Remittance inflows and economic development in Rwanda

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Kadozi, E.

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2019

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Kadozi, E. (2019). Remittance inflows and economic development in Rwanda.

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536731-L-sub01-bw-Kadozi 536731-L-sub01-bw-Kadozi 536731-L-sub01-bw-Kadozi 536731-L-sub01-bw-Kadozi Processed on: 11-10-2019 Processed on: 11-10-2019 Processed on: 11-10-2019

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CHAPTER EIGHT 8.0 Conclusion and Policy Implications

This thesis contributes to the ongoing mixed theoretical and empirical narratives about the development impact of remittances in developing countries. It examines the contribution of remittance inflows to the development outcomes in SSA countries and Rwanda in particular for the period between 1980 and 2014. It also considers the conditions under which remittances affect development outcomes and how these effects can be maximized. Specifically, this study examines 1) the effect of remittance inflows on economic growth in SSA countries and Rwanda in particular for the period from 1980 to 2014 and the factors conditioning the intensity of these effects in SSA and Rwanda; 2) the channels through which remittance inflows affect poverty and other development outcomes in Rwanda; and 3) how the development effects of remittance inflows play out among the different socio-economic layers of recipient households in Rwanda.

The anecdotes in Chapter Four illuminate the practical mechanisms through which remittance inflows contribute to the development outcomes (such as welfare, investments and human capital development) in Rwanda. The local policy and institutional framework influences the overall contributions of these inflows in the country. These practical experiences, coupled with the ongoing theoretical and empirical gaps in the literature on remittances and development, motivated this study. The study addressed the mostly overlooked theoretical, conceptual and empirical aspects in the development impact of remittances:

First, the consistent underestimation of the importance of a comprehensive theoretical and conceptual framework explaining the development impact of remittances. The lack of this framework has created theoretical and empirical gaps in explaining overall development outcomes of remittances, characterized by an empirical disconnect between micro and macro development outcomes of remittances. The role of institutional and development factors in causally conditioning the remittance-development outcomes has consistently been underestimated.

Second, this study addressed the causal mechanisms between remittance inflows, the policy and institutional framework and the remittance-development outcomes. This is affected by the country-specific context. Third, this study considered the methodological issues affecting the empirical analysis of the remittance-development effect. The problem of endogeneity and selection bias affect these results. The underlying issue here is how to

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estimate the counterfactual income of the remittance-recipient households. Thus far, the empirical analysis related to remittances and development has been heavily affected by the lack of a conclusive empirical approach (mostly at the macro level) that addresses these methodological issues. This is complicated by a lack of the correct instrumental variables and relevant statistical data in developing countries.

This study contributes to the above gaps by employing a comprehensive and systematic framework to study and explain the development outcomes of remittance inflows. It engages and employs different credible empirical mechanisms to measure and explain the development outcomes of remittances (the micro and macro development outcomes) and the mediating role of institutional and development variables in conditioning mechanisms that causally affect remittance-development outcomes. The study addresses the contextual gap by conducting first a cross-country analysis of SSA countries and then an in-depth analysis at country level (Rwanda) to examine and explain the development impacts of remittances. The theoretical and empirical strategies of this study are embedded in the theoretical and empirical debate between the three dominant theoretical approaches: the national account model, the endogenous growth theory and the NELM. These theoretical and empirical frameworks provide the impetus for looking at the remittance-development impact beyond the traditional remittance-growth effect and focusing on the multifaceted ways in which remittances affect the development outcomes. This points to the importance of examining how remittances affect aggregate development outcomes (the growth effect), the poverty effect, and other development outcomes and how the latter effect plays out among different socio-economic layers of recipient households. It also shows how the prevailing institutional and policy environment causally condition the choice of agents and the deployment of remittances to affect the overall remittance-development outcomes in the recipient country.

