but only for certain
types of workers. Beyond this, however, GATS negotiations can be used to create a sense of urgency that
may serve to bring migration authorities to the table
to discuss ways to manage mobility. Bilateral or regional approaches could, for example, include lowskilled workers and develop creative, cooperative approaches to issues such as remittance transfer, brain
drain, and loss of investment in education, prescreening of temporary workers, and return. These agreements could assist in building regulatory trust andimproving management schemes in receiving andsending countries. Over time, by creating a templateof basic requirements or criteria that could be applied to all countries on a nondiscriminatory basis,
they could be used to extend access to a wider groupof countries and so approach the MFN principle of
GATS.

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But the largest reason that nondiscriminatory approaches are limited is that people are
not goods: migration has much broader implications for society than does trade. Destination countries tend to be concerned that
immigrants from countries with very different
cultures will not integrate easily into society,and high-income countries tend to limit lowincome migrants for fear of overburdening
public services (see chapter 2). Thus eventhose countries that have immigration regimesthat do not discriminate by country tend to
discriminate by level of skill.
A final important distinction between tradeand migration is that trade is subject torelatively effective regulation, while many
countries of destination face considerable
difficulties (and internal disagreements) in regulating immigration. The lack of effective
regulation and incomplete efforts to control
immigration encourages many low-skilled migrants to run substantial risks that can lead toconditions akin to slavery, great physical danger, and even death. On the other hand, thesame lack of control works to the advantage of
migrants by offering opportunities that might
not otherwise exist and by benefiting groups
within destination countries. The evidence inthis chapter suggests that cooperation between
origin and destination countries, throughagreements that provide for temporary, lowskilled migration, and through enforcement oflaws protecting migrants from exploitation
and abuse, can improve the impact of migration for countries and for migrants.

Notes
1. Of course, migration may arise out of a combination of economic, political, and social goals. Also,
migration among developing countries is an increasingly important phenomenon, but given data limitations we focus here on migration from developing toindustrial countries.
2. Empirical work largely confirms the view that
income differentials are important determinants of
migration. Borjas (1987), Karemera, Oguledo, andDavis (2000), and Hatton and Williamson (2002)
found that migration to the United States was negatively related to source-country income per capita,

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among other variables. Solimano (2002) found that
real per capita income differentials between Argentina
and source countries were the main determinant of net
migration flows in the twentieth century.
3. See also chapter 2, which points out that
migrants’ earnings (per worker) increase eleven-fold,before adjusting for differences in purchasing powerin high-income versus developing countries.
4. The basic idea is that the opportunity to earnmoney based on developed country prices but spend it(through remittances) based on developing country
prices is a major benefit from migration. The same
adjustment from the perspective of the migrant is
discussed in the modeling exercise in chapter 2.
5. See the discussion of remittances and smoothingof household consumption in chapter 5.
6. By the late 1990s, public employment services
already played an insignificant role in the recruitmentof foreign workers, except where migration wascovered by bilateral labor agreements (ILO 1997). For
example, nine out of ten workers sent from Asia
have used private recruiters (Abella 1997); and forRomania, most jobs in countries with which the government has not secured bilateral agreements are foundby private intermediaries (Diminescu 2004).
7. Hugo (2004) describes how work contractors
are the primary source of information for potential
migrants from Indonesia, and relates this to the highlevels of exploitation of Indonesian contract workers
compared with workers from other countries.
8. Support services provided through Philippine
labor attachés have provided critical legal counselingand protection (Moreno-Fontes Chammartin 2005).
9. The funds operated by the Philippines, Pakistan
and Sri Lanka provide scholarships, legal aid indestination countries, insurance against death anddisability, and loans for predeparture costs, housing,and self-employment. The administration and delivery
can often be difficult, particularly on insurance (Tan
2004), and some emigrants may resent the mandatory
nature of the schemes (Abella 1997).
10. Also regarding Mexico, Mora and Taylor(2005) find that the presence of a family member in the
United States increases by 7 percent the probability
that an individual will migrate, while McKenzie (2005)
shows that larger migration networks increase theprobability of other community members migrating.
11. An irregular migrant in this context is defined
as any person entering, residing, and working in a country without proper documentation of their legal status
in that country, or any person who has committed acrime or breach of immigration law in that country andtherefore is not entitled to remain in that country.
12. However, Cornelius (2001) notes that the shareof irregular migrants who settle permanently in the

T H E

United States has increased—a trend accelerated bytighter border enforcement adopted in the mid-1990s.
13. Protocol to Prevent, Suppress and Punish Trafficking in Persons, Especially Women and Children;
and Protocol against the Smuggling of Migrants by
Land, Sea and Air, 2000. These supplement the Convention against Transnational Crime, 2000.
14. Dedicated government offices such as thePhilippines Overseas Workers Administration, unions
such as the seamen’s union in the Philippines, and nongovernmental organizations (NGOs) can help families
and communities make adjustments when family members migrate.
15. These data are described in Docquier andMarfouk (2004), which relies on census data (plusextensive estimations), and thus undercounts irregularmigrants, who are mostly low skilled. The data aretaken largely from industrial countries, so that lowskilled migration to other developing countries, as wellas high-income countries in the Middle East and Asia,
is not reflected (which, for example, reduces the ratioof low-skilled emigrants from South Asia).
16. Similarly, mine labor recruiting in South Africa
increased wages in the plantation sectors in both
Malawi and Mozambique, which ultimately resulted in
the curtailed permission to recruit in Malawi in theearly 1970s (Lucas 1987).
17. For example, the compulsory repatriation ofworkers to Kerala following the Gulf conflict in
1990–91 threw Kerala into a fairly sharp recession(Lucas 2004b).
18. This is not invariably true, for example, if thedeparture of one household member leaves his or her
dependents impoverished. In general, family income islikely to rise with emigration, but cases of real hardshipcaused by emigration do exist.
19. This calculation is based on income that includes remittances from the emigrant, so the number of
Sri Lankan households with a family member abroadthat were poor prior to migration is probably larger.
20. Much of the data on high-skilled migrationrefers to individuals who have some tertiary education,although other kinds of qualifications (electrician,plumber, ability to handle sophisticated machinery) areof economic interest.
21. See Lowell (2001) for a list of programs to
attract high-skilled workers.
22. For example, forgone income tax revenues
associated with Indian-born residents of the UnitedStates may be equal to one-third of current individual
income tax receipts in India (Desai, Kapur, andMcHale 2001), although this is a very low share of
total government revenues.
23. Such countries benefit highly from remittances.
Remittances to countries with populations of less than

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1.5 million totaled about 6 percent of gross national
income, compared with an average of 1.7 percent for
all developing countries.
24. Available data do not distinguish émigrés
educated at home from those educated abroad, an issueof growing importance as education is increasingly
marketed to the developing world by high-income
countries.
25. This theory is developed in Mountford (1997),
Chau and Stark (1999), Stark (2003), and Drinkwaterand others (2002).
26. These data do not include high-skilled emigrants to other developing countries, which may be an
important issue for many developing countries.
27. Microeconomic evidence tends to find that
education is associated with higher earnings (Mincer
1991). After some considerable debate, recent articles
find that years of schooling have a positive impact on
productivity growth (de la Fuente and Domenech
2002), and that the quality of education (as measured,for example, by pupil-student ratios or the dropoutrate) may matter more than the quantity (Barro and
Lee 2000).
28. Clemens (2005) presents an alternative view,
arguing that health systems in Africa are not greatly
weakened by emigration because the option to emigrate encourages entry into the medical field.
29. Institutions exist in countries of origin thattrain workers for external labor markets, for example
some nursing schools in the Philippines and a medical
school in Budapest that teaches in German. However,these schools do not receive funds from potential countries of destination (World Bank 2004).
30. Data are based on a survey carried out for abackground paper, available on request.
31. Workers who stayed in Albania had higherquality skills than returnees (De Coulon and Piracha
2002), and returnees from Sweden were found to beless successful economically than emigrants who stayed(Edin, LaLonde, and Åslund 2000). See also Hugo
(2002) on re-emigration from Australia and Constantand Massey (2003) on Germany.
32. See Pang, Lansing, and Haines 2002 on
Thailand, Lucas (2004a) on China, and the IOM officein Tunis on Tunisia.
33. The High-Level Committee on the Indian
Diaspora (2001) notes the role of expatriates in attracting R&D investments from Intel, Oracle, Texas
Instruments, Sun Microsystems, and IBM.
34. Recognizing benefits earned abroad may
reduce costs to the destination-country government, asmany such services are likely to be less expensive in developing countries. The cost implications have someuncertainty, as some migrants will choose to return
even without portability of benefits.

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35. For example, a program between Germany andEritrea disbursed only 65 loans from 1993 to 1997,
while a project in Italy’s Veneto region trained only 30
Albanian immigrants in setting up companies orlaunching joint ventures with local companies in theircountry of origin.
36. The Return of Qualified Africans program wasevaluated by the European Commission as contributing to development at micro levels (IOM 2005b).
37. The Return for Qualified Afghans has been
criticized for offering low compensation packages andinvolving few individuals despite being expensive torun (Jazayery 2002).
38. Australia, Argentina, Canada, and the UnitedStates entered into bilateral labor agreements withcountries of origin in the mid-twentieth century. The
bracero program admitted some five million Mexican
farm workers to the United States between 1942 and1966. In Europe, Germany and France recruited guest
workers from southern Europe, Turkey, and North
Africa after the Second World War until the economic
downturn of the 1970s.
39. An example is the agreement that provides forthe acceptance of Vietnamese information technology
credentials in Japan (Vietnam Trade 2005).
40. The pilot ended in January 2005, and the outcomes are being evaluated by the Dutch government.
41. Regional examples include the Regional Conference on Migration (Puebla Process) and Lima Process
in the Americas; MIDSA and MIDWA in Africa; and theManila, APC, and Bali Processes in Asia. Inter-regional
processes include the “5 plus 5” (a migration dialogue
established in 2002 between southern Europe—France,
Italy, Malta, Portugal, Spain—and the Maghrebgroup—Algeria, Libya, Mauritania, Morocco, andTunisia. Global consultation forums include the UN
Global Commission on International Migration, theBerne Initiative, IOM’s International Dialogue on Migration, and ILO’s International Labor Conference.

References
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for Low- and Middle-Income Countries. Geneva:
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———. 2004. “The Role of Recruiters in Labor
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Prospects and Policies in a Global Market, ed.
Douglas S. Massey and J. Edward Taylor. Oxford:
Oxford University Press.
Adams, Richard. 2004. “Remittances and Poverty in
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3418. World Bank, Washington, DC.
———. 2005. “Remittances and Poverty in Ghana.”
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4
Trends, Determinants, andMacroeconomic Effectsof Remittances
Chapter 3 reviewed the trends, opportunities,
and policy challenges associated with international migration. It also introduced theeconomic importance of the funds that international migrants send back to their countryof origin. In recent years, those funds haveemerged as a major source of external financing in developing countries. Although there isno universal agreement yet on how to measureinternational migrants’ remittances to developing countries, a comprehensive measure ofcertain officially recorded flows—workers’
remittances, compensation of employees, andmigrant transfers—produced an estimate of$167 billion for 2005, up from $160 billion in
2004. Given measurement uncertainties,
notably the unknown extent of unrecorded
flows through formal and informal channels,
the true size of remittance flows may be muchhigher—perhaps 50 percent or more. Becauseof their volume and their potential to reducepoverty, remittances are attracting growing
attention from policymakers at the highest
levels in both developed and developing
countries.1
This chapter and chapters 5 and 6 consider
remittances from several angles. The organizing framework is driven by three items on theinternational policy agenda: (1) understanding
the true size and trends in remittance flows todeveloping countries, as well as their macroeconomic impact; (2) evaluating the impact ofremittances on the households that receive

them; and (3) designing policies to reduce thetransaction costs of remittances, strengthen
the formal financial infrastructure supporting
remittances, and leverage remittances to improve access to financial services in recipient
economies.
Officially recorded remittance estimates
may significantly underestimate the real magnitude of remittances. Model-based estimatesand household surveys suggest that informal
flows could add at least 50 percent to the official estimate, with significant regional andcountry variation. The true size of remittanceflows could be even larger, in view of substantial underrecording of flows through formal
channels.
Despite the prominence given to remittances from developed countries, South–South
remittance flows make up 30–45 percent of
total remittances received by developing countries, reflecting the fact that over half ofmigrants from developing countries migrate toother developing countries. Remittance flows
to poor countries originate largely in the
middle-income developing countries.
Recorded remittance flows have surged inrecent years, driven by a combination offactors—among them better data collection,reflecting greater awareness of the development potential of remittances, as well as concerns about money laundering and terrorist
financing; lower costs and wider networks in
the industry that supports remittance; and85

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2 0 0 6growth in the number of migrants and theirincomes. Government policies to improvebanking access and the technology of moneytransfers have also helped increase the flow ofremittances and promote their transfer
through formal channels.
Efforts to encourage remittances, however,sometimes generate unwanted effects. Tax
incentives may attract remittance inflows, forexample, but they also create opportunities
for tax evasion. Likewise, matching-fundprograms for migrant associations may channel collective remittances to development
projects, but in so doing they may divert funds
from other local funding priorities.
For some recipient countries, remittances
are large enough to have broader macroeconomic implications. By generating a steadystream of foreign-exchange earnings, they
can improve a country’s creditworthiness forexternal borrowing, and through innovative
financing mechanisms (such as securitization),they can expand access to capital and lower
borrowing costs. While large and sustained
remittance inflows can contribute to currency
appreciation and so affect the production of
cost-sensitive tradables (such as laborintensive manufactures), this outcome may
be less severe than it is in the case of natural-resource earnings (since remittances are distributed more widely and may avoid exacerbating
the strains on institutional capacity that areoften associated with natural-resourcebooms). Furthermore, the “Dutch disease”
effects of remittances are of relatively minor
concern insofar as remittances grow gradually
over long periods. Remittances have a large
positive effect on national income in many developing countries, and there is compelling
evidence that they contribute significantly topoverty reduction (see chapter 5). Although
the evidence on the effect of remittances onlong-term growth remains inconclusive, in
economies where the financial system is underdeveloped, remittances appear to alleviatecredit constraints and may stimulate economic
growth.

86

The plan of this chapter is as follows. In thenext section, trends in remittance flows to developing countries are presented along with arange of estimates for their true size—that is,with informal flows included. We identify the
major sending and receiving countries, including those in the South. In the following section, we examine the factors affecting remittance flows, including the prospects for future
remittance growth, and policies and regulations in source and destination countries that
affect the cost of remittances. In the final section, we consider the macroeconomic effects
of remittances, including the effects on stability, country creditworthiness, international
capital-market access, the real exchange rate,and competitiveness.

Remittance data and trendsThe quality and coverage of data on remittances leave much to be desired. First, there
is no consensus on the boundaries of the phenomenon under study. Should only workers’ remittances be counted, or should we include
compensation of employees and migrant transfers? (See annex 4A.1 for more details on thesenomenclatural disputes.) Second, in several
countries, many types of formal remittanceflows go unrecorded, due to weaknesses in datacollection (related to both definitions and coverage).2 Reporting of “small” remittance transactions made through formal channels is notmandatory in most countries,3 and remittances
sent through post offices, exchange bureaus,
and other agents of money transfer operators(MTOs) are often not reflected in official statistics (de Luna Martinez 2005). Third, flows
through informal channels (such as unregulatedmoney transfer firms or family and friends whocarry remittances) are rarely captured. Finally,
remittances are often misclassified as export
revenue, tourism receipts, nonresident deposits,
or even foreign direct investment (FDI). Improving the quality of remittance statistics is thefocus of ongoing cooperative international
efforts (see box 4.1).

T R E N D S ,D E T E R M I N A N T S ,A N D

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R E M I T T A N C E S

Box 4.1 International working group on improving
data on remittancesAt its meeting in Sea Island in April 2004, the G-8
called upon the international financial institutions (IFIs) to lead a global effort to improve remittance statistics. In January 2005, the World Bankand International Monetary Fund (IMF) held aninternational meeting of data users and compilers
who agreed that balance-of-payments statistics were
the appropriate framework for collecting, reporting,and improving official statistics on remittances; thatbalance-of-payments concepts and definitions relating to remittances should be reviewed; and that
improved guidance for collecting and compiling
remittance statistics, including through the use ofhousehold surveys, was needed. Participants at theinternational meeting also agreed that improvements
to relevant statistical concepts and definitions should
be discussed in a Technical Sub-Group on the Movement of Persons (TSG), chaired by the UN Statistics
Division with membership from central banks andnational and international statistical agencies.
The TSG recommended that the “workers’ remittances” item in the balance of payments be replacedby “personal transfers.” The new term would cover
all current transfers in cash or in kind made orreceived by resident households to or from othernonresident households. It went on to recommendthat a new aggregate, “personal remittances,” bereported in the standard balance-of-payments presentation as a memorandum item. It was proposed that
personal remittances comprise current and capitaltransfers in cash or in kind, made or received, by

Officially recorded remittance flows
are surging
In this report (as in past editions of the WorldBank’s annual Global Development Financeand the IMF’s 2005 World Economic Outlook), migrant remittances are calculated as
the sum of workers’ remittances, compensation of employees, and migrant transfers (seeannex 4A.1). Thus defined, remittances received by developing countries, estimatedresident households to or from nonresident households, and “net” compensation of employees frompersons working abroad for short periods of time(less than one year).
The TSG also recommended that institutional
remittances—those involving government, corporations, and nonprofit institutions serving
households—should also be reported as a new memorandum item in the standard presentation ofbalance-of-payments statistics. That item would leadto a further memorandum item, “total remittances,”the sum of personal and institutional remittances.
Because the concepts of personal transfers andremittances are based on the concept of residence
rather than migration status, the TSG recommended
that the concept of “migrant” be replaced by theconcept of “residence” in the balance-of paymentsframework. Reporting of bilateral remittance flows
is not currently required in the balance of payments,
but the recommendation of the TSG is that flows toand from major partner countries be identified.
The TSG is expected to produce a final report inspring 2006.aaA concurrent effort to improve remittance statistics isunder way at the Center for Latin America Monetary Studies(CEMLA) with support from the Multilateral Investment Fundof the Inter-American Development Bank and technical advice
from an international advisory council that includes the IMF
and World Bank.

using officially recorded data, rose to$167 billion in 2005, up 73 percent from2001 (table 4.1). More than half of that increase occurred in China, India, and Mexico.
Low-income countries, led by India, registeredan increase of $18 billion during this period(box 4.2). Of 34 developing countries that received remittances in excess of $1 billion in
2004, 26 countries registered more than
30 percent growth during 2001–4: Algeria

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Table 4.1 Workers’ remittances to developing countries, 1990–2005$ billions

Developing countries
Lower middle income
Upper middle income
Low income
Latin America and the
Caribbean
South Asia
East Asia and thePacific
Middle East and North
AfricaEurope and Central
Asia
Sub-Saharan Africa
World (developing &industrial)
Outward remittances fromdeveloping countries
Outward remittances from
Saudi Arabia

1990

1995

2000

2001

2002

2003

2004e

2005e

Change (%)
2005–2001

31.2
13.9
9.1
8.1
5.8

57.8
30.0
14.5
13.3
13.4

85.6
42.6
20.0
22.8
20.1

96.5
47.4
22.3
26.8
24.4

113.4
57.3
23.0
33.1
28.1

142.1
72.5
27.8
41.8
34.8

160.4
83.5
33.0
43.9
40.7

166.9
88.0
33.8
45
42.4

73
86
52
68
74

5.6
3.3

10.0
9.7

17.2
16.7

19.2
20.1

24.2
27.2

31.1
35.8

31.4
40.9

32.0
43.1

67
114

11.4

13.4

13.2

15.1

15.6

18.6

20.3

21.3

41

3.2

8.1

13.4

13.0

13.3

15.1

19.4

19.9

53

1.9
68.6

3.2
101.6

4.9
131.5

4.7
147.1

5.2
166.2

6.8
200.2

7.7
225.8

8.1
232.3

72
58

6.1

12.5

12.1

14.3

18.7

20.2

24.1

–

–

11.2

16.6

15.4

15.1

15.9

14.8

13.6

–

–

Source: World Bank staff estimates based on IMF BoP Yearbook 2004 and country sources.
Note: Remittances are defined as the sum of workers’ remittances, compensation of employees, and migrant transfers (seeannex 4A.1). e  estimate.
– Data not available.

and Guatemala reported more than a tripling ofremittance inflows; Brazil, China, Honduras,
Nigeria, Pakistan, and Serbia and Montenegro
reported growth in the range of 101–170 percent. (Also, five high-income countries—
Austria, Australia, Belgium, Germany, andSpain—reported 45–79 percent growth inremittance inflows during 2001–4.)
The growing importance of remittances asa source of foreign exchange is reflected in thefact that remittance growth has outpaced
private capital flows and official development assistance (ODA) over the last decade(table 4.2). Recorded remittance receipts wereequivalent to about 6.7 percent of developing
countries’ imports and 7.5 percent of domestic investment. They also were larger than official flows and private equity (non-FDI) flows
in 2004. Remittances were larger than public
and private capital inflows in 36 developing
countries in 2004 and larger than total
merchandise exports in Albania, Bosnia and88

Table 4.2 Recorded remittances havegrown faster than private capital flows
and ODA$ billions

Workers’ remittances
Foreign direct investment
Private debt and portfolio equity
Official development assistance

1995

2004

58
107
170
59

160
166
136
79

Source: World Bank (2005).

Herzegovina, Cape Verde, Gaza, Haiti,
Jamaica, Kiribati, Lebanon, Nepal, Samoa,
Serbia and Montenegro, and Tonga. In another 28 countries, they were larger than theearnings from the most important commodity
export; for example, in Mexico, remittances
are larger than FDI; in Sri Lanka, they arelarger than tea exports; and in Morocco, they
are larger than tourism receipts.

T R E N D S ,D E T E R M I N A N T S ,A N D

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Box 4.2 The recent surge in remittance flows to India

I

ndia has reported a spectacular increase in remittance inflows—from $13 billion in 2001 to morethan $20 billion in 2003 (see figure). Several factors
account for this remarkable increase. First, the number of migrants has grown sharply. During the oilboom in the 1970s and 1980s, thousands of lowskilled Indian workers migrated to the Persian Gulf
countries. In the 1990s, migration to Australia,
Canada, and the United States, increased significantly, particularly among information technology(IT) workers on temporary work permits.a
Second, the swelling of migrants’ ranks coincidedwith (a) better incentives to send and invest money
Remittance flows to India$ billions
25
20
15
10

in India’s growing economy and (b) an easing of theregulations and controls, more flexible exchange
rates, and gradual opening of the capital account.
The elimination of the black-market premium on therupee and convenient remittance services provided byIndian and international banks have no doubt shiftedsome remittance flows from informal hawala channels to formal channels.
Third, nonresident Indians have also responded
to several attractive deposit schemes and bonds
offered by the government of India. These offer
attractive interest rates and an appreciating rupee.
While nonresident deposits are conceptually different from remittances (they are a liability item inthe capital account), evidence suggests that a largepart of such deposits is converted to local currency.
For example, for the Resurgent India Bond thatmatured in 2003, most of the redemption value
stayed in India to meet various local currency
needs of the nonresident depositors and their families. Nevertheless, remittances in the form of foreign-currency deposits can be speculative and may
reverse in the event of deterioration in theinvestment sentiment.

50
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20

Figure 4.1 identifies the top 20 remittancerecipients in 2004. Among developing countries, China, India, Mexico, and the Philippines
were among the top recipients. Several industrial countries appear in this list as well.
When remittances are calculated in percapita terms or as a share of GDP, a different
picture emerges. The top 20 recipients inshares of GDP are all developing countries;
all receive more than 10 percent of GDP as
remittance flows (figure 4.1). Small countries(Bosnia and Herzegovina, Haiti, Lesotho,
Moldova, and Tonga) are among the most dependent on remittances.

aIn particular, migration to United States doubled during
the 1990s. Remittances from United States as a share of total
remittances to India grew from 37 percent in 1997 to 51 percent in 2003.

High-income countries are the dominantsource of global remittance flows (figure 4.2).
The United States was the largest source
country with nearly $39 billion in outward
remittances in 2004. However, outward
remittances from developing countries
amounted to $24 billion in the same year.4
When expressed in terms of GDP shares, outward remittances play the largest role in theupper-middle-income developing countries(0.7 percent of GDP in these countries
compared to 0.2–0.4 percent in other developing countries and in high-income countries;
figure 4.2).

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Figure 4.1 Top 20 remittance-recipient countries, 2004
Billions of dollars

Share of GDP

India

21.7

Tonga

China

21.3

Moldova

18.1

MexicoFrance12.7

Philippines

11.6

Spain

31.1
27.1

Lesotho

25.8

Haiti

24.8

Bosnia and Herzegovina

6.9

22.5

Jordan20.4

Belgium

6.8

Jamaica

17.4

Germany

6.5

Serbia and Montenegro

17.2

United Kingdom

6.4

EI Salvador

16.2

Morocco

4.2

Honduras

15.5

Serbia4.1

Philippines

13.5

Pakistan

3.9

Dominican Rep.

