# **I.  Introduction**

Workers’ remittances to developing countries have experienced a dramatic increase over the past few years. According to the World Bank’s _Global Economic Prospects 2006_ , in 1990 remittances to middle and low-income countries amounted to about US$30 billion. Fifteen years later, they are estimated to have reached almost US$170 billion implying annual growth rates that are well above 10 percent. Remittances now account for about 30 percent of total financial flows to the developing world and provide significant foreign exchange earnings. They are more than twice as large as official development assistance flows, and represent the equivalent to 2.5 percent of the gross national income of the developing world. There is also some evidence indicating that remittances flows have a number of positive macroeconomic effects in recipient countries: large remittances flows improve a country’s creditworthiness for external borrowing and hence enhance its access to international capital markets. Similarly, there is evidence that some financial institutions in developing countries have been able to tap international capital markets at relatively favorable conditions through securitization of future flows.

Given the nature, magnitude, and evolution of these flows it should not be a surprise that remittances are now seen by development practitioners as having a potentially important role to play in supporting the development efforts of recipient countries. There are two main channels in which remittances can support these efforts. First, remittances could flow towards the neediest groups of the population and therefore directly contribute to poverty reduction. Thus it is possible that even if these flows are fully consumed, a concern mentioned by a number of practitioners, they have significant positive welfare effects. Second, with imperfect insurance and financial markets, remittances can also contribute to higher investment in human and physical capital. For example, these flows can remove some of the financial constraints faced by households and small-scale entrepreneurs that prevented them from investing. Similarly, remittances can provide insurance and therefore allow households and entrepreneurs to pursue more risky asset accumulation strategies. Thus in this regard, remittances may also potentially contribute to raising the country’s long run growth potential through higher rates of capital accumulation.

Unfortunately, in practice, these potential positive impacts may be counterbalanced by other more challenging effects. For example, if there are important costs associated to the act of migrating it is possible that migrants do not come from the lowest quintiles of the income distribution and therefore that remittances do not flow towards the poorest. In fact, as discussed below in the Latin American context, when one takes into account both the location of recipient households in the income distribution, and the magnitude of the corresponding flows it is difficult to defend that remittances are directed mainly towards the poor. In those cases, one should not expect remittances to have a large effect on poverty headcounts. Moreover, comparing observed poverty rates with those calculated on the basis of non-remittances income may exaggerate the estimated development impact of these flows. Indeed, before leaving their home countries migrants are likely to have contributed to their households’ income, which should be taken into account when calculating counterfactual poverty rates in a scenario of neither migration nor remittances. Adams (2006), for example, argues that failure to correct for the reduction in income associated with the absence of 2