This study finds that the three theories are complementary and not mutually exclusive in explaining the growth and development impact of remittances. They are however shallow and exhibit a disconnect between their theoretical stance and the empirical narratives. The cross-country analysis of SSA countries finds on average, no significant impact of remittances on economic growth in the region. This evidence seems to imply that the effect of remittances on economic growth varies within and across SSA countries. In other words, the effect plays out differently within and across the region. This heterogeneity is closely associated with variations in terms of an effective policy and institutional framework that causally conditions mechanisms through which remittances are utilized to affect development outcomes in the region. SSA countries differ in terms of level of development, effective institutional and

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policy frameworks and their policies towards the diaspora, which has a direct and indirect bearing conditional effect on the remittance-growth impact. The results of the country-specific analysis are significant and robust. In this regard, Chang (2010) observes that cross-country results themselves are problematic and complex in an empirical analysis of institutional variables. Rodrik (2004) claims that the development effect of remittances depends on local constraints and opportunities. He further notes that the importance of the local context has been underestimated, which has led to the ongoing inconclusive debate about institutions and economic development.

In line of the above, it remains imperative to employ institutional and development variables that reflect the actual contextual realities of the country. Indeed, the findings of this study reveal that the remittance-growth impact is positively conditioned by the country’s level of development, financial development and human capital development. This implies that remittances affect economic growth by positively contributing to the financial sector development and human capital development in the recipient economy. On average, however, the latter effect is undermined by the quality of institutional variables in the region, such as political instabilities and strict regulations.

In contrast, the country level analysis reveals the positive and significant impact of remittances on economic growth. The marginal effect of remittances on GDP per capita increases as more remittances flow to Rwanda. The results of the interaction term of the Rwanda dummy and remittances yield a positive and significant effect of remittances on GDP per capita in Rwanda over the period of study. This confirms the results of other estimation techniques (the Johansen test of cointegration and the ECM), which reveal plausible evidence of a long-run relationship between remittances and GDP per capita. The long-run causality runs from remittances to GDP per capita in Rwanda, but not vice versa. These findings suggest that the positive and significant effect of remittances on the economic growth in Rwanda can be attributed to the recent overall improvement in the development outcomes and to the policy and institutional framework that have causally conditioned the remittance-growth effect.

Furthermore, the study finds different mechanisms through which remittances affect economic development outcomes. This thesis reveals that international remittances significantly affect poverty and contribute to development outcomes (physical investments, savings, business and human capital development indicators) by increasing the income available to spend on these development outcomes. This results in a stronger overall multiplier effect on the improved welfare of remittance-recipient households than on that of

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non-recipients. Evidence from the empirical analysis suggests that the pro-development impact of international remittances is greater among recipient households who are poor. This implies that international remittances not only increase spending on development outcomes, but also provide an avenue for graduating out of poverty, as well as bridging income inequality. The findings suggest that the significant remittance-development outcomes in Rwanda have been causally conditioned by the overall institutional and policy framework. This has been coupled with the overall improvement of development indicators which have influenced mechanisms through which remittances affect development outcomes in the country.

In other words, it is not just the amount of remittance inflows, but the institutional environment that conditions mechanisms through which remittances affect the overall development outcomes. In that regard, I would like to conclude with this analogy: A seed planted in dry or barren soil does not have the same possibility of germination as a seed planted in fertile soil. Remittances are seeds for development, if their inflows and deployment are mediated by a good institutional and policy environment (fertile soil), their development impact will be significantly increased. The reverse is however also true.

8.1 The Contribution of this Thesis

The contribution of this study is rooted in its comprehensive and systematic theoretical and empirical framework employed to study and explain the development impact of remittances. The analytical framework of this thesis considers development aspects that have been ignored by the theoretical and empirical narratives related to remittances and development. The study claims that there is no linear relationship between remittances and economic growth; other mechanisms through which remittances affect development outcomes are also worth considering in both the theoretical and the empirical frameworks. In the empirical relationship between remittances and economic development, this study finds that the level of development and the policy and institutional environment are equally important to causally condition the mechanisms through which remittances affect development outcomes.

In reference to the case of SSA countries and Rwanda in particular, the heterogeneity across and within SSA countries in the way remittances affect growth and development is attributed to the deferential patterns in terms of the policy and institutional framework that causally condition mechanisms through which remittances are utilized to affect development outcomes in the region. In Rwanda, the significant contribution is attributed to the fact that,

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over last two decades, the country has embarked on building capacity to drive economic development. This has been driven by an institutional and policy environment that conditions the overall development outcomes. The remittance-development impact has been causally influenced by the prevailing effective policy and institutional framework in the country.