13.2

Brazil3.6

Lebanon

12.4

Bangladesh

3.4

Samoa

12.4

Egypt, Arab Rep.

3.3

Tajikistan

12.1

Portugal

3.2

Nicaragua

11.9

Vietnam

3.2

Albania

11.7

Colombia

3.2

Nepal

11.7

United States

3.0

Kiribati

11.3

Nigeria

2.8

Yemen, Rep.

10.0

0

5

10

15

20

25

0

15

30

45

Source: IMF BoP Yearbook, 2004, and World Bank staff estimates.

South–South remittance flows
are considerable
Official data show that several developing
countries (China, Malaysia, and the RussianFederation) are among the top 20 sources ofremittances. Anecdotally, outward remittancesfrom India and South Africa are also believed
to be large, although this is not reflected in theofficial data (Genesis Analytics 2005). The
World Bank (2005a) points out a strong association between remittance receipts and thelength of the border shared with more prosperous neighbors. Harrison and others (2004)
also report that most remittance flows occur
within the same region.
These factors all point to the conclusionthat South–South remittance flows are substantial. But placing more precision on theseflows is hard to do. First, relatively little is
known about bilateral migration flows—that
is, about how many migrants (or what share)in each receiving country come from each90

sending country. Comprehensive global data
are not available,5 but estimates are that inpoor countries of East Asia, South Asia, and
Sub-Saharan Africa, more than two-thirds ofemigrants migrate to a country in the same region. In South Asia and Sub-Saharan Africa,
most migrate to another developing country.
Second, even less is known about how bilateral remittance patterns differ. We do not
know, for example, how much, in total, is sentfrom one country to another, or how remittance propensities differ across sending andreceiving countries. But by making plausible
assumptions about these flows (in particular,that bilateral remittances are a function of thestock of migrants in the sending country), it
is possible to estimate bilateral remittanceflows and to calculate what proportion
comes through South–South links.6 Using thismethod, we estimate that nearly 30 percent of
total remittance flows to developing countries
originate in other developing countries. ThisT R E N D S ,D E T E R M I N A N T S ,A N DFigure 4.2 Estimated remittance payment,by country group, 2004

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Eastern Europe, Turkey, and North Africa;
and the Persian Gulf to South and Southeast
Asia.

Billions of dollars
125.3

15.4
3.0

5.7

Low-income
countries

Lowermiddleincome
countries

Uppermiddleincome
countries

High-income
countries

Share of GDP
0.7

0.4
0.3
0.2

Low-income
countries

Lowermiddleincome
countries

Uppermiddleincome
countries

High-income
countries

estimate is consistent with the fact that nearly
half of the migrant stock from the South migrate to another country in the South.7
One of the challenges of understanding
remittance flows is that their characteristics,
costs, and channels can vary widely from one
bilateral corridor to another (and also widelyfrom different locations within each country).
Understanding how remittance corridors
differ in the kinds of migrants they serve andtheir means of transferring money is useful for
providers of remittance services as well as policymakers (Hernandez-Coss 2004; Terry
2005; and chapter 6 of this volume). Some of
the major remittance corridors are those thatconnect Canada and the United States to Latin
America and Asia; the European Union to

Informal remittances are large
Remittances transferred through informal
operators or hand carried by travelers areunlikely to be captured in official statistics,
although they may represent a substantial
addition to remittances sent through official
channels. While it is extremely difficult to estimate the flows through informal channels,
they appear to be large. First, the fact thatrecorded remittances to several countries
through formal channels doubled, tripled, or
quadrupled between 2001 and 2003 suggeststhat a significant part of the increase is likely
to reflect a shift from informal to formal channels in response to the tightened regulatory
scrutiny that has occurred since September 11,
2001.
Second, evidence from household surveys
suggests widespread use of informal remittance channels (table 4.3).8 Household surveys also help identify factors affecting the useof remittance channels. In the presence of awell-developed formal sector, regular remittersand large remitters are unlikely to use theinformal sector. Trust in the financial system is
an important prerequisite for a growing bankpresence in the (formal) remittance market.
High remittance costs and the presence ofdual exchange rates are two key factors
affecting the choice of informal remittance

Table 4.3 Choice of remittance channel
in selected countries% remittances

Dominican Republic
Guatemala
El Salvador
Armenia
Moldova
Bangladesh
UgandaFormalInformal

96
95
85
62
53
46
20

4
5
15
38
47
54
80

Source: World Bank staff estimates based on household
surveys. See also Freund and Spatafora 2005.

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2 0 0 6channels.9 If there were no cost advantages tousing informal channels, there would be little
incentive to use them, and remittances could
arguably shift entirely to formal channels.
Thus if the costs of formal transfers werereduced to the range reported in the informal
sector (2–5 percent), and if official and parallel exchange rates were unified, the resultant
increase in recorded remittance flows could
be interpreted as an estimate of the size of
informal flows.
Table 4.4 reports the results of an exercise
to estimate the size of the informal remittancesector (see annex 4A.2 for a fuller explanation). Cross-country regression analysis
shows that reported remittances are lower,
and informal flows higher, in corridors whereremittance costs are higher and where there
are significant black-market premiums over
the official exchange rate. Using the estimatedcoefficients from these regressions, thepredicted increase in officially recorded remittances is calculated in response to a 2–5 percent decline in remittance costs and elimination of the exchange-rate premium. These
calculations suggest that the informal remittance sector is at least 50 percent of theTable 4.4 Estimated increase in formal
remittances if transaction costs werereduced to 2 to 5 percent and dual
exchange rates were eliminated
Percent
RegionAll developing countries
Sub-Saharan Africa
Eastern Europe and Central Asia
East Asia and the PacificSouth Asia
Middle East and North Africa
Latin America and the Caribbean

Cross-sectional
estimatesPanelestimates

69
201
151
56
25
165
51

54
122
73
..
55
..
99

Source: Freund and Spatafora 2005.
Note: Results averaged over 1995–2003. See annex 4A.2 fora fuller explanation of the procedures used. In column 3,
a reduced form equation is estimated on the basis of the
explanatory variables used in the cost regression reported intable 4A.2.2.
.. Negligible.

92

official sector.10 They also show significant
regional variation. Informal remittances appear to be larger in Sub-Saharan Africa, theMiddle East and North Africa, and Europe
and Central Asia than in other regions.11
While the magnitude of the regional estimatesvaries across methods, the relative ranking ofregional effects is more robust.

Factors affecting remittance flows

The surge in remittance flows over the past
few years reflects a mix of factors, as
noted. In some areas, there have been significant reductions in remittance costs—60 percent in the United States–Mexico corridor
since 1999. On the measurement side, the sizeable depreciation of the dollar against mostother major currencies (the euro in particular)
since 2002 has increased the dollar value of
nondollar remittances over time.12 Improvements in data recording by central banks—in
response to growing recognition of the importance of remittances by national authorities,
and as a result of broader efforts to improvedata quality—have generated sharp increases
in remittance flows in some cases. In addition,heightened security and scrutiny by immigration and finance authorities in many highincome countries may have encouraged outward surges in remittances, as undocumented
migrants responded to increased uncertainty
and risk of deportation or other legal action byremitting a larger share of their savings orincome. This factor has reportedly been important in Pakistan, which recorded a triplingof remittance receipts from 2001 to 2003.

The surge in remittances is likely tocontinue in the medium term
In addition to these special factors, powerful
economic factors also influence the growthof remittances. Increases in the number of
migrants will have the greatest and most direct
impact, of course, along with compositionalfeatures, such as the mix between temporary
and permanent workers (temporary workers

T R E N D S ,D E T E R M I N A N T S ,A N Dare believed to remit a larger share of theirincome) and the skill mix (low-skilled workers
tend to send a higher proportion of their lower
incomes). Employment opportunities in thehost country affect income, and therefore
remittances, while changes in the cost of living
may affect the size of the surplus that remitters
are able to send.
The complex interplay of these factors
makes assessing the future growth potential of
remittance flows quite difficult. It is plausiblethat in the coming years, official remittanceflows will continue to rise at the 7–8 percent
annual rate seen during the 1990s. With boththe supply and demand for migrants growing, migration flows—especially temporary
migration—are likely to continue to be strong.
Growing income levels in source countries andrising costs of living in receiving countries,
together with the falling costs of remittances,would also imply larger remittances, especially through recorded channels.
It is unlikely, however, that the surge inremittance flows seen in some countries since2001 will continue much longer. The shift inflows from informal to formal channels, to theextent that it occurred in response to tightened
scrutiny, is likely to dwindle. (In Pakistan,for example, remittance flows have flattenedsince 2003.) In the more mature UnitedStates–Mexico corridor, where remittancecosts have already fallen drastically (by 60 percent since 1999), the effect of further cost
reduction will not be as large as it was five
years ago.
Some analysts argue that in the more mature
markets, “remittance decay” may set in, especially if temporary or undocumented workers
are allowed permanent and legal residence.
While it is true that the marginal propensity toremit tends to decline with the length of a migrant’s stay in a host country, and ties with thehome country weaken over time, there is noempirical evidence that the dollar amount ofremittances actually declines in these circumstances.13 On the contrary, the effect of risingincomes of the migrant sender may show up as
an increase in remittances over time.

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R E M I T T A N C E SGovernment policies can affectremittance flows
Many sending and receiving governments
are only now beginning to think about policies
to increase remittance flows and promotetransfers through formal channels. In theremittance-receiving countries, these policies
include tax exemptions for remittance income; improved access to banking services byrecipients; incentives to attract investments
by the diaspora; access to foreign exchange
or lower duties on imports; support for the
projects of migrant associations; and help for
migrants in accessing financial systems. In theremittance-source countries, they include policies affecting access to banks, access to foreignexchange, support to migrant groups, types ofimmigration regimes, and cooperation withreceiving countries.14

Policies in remittance-receiving countries
Taxes on incoming remittances. Most
remittance-receiving countries today do not
impose taxes on incoming remittances. Theremay be some implicit tax on remittances, however, in the form of a general financial services
tax15 or on remittances in kind (for example,
food, clothing, electronic items, or vehicles).
When Vietnam removed its 5 percent tax onremittances in 1997, it found that the flow ofremittances through formal channels increased. Such tax exemptions may well increase remittance inflows,16 but they also raise
the possibility of misuse for tax evasion.
Travel and customs privileges for returns andimported goods. Many remittance-receiving
countries give preferential treatment tomigrants sending home or bringing with themgoods and equipment. For example, once a
year Tunisians are entitled to import goods
and/or services up to a customs value ofTD1,000 without paying tax, and a private
vehicle, home equipment, and furniture aretax free when they return; Guatemala permits
a once-a-year tax-free remittance of any commodity valued up to $500. Pakistan, Turkey,
Vietnam, and many other countries also offer
such import privileges.17

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Relaxation of exchange and capital controls.
Unification of exchange rates and allowing
more banks and financial institutions to undertake foreign exchange transactions havebeen among the most successful ways of attracting remittances to formal channels andexpanding remittance services in many countries. Also, allowing residents to hold foreign
currency deposits using remittances fromabroad is believed to have resulted in a large
increase in formal remittances in many countries in South Asia and Africa (Siddiqui 2004).
India’s liberalization of the exchange rate in1991 has been linked to a decrease in the useof illegal transfer channels to the state ofKerala; and the Philippines found that byabolishing exchange controls it quadrupled its
formal inward remittances in the same year
(Buencamino and Gorbunov 2002). Allowing
the market to decide exchange rates in 2002
also helped the Bangladesh Bank to curb theinformal hundi business significantly (Siddiqui2004). In 2004, an increase in foreign currency reserves in Zimbabwe was ascribed, inpart, to the introduction of a new moneytransfer system (Homelink) set up by the government to facilitate formal transfers.
Allowing domestic banks to operate overseas.
Governments have allowed more of theirdomestic financial institutions (including
microfinance institutions in some countries) toopen branches and provide services to theirmigrants working in other countries. These
domestic banks bring trust and offer remittance services at competitive prices. For example, the Groupe Banques Populaires has
picked up 66 percent of total remittances to
Morocco by offering low fees, simple procedures, and other nonfinancial services to
Moroccans abroad (Amin and Freund 2005).
Two small Armenian banks specializing in remittance transfers, Anelik and Unibank, havecome to dominate the formal transfer system
for Armenians in parts of Europe; andFonkoze in Haiti has expanded its U.S.–basedclientele in partnership with the City National

94

Bank of New Jersey. In Bangladesh the dramatic increase in formal remittances since2001 is, in part, the result of the improved services of the banking sector (Siddiqui 2004).
ID cards for migrants. Providing identification
cards to migrants (regardless of their legal migration status) to access banking facilities has
also opened up more opportunities for formal
remittance transfer. Mexican immigrants, forexample, can obtain a photo-identification
card in the form of a matricula consular from
the Mexican consulates abroad. This card is
widely accepted by commercial banks in the
United States to open bank accounts (and inmany states, for issuing driving licenses, seebox 6.1). Other Latin American governments
are discussing similar arrangements for theirnationals in the United States. Most sending
countries require legal documentation for any
bank transaction. Some receiving countries
issue ID cards to expedite domestic services
for their emigrants, for example, the Tunisiancarte consulaire for special customs clearance,
reduced airfares, and foreign currency bankaccounts in Tunisia.18
Support to hometown associations (HTAs)
and matching grants. Providing funds tosupplement or match collective remittances
made by emigrant groups is another means toengage migrants in the development of homecommunities. With enhanced institutional
capacities, HTAs could be valuable development partners for governments, the private
sector, and communities, but importantly as acomplement to, not a substitute for, strengthened financial and investment systems on the
ground (Gubert 2005). A careful evaluation of
support to HTAs through matching grantschemes and other means is yet to be undertaken (see box 4.3).
Loans/pension schemes and bonds targeted at
the diasporas. These measures can expand
opportunities for investment and provide incentives for the formal transfer of money fromabroad (see also chapter 6). While investments

T R E N D S ,D E T E R M I N A N T S ,A N Din the form of nonresident deposits or diaspora bonds are not, strictly speaking, remittances (because they involve the purchase of
assets, rather than transfers to households),
they may indirectly encourage remittances.
Many countries have successfully issued premium bonds to their diaspora (forBangladesh, China, Eritrea, India, Israel,
Lebanon, Pakistan and the Philippines, see
Carling 2005). Even when investments inthese bonds are in foreign currency terms,
after maturity some portion is likely to remain

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in the country. Such schemes were a major factor behind the doubling of remittance flows to
India between 2002 and 2003 (box 4.2).
Active policies and institutional arrangements
to support the diaspora. Countries like
Mexico and the Philippines with more successful remittance programs tend to have wellestablished institutional frameworks to train,
support, and ensure the welfare of their expatriates abroad. There is also a broad range ofoutreach activities to assist migrant welfare

Box 4.3 Collective remittances through hometown
associations and matching schemesM

any migrants are increasingly pooling theirresources and investing collectively indevelopment-related activities in home communities,
either through hometown associations (HTAs) orother migrant group schemes.a HTAs are the mostprominent, because of their proliferation among theLatin American and Caribbean diaspora in Canada
and the United States since the late 1990s. Similar
associations exist in France (some 1,000 organizations de solidarite internationale issues de migrations
or OSIMs), the United Kingdom, and Africa.b The
activities of HTAs are mixed and poorly documented, but they range from diaspora support in
the host country to community investment projects
in villages in the home country.
Collective remittances via HTAs currently accountfor only 1 percent of all remittances in Central
America, but it is estimated that they could rise to
3–5 percent in ten years if their management andinstitutional capacity improves (IFAD 2005).
Most HTAs tend to be small scale and philanthropic in orientation, and they invest in projects of
no more than $10,000. They have traditionallyfocused on infrastructure and social projects(schools, churches, recreational parks, medical outreach clinics, and household support) and on channeling post-disaster humanitarian aid (for example,
in El Salvador). In Africa, there is evidence that themore sustainable projects tend to facilitate household

distribution of consumer goods (as in general storesor grain banks) or the purchase of farming equipment (Gubert 2005). In Latin America, it is observedthat when at least 30 percent of households in a
town receive remittances, HTAs can help improve
the quality of life of households (IOM 2005). But thefocus of HTAs is expanding to include more investment in economic infrastructure and incomegenerating projects managed by the community andlocal NGOs or banks (Orozco 2003).
Governments have, on occasion, offeredmatching grants for remittances from diaspora
groups or HTAs to attract funding for specificcommunity projects.c The best known of thesematching schemes is Mexico’s 3-for-1 program,started in 1997, under which the local, state, andfederal governments all contribute $1 for every $1of remittances sent to a community for a designateddevelopment project. By 2002, the 3-for-1 program
had established projects totaling $43.5 million, twothirds of which benefited labor-intensive agricultural
economies in four high emigration states (IOM2005). In the period 2002–4, more than 3,000 suchprojects benefited some 1 million inhabitants in
23 Mexican states.d
Evidence from Mexico suggests, however, that
HTAs have not been very successful. But in somecases (for example, Zacatecas) where HTAs haveexchanged or debated project ideas and investment

95

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Box 4.3 (continued)
climate issues with the local and state governments,
they are believed to have been successful.e
On the positive side, HTA involvement in projects
is argued to ensure that programs are focused oncommunity needs. Resources have gone primarily torural areas, where they have increased the supply of
essential services (health, education, roads, and electricity). Donations by HTAs are often as much as ormore than the municipal budget for public works,
particularly in towns with small populations (Orozco
2003). HTAs can promote higher standards of transparency and accountability among local authorities,
and higher labor standards.
There are obviously limitations on the potential
for HTAs to serve as conduits for broader development projects. They may not have the best information about the needs of the local community, or they
may have different priorities. The capacity of HTAs
to scale up or form partnerships is limited by the factthat their members are volunteers, and theirfundraising ability finite. They can also become
divided and weaken their own advocacy potential(Newland and Patrick 2004). When matching funds
come from fiscally constrained governments, there isalso the problem that they may be diverted fromother—perhaps higher priority—development

projects, or from other regions with a greater needfor assistance.
aHTAs are grassroots migrant organizations, usually formed
around the interests and needs of a mutual hometown. The
term has been coined in the United States, where many thousands of Latin American and Caribbean HTAs have sprung up
in the past 15 years or so (Orozco and Welle 2004).
bMigrant associations exist in many countries, but are
mostly concerned with the conditions of the diaspora and networking abroad. Some, like the Sierra Leonean Women’s Forumin the United Kingdom, are concerned with immediate survival
needs (food, clothing) back home (Black and others 2004).
cIn addition to Mexico, the Salvadoran government partners
with HTAs in rural development projects in El Salvador. In
2001, the federation of HTAs (COMUNIDADES) and the National Corporation of Municipalities created the Social Investment for Local Development Fund (FISDL) to provide
matching project funding. In France, the Osims can also
receive institutional and financial subsidies from the government for social and economic development projects back home
(Magoni 2004).
dSee “3 por 1. Proyectos Compartidos,” prepared for theseminar “Migracion, remesas y el Programa 3 por 1 para Migrantes,” Secretaria de Desarollo Social, Mexico and IADB,
Washington DC, June 2005.
eSee Gubert 2005, Iskander 2005, and Orozco 2004. The
literature is not clear on what “success” means in these cases(beyond mere survival of the HTAs).

and promote remittances and investment in
the home country, from pre-migration information and orientation (Philippines), IDs forcustoms and other purposes (Colombia,
Tunisia), finance for study (Tunisia), support inlegal and administrative disputes (Morocco),
fairs and re-orientation visits for émigrés andtheir families (Colombia, Tunisia), shortened
military service (and payment of fee in lieu,
Turkey), hotline for migrant investors(Tunisia), and a diaspora trust fund (Nigeria).
Some countries like Bangladesh, Egypt,
Eritrea, Pakistan, Philippines, and Thailand(and Mexico and Turkey in the 1960s) have
tried to impose mandatory remittance require-96

ments on their émigrés, but with little success.
Also, restrictive emigration policies have driven migrants into using clandestine remittancechannels.19

Policies in remittance-source countries
Only a handful of remittance-sending countries have proactive remittance-supporting
policies. Most are noninterventionist or have
had little engagement to date, but this ischanging with the growing appreciation of thesignificance of remittances for development incountries such as Australia, Canada, theUnited States, and most West European states(Ellerman 2003, Carling 2005). USAID has

T R E N D S ,D E T E R M I N A N T S ,A N D

undertaken extensive research on remittances,as has the United Kingdom’s Department forInternational Development (DFID) and theNorwegian International Peace Institute(PRIO). All propose ways forward for moreproactive policies by sending countries—for
example, to support migrant associations, facilitate low cost, reduce bureaucratic remittance transfer, greater competition in the remittance market, and inform decision making
by migrants and affected communities.
Immigration policies. Policies that affect thesize, type, and tenure of migration flows also
affect remittance patterns. A larger migration
stock would in general imply larger remittanceflows to the country of origin. Given the migration stock, a larger share of temporary

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migrants is likely to lead to larger remittances.
Also, as discussed above, the ties of migrants
to their home country weaken with the passage of time, causing remittances to decline.
Given the personalized nature of remittances, governments are unlikely to have muchsuccess in using remittance policies to steer
migration differently. Some countries, like
Canada, France, and Germany, have tried todirect remittance flows to investments in thehome country to encourage return migration,
but these efforts have met with little success.
There are also some examples of “forced” remittance transfer programs between sending
and receiving countries, although these raise
vexing legal issues and do not appear to be effective either in encouraging migrant return or
mobilizing resources (box 4.4).

Box 4.4 Forced remittancesW

hile it is generally assumed that migrant
workers are free to choose how much, when,
and to whom to send money, there have been cases
when sending or receiving governments, banks in
the home country, or employers have decided to retain a certain proportion of pay for remittances. The
rationale for such “forced” remittances is to ensurethat temporary migrant workers do not stay on, but
return home after the end of their contract. Sometimes, the objective of such measures is to steer theuse of remittances to investment in the country oforigin.
For example, from 1942 to 1964 the “Braceroprogram” regulated migration of 4.6 million farmworkers between Mexico and the United States.
From 1942–9, a tenth of the wages earned by thesebraceros was deducted from their pay by the U.S.
employers and paid into accounts held by the Bankof Mexico at two commercial banks in San Francisco. From there it was transferred to the Bank of
Mexico and then on to the Banco de Credito Agricola. Alternatively, the employers gave the worker acheck for the deducted amount at the end of the contract to be cashed back home in Mexico. A 1946 report by the Mexican government claimed that

$8 million in forced savings had been paid out to exbraceros and only $6 million was unaccounted for;but the LA Times reported (on March 30, 2001) thata total of $34 million in forced savings was collectedduring 1942–6. The loss of the money was explainedby successive bank consolidations and restructuring,
and as a result, records of accounts had disappeared(Migration News, http://migration.ucdavis.edu/mn).
The braceros were mostly poorly educated peasants,
who did not even know about the deductions andwho later were intimidated by the forms and correspondence needed to claim their money (LA Times).
op.cit.). In March 2001, a class action suit was filed
on behalf of former braceros at a San Francisco district court claiming $30 million–$50 million in savings not returned and additional punitive damages.
This claim was rejected because of the statute of limitations (San Francisco Chronicle, August 29, 2002).
In 2003, the Mexican government agreed to reimburse, within six months, an upfront sum of $150
per person and then monthly rates of pesos 200 for
up to pesos 60,000, provided the ex-braceros could
produce identification (the Bracero Net program).
Forced remittances may also be used by a government to encourage the use of remittances for97

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Box 4.4 (continued)
investment in the domestic economy. Under theDeferred Pay Scheme, mine workers from Lesotho
have 30 percent (initially 60 percent, until 1990) of
their pay deposited at a Lesotho bank and the balance into a savings account at TEBA (The Employment Bureau of Africa) Bank. The certificate confirming the identity of the account holder is handedout by the TEBA Bank at the end of the contract,
before the mine worker goes home to collect thebalance from the deferred pay scheme.
A similar arrangement is foreseen in the memorandum of understanding between the Governmentsof Thailand and Laos on employment cooperation.
All Laotian guest workers are obliged to pay 15 percent of their earnings into a “deportation fund” set
up by the host country, Thailand. Workers who wish
to return home can claim their contribution in fullwith interest. The request must be filed three months
before the return date, and the money is to be paid
to the workers within 45 days after the last day of
employment (articles 11 and 12).
A milder form of induced remittances has been
introduced for temporary Mexican farm workers in
the United States and Canada. Before their departure
visas and work permits are issued, the temporary
farm workers register with the Ministry of Labor in
Mexico. After the papers are delivered, migrants
open a savings account with the subsidiary or an
associated institution of a North American bank in
Mexico. Once they arrive in the United States or
Canada, the temporary workers either make theremittance transaction themselves or arrange withthe farmer-employer to pay directly into their savings
account via payroll deduction.
Forced savings of this type raise legal issues inthat they violate an accepted principle of wage protection, that is, the idea that “wages shall be paid directly to the worker concerned” (article 5 ILO Convention 95 of 1949). The only exception provided
for is that the “worker concerned has agreed to thecontrary.” It is not clear whether that has been thecase with the braceros or with the other examples
cited here. Convention 95 states that “employers
shall be prohibited from limiting in any manner the
freedom of the worker to dispose of his/her wages.”
Article 8.2 further spells out that “workers shall be
informed of the conditions under which suchdeductions may be made.” (Mexico ratified thisconvention in 1955. The United States has not
ratified it.)Forced remittances are also probably not the mosteffective measure to ensure that temporary migrant
workers return home. If they return, it is likely not
driven by their desire to reclaim their savings. Whenoffered a choice, migrants avoid such systems. In
South Africa a considerable number of mine workers
from Lesotho did not participate in the deferred pay
scheme, often in complicity with the mining companies (Sparreboom 1996, p. 13). If the Lesotho deferred pay scheme was voluntary, then the volume ofsavings would drop to a level of the voluntary
schemes of workers from Botswana and Swaziland,
namely 1 percent of the levels of the obligatory
scheme (TEBA 1995).

