WPS4249

# **1. INTRODUCTION**

Flows of workers’ remittances have become a major source of external finance for developing countries. During the past ten years, the growth of remittances has outpaced that of private capital flows and official development assistance. In 2004, remittances to developing countries totaled about US$144 billion, and were equivalent to about 5 percent of imports and 8 percent of domestic investment. They reached almost 90 percent of FDI and were larger than official flows and private non-FDI flows.<sup>2</sup> Remittances are especially important in Latin America. With flows of US$40 billion in 2004 and 27 percent of all remittances to developing countries, Latin America is currently the top remittance receiving region in the world. With an annual growth rate of 15 percent over the past 15 years, Latin America has also experienced among the highest rates of growth in remittances inflows, trailing only East Asia.

Given the magnitude, stability and potentially beneficial macroeconomic effects of workers’ remittances, the growing interest in the topic among development practitioners should not come as a surprise. Yet, very little is still known about the poverty and inequality impact of these flows. Microeconomic evidence based on household survey data suggests that remittances are generally associated with reductions in poverty,<sup>3</sup> but they may increase or decrease income inequality depending on the initial level of migration of sending communities.<sup>4</sup> Several of the existing studies, however, are based on rural and village-level data<sup>5</sup> and only one focuses on a nationally representative survey for a Latin American country.

At the cross national level there are, to the best of our knowledge, only two recent studies (Adams and Page, 2005, and World Economic Outlook, 2005) that have looked at this issue. Both of them find that countries that receive remittances have lower poverty levels. Adams and Page find that a 10 percent increase in per capita remittances would lead to a 3.5 percent decline in the share of people living in poverty in the corresponding country. World Economic Outlook (2005), on the other hand, finds that a 2.5 percentage point increase in the remittances to GDP ratio is associated with a 0.5 percentage point decrease in poverty.

This paper contributes to the literature on the effects of remittances on poverty and inequality along several dimensions, using both aggregate country-level data and nationally representative household surveys for ten Latin American and Caribbean (Latin American hereafter) countries. First, we complement previous cross-country studies by using an econometric approach that allows us to estimate the separate impact of remittances on each of

> 2 See Global Economic Prospects (2006).

> 3 See, among others, Adams (2004, 2006) respectively on Guatemala and Ghana, Lopez-Córdova (2005) and Taylor et al. (2005) on Mexico, and Yang and Martinez (2006) on the Philippines.

> 4 This is the conclusion reached by Stark, Taylor and Yitzhaki (1986) and Taylor, Mora and Adams (2005) using data from rural Mexico. Other papers, however, have concluded that remittances have the effect of increasing income inequality: see for instance Adams (1989, 2006) on Egypt and Ghana, respectively, Barham and Boucher (1998) on Nicaragua, and Rodriguez (1998) on the Philippines.

> 5 The exceptions are the papers on the Philippines, Ghana and Guatemala. The data used by Lopez-Córdova (2005) is also nationally representative but it is aggregated at the municipal level.

2