# **1. Introduction**

High rates of labor emigration and inward flows of workers’ remittances characterize many of the transition economies of Europe and Central Asia (ECA). Labor migration and remittances have potentially profound long-term macroeconomic effects in the remittance recipient economies, which in turn have implications for long-term growth and development strategies. Much of the literature on the macroeconomic effects of remittances has focused on their impact on the real exchange rate. Less attention has been paid to the potential impact of migration and remittances on another channel which affects external competitiveness, real unit labor costs, through the supply of, and demand for, labor in the remittance receiving economy.

Real unit labor cost, defined as the cost of labor, in real terms, required to produce a unit of output, is an important component of external competitiveness given that labor comprises a large share of production costs, especially in labor intensive industries and because labor is much less internationally mobile than either capital or intermediate inputs and hence there is greater variation between countries in labor costs than in the cost of other inputs. Appreciation of the real exchange rate will raise unit labor costs denominated in an international currency, _ceteris paribus_ . But it is also possible that migration and remittances can exert upward pressure on the real unit labor costs denominated in domestic currency, through the domestic labor market, which would therefore intensify the rise in unit labor costs denominated in foreign currency. Hence the domestic labor market is a potential separate channel through which migration and remittances could adversely affect the international competitiveness of remittance recipient economies.

For some high remittance recipient transition economies, the rise in real unit labor costs, expressed in an international currency (which is the product of real exchange rate appreciation and the rise in real domestic currency unit labor costs) has been very steep and much greater than the real exchange rate appreciation alone. This suggests that the latter may not fully capture the extent to which high remittance recipient economies have lost external competitiveness, at least for their labor intensive traded goods industries. Given that labor intensive traded goods industries have been an engine of growth for many of the fastest growing emerging markets and developing economies (EMDEs), factors which affect the external competitiveness of such industries have potentially important implications for viable growth strategies (Rodrik, 2008).

This paper examines the empirical relationship between remittances and real unit labor costs using data from the transition economies of ECA. We show that real unit labor costs, measured in both local currency and US dollars, rose much more quickly on average among those transition economies which received high levels of remittances compared to other transition economies during the period 2003-17. Estimating panel data fixed effects and Generalized Least Squares (GLS) regressions on 28 transition economies and on a subsample of 11 high remittance recipient transition economies, the coefficient on remittances was positive and significant at the 1 percent confidence level. Although problems of reverse causality cannot be entirely discounted, the results suggest that remittances have a causal effect on real unit labor costs in the transition economies.

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