Banking and financial markets. Greater relaxation and competition in money transfer markets leads to reduced prices and more money
reaching the beneficiaries. This process is facilitated further by improving access of remittance service providers to national payment
and settlement systems. This seems to haveworked well within framed agreements suchas the United States–Mexican Partnership for
Prosperity program of 2001, involving thematricula consular to improve banking access98

of Mexican immigrants in the United States
and low-cost electronic transfers through theFederal Reserve Bank’s automated clearinghouse system for Mexico (see chapter 6).
Spain has initiated agreements between
Spanish and Latin American financial institutions to reduce transfer fees and foster theentry of new agents into the financial market,
particularly in rural areas. In the past,
Germany worked closely with Turkey to encourage remittances into formal channels

T R E N D S ,D E T E R M I N A N T S ,A N D(UN 2005). In some remittance-source countries, outward remittance flows are affected byexchange controls. For example, South
Africa’s policy of limiting foreign exchange
dealings only to banks has prompted (unbanked) remitters to use informal channels—
only 5 percent of remittances to other Southern African Development Community (SADC)
countries are being sent via formal channels,
according to Genesis Analytics (2005).20
ID arrangements for migrants. The U.S. facilitation of banking for both regular and irregular migrants from Mexico through the matricula consular mechanism has been highly
successful in drawing more migrants into
safer and cheaper remittance modes. The Federal Deposit Insurance Corporation (FDIC)
through its New Alliance Task Force initiative,
in collaboration with the Mexican consulates
and commercial banks, has been successful inimproving banking access as well as the financial literacy of immigrants.21
Support to HTAs or migrant associations.
HTAs and similar entities receive some support
from host governments in the United States,
France, and parts of Africa in recognition of
their development assistance potential. While
HTAs could potentially play a useful role incommunity infrastructure and other collectively
funded projects, their ability to effectively channel large amounts of aid remains untested.22

Macroeconomic effects
of remittancesU

ntil recently most of the discussion andresearch on remittances was focused onthe (microeconomic) end use by the recipient
households, including the effects on poverty(see chapter 5). But as outlined earlier in thischapter, the large size of remittances relative toother external flows and to the GDP in many
countries suggests that the macroeconomic
effects of remittances may be of critical importance in many countries (recall that the top 19
remittance recipients receive more than 10 percent of their GDP in remittances).

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R E M I T T A N C E SHigh levels (or large increases) in remittance flows can be expected to have direct
repercussions on foreign exchange rates, domestic interest rates, and the balance of payments, and indirect repercussions on macrovariables. Because of their relative stability
and targeting (directly to households), they
may bring some additional benefits. However,as the experience with and analysis of natural
resource booms have shown, large inflows canalso have some undesirable side effects (seealso box 4.5). And to the extent that remittance flows may naturally just go to countries
that are doing poorly or respond anticyclically(increase during downturns, due to a drought,
for example), it may be hard to disentangle
how remittances affect macro-performance. In
this section, we consider some of the macroeconomic channels through which remittances
affect recipient countries.

Remittances are stable andmay be countercyclical
Remittances may move countercyclically relative to the economic cycle of the recipient
country. Remittances may rise when the recipient economy suffers a downturn in activity or
macroeconomic shocks due to financial crisis,
natural disaster, or political conflict, because
migrants may send more funds during hardtimes to help their families and friends. Remittances may thus smooth consumption andcontribute to the stability of recipient economies by compensating for foreign exchange
losses due to macroeconomic shocks.
Many authors have observed an increase inremittance inflows following a natural disaster (Clarke and Wallsten 2004) or an economic downturn (Kapur 2003). Yang (2004)
showed that remittance receipts by Filipino
households increased following the 1997 financial crisis. A 10 percent appreciation of a
migrant’s currency against the Philippine peso
led to increases in household remittance receipts and a 0.6 percentage point decline in thepoverty rate in migrant households. He also
found evidence of positive spillover effects onhouseholds without migrant members due to99

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Figure 4.3 Remittances as percent of private consumption, two years before and two years
after natural disasters
Percent
20
18
15.5

16
14
12

10.4

10

4

9.6

8.9

8.4

7.9

8
6

11.3

11.3 10.8

7.7

5.7

5.1
4.4 4.7
3.8 4.2

8.4

5.2 5.5 5.6

2
0

2 1
0 1 2
Bangladesh

2 1
0 1 2
Dominican Republic

2 1

0 1 2
Haiti

2 1
0 1 2
Honduras

Note: The bar marked 0 is the year of the natural disaster.

increases in remittance-driven economic activity as well as by direct transfers from the migrant’s origin household. Mishra (2005) findsthat a 1 percent decrease in real GDP was associated with a 3 percent increase in remittances after a two-year lag in 13 Caribbean
countries during 1980–2002. To the extent that
remittances are used for investment purposes,
however, they may behave procyclically just asother investment flows do. In Turkey and thePhilippines, remittances were more volatile andprocyclical in the 1990s than in the 1980s.23
Remittance flows (as a share of personal
consumption) continued to rise after natural
disasters in Bangladesh, Dominican Republic,
Haiti, and Honduras (figure 4.3). In Albania,
after an initial disruption in remittanceinflows (as a share of personal consumption)in the year of conflict, remittance flows recovered quickly (figure 4.4). In Sierra Leone,
remittances increased in the year of the conflict.24 Remittances as a share of personal
consumption rose in response to the financial
crisis in Mexico in 1995 and in Indonesia andThailand in 1997 (figure 4.5).
Yang (2005) found that the increase in remittances makes up for 13 percent of income
losses in the current year and 28 percent

100

within four years of a hurricane. In contrast,
increases in ODA and FDI make up forroughly 26 and 21 percent, respectively,
within four years.

Remittances can improve country
creditworthiness
Remittances can improve a country’s creditworthiness and thereby enhance its access tointernational capital markets. The ratio of

Figure 4.4 Remittances as a share of
personal consumption, two years before
and two years after conflict
Percent
20
17.0

16.9 16.9
15

12.7

12.3

10

5

2.9 3.2
1.0 0.8

0.7
0

2 1

0

1 2

Albania

2 1

0

1 2

Sierra Leone

Note: The bar marked 0 is the year of the conflict.

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credit ratings for Lebanon and Haiti by two
notches; these would result in implied sovereign spread reductions ranging from 130 to
334 basis points (table 4.5).26

Figure 4.5 Remittances as a share of
personal consumption, two years before
and two years after financial crises
Percent
2.5
2.0

2
1.5

2.1
1.9
1.7

1.1

1.0

1

1.1

0.5 0.5

0.5
0Another way in which remittances affectinternational capital market access is throughthe use of structured finance techniques.
Several banks in developing countries (forinstance, Brazil) have been able to raise relatively cheap and long-term financing frominternational capital markets via securitizationof future remittance flows.
Remittance securitization typically involves
the borrowing entity (such as a bank) pledging
its future remittance receivables to an offshore
special purpose vehicle (SPV). The SPV issues
the debt (figure 4.7). Designated correspondent banks are directed to channel remittanceflows of the borrowing bank through an offshore collection account managed by atrustee. The collection agent makes principal
and interest payments to the investors andsends excess collections to the borrowing
bank. Since remittances do not enter the issuer’s home country, the rating agencies

1.5

1.4
1.2

Remittance securitization can help
countries raise external financing

2.0
2.0
1.8

2 1 0 1 2
Mexico2 1 0 1 2
Indonesia

2 1 0 1 2
ThailandNote: The bar marked 0 is the year of the financial crisis.

debt to exports of goods and services, a key
indebtedness indicator, would increase significantly if remittances were excluded fromthe denominator (figure 4.6). Country credit
ratings by major international rating agencies
often fail to account for remittances.25 Modelbased calculations using debt-to-export
ratios that include remittances in the denominator indicate that including remittances increditworthiness assessments would improve

Figure 4.6 Indebtedness classification including and excluding remittances, 2003
Debt as percent of exportsa
800
700

732
Excluding remittances

600
500
400

Including remittances
355

300

257
208

200

245
193
151

190

167
127

121

145

178

114

126

MoroccoJordan

116

100

124
82

0
LebanonEcuadorPakistan

Philippines

Jamaica

El Salvador

GuatemalaSource: World Development Indicators, and World Bank staff calculations.
Note: a. Present value of external debt as percent of exports of goods and services, and remittances.

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Table 4.5 Impact of remittances on country credit rating and sovereign spread
Remittances as %of GDP, 2004

Rating excluding
remittances

Rating including
remittancesa

Spread saving(basis points)

7
14
28
11
5

B
B
CCC
CCC
B

BB
B
B
B
B

150
130
334
209
161

Serbia and Montenegro
LebanonHaitiaNicaraguaa
Ugandaa

Sources: Standard and Poors and World Bank staff calculations.
Note: a. Calculated using a model similar to Cantor and Packer (1995); see Ratha and De (2005).

Figure 4.7 Remittance securitization structure
Beneficiary’s
account

Remittance senders

Issuing bank credits
beneficiary’s accountin domestic currency

Remittancepayments(foreign currency)
Message
Correspondent banks

Issuing bank

Remittance flows (foreign currency)

Trustee collateralaccount

Excess cash(foreign currency)

Issuing bank’s
account atcorrespondent bank

Debt service payment

International investors

believe that the structure mitigates the usual
sovereign transfer and convertibility risks.
Such transactions also often resort to excess
coverage to mitigate the risk of volatility andseasonality in remittances.
By mitigating currency convertibility risk,a key component of sovereign risk, the future
flow securitization structure allows securities
to be rated better than the sovereign credit rating. These securities are typically structured toobtain an investment grade rating. In the caseof El Salvador, for example, the remittancebacked securities were rated investment grade,
two to four notches above the sub-investment
grade sovereign rating. Investment-grade rat-

102

Offshore

Domestic

ing makes these transactions attractive to awider range of “buy-and-hold” investors (forexample, insurance companies) that face limitations on buying sub-investment grade. As aresult, the issuer can access international capital markets at a lower interest rate spread andlonger maturity. Moreover, by establishing acredit history for the borrower, these deals
enhance the ability and reduce the costs ofaccessing capital markets in the future.
The first major securitization deal involving international migrant remittances
occurred in 1994 in Mexico. The volume ofremittance securitization has grown rapidly
since then (figure 4.8a). Using this instrument,

T R E N D S ,D E T E R M I N A N T S ,A N DFigure 4.8 Securitization of remittances,
1994–2004
a. Millions of dollars
2,837

1,6001,690
1,1751,170

04

03

20

02

20

01

20

00

20

99

20

98

19

97

19

96

115

19

95

540

350

19

94
19

19

65

206

1,055

b. By country
El Salvador
6%

Kazakhstan
1%

Brazil 31%
Mexico24%

Panama1%

Peru
2%

Turkey35%
Note: Applies to the first half of 2004 only.

Mexico, El Salvador, and Turkey raised about$2.3 billion during 1994–2000. As electronictransfers became more widespread, it waseasier to track complex transactions, andremittances securitization gave way tosecuritization of diversified payment rights(DPRs), including migrant remittances, butalso payments related to exports and FDI.
During 2000–4, a total of $10.4 billion was
raised through securitization of DPRs by
Brazil ($5.3 billion), Turkey ($4.1 billion), El
Salvador, Kazakhstan, Mexico, and Peru (figure 4.8b). Following a sharp increase in borrowing costs in 2002 (in part because ofelection-year uncertainties), Brazil has raisedover $4 billion by issuing bonds backed by di-

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versified payment rights. These bonds resulted
in a spread saving of more than 700 basis
points compared to Brazil’s sovereign spread.
As experience with this instrument broadens, and investors become more comfortablewith its characteristics, it is possible that it
could be used by a wider range of countries (including poor countries) and for a broader rangeof external flows (remittances, tourism receipts, and commodity earnings). It is not easy
to estimate the potential size of such futureflow securitization. But preliminary calculations, assuming an over-collateralization ratioof 5:1 and using migrant remittance figures for
2003, show that developing countries could
potentially issue nearly $9 billion and lowincome countries could raise up to $3 billion
annually from international capital markets.
Several policy hurdles need to be crossed
before securitization deals can proceed. High
fixed costs of legal, investment banking, andcredit-rating services and long lead times canpose difficulties for developing countries withfew large entities and high borrowing needs. A
master trust arrangement can permit issuers to
structure a large deal but to tap the market inseveral tranches. Pooling receivables of several
branches (or even several borrowers) could
also help increase the deal size to justify large
fixed costs. While the absence of an appropriate legal infrastructure can also constrain
issuance, this need not require an overhaulof the entire legal system. A more focused
approach that concentrates on bankruptcy
law may suffice, by making sure that pledged
assets remain pledged in the event of default.
So far, only the top-rated (in local currency
terms) financial institutions have issued future
remittance-backed bonds in an effort to pierce
the sovereign foreign currency rating ceiling(that is, to obtain a higher rating for thesebonds than the sovereign foreign currency rating). The securitization transactions typicallydo not affect financial institutions’ ability todeliver remittances to the ultimate beneficiaries. Loosely speaking, the financial institutions that undertake a securitization transaction are pledging their rights to foreign103

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2 0 0 6currency, but not their obligations to deliver
remittances (typically in local currency terms).
Potential issuers should be reminded, however, of significant risks—currency devaluation and, in the case of flexible rate debt, unexpected increases in interest rates—that areassociated with market-based foreign currency
debt. Moreover, securitized debt is inflexible
debt. Securitization of remittances (and otherfuture flows) by public sector entities reduces
the government’s flexibility in managing its
external payments and can conflict with thenegative pledge provision included in multilateral agencies’ loan and guarantee agreements,
which prohibit the establishment of a priority
for other debts over the multilateral debts.

Large remittance inflows can leadto exchange rate appreciation andlower export competitiveness
Large and sustained remittance inflows cancause an appreciation of the real exchange
rate and make the production of cost-sensitive
tradables, including cash crops and manufacturing less profitable. Although empirical evidence on the adverse effect of large inflows offoreign exchange in terms of trade and growthis limited,27 it is plausible that this effect exists
and is significant for some small economies
where remittances are very high. AmuedoDorantes and Pozo (2004) found that a doubling of workers’ remittances resulted in realexchange rate appreciation of about 22 percent in a panel of 13 LAC countries (see also
Winters and Martins 2004). Rajan and
Subramanian (2005), however, did not findany evidence that remittance flows slow down
growth by affecting competitiveness.28 Moreover, as remittances tend to be relatively stableand persistent over long periods, the “Dutch
disease” effects of remittances are less of aconcern than similar effects of natural resource windfalls and other cyclical flows, andthe real exchange rate level achieved throughsensible policies may be sustainable (IMF
2005). Governments in countries receiving
large remittances can mitigate the effects ofreal exchange rate appreciation by allocating a

104

larger portion of government expenditures on
infrastructure and also practicing more liberal
trade policies; both these measures would
tend to increase exports and also contributeto improved labor productivity andcompetitiveness.
A related concern is whether reliance on unearned income in the form of remittances has
adverse effects on the incentives to work, aswell as on the quality of economic policies andgovernance, similar to the well-documented
effects of windfall gains from natural resources such as oil. While oil exports are almost always found to have a strong negative
impact on various governance indicators, suchas control of corruption and rule of law, preliminary cross-country analysis suggests that
remittance flows may not have such negative
effects (box 4.5).29

The evidence on the effect of remittances
on long-term growth is inconclusive
To the extent that they finance education andhealth and increase investment, remittances
could have a positive effect on economic
growth. Remittances may relieve credit constraints in the recipient community and spur
entrepreneurial activity (Funkhouser 1992,
Yang 2004, Woodruff and Zenteno 2004).
Faini (2002) finds that the impact of remittances on growth is positive. He argues that
remittances overcome capital market imperfections and allow migrant households to accumulate positive assets, as claimed by Stark
and Lucas (1988) and Taylor (1994). Mishra(2005) found that a 1 percentage point increase in remittance inflows in 13 Caribbean
countries increased private investment by
0.6 percentage point (all measured relative toGDP). To the extent that they increase
consumption, remittances may increase percapita income levels and reduce poverty andincome inequality, even if they do not directly
impact growth (see chapter 5).
On the other hand, large outflow of workers, especially skilled workers, can reduce
growth in labor-sending countries. Remittances may also indirectly affect labor supply,

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Box 4.5 Unlike oil windfalls, remittance inflows do
not weaken institutional capacityT

he economic performance of most mineral exporters, in particular oil exporters, has been far
less impressive than that of resource-poor countries(Gelb and others 1988; Auty 2001; Gelb, Eifert, andTallroth 2002). To a large extent this outcome seems
driven by mismanagement of the economy and weak
institutions. Sala-i-Martin and Subramanian (2003)
show empirically that concentration of resource
flows has deleterious effects on the institutionalframework and capacity of a country. Natural resource windfalls—oil rents, for example—often foster weak institutions because they allow the authorities to pursue arbitrary, costly, and inefficient policies(Ross 2001). States that control such resources may
resist secular modernization pressures because theycreate alternative sources of power (Isham andothers 2003). These rents also perpetuate economic

by encouraging some remittance-recipient
households to choose more leisure thanlabor. Chami, Fullenkamp, and Jahjah (2005)
argue that remittances may slow down growthby reducing work efforts by remittancerecipients.30
One recent study of the impact of remittances on growth over an extended period(1970–2003) for 101 developing countries
found no significant link between remittancesand per capita output growth, or between
remittances and other variables such as education or investment rates (IMF 2005). This
study, however, attributed this inconclusive result to measurement difficulties arising fromthe fact that remittances may behave countercyclically with respect to growth.31 Also, empirically it is difficult to measure the effects ofremittances on human capital formation,
which may occur over a very long period oftime.
Remittances, like aid, may be more effective in a good policy environment. For
instance, a good investment climate with well-inequality, which results in nepotism and a weak
civil society. Resource rents are also believed to be
associated with civil conflict (Collier and Hoeffler
2002).
In contrast, remittances are widely dispersed, thegreat bulk of them is allocated in small amounts, andfor the most part, remittances avoid the government“middleman.” Hence the expectation is that they can
avoid the negative effects of natural resource windfalls on poverty, growth, and institutional capacity.
This is similar to an argument by Birdsall and Subramanian (2004) that countries would be better off ifthey distributed the bulk of the returns from resource
flows to the general population, who would use thefunds more effectively than a highly centralized government, and also greatly reduce the incentives forcorruption.

developed financial systems and sound institutions is likely to imply that a higher share of
remittances is invested in physical and humancapital (IMF 2005). Indeed, Giuliano andRuiz-Arranz (2005) show that in theeconomies where the financial system is underdeveloped, remittances alleviate credit
constraints and work as a substitute for financial development, improving the allocation ofcapital and therefore accelerating economic
growth. Recent research also shows that
remittances may promote financial development (Aggarwal and others 2005), which inturn can enhance growth and reduce poverty(Beck and others 2004).

Annex 4A.1 World Bank dataon remittancesUsing the definition in chapter 7 of Global
Development Finance 2003, migrant remittances are considered the sum of workers’
remittances, compensation of employees, andmigrants’ transfers. Data for these variables

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Table 4A.1.1 Countries with alternative
estimates in 2004
$ millions
Algeria
China
GambiaIran
Kenya
Lebanon
Malaysia
Mauritious
Nigeria
Serbia and Montenegro
Vietnam

2,460
21,283
8
1,032
464
2,700
987
215
2,751
4,129
3,200

Total

$39,259

are taken mostly from the balance of payments(BoP) data file of the IMF (see also Ratha
2003). However, many countries do not report
data on remittances in the IMF BoP statistics,
even though it is known that emigration fromthose countries took place (see table 4A.1.1 fora list of these countries). In 2003 about 87
countries did not report any remittances’ data.
Further, there was no consistency in reporting
the data. For example, only 28 countries report workers’ remittances, compensation of
employees, and migrants’ transfers. Forty-fivecountries report both workers’ remittancesand compensation of employees; 11 countries
report compensation of employees and migrants’ transfers; and 3 countries report workers’ remittances and migrants’ transfers. There
are 14 countries that report only workers’ remittances and 19 countries that report only
compensation of employees.
Reported data for developing countries
show only $113.4 billion in total remittances
for the year 2003 (workers’ remittances$97.3 billion, compensation of employees$14.8 billion, and migrants’ transfers $1.3 billion), and 83.8 billion in 2004 (workers’ remittances $68.7 billion, compensation of employees $13.5 billion, and migrants’ transfers$1.5 billion). By filling in gaps for some developing countries for which remittance data
were missing, we arrived at an estimate of$142 billion in 2003, and $160 billion in

106

2004 (the latest year for which BoP data are
currently available). The gap-filling methods
followed, and the reasons for making theadjustments are documented below.
Workers’ remittances, as defined in the
IMF Balance of Payments manual, publishedin 1993 (fifth edition), are current privatetransfers from migrant workers who are considered residents of the host country to recipients in their country of origin. If the migrants
live in the host country for a year or longer,
they are considered residents, regardless of
their immigration status. If the migrants have
lived in the host country for less than a year,
their entire income in the host country should
be classified as compensation of employees.
Workers’ remittances are transfers, whereas
compensation of employees is considered factor income. In the earlier, fourth edition of the
BoP manual, compensation of employees wascalled labor income and was classified as nonfactor services (referred to just as services in
the fifth edition).
Although the residence guideline in the
manual is clear, this rule is often not followed
for various reasons. Many countries compile
data based on the citizenship of the migrant
worker rather than on their residency status.
Further, data are shown entirely as either
compensation of employees or as worker remittances, although they should be split between the two categories if the guidelines
were correctly followed; for example, Saudi
Arabia and Israel record only compensationof employees. India shows very little compensation of employees, but large workers’
remittances, although it is well known thatIndia supplies a large number of temporary
IT workers to the United States and European countries. On the other hand, thePhilippines shows large compensation of
employees and very few migrants’ transfers.
The distinction between these two categories
appears to be entirely arbitrary, depending
on country preference, convenience, and tax
laws or data availability. This fact has beenrecognized at the World Bank since the1980s, and worker remittances have been

T R E N D S ,D E T E R M I N A N T S ,A N Dtreated as part of labor income and added toexports of goods and services in calculatingdebt service ratios.
Though small in comparison to compensation of employees and workers’ remittances,migrants’ transfers have become anothersource of confusion. Migrants’ transfers are
the net worth of migrants that are transferredfrom one country to another at the time of
migration (for a period of at least one year).
Migrants’ transfers are considered capitaltransfers in the BoP fifth edition manual, although they were considered current privatetransfers in the fourth edition. As the numberof temporary workers increases, the importance of migrants’ transfers may increase.
Therefore, in order to get a complete pictureof the resource flow, one has to consider thesethree items together.
There are four main reasons for gaps inremittance data: vintage, missing data, data
recorded under other than the three categories
mentioned above, and data collection practices.

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R E M I T T A N C E Sfrom the country desks are used for The Gambia, Iran, and Serbia and Montenegro; anddata from central banks were used for
Lebanon and Vietnam. Some high-income
countries (notably Canada, Singapore, United
Arab Emirates) also do not report remittancedata.

Classification under other categories

The Balance of Payments Yearbook publishes
data with a one-year lag. That is, the yearbook
published in December of the current year
should have data up to December of the previous year. However, this is not true for anumber of developing countries, for which thelatest data available are two or even morethan three years old. For about 28 countries in
2003, and 59 countries in 2004, data havebeen obtained from World Bank country desks
or extrapolated on the basis of earlier trends.
In addition, two countries, Algeria andNigeria, have not reported data to the IMF fora number of years. For Algeria the IMF datastop in 1991, and for Nigeria data, stop in
1999. However, data for these countries areavailable from the country and reported in the
country databases of the World Bank and
IMF.

Due to the difficulty in classifications, countries have often classified workers’ remittances
either as other current transfers or as transfersfrom other sectors. For example, in the case of
Haiti, before 1989 and after 1997, data wererecorded as workers’ remittances, but during
1990–7, they were recorded as transfers fromother sectors. Kenya and Malaysia data have
similar difficulties. For these countries, data
under “other sectors” from the IMF aretreated as worker remittances. In China alarge proportion of workers’ remittances areclassified as other private transfers in the IMF
BoP file. Therefore, instead of the IMF’s workers’ remittances, we have used workers’ remittances data from the country desk. It is notjust the developing countries that follow thispractice, many high-income OECD countries(for example, the United Kingdom) do thesame.
There are also other problems in the data,such as the difficulty in separating travel expenditure from remittances, which have notbeen addressed here. The increased acceptanceof credit and debit cards in developing countries further complicates the issue. In somecountries, notably China, remittances may
have been misclassified as FDI. The OECD
definition of FDI (including the purchase ofholiday or second homes by nonresidents)
may be counted as FDI—a likely case in
China. In the case of India and many othercountries, remittances may have been classified as nonresident deposits, especially thosein local currency terms.

