appreciation of the bilateral US dollar real exchange rate and half to the rise in local currency real unit labor costs.

We estimated panel data fixed effects and GLS regressions for the local currency real unit labor costs in which the independent variables were remittances as a share of GDP, the capital output ratio, and net ODA receipts as a share of GDP. The regressions were estimated on both the sample of 28 transition economies and on a sub sample of 11 high remittance recipients. In all four regressions, the estimated coefficient on remittances was both positive and significant at the 1 percent confidence level. Although problems of reverse causality cannot be entirely discounted, this suggests that remittances have a causal effect on the evolution of real unit labor costs in the transition economies.

What are the policy implications of our findings? Estimates of changes in real exchange rates are often used as proxies for external price competitiveness, but for economies which receive substantial remittances, real exchange rate indices may not fully capture the extent to which they have incurred an erosion of external price competitiveness, especially with regard to labor intensive industries. Trends in real unit labor costs also need to be taken into account in analyzing developments in external competitiveness. The trends in real unit labor costs have potentially profound implications for feasible long term growth and development strategies because of their impact on the economy’s potential comparative advantage.

The very steep rises in real unit labor costs, incurred by some of the high remittance recipients in the South Caucasus and Central Asia, may undermine the feasibility of development strategies which focus on labor intensive industries, such as manufacturing. Instead, it may be more realistic for development strategies to focus more on traded goods industries whose competitiveness is less dependent on low cost labor. Tradeable services may offer a more viable alternative for some of these countries because tradeable services tend to be more heterogenous products than manufactured goods and thus their competitiveness may be less sensitive to relative costs. However, most tradeable services are dependent on skilled labor and so resources will have to be devoted to human capital investment in general and vocational training in particular if they are to be the focus of long term development strategies. Fortunately, many of the thigh remittance recipient transition economies in ECA already have fairly high levels of human capital relative to their GDP per capita, so they have a solid foundation on which to build a comparative advantage in skill intensive tradeable services.

# **References**

Acosta, Pablo A., Emmanuel K.K. Lartey, and Frederico S. Mandelman, (2007), “Remittances and the Dutch Disease”, _Journal of International Economics_ , Vol 79 Issue 1, pp102-116.

Amuedo-Dorantes, Catalina and Susan Pozo (2004), “Workers’ Remittances and the Real Exchange Rate: A Paradox of Gifts”, _World Development_ Vol 32, no 8, pp1407-15417.

Amuedo-Dorantes, Catalina and Susan Pozo (2006), “Migration, Remittances, and Male and Female Employment Patterns”, _American Economic Review_ , Papers and Proceedings, Vol 96 No 2, pp222-226, 22