WPS4249 the two potential drivers of poverty:<sup>6</sup> average income growth and income inequality. This is important because as noted in World Economic Outlook (2005) estimates of the poverty effects of remittances based on regressions that control for per capita GDP and indexes of income inequality – such as those in Adams and Page and the World Economic Outlook – can be substantially biased as they miss the effects that operate through changes in average income or inequality.

Second, unlike previous cross-country studies we introduce some degree of country heterogeneity in the analysis. Thus, in our regression estimates we allow the impact of remittances on growth and inequality to be different for Latin American countries. Moreover, when mapping the estimated effects of remittances on growth and inequality on the corresponding impact of remittances on poverty, we take into consideration each country’s initial level of inequality and development.<sup>7</sup> Third, in contrast to previous cross-country analysis of this topic, we exploit in our estimates the panel nature of the data, thus allowing for the possible existence of fixed effects, motivated for instance by time-invariant unobserved country characteristics. Moreover, we perform our estimation in a dynamic panel framework, using both internal and external timevarying variables to instrument for remittances. We are able to introduce some of these statistical refinements thanks to the larger availability of data on inequality and growth data, in comparison with the limited samples that are available in poverty databases.

Fourth, using household survey data for ten Latin American countries with quite different migration patterns, we estimate the effects of discrete and marginal changes in remittances on household income inequality. In this respect, we first make the assumption that remittances operate as exogenous transfers by migrants, and thus consider the counterfactual scenario of changes in remittances without changes in migration.

Fifth, to complement the above estimates, we compare observed levels of poverty and inequality with the levels that would prevail in the counterfactual scenario of no-migration and no-remittances. We pursue this alternative on the basis of the more realistic assumption that remittances are a potential substitute for home earnings, which we impute based on samples of non-migrant households, in a selection-corrected estimation framework.

To anticipate some of our main results, our cross-country estimates suggest that remittances have a positive and statistically significant effect on growth that is of a similar magnitude in Latin America and in the rest of the world. This result is robust to the use of different instruments (internal and external) for the indicator of remittances. The evidence on the impact of remittances on inequality, however, is somewhat more mixed. For the typical country in the global sample we find that remittances tend to increase the level of income inequality. On

> 6 In what follows all references to poverty should be understood as references to headcount poverty. The qualitative results of this paper, however, can be extended without loss of generality to the other two Foster, Greer and Thorbecke (1984)  poverty measures (the poverty gap and the squared poverty gap).

> 7 As argued by, among others Lopez and Serven (2006), the impact of growth and changes in inequality on poverty reduction depends on the country’s initial level of inequality and development. In other words, even if remittances had the same impact on growth and inequality in every country they could still have a different impact on poverty levels.

3