Missing data

Data collection practices

Several developing countries (for example,
Lebanon) do not report to the IMF.32 Data

A survey of central banks, based on responses
from 40 central banks, reveals widespread

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problems with remittance data collection
methodology (de Luna Martinez 2005). Mostof the central banks use remittance data reported by commercial banks, but leave out
flows through money transfer operators andinformal personal channels.
Even when data are available and properlyclassified, in many cases they are not based on
actual exchange records. In a number of cases,
the preferred methodology of estimating theworkers’ remittances is based on taking thenumber of emigrants, and multiplying by anaverage amount sent. The sources for thesedata are migration records, surveys of
exchange and financial houses, and household
surveys. However, these data are often weakor out of date. Also the methodology for
preparing estimates is not the same in all countries, and it is not always described in the
country notes in the publicly available balanceof-payments data. It is hoped that the increased
awareness about the importance of remittances
and the shortcomings in both the remittanceand migrant workers’ data will result in efforts
to improve the data transmission.
Table 4A.1.1 shows the countries where wehave used alternative estimates of workers’ remittances’ using either country desk or thecentral bank data.
Perhaps the most difficult aspect of remittance data is estimating informal flows. In
annex 4A.2, we discuss different ways of estimating informal flows. One way to estimate
the true size of remittances is to undertakesurveys of remittance senders and recipients.
Unless new, adequately randomized and representative surveys of recipients and senders
are carried out, evidence from existing household surveys would only be indicative rather
than comprehensive.

Annex 4A.2 A model-based
estimation of informal remittance
flows

E

stimating the size of unrecorded flows is
almost impossible. In what follows, we
make an effort to arrive at some crude

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estimates using a set of variables that are notedin the literature to affect the choice of the remittance channel. Empirically, this involves
first estimating officially recorded remittances
as a function of fee, exchange commission, andthe presence of a dual exchange rate (and othervariables shown in the equation below). Next,
using the estimated coefficients on thesevariables, we predict what remittances would
be if the values of these variables become
closer to those prevailing in regions where
informal flows are small. We then interpret thedifference between these predicted remittances
and the actual remittances as an estimate of informal flows.
For this purpose, we propose the following
model of remittances:
REMIT  ␤0  ␤1Host  ␤2Home
 ␤3 Migrant  ␤4Fee200
 ␤5Spread200  ␤6 Dual
where REMIT is the log of remittances (orremittance per migrant or per capita); Host is
the log of the host-country per capita output(trade or migration weighted across hosts);
Home is the log of home-country per-capita
output; Migrant is the log of the stock ofmigrant workers in OECD countries; Fee200
is the fixed fee for sending $200 from theUnited States to the source country; Spread200
is the exchange commission for sending $200;
and Dual is a dummy variable for dual exchange rates. The last three variables are likely
to have large impacts on the extent to whichmoney is sent via formal channels. The data on
remittances are available on a panel basis; dataon transaction costs and on the number of migrant workers are only available for a crosssection. In table 4A.2.1 below, we report regression results for a cross-section of countries(using average figures for 1995–2003 for remittances and other time series variables). In
table 4A.2.2, we show results of remittancecost functions estimated using cross-country
data. These equations estimate panel data on
remittance costs for use in panel data regressions reported in table 4A.2.3. Reduced form

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R E M I T T A N C E STable 4A.2.1 Regression results: determinants of worker remittances

Explanatory variables

Dual exchange rate
Service fee
Exchange-rate spread
Stock of migrant
workers
Main host per capita
incomeHome per capita
incomeIncomeNumber ofobservations

Dependent variable:
Ln (Remittances)IVa(2)

Dependent variable:
Ln (Remittances per
emigrant)(3)

Dependent
variable:
Ln (Remittanceper capita) (4)0.42(1.32)
0.06**(2.32)
0.04(0.50)0.73**(7.66)
0.10(0.77)
0.15(1.03)0.31**(4.05)
104

0.18(0.46)
0.12*(1.94)

0.31(0.90)0.07**(2.47)
0.02(0.26)

0.22*(1.75)
0.06(0.40)

0.74**(2.04)
0.04(1.00)0.05(0.52)0.22**(2.45)
0.11(0.69)
0.72**(4.35)

104

104

0.70

0.69

Dependent variable:
Ln (Remittances)
(1)

R2

0.64
(5.41)
0.05(0.31)
0.17(1.00)0.31(3.75)
85

0.08

0.35

Source: Freund and Spatafora (2005).
Note: Robust t-statistics appear in parentheses.
a. Instruments include financial development and dollarization. Hansen’s J-statistic is 2.49 (p-value 0.12), and the Shea partial
R-squared of the instruments is 0.37.
**significant at the 5 percent level; *significant at the 10 percent level.

Table 4A.2.2 Regression results: determinants of transaction costs
Dependent variable: remittance cost
Explanatory variables

(1)

(2)

(3)

Bank concentration

0.05**(2.29)
0.05**(2.41)
0.04(0.32)
4.12**(4.47)
0.22(0.46)0.03(1.10)
0.05**(2.38)
0.04(0.26)
3.92**(3.87)
0.56(1.02)
0.30(1.18)0.03(1.35)
0.05**(2.42)0.03(0.24)
3.92**(4.20)0.32(0.66)

Financial development
Financial risk
Dollarization
Domestic output
Remittances
Emigrant stock
R2
Number of observations

0.52
76

0.56
69

0.34
(1.18)
0.53
76

(4)

(5)

0.06**(2.54)
0.04(0.31)
4.10**(4.14)
0.75(1.47)
0.42*(1.85)

0.05**(2.53)0.01(0.02)
4.00**(4.33)
0.46(0.98)0.52
70

0.59**(2.40)0.52
78

Source: Freund and Spatafora (2005).
Note: The dependent variable is the percentage cost of remitting $200. Robust t-statistics appear in parentheses.
**significant at the 5 percent level; *significant at the 10 percent level.

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Table 4A.2.3 Panel regression results: determinants of remittances

Explanatory variables

Dual exchange rates
Fitted cost

Ln (Remittances)(1)

Ln (Remittances)(2)0.28**(2.69)
0.08*(1.70)0.22**(2.18)Bank concentration
Financial development
Financial risk
Dollarization
Net errors and omissions
Home per capita income
Host per capita income
Home income
Number of observations
R2

0.02**(2.07)2.10*(1.71)
1.37(1.39)
1.71(1.38)
295
0.27

0.00
(1.00)0.03**(5.13)
0.00(0.02)
0.62*(1.73)
0.02**(2.03)
3.64**(2.92)
1.28(1.34)
3.13**(2.46)295
0.35

Ln (Remittances
per capita)(3)

Ln (Remittances
per capita)(4)0.26**(2.48)
0.08*(1.74)

0.21**(2.03)

0.02**(2.12)0.43**(2.37)
1.33(1.33)

0.00(1.03)0.02**(4.30)
0.01(1.12)
0.58(1.60)
0.02*(1.97)
0.63**(3.31)
1.41(1.46)

295
0.21

295
0.29

Source: Freund and Spatafora (2005).
Note: All regressions include country and year fixed effects. Robust t-statistics appear in parentheses.
**significant at 5 percent level; *significant at 10 percent level.

equations for remittances using statisticallysignificant variables in the cost regressions arealso shown in table 4A.2.3.

Notes
1. In March 2004, the G-7 finance ministers indicated their intention to “continue to work on initiatives to reduce barriers that raise the cost of sending remittances and to integrate remittance services in theformal financial sector” and their commitment to“work with governments, the private sector, and multilateral development banks to broaden the access forfamilies and entrepreneurs to financial services.” At the
Sea Island Summit in June 2004, the G-8 heads of state
called for “better coherence and coordination of international organizations working to enhance remittanceservices and heighten the developmental impact of remittance receipts.” They indicated that “G-8 countries
will work with the World Bank, IMF, and other bodies
to improve data on remittance flows and to develop
standards for data collection in both sending and receiving countries.”110

2. One market study estimates that global remittances are about 2.5 times the size reported in the IMF
balance of payments (Aite Group 2005). The recent
upward revision of China’s remittances to $21 billion
in 2004, from an earlier estimate of $4.6 billion, lends
some support to this notion, although there is nostrong evidence that systematic misreporting is solarge. The discrepancy for China is reportedly due tothe fact that the Chinese figures include compensation
only for state employees. Some authors believe that a
portion of China’s FDI attributed to overseas Chinese
may actually be a misclassification of migrant remittances. Some also believe that the recent surge in remittances to China in part reflected speculative inflows
in anticipation of a revaluation of the yuan.
3. For example, the reporting threshold (typicallyper person per day) is $10,000 in the United States,
12,500 euros in western European countries (on average), and 3 million yen in Japan.
4. Saudi Arabia, the second largest source of remittances at $13.6 billion (or 5.4 percent of GDP) in
2004, is now classified as a high-income country. Saudi
Arabia’s per capita income level has risen in response

T R E N D S ,D E T E R M I N A N T S ,A N Dto the current high oil prices. The authorities preferthat Saudia Arabia be treated as a developing country.
5. Efforts are under way through the GTAP consortium to compile and estimate a comprehensive set ofbilateral migrant stocks, which are used here. See
Walmsley, Ahmed, and Parsons 2005.
6. More precisely, bilateral remittance flows arecalculated by allocating reported remittance inflows ineach country according to weights constructed asfollows:
R(i,j)  [Remittance flows to country j] *[M(j,i)/[sum over i of the nominator]]
R(i,j)  remittance flows from country i to country
j and M(j,i)  stock of migrants from country j incountry i. Data on migrant stocks M(.) are taken fromthe GTAP database (Walmsley, Ahmed, and Parsons2005).
7. Including Saudi Arabia as a developing country
would raise South–South remittances to 45 percent andSouth–South migration stock to 60 percent.
8. A World Bank survey of the African diaspora in
Belgium conducted in spring 2005 revealed that
42 percent of remittances from Belgium to Senegal,
and 55 percent to Congo and Nigeria, go through informal channels. Anecodotal evidence suggests thatnearly 70 percent of remittances in the France–Malicorridor take place through informal channels. Handcarriage is a popular yet informal channel of remittances in many countries. In the Philippines, 40 percent
of total flows are estimated to be remittances broughthome by migrants in person. Nearly 42 percent of outward remittances from South Africa are believed tomove through informal channels (Genesis Analytics
2005).
9. In a calibration model, El Qorchi, Maimbo, andWilson (2003) argue that the black-market premium isthe key factor determining informal flows. Other factors affecting the choice of the channel are trust in theintermediary and anonymity and convenience factors,
such as location, hours of operation, and language.
10. Results will underestimate the size of informal
flows to the extent that they are affected by other factors, such as a lack of legal documentation of migrants
and high tax rates. To the extent that there would still
be some informal flows even at this lower remittancecost level, the estimates are actually lower bounds on
the true size of informal remittances. However, it ispossible that the increases estimated in table 4.4 represent new remittance flows, and not just the shift fromthe informal to the formal sector, in which case theseestimates would overstate informality.
11. Page and Plaza (2005) use a similar methodology and find that the share of unrecorded remittances
relative to the total remittances averages 48 percent
worldwide (and 73 percent in Sub-Saharan Africa).

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12. Between 2001 and 2004, the euro appreciatedby 28 percent relative to the U.S. dollar. During thisperiod, outward remittances from France andGermany actually declined by 5 percent in euro
terms. Remittances from Italy and Spain increased
nearly 40 percent in euro terms and 93 percent in
U.S. dollar terms.
13. A survey of Congolese, Senegalese, and Nigerian
diasporas in Belgium did not reveal any significant relationship between the propensity to remit and thenumber of years a migrant has lived in Belgium. On thecontrary, several migrants who had been in Belgium
for more than two decades continued to send significant amounts of remittances. Evidence from the PacificIslands also do not support remittance decay (Connell
and Brown 2005; Simati and Gibson 2001). Grieco(2003), however, reported evidence of remittancedecay in the case of Micronesian migrants in Guamand Hawaii, caused by family reunification or death of
the beneficiaries.
14. The information presented here derives from asurvey of IOM country missions on the policies of their
host countries, as well as studies by ADB, ECOSOC,
USAID, DFID, and the World Bank.
15. For example, Colombia has a 0.4 percent tax
on transactions through money exchange bureaux andbanks, a temporary arrangement in effect until 2007.
Belarus also taxes remittances from nonimmediatefamily members.
16. For example, in Tajikistan the removal of thestate tax on cross-border bank transactions in 2003
reportedly helped raise remittances from $78 million in2002 to $256 million in 2003 (Olimova and Bosc
2003).
17. For example, nonresident Pakistanis remitting
over $10,000 through banking channels can importany personal item valued up to $1,200 duty-free perannum (World Bank 2005b).
18. Extension of voting franchise to migrants overseas and other policies of political inclusion may also
catalyze remittances and other financial flows to thecountry of origin (Carey 2003; Yang 2003).
19. For example, Pakistan does not permit women
under 35 to emigrate as domestic workers and Vietnambans females from working overseas in the entertainment sector. Bangladesh recently abandoned similar restrictions recognizing that although such restrictions
may protect migrants from exploitation, they may also
encourage more irregular migration, rendering themeven more vulnerable.
20. This is in part responsible for Western Union’s
withdrawal from the South African market (Genesis
Analytics 2005).
21. Such activities complement government objectives to improve banking access in poor neighborhoods

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2 0 0 6(e.g., through the Community Reinvestment Act; see
Frias 2004).
22. USAID also established an 18-month pilot program in 2004 with the PanAmerican Development
Foundation to strengthen the capacity of U.S.-based
HTAs. The UK government is also looking at the possibility of using HTAs as a conduit for development
aid.
23. See also Global Development Finance 2003,
chapter 7, and Sayan (2004). A separate study by
Sayan (2005) finds that in a sample of 12 low-income
and lower-middle-income countries during 1976–2003,
real remittances responded to a fall in real GDP with a
one-year lag. He also found evidence of countercyclicality due to consumption smoothing in India and
Bangladesh and procyclicality due to a stronger investment motive in Jordan and Morocco.
24. Black (2004, p. 12) reports that remittances remained substantial during the civil war in Côte
d’Ivoire.
25. This is likely to be the case in countries (suchas the Philippines or Lebanon) where the headline
worker remittance variable has underestimated or
missing data.
26. Sovereign spread rises exponentially as credit
ratings worsen along the rating scale. A one-notch improvement in credit ratings, therefore, results in higher
spread saving for countries at the bottom of the rating
scale.
27. See McMahon (1997) for a review of empiricalstudies on the so-called Dutch disease, a term coined by
The Economist in 1977.
28. They argue that migrants may lose interest inremitting money and prefer to send goods instead, if
the currency in the remittance recipient country is overvalued. Thus controlling overvaluation throughprudent macroeconomic policies can help attract
remittances.
29. Note that this result applies to cross-country
comparison. It would be extremely difficult to empirically estimate the effect of remittances on institutional
capacity over time in a given country, since institutional changes take place over a very long time. Also
such an exercise would require controlling for reverse
causality: remittances may respond to cyclical or
abrupt changes in economic growth and governance. A
priori, the effect of institutions on remittances can run
either way: On the one hand, better institutional
capacity may attract remittances meant for investment
purposes. On the other hand, better institutional
capacity (if they also mean better performance) may
mean less emigration and dependence on remittances.
30. However, reduced work effort by some individuals may not reduce the aggregate work effort in a

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typical developing country with a large pool of
unemployed.
31. It is difficult to disentangle the reverse-causality
problem (that growth also affects remittances) whilemeasuring the effect of remittances on growth. Some
researchers argue that the empirical results showing
a negative association between remittances and growth
may largely reflect the fact that remittances tend torise when growth is weak in the remittance-recipient
country.
32. The list of countries that do not report remittance data also includes the following 29 countries:
Afghanistan, Angola, Bahamas, Bahrain, Bhutan,
Burundi, Canada, Central African Republic, Chad,
Congo Democratic Republic, Equatorial Guinea, Iraq,
Kuwait, Liberia, Singapore, Somalia, Taiwan (China),
Turkmenistan, United Arab Emirates, Uzbekistan,
Zambia, and Zimbabwe.

References
Aggarwal, Reena, Asli Demirguc-Kunt, and Maria
Soledad Martinez Peria. 2005. “Do Remittances
Promote Financial Development? Evidence froma Panel of Developing Countries.” Unpublishedpaper, World Bank, Washington, DC.
Aite Group. 2005. “Consumer Money Transfers: Powering Global Remittances.” Unpublished paper.
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5
Remittances, Households,
and Poverty

Chapter 4 presented evidence on the macroeconomic dimensions of remittance flows—
their overall size, determinants of their composition (formal versus informal), the role ofgovernment policies in determining theirmagnitude and use, and their macroeconomic
impacts—to developing countries. But as previously noted, these aggregate flows are comprised of millions of individual remittancetransfers among private households, all undertaken by senders and receivers striving to
improve household welfare. This chapter considers the impact of remittance flows at the
micro-level, in particular on the welfare andopportunities of the recipient households andtheir members.
Evaluating household impact depends ondata and analysis carried out at the household
level, often through household surveys.
Surveys are available for many countries andperiods, and many of these have common orcomparable structures, but substantial differences in coverage and circumstances complicate their interpretation. Such caveats
notwithstanding, the evidence presented inthis chapter suggests that remittances can:• Reduce poverty, even where they appear
to have little impact on measured inequality;• Help smooth household consumption by
responding positively to adverse shocks(for example, crop failure, job loss, or ahealth crisis);• Ease working capital constraints on
farms and small-scale entrepreneurs;• Lead to increased household expenditures in areas considered to be importantfor development, particularly education,
entrepreneurship, and health.1
Our evaluation of the empirical analysis on
remittances and development is structured asfollows. In the next section, we consider the effects of remittances on poverty and inequality.
We then explore how remittances can alleviate
the difficulties that households face in smoothing consumption. The next section considers
the indirect effects of remittances on household budgets in terms of induced labor supply
effects, increased access to working capital,
and multiplier effects. We then examine how
households allocate remittances to various
categories of spending, with a particular emphasis on evidence of remittance-funded investments in human capital, micro-enterprises,and property.
Before continuing, two broad observations
on the scope and interpretation of the available analysis help to put the results in perspective. First, in evaluating the impact ofremittances, it is important to consider thealternative (or counterfactual) situation thatserves as a comparison. If a household

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2 0 0 6member migrates and sends back remittances,
one could evaluate the net change in the migrant’s contribution—that is, adding the remittances and subtracting the income of the
migrant had he or she stayed and worked athome.2 That approach is the appropriate
focus when the goal of migration is to generate remittances, or when we are interested in
the overall effect of migration on remaining
household members. The alternative is to ignore the lost domestic contribution—so thatthe counterfactual is now simply no remittances. This approach measures the narrow
impact of remittances, which seems appropriate when migration is being treated as exogenously given, and our interest is simply in theremittance flows generated by the existing migration stock. The second approach merits
close attention because the existing migrant
stock is large, and also because not all remittances are received from migrant relatives
abroad; third-party remittances are common.3
Second, in evaluating the benefits of remittances, we also need to weigh the welfare of
the migrants themselves. To take a concrete
example, imagine the migration decision facing a young husband and father in a country
with a long-established migration history thatborders on a much richer country. Economic
opportunity (and possibly social pressure)
may make remittance-motivated migration
irresistible. However, separated from family
and community support, this young man
could end up living a quite miserable existence. Clearly, a simple tracking of cash provides an inadequate guide to the welfare implications of the move.

Remittances, poverty,
and inequality

Remittances directly affect poverty by increasing the income of the recipient. They
also indirectly affect poverty in the recipient
country through their effects on growth, inflation, exchange rates, and access to capital.
Measuring the impact of remittances is complex (in part because of the difficulties of118

accounting for the counterfactual loss of
income from migration, as just mentioned).
But a growing body of evidence from poverty
simulation models, cross-country regressions,and analysis of household survey data showsthat remittances, in fact, do reduce poverty—
although the evidence of their effect on inequality is mixed.

Remittances reduce poverty
In what follows, we present evidence on thepoverty effects of remittances, based on threesources: a poverty simulation model, a crosscountry regression analysis, and household
survey data from selected countries. The illustrative poverty simulation model asks astraightforward question: how would poverty
rates change in our sample of developing
countries if remittances were to disappear
completely? Because this model is easy to implement for most countries, it can provide
some sense of the effect of remittances acrosscountries. However, the model is relatively
crude and cannot account for the fact thatwhile remittances affect poverty, the level ofpoverty also affects the volume of remittances.
In comparison, cross-country regression
analysis requires more data and is harder toimplement, but it is better able to control forreverse causality between remittances andpoverty. Household surveys are most likely toprovide the data required for a rigorous analysis of the relationship between remittancesand poverty. The surveys also allow one to analyze the counterfactual loss of income due tomigration. It is difficult, however, to generalize across countries on the basis of household
data, particularly because most available
household surveys do not have usable
data on remittances, especially international
remittances.
To understand how remittance flows might
affect measures of poverty, we start with an illustrative poverty simulation model and ask astraightforward (although unrealistic) question. The model relates the change in poverty
to income growth and inequality change. Itis estimated using cross-country data forR E M I T T A N C E S ,H O U S E H O L D S ,A N DP O V E R T Y

Box 5.1 Estimating a cross-country poverty
change modelT

he basic idea behind a poverty change modelis that a particular measure of poverty (say thefraction of the population with incomes below$1 per day) is a function of descriptive parametersof the income distribution, such as the mean and theGini coefficient. Building on Ravallion (1997), we
posit a conditional constant elasticity specification,in which there is a constant growth elasticity ofpoverty reduction that varies with the initial levelof inequality. After reformulation, the basic
relationship (see annex 5A.1) relates the rate ofpoverty change to a measure of inequality-adjusted
income growth and an income-adjusted change ininequality.

To estimate the relationship, we use the dataset
assembled by Adams and Page (2005), in which theobservations relate to the period between comparable nationally representative household surveys. For
each country, we have data from surveys for the initial and final values of poverty, inequality, and per
capita income. Below is the estimated poverty change
equation for the headcount measure of poverty.
Using survey income and consumption data as theincome variable (last column), results from themodel are robust, with statistically significant impacts from both income growth and inequalitychange on the headcount rate.

Estimated poverty change model
Income variable
Dependent variable—proportionatechange in the headcount rate
Intercept

Income variable
GDP per capita

Survey mean income or consumption

0.39(2.21)

0.33(2.42)

4.93(2.57)

5.60(2.27)

Income-adjusted inequality change

0.60(1.57)

1.11(2.82)

R2
Number of observations

0.08
81

0.30
81

Inequality-adjusted growth

Source: World Bank staff estimates.
Note: Standard errors are robust to country-level clustering; t statistics are in parentheses. The model is estimated using firstdifference of variables. The poverty line for the headcount poverty calculation is $1.08 in purchasing-power-parity-adjusted
1993 dollars (equivalent to $1 in 1985 dollars). The per capita income measure is mean survey income or consumption(depending on availability from the survey).

81 countries. The methodology and results arepresented in box 5.1 and in annex 5A.1. The
premise behind the analysis is that the incremental income from remittances can be analyzed in the same way as incremental income
from economic growth—so we can simulate
the impact of eliminating remittances by modeling an income decline equal to the original
remittance level. For the sake of simplicity, we

assume that nothing else changes—that there
are no offsetting increases in domestic sourcesof income or other adjustments to spending
behavior or labor supply.4
Results from the simulation are summarizedin table 5.1 (see also annex 5A.1). We report
averaged results for different groups ofcountries—first, by distinguishing between
higher-remittance recipients (greater than119

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Table 5.1 Simulated impact of eliminating remittances on poverty rate
Country group

Low remittances
Low headcount rate
High headcount rate
High remittances
Low headcount rate
High headcount rate

No. of countries

Remittances/GDP (%)

Poverty headcount rate

Change in headcount rate, noGini change

23
12
11
14
7
7

2.2
2.0
2.5
11.0
8.0
14.1

25.6
11.8
40.6
24.8
10.7
38.9

5.0
1.2
9.1
12.2
4.1
20.3

Source: World Bank staff estimates.
Note: Low (high) remittances refer to the remittance share in GDP less (greater) than 4 percent. Low (high) headcount rate refers
to a rate less (greater) than 20 percent. Allowing inequality to change 2 Gini points has minimal effects on the change in theheadcount rate. See annex 5A.1 for detailed results.