The thesis establishes a systematic causal path from micro outcomes to the aggregate macroeconomic outcomes driven by the prevailing local institutional frameworks that influence the choices of agents (recipient households and the diaspora) to productively utilize remittances. The study finds that the same institutional and development factors create opportunities locally for productive use of these inflows, which positively affects microeconomic outcomes, which then ultimately aggregate into the macro picture we observe through the remittance-growth impact.

The findings of this study suggest that context matters when explaining the development impact of remittances in developing countries. This thesis finds that the cross-country analysis explains the comprehensive causal mechanisms through which remittances affect development outcomes only to some extent. This can be attributed to the fact that countries vary in terms of policy and institutional variables that mediate the remittance-development outcomes. They also differ in terms of their policies of engaging the diaspora in the national development. These factors all have a bearing effect on how remittances are transferred and productively utilized to affect overall development outcomes. These factors are country specific. The in-depth analysis of Rwanda provides a comprehensive framework to better study and explain the different mechanisms influencing remittance-development outcomes.

This thesis has contributed to filling in some of the methodological gaps in the empirical studies about remittances and development. It establishes micro and macro development outcomes of remittances to better understand the comprehensive impact of remittances. To ensure the validity and credibility of the findings, this study employed instrumental variable techniques to address the endogeneity problem in the macro-level analysis using macro data. At the micro level, I customized the empirical analysis at a local level (as suggested by several empirical studies) to address the selection bias that exists between remittances and development. I employed the RCT technique and the PSM technique, both of which have empirical credibility in addressing the problem of selection bias. Several other studies employ a one-sided approach and thus fail to provide a comprehensive understanding of remittance-development outcomes and to address the problem of endogeneity and selection bias.

Overall, the findings of this thesis increase our understanding of the development impact of remittances in the context of SSA countries and Rwanda in particular. It sheds light on the

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indispensable role of remittances in development. It has shown that the development impact of remittances is not linear. Instead, the causal interplay of institutional and development factors condition remittance-development outcomes and thus matter in theoretical and empirical narratives. The study’s context allows for the customization of the analysis, taking the local institutional and policy framework that influence the impact of remittances into consideration. The channels and mechanisms through which these inflows affect development are equally paramount and need to be considered in the theoretical and empirical frameworks explaining the development impact of remittances. The study advances the claim that remittances are potentially complementing factors for broad-based development endeavors but not panacea for all of it. Their development effects depend on the underlying institutional and policy environment like other external capital inflows in the recipient economy. The development impact of remittances entails a systematic and holistic development outcome, not necessarily a macro impact. Moreover, the causal mechanisms influenced by the local institutional and policy framework causally condition how these inflows are utilized to affect micro development outcomes, which aggregate to macro outcomes. The findings of this study contribute to the empirical narratives about remittances and inequality. The study provides empirical evidence that the pro-development impact is stronger among poor recipient households than among non-poor recipient households, challenging previous pessimistic studies about the effects of remittances. The evidence of this study suggest that remittance inflows help to bridge income inequality in developing countries by boosting the financial capacity of poor recipient countries. This leads to important policy implications, which are described in the next section.

8.2 Policy Implications

The findings of this thesis reveal that remittance inflows positively affect development outcomes through institutional and development facts in SSA countries and Rwanda in particular. They significantly contribute to poverty reduction and development outcomes by increasing consumption expenditure per adult equivalent, savings, business, physical investments and human capital development variables of recipient households in Rwanda. The findings suggest that the pro-development impact of international remittances is marginally greater among recipient households who are under poverty conditions. This implies that international remittances not only increase spending on development outcomes, but also provide an avenue for recipients to graduate out of poverty, as well as bridging income inequality. The evidence from this study strongly suggests that the institutional and

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policy framework are equally important in causally conditioning the overall development outcomes of remittances. The analysis of this thesis suggests the following policy implications in order to maximize the remittance-development outcomes in SSA countries.

