Policy implications of remittances, trade liberalization and Dutch disease – A comparative analysis based on income categorization

Abstract

Prior research does not provide any consensus on whether Dutch disease can be caused by international remittances. However, remittances cause sectoral imbalances, which may adversely affect the economy. This study's main objective is to determine the impact of remittances on the real exchange rate movement from 1999 to 2019 in 199 countries and territories. This paper will apply the one-step system Generalized Methods of Moment (S-GMM) to the linear dynamic panel data (DPD). This study's main findings indicate that remittances have a depreciating effect on the exchange rate in all countries and in lower-middle-income countries. In comparison, the first lag of remittances has a significant negative impact in high-income countries but a significant positive impact in lower-middle-income countries. The results indicate that lower middle income and low-income economies should adopt macroeconomic policies to neutralize the Dutch disease. From a policy perspective, the imposition of a variable tax or retention on the exports will increase the exporters' cost, and the exchange rate will depreciate accordingly. Such a policy formulation would allow countries to recover from Dutch disease while instigating trade of commodities, which could benefit the economy in the long run. The self-balancing mechanism would also protect the economy against long-run depreciation of currency value.