4 percent of GDP) and lower (less than 4 percent but greater than 1 percent), and second, by
the extent of poverty (headcount above 20 percent or below 20 percent).
These results show that the impact of eliminating remittances depends on how large they
are to begin with (higher initial levels mean
steeper income declines), the initial extent ofpoverty, and the degree of inequality. For example, the average increase in the headcountratio for higher-remittance countries (12.2 percentage points) is more than twice that of
the lower-remittance countries (5 percentage
points). Similarly, with each of these twogroups, the impact is much greater for thosecountries with higher headcount ratios to startwith. The estimated impact of inequality—
an assumed 2 point worsening in the Gini
coefficient—has only a small marginal impact
on the estimated change in the poverty rate.
This simple analysis has significant limitations. First, the simulated effects depend on
accurate country-level measures of remittances, which, as emphasized in chapter 4,
are of variable reliability. Second, many of thecountry simulations are made outside the sample used for the regression analysis and are
therefore subject to the standard out-ofsample prediction problems. Third, the analysis assumes that remittances are included inhousehold income when calculating the measures of poverty and inequality from household surveys. In reality, there is variation120

across surveys in how remittances are accounted for in the household surveys.5
The results just described provide an indication of the role that remittances can play in
reducing poverty, but because of the simplicityof the model and other limitations, the results
are not conclusive. More rigorous analytic
work has been undertaken to investigate thelink between remittances and poverty basedon careful analysis of cross-country data.
In a model that relates national poverty
levels to mean income and the Gini measureof inequality for 71 developing countries, a
10 percent increase in per capita official international remittances leads to a 3.5 percent decline in the share of people living in poverty(Adams and Page 2005).6 Other recent studies
have broadly confirmed these findings, including IMF (2005) (see chapter 2), which uses asample of 101 countries for the period
1970–2003.
Although the available evidence is still relatively limited, growing evidence from household survey data complements the findings ofthe model that international remittances have
reduced the incidence and severity of poverty
in several low-income countries. According
to that evidence, remittances are believed tohave reduced the poverty headcount ratio by
11 percentage points in Uganda, 6 percentage
points in Bangladesh, and 5 percentage points
in Ghana (Adams 2005b). Completely removing remittances for Lesotho would raise theR E M I T T A N C E S ,headcount poverty ratio (with a poverty line
equal to 60 percent of mean household expenditure) from 52 to 63 percent (Gustafsson and
Makonnen 1993).
While remittances had only a limited role
in reducing the number of poor people in
Guatemala, they did significantly reduce thedepth and severity of poverty (Adams
2004a).7 International remittances accounted
for 60 percent of income for households in thelowest income decile, but were not very large
for households located near the poverty line
(roughly the fifth income decile). As a result,international remittances had more impact on
reducing the depth of poverty than on thepoverty headcount; in other words, they werereally helpful for the poorest of the poor.
Wodon and others (2002) conclude that in
Guerrero and Oaxaca, two southern Mexican
states with significant international emigration and remittance inflows, the share of the
population living in poverty is lower by 2 percentage points due to remittance income. They
argue that this poverty effect is similar in magnitude to that of many government programsin poverty reduction, education, health, andnutrition. Taylor, Mora, and Adams (2005),
using data from a 2003 survey, find that international remittances account for 15 percent of
per capita household income in rural Mexico.
They conclude that an increase in international remittances would reduce both thepoverty headcount and the poverty gap.
Yang and Martinez (2005) studied the impact of variations in the exchange rate on remittances sent by Filipino workers and the ultimate impact of remittances on poverty in therecipient regions. Using a large dataset fromthe Overseas Filipino Survey, they found thatan appreciation of the Philippine peso led to
an increase in remittance flows, which contributed to the reduction in poverty. Interestingly, increased remittances not only reduced
poverty in the migrant families, they also
had spillover effects on nonmigrant families.
(We will have more to say on multiplier effects
later in this chapter.)H O U S E H O L D S ,A N DP O V E R T Y

The effect of remittances on inequality
is unclear
In contrast to the link between remittancesand poverty, no strong conclusion is found inhousehold studies of the relationship between
remittances and inequality: remittances sometimes go disproportionately to better-off
households and so widen disparities, but inother cases they appear to target the less welloff, causing disparities to shrink. Some studies
suggest that the remittances from new migration may raise inequality in the short term,
but the effect on inequality is small over thelong term.8 Calculations that impute incomes
for the migrant had he stayed and worked athome generally show an increase in inequality
from the combined effect of migration and remittances. For example, inequality was foundto have increased in Bluefields, Nicaragua,when an imputation was made for the lost domestic income of migrants, but it fell when thedomestic income of migrants was ignored(Barham and Boucher 1998).
Two recent studies, however, did not findan increase in inequality even after controlling for the counterfactual income loss from
migration: Adams (2005a) found that in
Ghana, the inclusion of international remittances in household expenditures led to only aslight increase in income inequality, but that
the Gini coefficient remained relatively stable,
between 0.38 and 0.40.9 De and Ratha (2005)
found that in Sri Lanka, the Gini coefficientdrops from 0.46 to 0.40 as a result of remittance receipt.
Differences in findings on the impact ofremittances on inequality also stem from varying geographic and historic circumstances,such as the distance from high-income
destination countries and the prevalence of
networks of earlier migrants. Both proximity
to high-income countries and establishednetworks will tend to reduce the cost of
migration, making migration an option forpoorer (and often credit-constrained) households.10 For example, remittances to a Mexican village with a well-established history of121

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international migration had an equalizing effect, whereas remittances to another Mexican
village for which international migration wasa relatively new phenomenon tended to makethe distribution of income more unequal(Stark, Taylor, and Yitzhaki 1986). For a large
number of Mexican communities, the overall
impact of migration and remittances is estimated to reduce inequality for communities
with relatively high levels of past migration(McKenzie and Rapoport 2004).11
One reason for the inconclusive empiricalevidence on inequality effects is that the Gini
coefficient does not adequately capture income
mobility; it remains unchanged, for example,
if one person moves up and another moves
down the income ladder. Using household survey data from Sri Lanka, De and Ratha (2005)
show that the poor income deciles also havesignificant overseas migration and that remittance recipients in the middle income deciles
move up the income ladder (figure 5.1).12
Beyond the contradictory or inconclusive
results, some scholars question whether thelink between remittances and inequality is allthat important. Inequality matters when it interferes with the functioning of the economy(for example, when credit constraints bindmore households13) or the political system(for example, when growing inequality increases support for governments that pursue
damaging populist policies14). Greater inequality may also be considered bad becauseof its impact on social welfare (see Sen 1973
for a discussion). But it should be kept in mind
that in the context of remittances, inequality
relates to income differences among groups
that would all be viewed as relatively poor in
an industrial-country context. The rich in developing countries probably receive little in
the way of remittances; the rich who migrate
tend to take their families with them.

Remittances and household
consumption smoothingR
122

emittances may play a significant role insmoothing consumption. Poor households

Figure 5.1 Sri Lankan migrationa Percent of Sri Lankan households with
migrants abroad
Percent
12
10
8
6
4
2
0
1

2

3

4

5

6

7

8

9

10

Income decile

Source: De and Ratha 2005.

b Percent of Sri Lankan households that moved up
to a higher income decile after receiving remittances
Percent
25
20
15
10
5
0

1

2

3

4

5

6

7

8

9

10

Income decile

Source: De and Ratha 2005.

that lack access to insurance and credit
markets are vulnerable to severe declines inincome from adverse shocks, and they may
be forced to forgo income-generating—but
risky—strategies (Morduch 1994). Informal
community institutions generally play a limited
role in mitigating risk (see, for example, Coateand Ravallion 1993 and Fafchamps 2004), especially in the face of adverse events such as acommunity-wide crop failure. One strategy to
reduce risk is for households to send family
members to other regions or countries, where

R E M I T T A N C E S ,they are not likely to face the same income
shocks as those found in the domestic
market.15 Migration patterns and policies thatencourage migrants to travel unaccompanied
by family members encourage this form of risk
sharing.
There is some evidence that remittancesfrom internal migration provide insurance.
Remittances to Botswana increased with theextent of drought in the migrant’s home region, and the responsiveness of remittance levels to drought was greater for households withmore drought-sensitive assets such as cattle(Lucas and Stark 1985).16 The anticipation of
insurance may allow the household to pursue
a more risky asset accumulation strategy—
although it is also possible that householdswith more to lose from drought (whatever thereason) are simply more likely to receive remittances. The likelihood that Thai internalmigrants move to Bangkok is reduced themore closely income in Bangkok aligns withincome in the province of origin (Paulson
2000).17 The effect is particularly strong for
remittances to rural households, which are
likely to be poorer and have less access to formal insurance products to mitigate weatherrelated risks. The more volatile a household’s
income (and the more restricted its ability to
self-insure), the greater the distance thathouseholds in rural India tend to send theirdaughters to marry (Rosenzweig and Stark
1989). Greater distance means that the covariance of income shocks with the home region
will be smaller, facilitating consumptionsmoothing transfers between these relatedhouseholds.
Studies of how remittances respond to adverse household shocks generally support theview that remittances provide some insurance.
However, interpreting these correlations iscomplicated by the likelihood of reverse
causality (remittances can influence household
outcomes as well as be influenced by them)and omitted variable bias (certain hard-tomeasure household characteristics may affecta household’s susceptibility to risks as wellas the likelihood of receiving remittances).

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Consider, for example:• Migrants responded to the cost of hurricane damage borne by Jamaican households, with each additional dollar of
hurricane damage leading to $0.25 inadditional remittances (Clarke andWallsten 2004. The authors use panel
data to control for the household-levelrisk aversion and vulnerability effects
that potentially bias the estimates.18)• Remittances are estimated to have replaced 60 percent of income loss due toweather-related shocks in a sample ofFilipino households (Yang and Choi2005.19 Rainfall is used as an instrument
for income to avoid reverse causality;
panel data are used to control for the tendency for risk-averse households to locate
in places where incomes are more stable
and to send migrants to manage risk.)• In cross-country data, a dollar’s worth of
hurricane damage leads to roughly $0.13
in additional remittances in the year of
the hurricane and $0.28 cents over five
years (Yang 2005). (Yang uses meteorological data to instrument for reported
disaster damage, because damage reports
may be affected by the anticipation offinancial flows.)

Remittances and indirect effects
on household incomeRemittances may indirectly affect household income through changes to the labor
supply of those remaining behind; relaxationof working capital constraints that expand income from entrepreneurial or farming activities; and multiplier effects on household income. Unfortunately, the evidence on each ofthese channels is quite limited, so we are constrained here to identifying important areas for
additional research.

Remittances may affect labor supply
Remittances may tend to reduce the supply oflabor provided by remaining household
members, who may take a portion of the123G L O B A L

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remittance gain as leisure. This income effect isgenerally not a concern, because it represents
part of the welfare gain from remittances. By
contrast, remittances may change the return tosupplying labor, for example, if the migrantconditions the remittance on low householdincome.20 Such a substitution effect will reduce the welfare gain from remittances by
distorting household labor decisions.
However, it is difficult to separate income
and substitution effects of remittances on thelabor supply of those remaining behind. Looking at the overall effect, a rise in remittances
reduced labor force participation in Managua,
Nicaragua, but increased self-employment(Funkhouser 1992). Remittances were estimated to reduce the participation rates ofremaining household heads in a number of
Caribbean countries, although the directionof causality was hard to establish (Itzigsohn1995). Yang (2004) points to more encouraging labor-supply effects than the standard
model when he determined that remittances
reduce the supply of child labor but increasethat of adult labor.

Remittances provide working capital
There is some evidence that remittances provide working capital to households that lackaccess to credit markets. For example, migration to South Africa’s mines initially reduced
agricultural production in countries of origin,
because labor was removed from the farm
(Lucas 1987). However, over time productionrose with migration, perhaps due to remittance-funded capital investment and a greater
willingness to take risks with agricultural production, owing to the more diversified sourcesof family income. Remittances had a small
negative effect on household income for Mexico in 1982, but a large positive effect for 1988
(Taylor 1992). One possible explanation isthat over time the development of migrant networks allowed migration from poorer households that are more likely to be credit constrained (see the discussion of inequality,
above). The effect of remittances on householdincome depends on both the liquidity of124household assets (which determines their value
as collateral) and on the availability of inputs
that complement entrepreneurial activity (Taylor and Wyatt 1996). The role of remittancesin relaxing household credit constraints inrural cropping income in China dominated the
direct loss of productive labor from migration,
so that internal migration increased per capita
household income (excluding remittances) by
14 to 30 percent (de Brauw, Taylor, andRozelle 2001). Mishra (2005) found that a 1
percentage point increase in remittance inflows in 13 Caribbean countries increased private investment by 0.6 percentage point (allmeasured relative to GDP).
Remittances may ease credit constraints because a stable stream of remittance income
may make households more creditworthy inthe eyes of formal sector financial institutions.
Remittance receipts that increase when thehousehold receives an adverse shock may beeven more important in relaxing credit constraints, since they increase the lender’s confidence that they will be repaid even if things
turn out badly for the household. This creditworthiness effect deserves careful empiricalinvestigation, given the increasing interest inchanneling remittances through formal financial channels.

Remittances may have multiplier effects
Some studies have found that remittances
have a multiplier effect, whereby the increasein domestic income is some multiple of the remittance income. For example, each dollar
sent by Mexican migrants to the United States
was estimated to boost Mexican GDP by$2.90 (Adelman and Taylor 1992). Such multipliers will occur if output is constrained byinsufficient demand. However, in many developing countries sustained underemployment islikely to have supply-side causes, for example,
government policies that increase the cost of
hiring and firing workers, so that increased
demand will ultimately result in higher inflation rather than increased output.21
Nevertheless, there may be greater scopefor sustained multiplier effects at the regional

R E M I T T A N C E S ,level. The local spending of remittance income
will generate further income for other local
households, which in turn is likely to cause
local inflation for nontraded goods and possibly a small increase in national inflation. A national government with a formal or informal
inflation target is likely to respond to any increase in the national inflation rate by tightening monetary policy, thereby leading to an offsetting effect on national aggregate demand.
The net effect would be multiplier effects at
the local level but not at the national level. Indeed, the local gains come partly at the expense of the regions that do not receive the remittances but are forced to suffer the tightermonetary policy.
Remittances also may have multiplier effects in the context of increasing returns, typically as the expansion of one sector increases
the optimal size of other sectors.22 Althoughsuch income-expanding feedback loops could
be present at the national level, they are again
more likely to be relevant at the regional level,
because expanding regions attract labor andcapital from elsewhere in the economy. The
bottom line is that remittance-induced multiplier effects cannot be ruled out—especially at
the regional level—but our current empirical
understanding of their importance is quite
limited.

Remittances, savings,
and investmentD

oes it matter how households allocate remittance income between consumption
and saving? Allocations to the latter may boost
household investment or national investment
through allocation to financial assets. But froma welfare perspective, an extra dollar of investment is only better than an extra dollar of present consumption if the marginal social valueof investment is greater than its marginal private value.23 Although a number of factors candrive a wedge between social and private values (such as capital income taxes, monopoly
powers, and credit constraints), one prominent
reason raised in the development context is the

H O U S E H O L D S ,A N DP O V E R T Y

possible existence of positive externalities frominvestment expenditure.24 Thus the way that
remittances are allocated by households may
affect the social value of a given remittanceflow.
The rate of investment of remittance income will be high when:• Remittance flows are viewed by thehousehold as transitory rather than permanent and thus should be saved (andinvested) rather than spent.
• The sender conditions the remittance on
it being spent for particular purposes,
which are more likely to involve investment than current consumption. Examples include education or the purchase of
new farm machinery.
• The remittance is targeted (or “tagged”)
to household members more likely to
use the funds for investment purposes(women rather than men).25• Households practice a form of mental
accounting with their overall budget,with remittances being disproportionately put in accounts set aside for investment purposes.26
On the other hand, some of the literature already reviewed suggests reasons to expect thatthe marginal propensity to invest remittanceincome will be low when (a) remittances aretargeted to poor households that are struggling
to meet subsistence needs and (b) they are targeted to credit-constrained households that areexperiencing adverse consumption shocks.
The empirical challenge in identifying thecausal effect of remittances on investment isthat remittances are likely to be correlatedwith the extent of opportunities for investment, thereby biasing the estimated remittanceeffect. That correlation could be positive or
negative. When more enterprising households
are the ones sending migrants and the ones
with substantial investment opportunities,
high remittances will be wrongly associatedwith high investment. On the other hand, tothe extent that households send migrants

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when investment opportunities are absent at
home, then high remittances will be wrongly
associated with low investment. The empiricalsolution is to find a source of variation in remittances that is plausibly unrelated to household investment opportunities.
Measuring the impact of remittances on investment—either in physical or in human capital—is not easy. Household budget surveys
are best suited for this purpose, but most of
the existing surveys either do not record dataon international remittances or are poorly
designed. Since remittances are fungible, it isdifficult to isolate their effects from those ofother sources of income. Simply asking how
remittances are spent is unlikely to reveal thetrue marginal effect on spending, because remittances, even when used for investment purposes, may free up the marginal dollars for
consumption spending.27

Remittances can lead to investments
in education and healthSome of the clearest evidence for remittanceinduced investments comes from work on
human capital. The dramatic depreciation of
the Philippine exchange rate during the Asianfinancial crisis increased remittances from
Filipino migrants (because from the migrants’perspective, exchange-rate depreciation raised
the relative price of their own consumption
in the destination country compared with
consumption by household members backhome), leading to greater child schooling, reduced child labor, and increased educational
expenditure in origin households (Yang
2004).28 In El Salvador, remittances are estimated to reduce the probability of children
leaving school by 10 times the effect of othersources of income in urban areas and by 2.6
times in rural areas (Cox Edwards and Ureta
2003).29 They speculate that remittances havea disproportionate influence on schooling expenditures because the migrant has made it acondition for the financial support. Mexican
children in households with migrants completed significantly more schooling, with the126largest impact (an additional 0.89 years ofschooling) for girls in households where themother has a low level of education (Hanson
and Woodruff 2003).
Health status is both an important component of human capital and a central element ofwell-being in its own right. Unfortunately,
the effect of migration on the health offamily members remaining behind—notably
children—is poorly understood. Migrationfrom Mexico is associated with lower (by3 percent) infant mortality and higher birthweights of children left behind (Hildebrandt
and McKenzie 2005). The positive health effects come through increased access to healthrelated knowledge as well as through increased household wealth. Notwithstanding
these encouraging outcomes, the authors caution that the impact of migration on childhealth is quite nuanced, with migration associated with lower measures of preventive
health care such as breast-feeding and vaccinations.30 De and Ratha (2005) find that in
Sri Lanka, remittance income has a positiveand significant impact on the weight of children under five; this result is especially strong
for female-headed households. However, thehealth impact of absenteeism of one of theparents is negative.

Remittances can encourage
entrepreneurship
There has been a marked shift from the belief
that migrants are unlikely to establish new
business enterprises in their countries of origin(either upon return or through remittancefinancing) to the view that migration encourages entrepreneurship. Large receipts ofremittances from the United States are associated with a greater likelihood of productive
investment in Mexico (Massey and Parrado
1998).31 A survey of 6,000 small firms in 44
urban areas in Mexico shows that remittances
are responsible for almost 20 percent of thetotal capital in urban micro-enterprises(Woodruff and Zenteno 2001). The share rises
to one-third for the 10 states with the highest
rates of United States–bound migration.

R E M I T T A N C E S ,Remittances also appear to ease credit constraints on new business formation in thePhilippines (Yang 2004). The effect of exogenous increases in remittance income on theprobability of entering into entrepreneurshipis larger for low- to middle-income households, which are the ones most likely to facecredit constraints. Policies that facilitate easy
exit and reentry for migrants may encourageincreased involvement in remittance-funded
investments or enterprises.

Remittances are often invested
by recipient households
Contrary to the conventional wisdom that
remittances tend to be “frittered away” by recipient households, recent work has estimatedthat a large proportion of remittance income
is saved. Only 12 percent of net increments
to expenditure by rural Egyptian households
were allocated to consumption, with large
propensities to invest in the construction andrepair of houses, and in agricultural or building land (Adams 1991). This relatively highpropensity to invest is assumed to result fromhouseholds treating remittance receipts as
temporary income flows, which forwardlooking households save (and invest) rather
than consume. These findings are largely confirmed in a later study of Pakistani households(Adams 1998).32 In Guatemala, remittancereceiving households are found to have lower
marginal propensities to consume and ahigher propensity to invest in education,
health, and housing than other households(Adams 2005c).
It should be noted that some survey results
for a number of Latin American countries
point to much higher propensities to consume
remittance income (see, for example, IADBMIF 2004). The percentages of remittances
spent on household expenditures are 78 percent in Mexico, 77 percent in Central America, and 61 percent in Ecuador, while spending
on real estate and education is low. However,surveys of how income from a particularsource is spent tend to be unreliable, becausemonies from different sources are considered

H O U S E H O L D S ,A N DP O V E R T Y

perfect substitutes by the household. In contrast, studies such as Yang (2004) econometrically estimate expenditure propensities given
exogenous changes in remittance income, sothat the estimates should be less susceptible tothe fungibility problem. A second explanation
for the different results is that the econometricstudies measure marginal propensities,
whereas the direct surveys measure average
propensities. It is the marginal propensity thatis of interest when we consider the expenditure effects of policies that increase remittanceflows.33
The role of remittances in funding investment has recently been questioned in a macroeconomic paper by Chami, Fullenkamp, andJahjah (2005), who find that remittances tend
to be negatively associated with economic
growth. This countercyclical behavior of remittances is consistent with the evidence discussed above that remittances respond to adverse household shocks. But the observationthat remittances tend to move countercyclically does not necessarily obviate their role infunding investment. The micro studies we reviewed point to remittances as both smoothing consumption and providing funds for investment. Moreover, the increased flow ofremittances in the face of adverse shocks may
allow households to sustain funding for key
investments in areas such as business working
capital, education, and health care.
The evidence reviewed in this chapter suggests that remittances play multifaceted roles
in poverty reduction, consumption smoothing,and investment, with the balance of roles
varying by time and place.

Annex 5A.1 Poverty simulation
model: description and resultsT

he poverty change model assumes that a
particular measure of poverty (say thefraction of the population with incomes below$1 per day) is a function of descriptive parameters of the income distribution, such as themean and the Gini coefficient. Building on

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Ravallion (1997), we assume that there is aconstant growth elasticity of poverty reduction,
but we allow that elasticity to vary with theinitial level of inequality.34 We call this aconditional constant elasticity specification.
Specifically, the poverty measure, P, is given by,measure of inequality (which we take to be theGini coefficient), and A and ␤ are parameters.
Differentiating the poverty equation and writing it in rate-of-change form yields our basic
poverty change model,dPdY ␤(1  I)
 ␤ln Y dIPYP  AY␤(1  I),
where Y is per capita income (measured asmean survey income or consumption), I is theThis equation can be interpreted as sayingthat the rate of poverty change depends on a

Table 5A.1 Effect of removing remittances on the poverty headcount rate
Country

Armenia
Azerbaijan
Bangladesh
Bolivia
Botswana
Burkina Faso
Colombia
Côte d’Ivoire
EcuadorEgypt, Arab Rep.
El Salvador
Gambia, The
Georgia
GuatemalaHonduras
India
Kenya
Lao PDR
LesothoMali
MexicoMoldova
Mozambique
Nepal
Nicaragua
Pakistan
PanamaParaguay
Peru
Philippines
SenegalSierra Leone
Sri Lanka
Swaziland
Tajikistan
UgandaYemen, Rep.

Survey year

1998
2001
2000
1999
1993
1998
1999
1998
1998
2000
2000
1998
2001
2000
1999
2000
1997
1997
1995
1994
2000
2002
1997
1996
2001
1999
2000
1999
2000
2000
1995
1989
1996
1996
1999
1999
1998

Poverty headcount rate($1 a day, PPP, $1993)

13
4
36
14
31
45
8
16
18
3
31
54
3
16
21
35
23
26
36
72
10
22
38
39
45
13
7
15
18
16
22
57
7
8
14
85
16

Remittances as shareof GDP (%)

5
2
4
1
2
3
2
1
3
3
13
7
6
3
6
3
3
2
44
6
1
19
2
1
2
2
2
4
1
8
3
3
6
6
6
4
19

Change in headcount rate (Gini ⴝ 0)

Using percapita GDP
2
0
5
0
1
3
0
0
2
0
10
9
0
1
3
3
2
2
29
10
0
13
2
1
3
1
0
1
1
3
2
3
1
1
3
9
10

Source: World Bank staff estimates.
Note: Remittance share is 1995 for Sierra Leone. Estimates are based on poverty reduction model.

128

Using survey
mean income
4
0
13
1
3
4
0
1
3
1
41
12
0
2
4
23
2
4
34
17
1
21
2
2
13
2
0
2
2
10
3
4
3
1
3
40
7

R E M I T T A N C E S ,measure of inequality-adjusted growth and an
income-adjusted change in inequality.35
To estimate the relationship, we utilize thedataset assembled by Adams and Page (2005).
The observations relate to spells between comparable nationally representative household
surveys. For a given spell, we have data for the
initial and final values of poverty, inequality,and per capita income.36 The estimated equation for the headcount measure of poverty isreported in the table in box 5.1 in the maintext. Similar results were found for thepoverty gap measure.
The next step is to simulate the effect ofremoving remittances on the poverty measure
under various assumptions about how remittances affect inequality. The proportionate increase in per capita income due to remittances
is given simply by the share of remittances in
GDP multiplied by the ratio of per capita GDP
to mean survey income/consumption.37 It is
important to emphasize that the simulated
poverty-increasing effect of removing remittances applies to the latest year for which asurvey is available for that country, and thus
different years are being used for different
countries. Care should thus be taken in making comparisons about the importance of remittances in reducing poverty across different
countries. Where the headcount rate is below
2 percent we do not attempt to estimate thepoverty change effect of remittances.
Table 5A.1 shows results on the poverty
headcount when remittances are removed(assuming there is no impact of remittances oninequality) for 37 countries where remittances
are above 1 percent of GDP and where thepoverty headcount rate is greater than 2 percent at the outset.