First, a conducive institutional environment (local policies and institutional delivery) is a prerequisite factor for recipient countries to reap the development impact of international remittances. The findings suggest that an overall institutional environment that improves the functioning of governance institutions (economic and political) that enforce the efficient regulatory environment and sound financial sector development is essential. Such an environment encourages formal remittance transfers and the channeling of these inflows into productive use in the local economy, thus enhancing the growth and development impact of remittances. Based on the empirical evidence from Rwanda, other SSA countries need to strengthen their local institutional and policy framework, particularly the economic and political institutions that enhance mechanisms through which remittances are productively utilized to affect overall development outcomes. Countries need to create effective institutional frameworks that create inclusive opportunities for everyone. This will lead remittance recipients and the diaspora to seize these opportunities to use remittance inflows to improve their socio-economic status. Effective pro-poor development policies and programs are equally important within SSA countries. The contribution of remittances needs to be moderated by the development-friendly opportunities created by such policies and institutions. This has to go hand in hand with political stability in the region.

Second, this thesis finds strong evidence in support of the role of the institutional environment in conditioning the remittance-development impact in the SSA region. However, the institutional indicators play out differently in the region. In a context where indicators of institutional quality (such as political stability, government effectiveness, lack of corruption, rule of law, property rights, business regulatory environment) exist and are improving and where policies and the market environment encourage productive investments such as channeling remittance inflows into savings, business, physical investments and support for human capital development, remittances will be far more effective than in less conducive contexts. The institutional environment can enhance the growth and development outcomes of remittances. Most SSA countries need to work on these institutional indicators to be able to reap the benefits of external inflows into the region. Otherwise remittance inflows will remain resources to be used for conspicuous consumption, which will continue to undermine development in the region.

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Third, the country’s level of development is positively associated with the remittance-development effect. The findings of this thesis reveal that the remittance-growth effect in SSA countries is conditioned by the country’s level of development. This seems to signal that the development impact of remittances goes hand in hand with the ongoing overall development in the country. This is in support of the stylized facts from Rwanda. The thesis finds that the recent steeper growth of remittance inflows and their significant effect on growth and other development outcomes accompanied the observed steady growth of the economy in recent years. In the same period, we observe impressive development in different institutional and economic reforms. This implies that the development impact of remittances preceded the overall positive development trends of the economy in Rwanda. In other instances, remittances are attracted by extreme poverty and misery in the recipient country, but in such cases, the overall effect of these inflows will be insignificant and undermine growth and development. However, when the overall development in the recipient country is increasing, the diaspora gains confidence in the country and development opportunities are provided, which attract even more remittance inflows. In such a situation, the overall development impact is expected to be significant. Therefore, the level of development in the country mediates the remittance-development impact.

The macroeconomic empirical literature suggests a threshold beyond which the marginal impact of remittances on development becomes negative, although the level or rate of this threshold has not yet been determined. The literature does not demonstrate what people do with remittances or what the stake of the institutional and policy framework is in conditioning the development impact of remittances. I argue that it is not that there is a threshold, instead it is imperative to stimulate growth and development as a prerequisite factor for developing countries to tap the remittance-development impact in their economies. This should go hand in hand with local inclusive and effective socio-economic policies that encourage the development impact of remittances. In relation to the SSA region, countries need to stimulate growth and development as they productively engage their diaspora in the national development. A conducive institutional and policy environment in the country is a pre-requisite condition for SSA countries to take advantage of remittance inflows. Otherwise, remittances will be channeled into conspicuous consumption which perpetuates the vicious circle of poverty, continued dependence on remittances by recipient countries and households, and brain drain, which in turn negatively affects growth and development within and across the region.

