Remittances, finance and growth: Does financial development foster the impact of remittances on economic growth?

Abstract

Abstract There is no consensus in the literature regarding the long-run impact of remittances on economic growth. Previous studies have shown that it might be related to financial development in the transfer-receiving country, but the direction of the link remained unclear. I contribute to this literature by using a newly created index of overall financial development and two different estimation methods. I measure the importance of remittances given financial development for economic growth in developing countries. As there is no widely accepted measure of financial sector development, I estimate an index of overall financial conditions. It is created by means of an unobserved components model and used to determine the relevance of the financial sector as a transmission channel for remittances to affect economic growth. I show that the more financially developed a country is, the smaller the impact of remittances on economic growth. Remittances can foster growth, but the effect is significant only at low levels of financial development. This is in line with previous studies, which found remittances and financial development to be substitutes. However, the interaction between the two factors becomes weaker once size, depth and efficiency of the financial sector are taken into account. My results suggest that, while attracting migrants’ transfers can have important short-run poverty-alleviating advantages, in the long-run it might be more beneficial for governments to foster financial sector development.