Notes
1. This represents a significant shift from the traditional earlier pessimism about the role of remittances
in development. For example, Papademetriou andMartin (1991) emphasize how migration increases thedependence of emigration countries that are unable “toregulate or channel remittances,” while Jacobs (1984)

H O U S E H O L D S ,A N DP O V E R T Y

states that remittances “did nothing to convert stagnation to development” in abandoned regions.
2. Since data on what the migrant was earning before leaving are typically unavailable, the lost domestic
income is estimated or imputed based on observed
characteristics of the migrant and on knowledge of
how those characteristics are rewarded in the domestic
economy.
3. In the Sri Lanka Integrated Survey 1999–2000,
nearly a third of households receiving remittances did
not report having a migrant member overseas. It is possible that those households received remittances fromtheir extended family; it is also possible that they received remittances from friends (De and Ratha 2005).
The literature also notes third-party remittances inother countries (see, for example, Yang 2004 for thePhilippines). A survey of African diasporas in Belgium
found that more than one member in a typical migranthousehold sent regular remittances and that each remitter might send remittances to different recipients.
4. This situation is akin to the second counterfactual(a decline in remittances but no change in migrationand hence household income) discussed at the outset.
To the extent that a decline in remittance income may
encourage households to devote more labor hours todomestic income-generating activities, the total decline
in household income and the consequent poverty effectmay be smaller than assumed in the simulation, a point
made in Adams (2004a).
5. If we adopt the other extreme assumption—that
remittances are not included in household income—theresults can be interpreted with a simple reversal of thesign, which gives the reduction in poverty that would
result if remittances were included.
6. As higher poverty increases the incentive to migrate, the ordinary least squares (OLS) estimates of
the impact of remittances and stock of migrants arebiased downward. On the other hand, when creditconstrained poor families do not have the resources tosend migrants, the OLS coefficients are biased upward
as poorer countries send fewer migrants. To deal withthe bias, Adams and Page (2005) allow for remittancesand emigrant stock variables in their regressions, using
measures of international distance, government stability, and levels of education.
7. The poverty depth is the average shortfall below
the poverty line expressed as a fraction of the poverty
line (or simply the poverty gap ratio); and poverty
severity is the squared poverty gap ratio. A key featureof this severity measure is that it is sensitive to the distribution of income among the poor (Foster, Greer, andThorbecke 1984).
8. Stark, Taylor, and Yitzhaki (1986) found that a
1 percent increase in international remittances leads to129

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a 0.14 percent increase in the Gini coefficient in thecase of Mexican villages with a short migration history; but in other villages with a long migration history, the Gini coefficient actually declines by 0.01 percent. Taylor (1992), McKenzie and Rapoport (2004),
and Taylor, Mora, and Adams (2005) also find negative effects on the Gini in the case of Mexico.
9. Nearly 40 percent of households in a representative sample in Ghana receive remittances, of those remittances, 4 times as many households receive internalthan international remittances (Adams 2005b). Households receiving internal remittances are disproportionately poor, indicating the importance of internal remittances in reducing poverty. Households surveys in
Europe and Central Asia also show that in a number ofcountries (Albania, Kosovo, Moldova, and Tajikistan,for example) a large number of households receive remittances, many in rural areas (World Bank 2005).
10. Research has also shown that the inclusion ofremittance-induced, indirect effects on income—suchas income-induced reductions in nonmigrant labor
supply or increases in entrepreneurial income due tothe relaxation of credit constraints—can change thedirection of the inequality effect.
11. The authors experiment with various instruments for location-specific migration levels in their regressions. The instruments include the historic (1924)
state-level migration rate and unemployment rates for
the U.S. state that includes the city that is the likely
destination for migrants from a particular Mexican
location.
12. This study imputes the counterfactual income
by calculating the income from equivalent activities athome. In the bottom two deciles, remittance income isoffset by the counterfactual loss of income from
migration, whereas in the top two deciles, remittanceincome falls short of the counterfactual loss of income.
13. See, for example, Banerjee and Newman (1993).
14. See, for example, Alesina and Rodrik (1994)
and Persson and Tabellini (1994).
15. The New Economics of Labor Migration(NELM) emphasizes that (a) migration is often better
viewed as a family rather than an individual decision;(b) risk management and provision of credit are seen toplay a central role in migration and remittance decisions; and (c) migration is often seen as a response to
the failure of markets for insurance and credit (Taylor
1999). Rosenzweig (1988, p. 1167) highlights theinformational problems that undermine crucial markets and emphasizes how ties of common experience,
altruism, and heritage “enable families to transcendsome of the informational problems barring the development of impersonal markets.”
16. See also Stark and Lucas (1988).

130

17. Rainfall is used as an instrument for provincial
income in establishing the covariance pattern.
18. Simple cross-sectional estimates of how remittances respond to hurricane damage will be biased downward if more risk-averse households are more likely tosend migrants as a general insurance strategy and are
more likely to take actions to reduce the risk of costly
damage to the home. They will be biased upward ifhouseholds with more vulnerable dwellings are more
likely to send migrants and more likely to suffer hurricane
damage. An additional complication is moral hazard,
where insured (remittance receiving) households haveless incentive to avoid risky behavior. Clarke andWallsten (2004) deal with the potential endogeneity
problem by using the average damage done in the neighborhood as an instrument for household-specific damage.
19. They cannot reject the null hypothesis that allof an exogenous decline in income is matched by anincrease in remittances.
20. There is a disincentive to work if remittances
are conditioned on low income. Conversely, if remittances are conditioned on domestic labor supply—“I
will help you if you help yourself”—there is an added
incentive to work. From the migrant’s perspective,
there is some similarity with the challenges faced bygovernments in providing social assistance without creating poverty traps and dependency. A traditional“welfare” model conditions remittances on householdincome, whereas the modern “workfare” model attempts to condition remittances on household effort in
an attempt to avoid putting the household in a trap
where working makes little economic sense. However,from the strict welfare perspective of the standard
model, any distortion to the labor supply of the remaining members—negative or positive—reduces thewelfare gain from the remittance.
21. See Layard, Nickell, and Jackson (1991) for a
discussion of supply-side constraints on employment.
22. See Cooper (1999) for an introduction to multiplier effects under increasing returns where the outputs in different sectors are “strategic complements.”
23. These values are assumed to be expressed inunits of current consumption.
24. As examples, consider that the social returnfrom human capital investments is greater than theprivate return due to knowledge spillovers (Moretti2003); the social return from investments in vaccination is greater than the private return due to thespillover of reduced disease contagion (Miguel andKremer 2001); and that the social return from entrepreneurship is greater than the private return due toexternalities from demonstration effects about where acountry’s comparative advantage might actually lie(Hausmann and Rodrik 2002).

R E M I T T A N C E S ,25. See Bourguignon and Chiappori (1992) and
Browning and others (1994) for treatments of collective decision making in the “nonunitary household.”
Duflo (2003) demonstrates that pensions received by
women in South Africa have a larger impact on theweight and height of girls than of boys living in thehousehold. In other words, how that income is spentdepends on who receives it. Using data from the Côte
d’Ivoire, Duflo and Udry (2004) show that where husbands and wives farm different plots of land, the effectof rainfall shocks that differentially affect the plots has
implications for the composition of household expenditure. They consequently reject the hypothesis of “fullinsurance” within the household.
26. See Thaler (1990) for a discussion of mental
accounting.
27. Adams 2005a. See also Swaroop and Devarajan(2000) for a discussion of the fungibility problem in thecontext of evaluating the impact of official flows.
28. This is a useful test of the allocation ofremittances between consumption and savings if thedepreciation-induced change in remittances is independent of household investment opportunities.
29. This finding is subject to the problem of identifying whether remittances increase schooling orwhether households with migrants are more likely to
use additional income for schooling. The authors argue
that remittances are closer to a randomly assigned transfer, particularly for political exiles whose migration isless likely to be correlated with household factors that
affect the likelihood of human-capital investment.
30. Again, it is difficult to separately identify the
impact of migration on health outcomes. Individuals
from households with poor health status may not bewell enough to make a difficult border crossing; themost prosperous and healthy households may findthat local opportunities outweigh those yielded by arisky illegal move; or adverse shocks may affect bothmigration decisions and health status. Hildebrandt
and McKenzie’s (2005) empirical solution to thisidentification problem is to instrument for migration
using the historic migration rate for the migrant’s
community.
31. Remittances sent during a household head’s
absence do not affect the likelihood of starting a new
business; rather the resources accumulate and areavailable as seed capital after an adjustment period
following the migrant’s return. This delay may explain
why contemporaneous surveys miss the business funding effect.
32. Likewise, Yang (2004) finds no evidence that
aggregate household consumption expenditures wereaffected at all by the remittance-inducing exchangerate shocks he studies, which contrasts with the signif-

H O U S E H O L D S ,A N DP O V E R T Y

icant positive effects he finds for education spending,adult labor supply, and capital investments.
33. On the other hand, the exogenous changes inremittance income that are used to identify the expenditure propensities in studies such as Yang (2004) arelikely to be viewed by the household as temporary,leading the forward-looking households to invest
rather than consume. These estimates would then provide a poor guide to the expenditure effects of policies
that led to more sustained increases in remittanceflows—for example, policies that permanently lower
the cost of sending remittances.
34. Bourguignon (2003) uses a highly flexible functional form with multiple interactions between the key
variables to estimate the relationship between poverty
reduction, growth, and changes in inequality. Here we
make stronger assumptions about the functional formof the relationship as a first pass in estimating thepoverty-reducing effect in a relatively simple povertyreduction model.
35. We actually take a slightly less restrictive versionof this equation to the data by allowing for an intercept
and allowing the coefficients on the two explanatory
variables to differ. We also allow for the change in inequality to enter in separately, but the coefficient on
this variable is insignificantly different from zero.
36. Observations where the initial and/or final
poverty measure for the interval is zero are excluded.
We also exclude observations from the Eastern Europe
and Central Asian region due to concerns aboutcomparable measurement during post-communist
transition.
37. The growth in per capita income is given by∆Y/Y. Denoting per capita remittances as R, and letting
the absolute change in per capita income equal the levelof per capita remittances (that is, ∆Y  R), then thegrowth rate of income due to remittances is simply
R/Y. Since we use mean survey income/consumption as
our measure of per capita income, R/Y is conveniently
calculated as (R/YGDP)  (YGDP/Y), where the firstterm is equal to remittances as a share of GDP, and thesecond term is the ratio of per capita GDP to mean
survey income.

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6
Reducing Remittance Fees

Following the discussion in chapters 4 and 5,
on the macro- and microeconomic importanceof remittances, chapter 6 focuses on a specificpolicy issue: reducing remittance costs andstrengthening the financial infrastructure that
supports remittances. Reducing the cost of
personal remittances is the most promisingarea of policy intervention for several reasons.
First, it will stanch a drain on the resources ofpoor migrants and their families back home.
Second, it will increase flows through formal
channels, especially banks. Third, it will
improve financial access for the poor in developing countries.
Cost is usually not an issue in large remittances (made for the purpose of trade, investment, or aid), because, as a percentage of theprincipal amount, it tends to be small. But forsmall, personal transfers, remittance costs are
high—unnecessarily so. Providers of remittance services in the formal sector typicallycharge a fee of 10–15 percent of the principal
amount to handle the small remittances typically made by poor migrants.1 High fees placea financial burden on the migrant remittersand on the recipients of the remittances, whoreceive a smaller amount of the much-needed
funds sent by their family members.
Major international banks tend to focus onlarge-value remittance services rather than onservices for migrants. Poor migrants may feel
uneasy about using a major bank for remittance services; they tend to prefer smaller financial institutions, money transfer operators(MTOs), or informal channels, such as afriends, family members, export-import firms,
and transport companies.
The main messages of this chapter are as
follows:
There is significant scope to reduce the fees on
remittance services, especially for the smalltransfers typically made by poor migrants.
Remittance transaction costs are often significantly lower than the fees that most customers
pay. Reducing transaction fees will increase
the disposable income of poor migrants andincrease the incentives to remit (as the net receipts of beneficiaries increase). It may alsosignificantly increase annual remittance flows
to developing countries. Cross-border payments for retail trade, investment, and pension
benefits (typically defined in foreign currency)
would also increase in response to a reduction
in remittance fees.
A weak competitive environment in the remittance market, lack of access to technologysupporting payment and settlement systems,
and burdensome regulatory and compliancerequirements all tend to keep fees high. Competition in the remittance market could be increased by lowering capital requirements on
remittance services and opening up postal,banking, and retail networks to nonexclusive
partnerships with remittance agencies. Disseminating data on remittance fees and establishing a voluntary code of conduct for fairtransfers would improve transparency in135

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2 0 0 6

remittance transactions. In countries withexchange controls, efforts to align the official
and the market exchange rates would reduce
the foreign-exchange spread in remittancetransactions.
Reducing remittance costs and improving
access to the financial system for migrants andtheir families will do more to encourage theuse of formal channels than will regulation of
so-called informal services. While regulation isnecessary for curbing money laundering andterrorist financing, overregulation of informal
services may conflict with the objective of
reducing remittance costs.
Expanding migrants’ access to banking
services may enable remitters to bundle remittances and thereby take advantage of thelower fees available for larger remittances.
This would require expanding the banking
network, allowing domestic banks from origin
countries to operate overseas, providing identification cards to migrants, and facilitating
the participation of savings banks, credit
unions, and microfinance institutions inproviding low-cost remittance services. Remittances, in turn, can be used to support financial products—such as deposits, loans, andinsurance—for poor people, and to contributeto the financial development of the recipient
economy.
The plan of this chapter is as follows. The
first section describes remittance fees andcosts in various remittance channels. It shows(a) that remittance fees paid by customers arehigh for smaller transactions, especially in
low-volume corridors; (b) that the cost ofproviding remittance services need not be sohigh; and (c) that remittance flows to developing countries would increase if remittancecosts were reduced. The next section examines the factors underpinning remittancefees—market competition, regulations, payment infrastructure, and technology—andsuggests policies for reducing costs and fees.
This section also briefly discusses the recommendations of the international Financial
Action Task Force (FATF) to prevent misuse

136

of remittance systems for criminal purposes.
The last section discusses complementarities
between remittances and other financial
products such as loans, deposits, and insurance. Finally, an annex to the chapter briefly
describes the historical evolution of threemajor remittance service providers (Western
Union, MoneyGram, and Bank of America)
to provide a perspective on the remittancemarket.

Remittance fees and costsT

he remittance industry consists of formal
and informal fund transfer agents. Major
competitors include a few large global players,
such as the major money transfer operators(MTOs) and banks, as well as hundreds ofsmaller participants that serve niche markets inspecific geographic remittance corridors. The
informal fund transfer agents include friends,
family, and unregistered MTOs such as hawala
dealers and trading companies.
The price of a remittance transaction
includes a fee charged by the sending agent(typically paid by the sender when initiating
the remittance transaction) and a currencyconversion fee for delivery of local currency tothe beneficiary in another country. (A stylized
remittance transaction is presented inannex 6A.1.) Some smaller MTOs require thebeneficiary to pay a fee to collect remittances,presumably to account for unexpectedexchange-rate movements. In addition, remittance agents (especially banks) may earn anindirect fee in the form of interest (or “float”)
by investing funds before delivering them tothe beneficiary. The float can be significant incountries where overnight interest rates arehigh.2 Many recipients spend considerable
time and travel considerable distances tocollect remittances. These costs typically are
not included in the price.

Remittance fees are high, regressive,and nontransparent
Remittance fee pricing is complex, and rarely
are senders informed about the full andR E D U C I N G

precise price of a remittance transaction. Fees
may be as high as 20 percent of the principal,
depending on the remittance amount, channel, corridor, and transaction type. The average price is reported to have been around
12 percent of the principal in 2004 (Taylor
2004; Kalan and Aykut 2005). Prices are believed to have declined recently but are still
very high in low-volume corridors. Currencyconversion charges are even less transparent
than remittance fees; they, too, vary depending on the competitor, corridor, and channel,
ranging from no charge in dollarized
economies to 6 percent or more in somecountries (Orozco 2004; Hernández-Coss
2004; Kalan and Aykut 2005).
Major MTOs such as Western Union andMoneyGram apparently charge higher remittance fees than banks and other financial
institutions that offer remittance services
to attract migrant customers (table 6.1).
Informal channels such as hawala are reported
to be cheaper than formal services. Someheavily traveled remittance corridors, such as
United States–Mexico and South Africa–
Mozambique, are much cheaper than others.
Urgent transactions delivered in minutes costmuch more than next-day transfers, and electronic transfers cost more than bank checks or

R E M I T T A N C E

F E E S

drafts, because they also clear much fasterthan the latter.
The fee amount also depends on the remittance amount. Average remittance fees, as apercentage of money sent, decline rapidly as
the transaction size increases, indicating scaleeconomies and the potential advantage ofbundling remittances—that is, the advantage
of sending more funds, but less frequently.
According to one firm’s fee schedule, the costof sending money from Belgium to Africa
drops from 21 percent to below 4 percent
as the transaction amount increases from
40 euros to 900 euros (figure 6.1). Similarly,
the cost of remittances from the United States
to Mexico (through the major MTOs) is morethan 10 percent for $100, but less than 3 percent for $500 (figure 6.2).
In recent years, remittance fees have declined in high-volume corridors in response to
several factors. First, global and regional
MTOs have intensified their competitionin mature corridors (United States–Latin
America, for example), as new competitors
have been attracted by high and growing
remittance volumes. In the United States–
Mexico corridor, for example, remittance fees
have dropped nearly 60 percent since 1999
(box 6.1).3 Second, Bank of America andTable 6.1 Approximate cost of remitting $200
Percent of principal amountBelgium to Nigeria*
Belgium to Senegal*
Hong Kong, China, to the Philippines
New Zealand to Tonga ($300)
Russia to Ukraine
South Africa to Mozambique
Saudi Arabia to Pakistan
United Arab Emirates to India
United Kingdom to India
United Kingdom to the Philippines
United States to Colombia
United States to Mexico
United States to Philippines

Major MTOs

Banks

Other MTOs

Hawala

12
10
4.5
12
4
—
3.6
5.5
11
—
—
5
1.2–2.0

6
—
—
3
3
1
0.4
5.2
6
0.4–5.0
173
0.4–1.8

9.8
6.4
—
8.8
2.5
—
—
2.3
—
—
10
4.7
—

—
—
—
—
1–2
—
—
1–2
—
—
—
—
—

Source: Brocklehurst 2004; Orozco 2004; Gibson, McKenzie, Rohorua 2005; Hernandez-Coss 2004; Ratha and Riedberg 2005;
Kalan and Aykut 2005; Andreassen and others 2005.
*World Bank survey of African diasporas in Belgium.
Note: Figures do not include currency-conversion charge.
— Data not available.

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policies to improve transparency in remittancetransactions (as in the United Kingdom), provide financial training to migrants (as in thePhilippines), and establish bilateral initiatives(such as the Partnership for Progress between
the United States and Mexico) have helped
reduce remittance costs.
These positive developments remain the
exception. In most corridors, particularly
the low-volume corridors, remittance fees
continue to be very high. In the New
Zealand–Tonga corridor, for example, fees
are about three times as high as those in the
United States–Mexico corridor. The wide gap
between remittance fees and costs shows thatboth should be reduced.

Figure 6.1 Remittance costs are high andregressive
Percent of principal amount
21

13

5

4

4

4

4

3

5
93
0
11
20
13
05
14
90
18
60

56

0

6

74

5

7

37

0

8

30

0

5

15

9

22

40

75

10

Principal amount, €Source: Western Union branches in Brussels and Paris.

other banks in source countries are using minimal transfer fees to attract migrant accounts,
while a growing number of banks in recipient
countries (including ICICI and Bancomer) arecompeting for remittance customers. Third,
the use of Internet-based technology for messaging and advanced clearing and settlement
has reduced the cost of remittance transactions. In some countries, new remittance tools
have emerged, based on cell phones (seebox 6.6) and smart cards. Finally, government

The cost of a remittance transaction
appears to be far lower than the priceService providers’ remittance costs appear to
be much less than the fees charged to customers. Domestic transfer fees are only a fraction of the cross-border remittance fees (net ofthe currency-conversion charge). The cost of adomestic automated clearinghouse (ACH)payment in the United States is one-third ofa cent. Domestic transfers using Visanet cost
2 cents per transaction, as opposed to 51 cents

Figure 6.2 Remittance fees in the United States–Mexico corridor
Fees as % of remittance16
14
12
Western Union
10
Moneygram
8

Vigo

6

Dolex

4
2
0
100

200

300

400

500

600

Size of remittance, $Source: Kalan and Aykut 2005.

138

700

800

900

1,000

R E D U C I N G

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F E E SBox 6.1 Decline in remittance costs in the UnitedStates–Mexico corridorT

he cost of sending $300 from the United States
to Mexico declined nearly 60 percent between
1999 and 2005—from $26 to $11 (according to
PROFEC data, see figure). The decline can be traced
to greater competition. Prices generally remained
stagnant when one MTO dominated the transmission service through exclusive contracts with distributors. Practitioners inside the industry cite thebreakup of these exclusivity contracts and the entryof new competitors—especially banks—into thecorridor as key events leading to a steady decline inprices.
Starting with Citibank’s acquisition of Banamex
in 2001—a $12.5 billion deal reportedly motivatedby the attractiveness of Banamex’s remittance business, U.S. banks have increased their stake in the
United States–Mexico remittance market in the past
two years. Being able to use the matricula consular
identification card to establish identity when opening
an account has helped this process. The card is

per transaction for international transfers(Brocklehurst 2004). In some corridors, fees
for international remittances are as low as$1.80 per transaction (London-Manila),
which hints at a falling lower bound for thecost of remittances. The fact that some banks
have been offering free remittance services as
loss-leaders to attract new business suggeststhat the actual cost of remittances is modest.
Courier services that offer remittances also
charge small fees for this additional service.
Finally, industry cost estimates as well asother calculations presented below suggestthat remittance costs are not very high.
The cost of providing remittance services
varies with the business model used by the service provider. Western Union, MoneyGram,and Vigo use agents who pay all operating
costs in exchange for their franchise and acommission on sales. In the “branch” model
used by Dolex and many of the smaller

United States–Mexico, remittance fee per $300
Dollars

Billions of dollars

28

20
Cost
(left scale)25
22

Remittances
to Mexico(right scale)

19

15

10

16
13

5

10
1999

2000

2001

2002

2003

2004

2005

accepted as a valid identity document in 32 U.S.
states, more than 1,000 police stations, 409 cities,
125 counties, and 280 banking institutions.

regional MTOs, the fixed and operating costs
associated with each branch are paid by the
MTO. By leveraging existing businesses on acommission basis, the agency model is muchless capital-intensive than the branch modeland can be expanded rapidly through partnerships, but it has higher variable costs.4 In bothmodels, relatively high fixed costs are associated with transaction-processing operations,compliance with regulatory requirements,
marketing, and administration.5
Data on MTOs’ costs of providing remittance services are hard to obtain. However, ananalysis of profitability of the market leaders6
using publicly available financial statementssuggests that remittance costs are significantly
lower than the fees charged to customers.
Western Union has sustained operating
margins that are at least 50 percent higher
than other MTOs and industry peers in thepayments and electronic processing market

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2 0 0 6(table 6.2).7 Its operating profit per remittancetransaction may have averaged $8 to $9 in2004. This is consistent with an earlier annual
report (Western Union 2000) that put thecompany’s operating profit at $684 million(or 30 percent of its $2.3 billion revenue). The
operating profitability of the other major market players (MoneyGram and Dolex) has beenin the range of 15–20 percent (table 6.2). Avery simple model for Western Union (whichassumes that agency commission costs are 35
percent of revenues after deduction of fixed
costs and that all other costs are fixed costs)
suggests that average transaction fees could be
reduced by as much as one-third while maintaining operating margins within the samerange as those of other major MTOs and peers.
Reducing these operating profits to zerowould provide a rough estimate of the breakeven cost for these firms. Such an exercise reveals that the break-even fee for Western
Union is probably around $9 per transaction
and would fall below $5 if the volume oftransactions were to double (box 6.2). Although it would be unreasonable to suggestthat any company reduce its prices to cost, thissimple model does appear to indicate that there
is considerable latitude for reductions in transaction fees within the higher-priced corridors.
A more direct way of estimating the cost ofa remittance transaction in a hypothetical
MTO is to add up plausible cost components,

Table 6.2 Operating profits of major MTOs
Percentage of revenue
2004

First Data Corporation, Western Union
money transfer operationsa
MoneyGram money transfer operations
Global Payments money transfer operations,
including Dolexb
Peer group averageb

32
15
20
18

Source: Yahoo Finance Database financial summaries; Kalan
and Aykut 2005; Piper Jaffray Equity Research; MoneyGram
International.
a. 90 percent Western Union; 50–55 percent non-UnitedStates/Canada consumer-to-consumer money transfers.
b. Includes American Express, Total System Services, DST
Systems, Sunguard Data Systems, and Fiserv. These companies are not directly comparable to the MTOs as they are notnecessarily in the money transfer business.

such as staff to process the transaction andprovide security, rental of the premises, fixed
costs (including franchise licensing), the costof network and technology, and administrative costs for regulatory compliance.8 Thismethodology yields a cost estimate of $5.50
for the first remittance transaction (table 6.3).
Because most remittance transactions tend
to be repetitive—the same amount is remitted from the same location to the same
beneficiary—the cost for subsequent transactions drops to $3.60 (less staff time is required). It drops to under $3 per transaction if
electronic processing is used.
Admittedly, the calculations in table 6.3
are based on a theoretical model of a basic

Table 6.3 Estimating the cost of a remittance transaction
Cost in dollars
First
transaction

Subsequenttransaction

Electronic
processing

Sending staff
Receiving staff
Fixed costs

2.50
0.17
0.27

0.83
0.17
0.27

0.50
0.17
0.27

IT, telecommunications
Rent
Administrative costs

0.60
1.50
0.50

0.60
1.50
0.50

0.60
1.50
0.50

Total costs

5.54

3.60

2.94

Source: Ratha and Riedberg 2005.

