WPS3704

# **Remittances: Transaction Costs, Determinants, and Informal Flows***

Caroline Freund, World Bank Nikola Spatafora, International Monetary Fund Abstract: Recorded workers’ remittances to developing countries have grown rapidly, to more than $100 billion in 2004, bringing increasing attention to these flows as a potential tool for development. But even these statistics are likely to significantly understate true remittances, as a large share is believed to flow through informal channels. Estimates of the importance of the informal sector vary widely, ranging from 35 percent to 250 percent of recorded flows. The primary motivation of the study is to develop the first empirical methodology to estimate informal flows. We use insights from the literature on shadow economies and empirically estimate informal remittances for more than 100 countries, using historical data on workers’ remittances from the Balance of Payments (BOP), as well as data on migration, transaction costs, and various country characteristics. Our results imply that informal remittances amount to about 35–75 percent of official remittances to developing countries. There is significant regional variation: informal remittances to Sub-Saharan Africa and Eastern Europe and Central Asia are relatively high, while those to East Asia and the Pacific are relatively low. These estimates are supplemented with detailed household survey data on remittance receipts in a number of countries.

Our results also shed light on the determinants of recorded remittances and the associated fees in the formal sector. We find that the stock of migrants in OECD countries is the primary determinant of remittances. In addition, money transfer fees and the presence of dual exchange rates reduce the share of remittances reported in national accounts. In turn, transaction costs are systematically related to concentration in the banking sector, lack of financial depth, and exchange rate volatility. There is also evidence that remittances are misrecorded in the BOP as “Errors and Omissions”.

World Bank Policy Research Working Paper 3704, September 2005 _The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org._

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*Email: <u>cfreund@worldbank.org, nspatafora@imf.org. We are grateful to Irena Omelaniuk for</u> providing us with IOM studies of remittances in several countries and for helpful discussions, to Dean Yang for generously providing data and summary statistics on the mode of remittance transfer in the Philippines, and to Angela Cabugao Espiritu for outstanding research assistance. We are also grateful to Dilip Ratha, participants at a World Bank seminar, and an anonymous referee for comments.