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Fourth, improving international remittance data collection and reporting is critically important for policy makers and scholars to better understand the development impact of these inflows. In this regard, over the years, remittances have been defined differently by researchers, countries and international organizations. This affects the quality of remittance data, which affects both macro and microeconomic implications of these inflows. Catrinescu et al. (2006) argue that large quantities of international remittances are transmitted through informal channels and are not recorded in the balance of payment, which is the case for most developing countries, including Sub-Saharan Africa and Rwanda in particular. As a result, actual inflows are underestimated. Remittance data governance and reporting remains challenging, especially in SSA countries, which has evidence-based policy implications in the field. International organizations such as the World Bank, the IMF and the African Union need to develop remittance data governance and reporting. Remittance data indicators, collection tools and reporting need to be harmonized and effectively implemented across all countries. In cases where remittance data is still scarce, household survey data could be used to study the development impact of remittances.

8.3 Future Research

In light of the theoretical approaches and analytical methodologies employed and of the empirical findings and conclusion of this thesis, future research should address the following key issues that were not addressed by this study:

First, the heterogeneity of the remittance-growth effect in SSA countries and the positive and significant effect of remittances on development outcomes in Rwanda prompt the need to study what determines this variation (other than the policy and institutional framework). Which other SSA countries show a positive and significant effect of remittances on development? Rwanda could be compared with other country/ies with a significant development effect of remittances to determine other conditioning factors than the ones identified in this study. An in-depth country study would provide comprehensive and reliable findings about the remittance-development outcomes. With regards to the intermediate factors influencing the remittance-development impact, cross-country data and indicators are unable to provide all mechanisms that causally condition the remittance-development impact, both because of the country heterogeneity and because of challenges regarding the availability of data.

Second, early empirical narratives postulate the negative effect of remittances on development, while the recent empirical findings increasingly suggest the opposite. Looking

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at historical and recent successful cases of development, particularly in developing countries such as for instance East Asian countries and African countries such as Botswana, Ethiopia, Ivory Coast, Mauritius and Rwanda, it would be worth examining the stake of remittances in these developments.

Third, considering the difficulty of endogeneity and selection bias that exists between remittances and economic growth and the methodological and data issues (mostly macroeconomic data at cross-country level), it remains imperative for future research to explore other approaches through which remittances could be affecting development outcomes in the SSA countries. This should involve devising mechanisms of employing external instrumental variables from the field of migration and development rather than relying on internally developed ones. The cost of sending remittances to the country of origin could be an external instrumental variable that could be explored with the availability of data. This is conditional upon countries and international organizations such as the World Bank and the IMF being able to provide reliable and harmonized statistical remittance data.

Fourth, in the context of Rwanda, considering the problem of selection bias that could stem from other existing pro-poor social protection programs in the country, such as VUP and FARG financial transfers, further research is needed to investigate the effect of international remittances in relation to these programs in contributing to poverty reduction in Rwanda. For instance, how do these different sources of financial transfers affect poverty and what is the stake of them in the poverty reduction process in Rwanda?

Fifth, further focused household panel data analysis is equally important to examine trends on how international remittances affect investments, inequality and poverty in the country using different cohorts of household survey data in SSA countries to better understand how remittances affect poverty over time. Do remittances enable recipient households to sustainably graduate out of poverty and if so, how?

Finally, further cross-sectional research is needed on how economic institutions (such as financial institutions) causally condition the remittance-development impact in the SSA region. This research could consider the role of a conducive business environment and financial institutions in providing mechanisms fostering the formal remittance-driven development effect. Several empirical studies have documented a strong positive impact of remittances on economic growth through quality financial institutions. In SSA countries, which still exhibit weak political institutions with no recent promise of development, financial institutions and the business environment could provide an alternative approach to condition the remittance-development effect in the region.

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This study demonstrates a comprehensive and systematic framework for studying the development implications of remittances. It has provided a broader understanding about the development impact of remittances in contrast to the previous linear and one-sided frameworks that focused on either the macro or the micro impact of remittances. This study provides a broader view of the development impact of remittances, including the importance of the institutional and policy framework which conditions how remittances are transferred and productively deployed to affect development outcomes. It employs a nested micro-macro analytical framework with more cases (cross-country and country-level analysis) to increase our theoretical and empirical understanding of remittance-development outcomes. The contribution and novelty of the findings of this study are attributed to the comprehensive and systematic analytical framework employed, using different kinds of data: time series data, country household survey data, structured interview data and data from personal professional experience from the field.