140

Explanation

10 minutes of staff time at $15 per hour
10 minutes of staff time at $1 per hour
$40 million system cost recovered over
10 years; 2,000 branches with20 transactions per day
1 minute international phone call
$30 rent per day; 20 transactions per day
Compliance, general overhead

R E D U C I N G

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F E E SBox 6.2 Estimating remittance industry costs

Remittance industry costs are difficult to obtain.
Isolating the cost of remittance services is difficult in the case of financial institutions that provide
other services as well. Estimating costs is not easy
even in the case of dedicated remittance service
providers because of the differences in the quality
and reliability of remittance services (only someproviders give customers legal redress). In Remittance industry costs, therefore, we have used publicly
available information on Western Union, the largest
MTO that is also a publicly listed company.
We used a simple model to estimate a break-even
fee for Western Union’s international money transfer
operations. The model suggests that for Western
Union’s operating margins on its international moneytransfers to drop to the peer group average of 17.8
percent (table 6.2), the average transaction fee would
have to be lowered from $22.90 to $15.30 (column 2of the table below)—very close to the company’s current fee in several U.S. corridors. The model also indicates that the break-even fee at which the operating
profit becomes zero is $9.30 (column 3). This price isin the same range as MoneyGram’s standard flat
price in the U.S. corridors. A sensitivity analysis using
this model suggests that the break-even fee would be$6.50–$7.00 if agency commissions were 25 percent,and around $11 if commissions were 45 percent.

Operating margin (operating profit
over revenue) (%)
Operating profit per transaction(revenue minus costs) ($)
Costs ($)
Agency commission, 35% of fee
Fixed costs
Revenue ($)
Foreign-exchange commission
Fee

Western Union: Operating profit
break-even price vs. volume
Dollars
10
8
6
4
2
0
75

100

125

150

175

200

225

250

275

300

Transaction volume (millions)
Source: Kalan and Aykut 2005.

The figure illustrates how the break-even fee
shown in the table decreases as the number of transactions increases. If transaction volume doubled
from the current 76 million to 150 million, thelowest fee at which the international operation
would remain profitable would be $4.74.

2004 data

Calculation assuming
peer group marginof 18%

Calculation
assuming
break-even margin

30

18

0

8.8

3.9

0.0

20.4
8.0
12.4
29.3
6.4
22.9

17.7
5.3
12.4
21.6
6.4
15.3

15.7
3.3
12.4
15.7
6.4
9.3

Source: Western Union financial statement for 2004.
Note: Reflects 76 million transactions in 2004. Fixed costs include marketing, administration, depreciation, and amortization,agency start-up, and other unidentified costs. Figures may not add up due to rounding errors.

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2 0 0 6

remittance transaction that does not capture
the global network and diversified services
provided by major MTOs. Moreover, themodel’s assumptions are subject to considerable uncertainties, the greatest of which is that
average costs would be higher if the number oftransactions were smaller. It is worth noting,however, that many independent agents provide remittances as a side business: for them,
fixed and variable costs could be significantly
lower than for dedicated remittance service
providers. Indeed, there may be a case for providing free remittance services in order todraw customers for other products and services, as practiced by certain banks.
Remittance costs should continue to fallunder the influence of increased competition
and better technology. Large MTOs may
have considerable latitude to reduce fees
while maintaining reasonable profit margins.
In corridors where costs have already fallen
significantly, further decline may be modest;but elsewhere there is scope for significant decline, especially with the volume of transactions rising rapidly.

Reducing remittance fees will increase
remittance flows to developing countries
Reducing remittance fees would increase thedisposable income of remitters, encouraging
them to remit more. It also might encourage

smaller and more frequent remittances.
And lower prices in a particular channel
might encourage remitters to shift from otherchannels—notably informal ones.
The degree to which a fee reduction would
result in an increase in flows depends on the
purpose of the remittance. At one extreme,
where the purpose is to meet a specific need—payment for tuition, a medical emergency, asocial ceremony, or the purchase of a gift
item—the amount of remittance may not besensitive to the remittance fee. At the otherextreme, remittances by a poor, cash-strapped
remitter may be highly cost elastic. Similarly,
remittances meant for investment are likely to
be cost elastic. In reality, most remittancetransactions fall between these two extremes.
Even when remittances are driven by altruism,
they will tend to be cost elastic, as evidenced
by the literature on charity, which shows thatpeople tend to donate more as the cost of
donating declines (box 6.3).
In a recent survey of Senegalese migrants in
Belgium, two-thirds of the migrants said theywould send more if the cost of sending went
down. In a survey of Tongan migrants in New
Zealand, 30 percent of remitters said theywould increase the amount of remittances by
0.74 percent (on average) if costs fell by 1 percent (Gibson, McKenzie, and Rohorua 2005).
That survey found the overall cost-elasticity ofBox 6.3 Even charitable donations are sensitive
to costC

haritable donations and bequests, like altruistic
remittances, increase when the costs of such actions decline. In one of the best-known early studiesof the responsiveness of gift-giving to tax deductions,Feldstein and Taylor (1976) estimated a price elasticity of the amount given of ⫺1.3.a Although this finding has been challenged on the ground that giftgiving responds more to temporary changes in thecost of giving (Glenday, Gupta, and Pawlak 1986),
the general agreement is that people give more when142

it costs less to do so (Cordes 2001). The literature on
charitable bequests reaches a similar conclusion.
Bakija, Gale, and Slemrod (2003) estimate a priceelasticity of ⫺2.14 for charitable bequests.

aIn the United States, taxpayers can deduct the amount ofcharitable contributions from their income for tax purposes.
Thus, Feldstein and Taylor (1976) view an increase in the income tax rate as a decline in the price of charitable donations.

R E D U C I N G

remittances with respect to the fee (averaging
the elasticity over those who would increase
remittances and those who would not) to be–0.22. Based on this estimate, Gibson and others (2005) calculate that lowering the fixed
cost of sending money through banks and
MTOs from New Zealand and Tonga to competitive levels in the world market would result in a 28 percent increase in remittancesfrom existing remitters. It might also induce
some nonremitters to start remitting.9
If the cost elasticity (–0.22) of the New
Zealand–Tonga study were applicable to all
developing countries, a reduction inremittance cost from 12 percent to (say) 6
percent could result in an 11 percent increasein annual remittance flows to developing
countries. One caveat to this calculation isthat the cost elasticity applies only to highcost corridors, which also tend to have low
volumes. In corridors where the remittancecost is already low, further decreases may notincrease flows. For example, a fee reduction
by a major MTO may not produce much effect if a major part of the flows is alreadymoving through low-cost informal channels.
This is confirmed by the World Bank surveyof Senegalese migrants in Belgium; half of the
respondents who paid remittance fees of 20
percent or more said they would send more if
costs were halved; not even one-fourth of
those who paid less than 10 percent said theywould send more (table 6.4). Almost 75 percent of the Senegalese migrants who sendmoney through the large MTOs said that

Table 6.4 Remittances are more costelastic when costs are higher% of respondents who would
remit more
Cost(% of principal)

SenegalNigeria

1–9
10–19
20 and above

23
50
50

64
67
83

Source: World Bank Survey of Senegalese and Nigerian
diasporas in Belgium.

R E M I T T A N C E

F E E S

they would send more if the costs werelowered, a result confirmed by findings froma World Bank survey of the Nigerian diaspora
in Belgium.
An indirect implication for cost elasticity
may be drawn from Yang’s (2004) finding ofan elasticity of 0.6 for remittance receipts
denominated in Filipino pesos with respect
to the peso–dollar exchange rate. Applying
this elasticity to a remittance transaction of$150, if the remittance fee were halved from(say) 12 percent to 6 percent, remittance receipts would rise by 3.6 percent, or $5.4,
while the remittance fee would decline from$18 to $9.31.10 If the same elasticity were
to apply to the entire flow of remittances todeveloping countries, remittance receipts, in
response to a halving of costs would increase significantly, by more than $5 billion
using only recorded flows, and more than
$8 billion using both recorded and unrecorded flows.
Reductions in remittance fees would also be
likely to increase other cross-border retailflows such as transfers from public and private
institutions to individual beneficiaries (pensions, child-care payments), small-value payments in exchange for goods and services, acquisitions of assets, and debt servicing.11 In
more developed countries, migrant remittances
are only a small share of retail payments,
which, in turn, are a fraction of wholesale payments. But in developing countries, especiallyin smaller and poorer countries, remittances
are a significant source of funding in relation
to the size of the economy and, therefore, of
the retail payment system. A reform of the retail payment system to facilitate remittances
would probably benefit other (not easily quantifiable) components of retail payments.
Based on the evidence presented above,notably the finding that the cost elasticity ofremittances is negative, policies that aim tolower remittance costs by increasing accessto banking services, promoting competition,and disseminating information have thepotential to provoke sizeable increases inremittance flows to developing countries.

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Factors underpinning highremittance feesW

hat accounts for high transaction costsin the remittance business? Are they related to large sunk costs, regulatory measuresthat restrict competition, or the lack of accessto low-cost public infrastructure (such as payments systems)? Do exchange controls, country risks, or other specific factors keep the costof cross-border transfers higher than those ofdomestic transfers?
Before answering these questions, it isworth noting some general findings from across-country regression analysis of remittancefees (Freund and Spatafora 2005). Remittancefees tend to be higher in corridors in whichbank concentration is high and competition
low (as reported in chapter 4, table 4A.2.2).
They tend to be lower in more developed financial sectors (proxied by the ratio of deposits
to GDP) in the recipient country and in dollarized economies and other economies that present low exchange-rate risk. Greater credit
risk12 reduces the willingness of agents to provide remittance services. Finally, high wages at
the recipient end (as proxied by domestic output) are associated with more costly remittanceservices. These results, which should be treatedas indicative rather than conclusive, suggestthat measures to increase competition among
remittance-service providers and to reduce financial risk and exchange-rate volatility arelikely to reduce the transaction costs associatedwith remittances.13
Several factors related to conditions in thecorridor and in the sending and receiving
countries have significant impacts on remittance pricing. Two corridor-related factorsthat have a significant impact on price are the(potential) level of competition in the corridor
and special arrangements with postal systems
to handle distribution.
A high level of competition may considerably reduce remittance prices in a corridor.
The level of competition in a corridor
can be proxied by remittance volume, sincehigh-volume corridors attract more competi-

144

Figure 6.3 Fees and foreign exchange
spreads for $200 in Western Union
transfers from New York City (percent)
13.5
10.6

7.0

Low-volume
corridors
High-volume
corridors

8.8

2.9
1.8

Transfer fee

Foreign exchange
spreadTotal cost

Source: Kalan and Aykut 2005.

tors, particularly small niche players thatcompete primarily on price. The relatively
lower prices in high-volume corridors, suchas United States–Mexico and Saudi Arabia–
India, can be ascribed in part to the presenceof regional and smaller players, in addition to
the major MTOs (and in part to scale economies). The remittance prices of the global market leader, Western Union, are significantly
lower in the high-volume U.S. corridors thanelsewhere (figure 6.3).14
High volume in a corridor does not always
guarantee high competition, however. Exclusive access to an extensive distributional
network (such as a post office network) may
distort competition in the corridor. Using post
offices as money transfer agencies can give an
MTO a significant advantage, because thepostal system almost always offers the most extensive distribution networks in both sending
and receiving countries, particularly in rural
areas. Exclusive arrangements with postal systems have been employed by the two largest
MTOs, Western Union and MoneyGram.
Exclusive arrangements can block or
bar entry by small competitors and may
thus allow the company that enjoys the arrangement to maintain a high price premium. Moreover, exclusive arrangements with the post office, typically a trusted and ubiquitouspresence, may facilitate price leadership andR E D U C I N G

Figure 6.4 Exclusive arrangements withpost offices skew competitiona. Fees for $200 remittance, France–Morocco corridor
Percent
11.7

12
10
8
6

4.9

4
2
0
Western Union

MoneyGramb. Fees and foreign exchange spread for $200
remittance, United States–Vietnam corridor
Percent
Western Union

6
5

5.0

5.0

4
3.0

3
MoneyGram

2

1.0

1
0
Transfer fee

FX spreadc. Western Union price premium over MoneyGram for$200 remittance when Western Union has post office link
Price premium, $
16

12

8

4

0
All
corridors

High-volume
corridorsAll
corridors

High-volume
corridors

Source country

Recipient country

With post office link

Without post office link

Source: Kalan and Aykut 2005.

R E M I T T A N C E

F E E S

price signaling—thereby raising the fee structure across the board. For example, arrangements with the postal systems in France andMorocco may help explain Western Union’s
ability to charge significantly higher fees inthat corridor than its major competitor,
MoneyGram (figure 6.4a). However, in
the United States–Vietnam corridor, where
MoneyGram has such an arrangement, Western
Union lowers its price to the same level as
MoneyGram’s, whereas MoneyGram charges
higher foreign-exchange commissions (figure 6.4b).
At the global level, Western Union’s pricepremium over MoneyGram’s fees, even in
high-volume corridors, appears to be significantly higher when the company has a linkwith the postal system in either the sending or
receiving country (figure 6.4c).15 On the other
hand, when MoneyGram, which almost
always offers lower prices than Western
Union, has the agency relationship with thepost office, its strong distribution advantage
forces Western Union to lower its prices tocompete in the corridor.
Other factors that appear to have an
impact on corridor pricing include active
participation of banks, credit unions, or othernonbank financial institutions in the remittance market; cultural and geographic commonality with a group of countries that
includes one highly competitive, high-volume
corridor with lower prices; the size of informaltransfer network in the corridor; and government policy initiatives within the corridor.
Regulatory and policy decisions have asignificant effect on remittance costs. In a recent survey of providers of remittance services
in the United States, 40 percent of those surveyed cited the process of getting a license as
the chief barrier to their operation, followed bybuilding a compliance system (figure 6.5). In
the United States, remittance service providers
are supervised by state departments of consumer affairs and banking. Not all states havespecific regulations on remittances. And registration requirements vary widely from state tostate (annex 6A.2). To set up a money transfer

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2 0 0 6

Figure 6.5 Barriers perceived by remittance service providers% of firms
50

40

40
32

30

27

27
23

23
18.2

20

16

14
11

10

7

7

an
fin

hi

ng

co

m
m
co er
nt cia
ac l
A
ci c
ts
al ce
in ss
fra in
st g
ru U.
ct S
ur .
e

y
og
ol
hn
Te
c
bl
is
ta
Es

G

et

tin
g
lic U.
en S.
C
se
re
at
in
g
ne ag
Bu
tw en
ild
or t
in
k
g
co
m
p
G
sy lia
et
st nc
tin
em e
g
ba
s
nk
ac
co
un
G
et
t
tin
g
U.
S.
bo
nd
Fu
nd
in
g
w
o
ca rkin
pt g
G
ia
et
l
tin
g
lic
ab en
Bu
ro se
ild
ad
in
g
co
ns
um
Ac
qu
tru er
iri
st
ng
kn
ow
-h
ow

0

Barriers to entry cited by firms
Source: Andreassen 2005.

business with offices in all 50 states would require net worth and bonds of more than $5
million (Ratha and Riedberg 2005). Althoughbond and capital requirements protect consumers and deter fraudulent practices, the wide
variation in requirements from state to state,mirrored in wide variances among countries,
can be confusing and costly, thereby discouraging competition from new, smaller players.
Many countries, including France, Italy, andthe Russian Federation, require a provider ofremittance services to be a fully licensed bankor financial institution. Only recently did Germany allow remittances to be conducted undera financial institution license instead of underbanking regulations. Costly and stringent licensing requirements, like bond and capital requirements, discourage the entry of smaller
players that could provide effective competition in many remittance corridors.

Regulating informal remittances
may raise costs
Since the terrorist attacks of September 11,
2001, authorities in many countries have146

adopted more stringent regulations and steppedup enforcement of existing rules governing thetransfer of foreign exchange.16 An increasing
number of countries are requiring MTOs to register with the authorities and to report transactions on a regular basis. These regulatory requirements have raised the cost of fundtransfers to the remittance service providers,which tend to pass them on to customers.
National requirements center on the registration of transfer businesses, application of
know-your-customer procedures, detailed
record-keeping, and frequent reporting.
“Money service businesses” in the UnitedStates must maintain a list of their agents andmake the list available to the Financial Crimes
Enforcement Network (FinCEN) upon request. Operating such a business without registering it is a crime. The introduction of the
USA Patriot Act in late 2001 tightened theknow-your-client requirements for fund transfers. In addition, U.S. financial institutions are
required to comply with the recommendationsof the international Financial Action Task
Force to Prevent Money Laundering (FATF

R E D U C I N G2005), which are incorporated into U.S. regulations, and to comply with the sanctions list
maintained by the Treasury Department’s
Office of Foreign Assets Control.
Since early 2005, correspondent bank accounts of hundreds of money service businesses
in the United States have been closed by banks
for fear that they may be targeted by authorities for servicing customers regarded as “highrisk.” The wave of closures can be traced to aJune 2004 notice from the Office of the Comptroller of Currency that “[s]ome nationalbanks also provide banking services to foreign[money service businesses], a line of businessthat can carry significant money launderingrisks.”17 Clear guidance on how to assess risks
and spot suspicious activity is lacking.
Some argue that the users of informal
remittance channels face a great risk of fraud
and default. Requirements for bonds, capitalization, auditing, reporting, and disclosure
can shield consumers from excessive fees,
fraud, or other losses. At the same time, trustand self-regulation, characteristics of informal remittance networks such as hawala,hundi, padala, fei chien, and others, have
proven effective in protecting customers
against losses, although they are by no means
immune to fraud. Moreover, their low cost,
speed, reach, and convenience of informal
door-to-door remittance services remain
extremely competitive compared with the inefficiencies of formal operators (Ballard
2005; El Qorchi, Maimbo, and Wilson 2003;
Maimbo and Passas 2005). Law enforcementcases from all continents show that formal
and informal remittance channels are bothsusceptible to criminal abuse.18
The regulatory regime governing remittances must strike a balance between curbing
money laundering, terrorist financing, andgeneral financial abuse, and facilitating theflow of funds through efficient formal channels. Policies that encourage formal operators
to imitate the best practices of informaltransfer systems will benefit poor migrants.
Strengthening the formal remittance infrastructure by offering the advantages of low

R E M I T T A N C E

F E E S

cost, flexible hours, expanded reach and language, and increasing efforts to identify andregulate the unregulated sector, would effectively facilitate remittance flows while preserving their integrity.

Policies to reduce remittance costsM

easures to reduce remittance costs
should aim to improve the efficiency ofremittance transactions by (a) enhancing market competition to reduce high profit margins;(b) helping remittance service providers’ accessto new payments technology; and (c) devising
ways to encourage remitters to send larger
amounts (table 6.5). As a way to enhancecompetition, governments can encourage
postal systems and other state-owned distribution alternatives to open their networks tomultiple MTO partnerships on a nonexclusive
basis. In addition, they should avoid overregulation, excessive monitoring, or reporting requirements that could drive out smaller competitors that lack the economies of scale toabsorb the cost of compliance.
Developing a shared network would be a
powerful way to increase competition. Cooperation on infrastructure and competition
in service provision would allow network
benefits to accrue to the consumer.19 The
technology required to set up a paymentprocessing infrastructure with large capacity
is no longer an expensive proposition. A
functioning payment infrastructure could be
extended to a new country at a minimal costand in a matter of weeks.20 There have beensome attempts to set up shared networks in
the remittance-source countries (for example, the United States–Mexico FedACH
system, box 6.4). Also some governments
in remittance-receiving countries havefacilitated the establishment of payment networks that are shared by savings banks,
credit unions, and microfinance institutions
operating in poor and remote areas (forexample, BANSEFI in Mexico21 and Apex
Link in Ghana).22147

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Table 6.5 Policies to reduce costs, regulate
informal providers, and provide remittancelinked financial services

Reducing costs
Increase competition
Avoid exclusive arrangements
Harmonize regulation and capitalrequirements (same policy for
all players)
Introduce and harmonize electronic
payment systems (card-based
products)
Improve data on corridors
Voluntary code of conduct
Bundling of transactions
Regulating informal providers
Make formal sector operations
more convenient anduser friendly
Improve banking access
Leveraging remittances
Improve banking access
Encourage microfinance institutions
and credit unions to provide
remittance services

Sourcecountry

Recipientcountry

X
X
X

X
X

X

X
X
X

X
X
X

X

X

X

X

X
X

X
X

Another way to address the issue of high feesin the remittance industry would be to develop
best-practice guidelines for remittance service
providers. Several such guidelines have been issued by Credit Union National Association,
Inter-American Development Bank, and World

Savings Bank Institute, which urge service
providers to disclose fees, exchange rates, and thetime of delivery. At the end of 2004, the WorldBank and the Bank for Committee on Payment
and Settlement Systems (CPSS) set up a task
force, with participation from the IMF, to develop voluntary principles for remittance service
providers, regulators, and supervisors for improving transparency in the market (box 6.5).23
Such guidelines would have to be voluntary.
Central banks generally are not willing to impose such guidelines or to cap remittance fees
and foreign-exchange commissions. A recent
survey (de Luna Martinez 2005) revealed thatin only 9 of 40 countries—Brazil, Bulgaria, Indonesia, Pakistan, Philippines, Russian Federation, Thailand, Tunisia, and República Bolivariana de Venezuela24—did central banks
even have the legal power to do so. All 40 central banks indicated that even if they had thepower to limit fees, they would not do so, preferring to leave fee-setting to financial institutions in response to market competition.25
Raising consumer awareness throughfinancial literacy efforts and publicizing information on costs (as Mexican authorities havedone through the PROFECO initiative) will
strengthen competition among remittanceservice providers. In April 2005, Britain’s
Department for International Development

Box 6.4 United States–Mexico FedACH

U

nited States–Mexico automated clearinghouse
was created as part of the U.S.-Mexico Partnership for Prosperity to reduce the cost of sending remittances between the two countries. In 2002, thecentral banks of the United States and Mexico undertook a cooperative effort to link their automatedclearinghouse (FedACH) systems. The cross-borderservice began operating in February 2004. Today, approximately 23,000 payments are sent from theUnited States to recipients in Mexico through thischannel each month. The cost of a remittance transaction is just $0.67; the exchange-rate spread is only
0.21 percent. Since July 2005, the cross-border148

service has made funds available to a recipient on thefirst business day after a payment is originated.
But FedACH has not been as popular with thebanking community as was expected. It sufferedfrom some technical weaknesses—for example, insufficient coding flexibility for certain remittances. Also,
major international banks that earn significant remittance fees from their own proprietary payment systems and from foreign-exchange commissions havebeen slow to join FedACH. And other cross-border
ACHs between the United States and Canada andbetween the United States and Europe have had similar difficulty attracting participation from banks.

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F E E SBox 6.5 The World Bank/CPSS task force on generalprinciples for international remittance systemsAt the end of 2004, the World Bank and the Bankfor International Settlements’ Committee for
Payment and Settlement Systems (CPSS) convened atask force, with members from central banks ofsending and receiving countries, international financial institutions, and development banks, to address
the need for international policy coordination in remittance systems. The task force is expected to issue(DFID) launched a website that provides information on remittance costs and options inseveral countries.26
Assisting remittance service providers to
adopt new payment systems technology andinstruments would help lower their service costs.
Some technologically advanced methods ofsending transfers already exist. Card-based instruments, such as stored value cards (similar tophone cards), credit cards, and debit cards, arenow frequently used to send remittances tourban locations that have access to card-processing machines. Systems such as iKobo.com
use the Internet to make remittances. PayPal andother services move money between virtual accounts, although they do not (yet) focus on immigrants’ transfers. Similar technology has been
adapted by an operator in the Philippines tosend fast—and reportedly cheap—remittances
using a cell phone (box 6.6).

