# **1 Introduction**

Developing countries remain extremely vulnerable to adverse exogenous shocks. The global financial crisis and the world food price crisis of 2008 delivered a reminder of their macroeconomic, external, and fiscal vulnerabilities (Figure 1, left panel). In addition, over the past decades developing countries have been increasingly subject to natural disasters, again with severe consequences in terms of output, trade, and fiscal balances (Raddatz, 2007; Noy, 2009). As a result, the policy debate is again focusing on developing countries’ vulnerability (Schindler _et al._ , 2011).

This paper examines how remittances are affected by structural characteristics, macroeconomic conditions, and adverse shocks in both source and recipient economies. It therefore sheds light on whether remittances should be viewed as a countercyclical shock absorber, helping smooth consumption during a downturn, in contrast to the typically pro-cyclical private capital flows. This issue is particularly salient for two reasons. First, spurred by increasing migration, remittances to developing countries have grown steadily relative to capital flows (Figure 1, right panel). Remittances to developing countries are projected to reach USD 414 billion in 2013, more than three times the size of official development assistance, and USD 540 billion by 2016 (The World Bank, 2013). Second, remittances have proved very resilient since the onset of the global financial crisis.

The existing empirical evidence on the role of remittances as a shock absorber is inconclusive. Some studies suggest that remittances are countercyclical with respect to output in the recipient country, because they are driven by altruism (Agarwal and Horowitz, 2002; Osili, 2007), or because household members migrate as part of a risk-diversification strategy aiming to insure against income shocks (Yang and Choi, 2007). Other studies emphasize that remittances can be pro-cyclical, because migrants’ decision to remit is also driven by factors such as investment in physical and human capital (Yang, 2008; Adams Jr. and Cuecuecha, 2010; Cooray and Mallick, 2013).

This paper re-examines the question using a novel, rich panel dataset, covering bilateral remittances from 103 Italian provinces to 87 developing countries over the period 2005-2011, to estimate a model for bilateral remittances. In this dataset, remittances display significant variability, both over time and across source provinces and recipient countries. Italy can be considered a representative case study given that remittance outflows increased substantially in the last years, notwithstanding the global slowdown, and they are destined to all world regions and not limited to neighboring regions such as Eastern Europe, Central Asia or Northern Africa.

More specifically, the paper makes three main contributions to the literature. First, the availability of bilateral panel data for a large sample of recipients makes it possible to analyze systematically the correlation between remittances and the business cycle in both source and recipient economies, washing out the effect of time invariant factors at the level of country-province pairs. We consider separately the cyclical and trend components in GDP per capita. In addition, we control for specific factors of vulnerability in recipient countries, including in particular natural disasters, large declines in the terms of trade, and armed conflicts. In contrast, the existing literature focuses mainly either on bilateral remittances for a limited sample of receiving countries (Lueth and Ruiz-Arranz, 2008; Frankel, 2011; Docquier _et al._ , 2012), or on country pairs, such as the US-Mexico or the GermanyTurkey corridors (Sayan, 2004; Vargas-Silva, 2008). As a result, existing works fail to settle the 2