Migrant workers need easier accessto the formal financial system
Improving migrant workers’ access to banking
services could reduce transaction costs, and at
the same time, help to develop the financial
system in the countries where remittances arereceived. Sending and receiving countries alike
could support migrants’ access to banking by
providing them with the means to establish
their identity.
In receiving countries, the factor that exerts
the greatest effect on remittance costs (and on

general principles for international remittance systems in the first half of 2006. The purpose of theprinciples is to promote a sound, efficient, andcompetitive market in remittance services. The
recommendations of the task force are expected tocover market environment, consumer protection
and transparency, market infrastructure, and public
policy.

the choice of remittance channel) is the reach of
the remittance agent’s distribution network. Recipients in rural areas underserved by banks may
have to pay high costs for receiving remittances,
especially through formal channels. Partnerships
between remittance operators and institutions
that have wide networks in rural areas (such as
post offices) would help reduce such costs.27 In
countries where residents are allowed to holdforeign currency deposits, permission to deliver
remittances in U.S. dollars (or the same foreign
currency sent by the remitter) would significantly reduce (if not eliminate) the exchange rate
spread on remittances (as seen in the case of dollarized economies such as El Salvador).

Remittances and financial
institutions

B

anks and smaller financial institutions,such as credit unions and microfinance institutions, can deliver convenient and possibly
low-cost, remittance services in developing
countries, especially in rural areas. In contrast
to cash transactions, remittances channeledthrough bank accounts may encourage savingsand enable a better match for savings and investment in the economy. Remittances, in turn,can be used to support business and consumer
loans, insurance, and other financial products
for remittance recipients.28 Some institutions
are exploring ways to target remittances tospecific uses such as school fees or medical

149

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Box 6.6 Smart’s phone-based remittance systemin the PhilippinesT

he largest mobile phone company in the Philippines, Smart Communications, has developed an
innovative remittance system based on cell-phone
text messaging. Cell phones are widespread in thePhilippines, in use by at least 30 percent of the 84
million Filipinos. A standard Smart remittance works
like this: A Filipino in Hong Kong, China, deposits
money to be remitted with one of Smart’s remittancepartners, which then sends a text message to the beneficiary in the Philippines, informing him or her of
the transfer. The remittance is credited into a Smart
Money “electronic wallet” account by any Smartmobile customer. The money can be withdrawn froman ATM using the Smart Money cash card, which
can also be used as a debit card for purchases.
Smart’s partners in the Philippines—among them
McDonald’s, SM malls, SeaOil gas stations, 7-Elevenstores, and Tambunting pawn shops—will also pay
out cash to Smart customers.
Smart has already formed remittance partnerships
with Travelex Money Transfer; Forex International
Hong Kong; Dollar America Exchange in California;
CBN Grupo in Greece, Ireland, Japan, Spain, and theUnited Kingdom; New York Bay Remittance; andBanco de Oro Bank in Hong Kong, China.
The system’s simplicity keeps fees down. Fees atorigination vary from country to country. In Hong
Kong, China, it is about $2. In the Philippines, it is
1 percent plus the cost of the text message.
The Smart system also appears to be secure. The
use of different PINs for the cell phone and the
Smart account make it difficult for a thief to accessthe funds. An ID is required when collecting cash.

bills. Others are exploring insurance products,
for example, to ensure a stable flow of income
to the remittance beneficiary in the event thatthe sender suffers an income shock.
Credit unions in El Salvador, Guatemala,Honduras, Nicaragua, Mexico, and Jamaicathat are members of the World Council of
Credit Unions (WOCCU) encouraged
WOCCU to establish the International Remittance Network (IRnet) in July 1999 to facilitate remittance flows from the United States toLatin America. That initiative has lowered remittance costs by raising customer awarenessof remittance fees and by generating somecompetition in the remittance market. To
send up to $1,000, IRnet charges a flat $10—
much less than the fees charged by major
MTOs. Besides fee income, IRnet institutions
hope to use remittances to build relationships
with customers. It is reported that 14–28 percent of nonmembers who visited WOCCUaffiliated credit unions to transfer funds eventually opened an account; 37 percent of credit
union members saved a part of theirremittance receipts (Grace 2005).

150

Smaller nonbank financial institutions facechallenges in entering the remittance market
because of regulatory constraints—such as
licenses for transactions involving foreignexchange and access to national payment
systems. For prudential reasons, access to payment and settlement systems is typically restricted to well-capitalized and well-establishedbanking institutions. Microfinance institutions and smaller institutions generally mustenter into corresponding banking relationships with commercial banks29 and with international remittance providers (such as the
IRnet or the major MTOs).
A survey of central banks found that 35 of 40
developing-country authorities were not enthusiastic about allowing small financial institutions to have access to clearing and settlement
systems (de Luna Martinez 2005). Central
banks appear to believe that most nonbank financial institutions in developing countries lackthe technological infrastructure required to participate directly in clearing and settlement systems. Also, central banks believe that giving
nonbank financial institutions direct access toR E D U C I N G

central banks’ clearing and settlement systems
may not help reduce the remittance fees charged
by those institutions. According to the survey,
only five countries—Azerbaijan, Belarus, Bolivia, Philippines, and Thailand—are contemplating granting access for clearing and settlement systems to a few large nonbank financial
institutions (mostly post offices).
Even if microfinance institutions were tooffer remittance services, they might face restrictions on taking deposits and offering loan
and insurance services, again for prudential
reasons. Given these constraints, sources offunds for such institutions tend to be expensive and their capacity to offer financial products limited.

Annex 6A.1 A stylized remittancetransaction—structure, players,
instruments

A

typical remittance transaction takes placein three steps: (1) initiation of remittances
Step 1F E E S

by a migrant sender using a sending agent,(2) exchange of information and settlement offunds, and (3) delivery of remittances to thebeneficiary. In step 1, the migrant sender pays
the principal amount of the remittance to thesending agent using cash, check, money order,
credit card, debit card, or a debit instruction
sent by e-mail, phone, or Internet. In step 2,
the sending agency—which may be an MTO,
bank, or other financial institution, moneychanger, or merchant (gas station, grocery
store)—then instructs its agent in the recipient’s country to deliver the remittance. In
step 3, the paying agent makes the payment tothe beneficiary. In most cases, there is no realtime fund transfer; instead, the balance owed
by the sending agent to the paying agent issettled periodically according to a mutuallyagreed schedule. Settlement usually occurs
through commercial banks acting through thenational clearing and settlement system. A portion of informal remittances is settled throughgoods trade.

Step 2
Information

SenderR E M I T T A N C E

Step 3
Beneficiaryby phone or mail
Cash
Check, money order
Bank transfer
Credit, debit, prepaid card
Transfer order in person,by phone, or by internet

Sending agent
MTOs, banks, credit
unions, microfinanceinstitutions, merchants,
money exchanges,
friends, relatives,
missionaries, cell-phonecompanies

Information forwarded bye-mail, SWIFT, proprietary
networks, fax, phone, ACH
Settlement in cash, via banktransfer, netting against other
trade

Cash
Check, money order
Bank transfer
Credit / debit card
Internet
Goods

Paying agent
MTOs, banks, credit
unions, microfinanceinstitutions, merchants,
money exchanges,
friends, relatives,
missionaries, cell-phonecompanies151

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Annex 6A.2 Licensing and registration requirements for remittanceservice providers
Country

Net worth($)

Auditedfinancials
required?

United States27
California

Min. $500,000 in equity

If available

Florida100,000 plus $50,000 per
location up to $500,000

Yes

Illinois

Depending on locations:1 ⫽ $35,000
25⫹ ⫽ $500,000

Yes

Massachusetts

None

No

New Jersey(1) Min. $100,000 plus
$25,000 per location (oragent) in NJ up to$1,000,000(2) $50,000 for foreign
money transmitter plus
$10,000 per location (oragent) up to $400,000

New York

Liquidity equivalent tooutstanding payments

Pennsylvania$500,000

Texas$25,000 per location up to$1,000,000

Virginia$100,000–$1,000,000 as
determined by thecommission“Suitable to conductbusiness”
Should not be lower than
$10,000
None

Wisconsin

Canada152

Yes,
2 years

Bond

Comment

Discretionary depending on sizeof business. Min. $200,000.
1% of annual turnover, max$250,000; can be set at$500,000 in exceptional
circumstances; may be waived
upon request
Greater of $100,000 or the
average daily outstanding for
12 months, maximum$2,000,000$50,000 (or 2x amount ofoutstanding transactions)(1) Not less than $100,000 and
not more than $1,000,000(2) Foreign remitters: depending
on business volume, $25,000
to $100,000; commissioner
may require up to $900,000

Fee $5,000 plus $50 per
agent
Application fee $500 plus
$50 per agent; renewal$1,000 plus $50 per
agent up to $20,000.

In general: investments not lessthan outstanding payment
instruments; this can bewaived by the commissioner$500,000 unless thesuperintendent lowers theamount$1,000,000

Yes$100,000 for first location,$50,000 for each additional,
max. $400,000$25,000–$1,000,000 as
determined by the commission

No$10,000 for 1st location ⫹$5,000 for each additional
Max. $300,000

No

None

FranceMin. €2,400,000
plus capital to cover firstyear’s expenses

Yes,
3 years

None

Germany(federallegislation)€125,000 capital
Net worth must be
sufficient to cover
exposures

Yes

None

Fee $100
Licensing ⫹ $100
$10 per location; $100
renewalFee $250

Application fee $1,000
Licensing fee up to$4,000
Biennial fee $25 per
location up to max. of$5,000

Fee $500
Licensing ⫹ $1,000
investigation.
Application fee $1,000
Renewal fee $300
Fee $500 licensing ⫹$2,500 investigation
fee
Licensing fee $500
Renewal fee $750
Fee $500 license (annual)⫹ $300 investigation⫹ $5 per location(annual)Reporting threshold:
Can$3,000
STR and CTR above
Can$10,000
Full bank license;
the ownership
structure must be
adequate
AML procedures
scrutinized
Reporting threshold:€2,500
STR; AML laws must be
followed; 2 managing
directors must havesuitable backgrounds

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F E E S

Annex 6A.2 (continued)
Country

Net worth($)

Italy

United Kingdom€750,000

None

Auditedfinancials
required?

Bond

Comment

Yes

None

No

None

Reporting threshold:€12,500
STR; the license is only
required by the service
provider, not by his
agentsRegister normal business;
Moneys may not be held
for more than 3 days, asa bank license (deposits)
would be required inthis event

Source: For United States, www.rubinsanchez.com; Canadian Bankers Association; French Central Bank, Banque de France, Comitédes Etablissements de Crédit et des Entreprises, d’Investissement (CECEI), Committee for Credit Institutions and Investment Companies; German Financial Supervisory Board, Bundesanstalt für Finanzdienstleistungsaufsicht; Italian Law 106; Bank of England.
Note: Licensing and registering approaches may differ. See FATF Typologies Report (FATF 2005). STR ⫽ suspicious transaction
report; CTR ⫽ currency transaction report; SAR ⫽ suspicious activity report; AML ⫽ anti-money laundering.

Annex 6A.3 A brief history ofsome remittance service providersT

his annex describes the historical roleof three key providers of remittanceservices—Western Union, MoneyGram, andBank of America. The intention is to shed lighton their business strategies.

Western Union
Western Union descended from the New Yorkand Mississippi Valley Printing TelegraphCompany, originally formed by a group ofbusinessmen in Rochester, New York, in
1851. The Western Union Telegraph Company was subsequently formed in 1956 following the acquisition of several competing
telegraph systems. Having completed the firsttranscontinental telegraph line by 1861, thetelegram network started providing the Western Union Money Transfer service nationallyby 1871.
Historically, Western Union has been
involved in a wide range of telecom and otherproducts. These included introducing the
New York Stock Exchange stock ticker in
1866, offering a nationwide standard time, introducing teletypewriters in 1923, offering thefirst intercity fax service, and launching thetelex. It also launched the first domestic communications satellite, Westar I in 1974.30
Today, Western Union is primarily a remittance company.
Western Union has always followed thestrategy of developing its own proprietaryproducts. For money transfers, Western
Union has developed its own software andnetwork of exclusive agents. It has been able
to develop this network by being the first
truly global remittance company. Currently
its network comprises slightly more than
220,000 locations in about 19531 countries(including the network of its subsidiary Orlandi Valuti). The growth rates in Western
Union’s international remittance transactions(excluding Mexico) were 32 percent, 25 percent and 24 percent for the years 2002, 2003,
and 2004, respectively.

MoneyGram
The MoneyGram money transfer service wasstarted in 1988 by Integrated Payment
Service, a U.S.–based division of First Data
Corporation (FDC), a data processing company owned by American Express at the time153

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2 0 0 6of inception.32 FDC divested its MoneyGram
operation in December 1996 through an initial public offering of its common stock tocomply with the company’s agreement with
the Federal Trade Commission as part of amerger with FFMC.
In 1998, Travelers Express, a division ofViad Corp. acquired MoneyGram. On June30, 2004, the Travelers Express business was
spun off from Viad Corp.,33 and became an
independently traded company called MoneyGram International, Inc. Travelers Express
and MoneyGram Payment Systems, Inc.
continue as operating companies under thisnew corporate umbrella.
Whereas Western Union insists on a strategy of exclusive partnership with its agents,
MoneyGram allows its agents to represent
other remittance companies as well, as shownby its partnership with the World Councilof Credit Unions and Bancomer Transfer
Services.

Bank of America
Bank of America (BoA) was established in
1929 as an outgrowth of the merger between
the Bank of Italy and the Bank of America,
Los Angeles. California became the fastestgrowing state after World War II, with thehighest use of checking accounts. To cope withthe transaction volume, the bank invested
heavily in information technology and isgenerally credited, together with GE and SRI,
with inventing modern centralized bank operations; BoA has a number of financial transaction processing technologies, such as automatic check processing, account numbers, andMagnetic Ink Character Recognition (MICR),
and, based on these technologies, credit cards
linked directly to individual bank accounts.
Because of the efficiency of these technologies,
BoA had significantly lower administrative
costs than other banks and was able to expand
further, until it was the world’s largest bank by
the early 1970s.
In 1959, BoA invented the bank credit
card, the BankAmericard, which changed its
name to VISA in 1975. A consortium of154

other California banks founded Master
Charge (now MasterCard) in order to compete with the BankAmericard.
BoA offers remittance services along withregular savings and loan products to its customers. It has a banking relationship with
44 percent of all Hispanic households; it
opened more than 1 million checking accounts
for Hispanic customers in 2004. The bank offers remittances under the SafeSend brand to its
customers wishing to send money to Mexico. In
early 2005, it announced that it would eliminate the $10 transfer fee for all checking account holders for remittances from the UnitedStates to Mexico to attract new business from
migrant customers.

Notes
1. Western Union reports an average fee of
6–8 percent and an additional foreign exchange spreadof 2 percent on its global remittance services. The average size of a Western Union remittance (covering personal remittances as well as small business-to-business
remittances), however, is around $700, much higher
than the average transaction size (under $200 reported
in household surveys of migrants by, for example, a
Pew Hispanic Center study on Mexican migrants in the
United States and a Genesis Analytics study on South
Africa). A World Bank survey of African diaspora in
Belgium found that the average monthly remittanceswere 154 euros in the case of Senegalese migrants, 126
euros for Nigerian migrants, and only 78 euros forCongolese migrants.
2. For example, if a Brazilian bank received remittances on October 11, 2004, delayed payment to thebeneficiary for two weeks, and invested the funds inthe overnight money market, it would earn a float of
2.85 percent (IOM 2005). Humphrey, Keppler andMontes-Negret (1997) note widespread use of floats bybanks, especially in the Russian Federation.
3. Some banks have announced even more aggressive price cuts recently. Bank of America, for example,
eliminated fees for United States–Mexico remittances,
to attract customers from the Mexican migrant community. Banks have also been providing free remittanceservices in some other corridors as well. It is worth
noting, however, that there are hidden fees—accountmaintenance fees, minimum balance requirements,
taxes on interest income—involved in such transactions
besides the cross-selling of loan and deposit products.
4. According to the Piper Jaffray Global Money
Transfer Report (2005), Western Union has said that it

R E D U C I N G

can add a new agency for $1,000–$1,500 (the cost of
setup, terminal, software, and training), while Dolex
requires $12,000–$15,000 to establish a new branch.
5. In the case of banking institutions (also gas
stations and grocery stores), remittance services may becross-subsidized by other product lines, which renders
remittance costs hard to determine.
6. The leading MTOs are Western Union, with areported 13 percent market share, and MoneyGram,with a 3 percent market share. Vigo and Dolex are thethird and fourth largest MTOs, respectively, with
about a 2 percent combined market share. See Aite
(2005) for their U.S. market shares.
7. Western Union has sustained high margins bytaking the initiative to enter underserved markets,
building a strong distribution network, and leveraging
its brand name. Overall, the company has provided remittance services to millions of individuals in previously underserved markets.
8. This methodology is similar to that suggested
by Humphrey, Keppler, and Montes-Negret (1997) for
pricing payment services. These calculations do not include the costs of advertising and security.
9. This analysis is less conclusive with respect tothe sensitivity of remitters to exchange-rate commissions. Migrants do have fairly accurate knowledge ofthe exchange rate used by their remittance operator,
but they may be less informed about the premium
involved in this rate. The estimate of cost-elasticity
from the New Zealand study is based on responses
from a small random sample of new Tongan migrants
to questions about how they would react to a potentialchange in costs. It was not based on actual reactions.
10. This example assumes no change in theexchange rate.
11. There is no standard definition of a retailpayment. Here it is defined as a transaction originatedby, or payable to, an individual, the counterparty being
an individual, a firm, or a government agency. It also
includes frequent, small-value business-to-businesspayments. See also BIS (1999).
12. As measured by the International Country
Risk Guide, credit risk is based on foreign debt as apercentage of GDP, foreign debt service as a percentage of exports of goods and services, current accountas a percentage of goods and services, the import coverof international reserves, and exchange-rate stability.
13. The regression that generated these results isbased on remittance fees from a single large MTO, so theresults are not representative of costs in the remittanceindustry as a whole. Also the low R2 suggests that the
regression does not fully explain the cost structure.
14. The remittance price estimates provided byWestern Union and MoneyGram on their Web sites
often differ from the actual transfer fees. For this study,

R E M I T T A N C E

F E E S

we gathered remittance price data by visiting Western
Union and MoneyGram agents in Washington, New
York, Brussels, Paris, London, and Singapore and bycalling agents in other cities in various parts of theworld. At various points, seven individuals were collecting remittance fee data in various corridors (for example, North America to Latin America and Asia, theEU to Africa and South Asia, the Gulf to South Asia,
Eastern Europe to Central Asia, and East Asia to Southeast Asia). We collected daily foreign exchange data (forWestern Union transfers to a broad range of countries
from the United States and the United Kingdom and for
Moneygram transfers from the United States to thesame countries) on four consecutive business days inearly June and calculated the FX spread by comparing
these data to the exchange rates quoted on Bloomberg.
15. Lack of competition has been a persistent problem in this industry. In December 1996, MoneyGram
was spun off from First Data Corporation, the holding
company of Western Union, as part of an agreementwith the U.S. Fair Trade Commission. See the annex fora history of remittance service providers.
16. In July 2005, the European Commission
proposed that banks in the European Union be required to register the name, address, and bank accountof anyone making an international money transfer. The
requirements, which the commission hopes will comeinto force in January 2007, are the latest EU responseto terrorism following the bombings in London on July
7, 2005.
17. OCC Advisory Letter 2004-7, www.occ.treas.
gov/ftp/advisory/2004-7.doc.
18. Abuses include money laundering, the transfer
of corrupt payments, payment of human smuggling
fees, tax evasion, customs offenses, violations ofcurrency controls, subsidy frauds, smuggling, illegalarms sales, and funding of terrorism. International
trade is subject to many of the same abuses, but it is
widely recognized that efforts to curb them must notinterfere unduly with vital trade.
19. This is easier said than done, however, because
major remittance service providers that have invested
in their own proprietary networks and used them toexpand their market share may not willingly sharethem. Furthermore, even if a shared network weredeveloped with public funding, it may not easily gain
participation by key banks and financial institutions(box 6.4). Federal Reserve Bank (2004, pp. 33–37) lists
major proprietary payment networks.
20. Visa reported that in 2004 it set up a Visanet
system in Iraq within eight weeks and for less than$200,000 (Brocklehurst 2004).
21. BANSEFI has a commercial alliance (L@Red
de la Gente) with 62 regulated saving banks and MFIs
operating mostly in areas where commercial banks

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2 0 0 6have no presence. This network provides a common
platform for collecting and distributing financial products; for example, it facilitates migrant remittances aswell as government transfers for pension and socialand education programs, and it offers savings accounts
and mortgage and consumer loans, small business
lending, and health insurance products to the poor. Its
IT network is aimed at offering the advantage of scaleeconomies to its members.
22. Apex Bank in Ghana was set up (with support
from the government and the World Bank) to provide
banking services in rural areas. The Apex Bank has developed Apex Link, a domestic funds-transfer scheme
among 75 rural and community banks. The Apex Bankis also collaborating with some financial institutions
for the payment of foreign inwards remittances
through the rural and community banks to beneficiaries in the rural areas.
23. The International Remittance Protection Act
proposed by U.S. senator Paul Sarbanes in September
2004 marks an effort to improve disclosure of fees andexchange-rate commissions in remittance transactions.
24. In the European Union, the fees that financial
institutions charge their customers for money transfers
between EU countries cannot be higher than the fees
charged for domestic money transfers.
25. In some cases, consumer rights legislation has
enabled customers to challenge price gouging. In 2002,
Western Union paid $30 million to settle two classaction suits stemming from its use of different exchange
rates for converting remittances than the rates it
received in the international money market (Aite 2005).
26. The related websites are www.profeco.gob.mx
and www.sendmoneyhome.org.
27. For example, BANSEFI and Apex Link (asmentioned earlier).
28. This correspondent banking relationship between MTOs and some commercial banks, which had
been working smoothly for a long time, came underpressure recently because of a misunderstanding of
the know-your-customer rules. More than 300 small
MTOs that collected remittances and then wired themthrough a correspondent bank were told in February2005 that such transfers were no longer permitted. On
March 30, 2005, FinCEN, FDIC, the Federal Reserve,
and the Office of the Comptroller of Currency issued ajoint statement that such transactions were indeed
legitimate.
29. Source: www.rubinsanchez.com, representing
the legislations for the different states of the UnitedStates.
30. Historical data on Western Union fromwww.westernunionalumni.com/history.htm.
31. PR Newswire, February 1, 2005.

156

32. Seewww.sec.gov/divisions/investment/
noaction/firstdata011304.htm. In 1992, AmEx andFirst Data completed an initial public offering that resulted in approximately 40 percent of the commonshares of First Data being held by the public. Over the
next five years, AmEx sold its remaining shares to third
parties, and by 1997 AmEx had no reportable ownership interest in First Data.
33. Source: www.MoneyGram.com.

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International migration creates
opportunities for developing
countries but also poseschallenges. Migration canmake migrants and their families
better off, while the remittances
migrants send home boost
developing countries’ foreignexchange earnings and help
alleviate poverty. But in manycases, the size of flows and theirrole in poverty reduction islimited—especially for poor
migrants—by high transaction
costs, restricted access to financial
services, and inappropriate
regulations or policies. Global
Economic Prospects 2006 analyzes
the impact of remittancesand migration on migranthouseholds and migrant-sending
countries, and considers policies
to increase the development
impact of remittances.
—François Bourguignon
Senior Vice President andChief Economist

Global Economic Prospects 2006: Economic Implications of Remittancesand Migration explores the gains and losses from internationalmigration and policies to improve the developmental impactof migration, with particular attention to remittances.
Recorded remittances sent home to developing countries by international migrants are expected to reach $167 billion in 2005. Unrecorded
remittances through formal and informal channels are estimated to be atleast half as large as recorded flows, making remittances the largest sourceof external financing in developing countries. Remittances substantiallyreduce the incidence of poverty and help support household consumption
in response to adverse events.
International migration generates significant economic gains for
migrants, their countries of origin, and their countries of destination.
The benefits to the countries of origin are especially large in the case of
migration of low-skilled workers.The most feasible means of increasing
such migration would be to promote joint origin-destination country
programs that combine temporary migration of low-skilled workers withincentives for return.
The price of remittance transactions is often unnecessarily high for thesmall transfers typically made by poor migrants. Governments could lower
fees and expand remittances by improving the access of poor migrants andtheir families to formal financial services, and by promoting competitionin the remittance transfer market (for example, by lowering capital requirements on remittance services, improving transparency, and opening up retailfinancial networks to nonexclusive partnerships with remittance agencies).
Increasing migration of low-skilled workers and reducing remittance fees
could significantly help alleviate poverty.
Chapter 1 of this study reviews recent developments in and prospects
for the global economy, and their implications for developing countries.
Chapters 2 and 3 evaluate the costs and benefits of migration, throughmodel-based simulations and a review of the economic literature. Subsequent chapters address remittances, including their size and macroeconomic
impact (chapter 4), their impact on households (chapter 5), and policy
measures to lower the cost of remittance transactions for poor migrants(chapter 6).
For additional information, please visit www.worldbank.org/prospects.
To access Prospects for the Global Economy, an online companion
publication, please visit www.worldbank.org/globaloutlook.

ISBN 0-8213-6344-1