Remittance inflows and economic development in Rwanda

(1)

UvA-DARE is a service provided by the library of the University of Amsterdam (https://dare.uva.nl)

Kadozi, E.

Publication date

2019

Document Version

Other version

License

Other

Link to publication

Citation for published version (APA):

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

General rights

It is not permitted to download or to forward/distribute the text or part of it without the consent of the author(s) and/or copyright holder(s), other than for strictly personal, individual use, unless the work is under an open content license (like Creative Commons).

Disclaimer/Complaints regulations

If you believe that digital publication of certain material infringes any of your rights or (privacy) interests, please let the Library know, stating your reasons. In case of a legitimate complaint, the Library will make the material inaccessible and/or remove it from the website. Please Ask the Library: https://uba.uva.nl/en/contact, or a letter to: Library of the University of Amsterdam, Secretariat, Singel 425, 1012 WP Amsterdam, The Netherlands. You will be contacted as soon as possible.

(2)

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

Processed on: 11-10-2019 PDF page: 87PDF page: 87PDF page: 87PDF page: 87

CHAPTER 3 3.0 The Novel and Conceptual Framework

This thesis responds to policy makers’ and scholars’ growing need to better understand how remittances affect development outcomes. It seeks to contribute to the existing theoretical, empirical and methodological gaps discussed in the previous chapter using the case of SSA countries and Rwanda in particular. This thesis is embedded in three dominant theoretical approaches, the NELM, the national account model and the endogenous growth model. The national account model and the endogenous growth theory explicitly focus on the macroeconomic implications of remittances, while the NELM theory focuses on the micro implications of migration, determinants of migration (at household level), and how remittances come into play as a return on investment for migration by the immigrant-sending household. These theories are not mutually exclusive, but none of these approaches systematically explain the causal mechanisms by which remittances affect development outcomes, from micro to macro outcomes, mediated by the prevailing institutional and policy environment in the recipient country.

Despite the surge in remittance inflows to the SSA region, gaps still remain in the study of how these inflows contribute to development outcomes in the region and the conditions and mechanisms through which they do that. Unfortunately, the importance of a comprehensive framework has been largely underestimated in both theoretical and empirical narratives. We need to better understand the mechanisms through which remittances affect micro and macro development outcomes and how agents interact with institutional and policy frameworks to attract and deploy remittance inflows productively to affect micro outcomes, which then ultimately leads to the aggregate outcomes.

The existing empirical studies on remittances and development in SSA countries (mostly dominated by macro studies) show mixed findings within countries and across the region. The sparse studies on the microeconomic effect of remittances (mostly at the country level) tend to concur on the positive effect of remittances on microeconomic outcomes. However, the question remains as to why remittances positively affect growth in some countries and not in others and why the micro effects are more visible than the macro ones. These questions propel this study to investigate different mechanisms or channels through which remittances affect development outcomes. The study systematically assesses both the micro and the macro remittance-development outcomes, but also the mediating effect of policy and institutional mechanisms that influence the remittance-development impact. In doing so, it

(3)

considers the contextual aspects in the analysis. Sub-Saharan African countries vary in terms of the level of development and institutional quality. On average, the region is characterized by poor quality institutions (both political and economic institutions) which affect their economic performance. We know well that an inefficient institutional quality and policy environment strongly affects the overall remittance-development impact. Because they strongly influence the volume of remittance inflows and how efficiently remittances are utilized in the productive investments that spur economic growth. Indeed, Faini (2002) finds remittance-growth impact and this impact is conditioned by the sound policy environment that fosters macroeconomic certainty and supports the build-up of social and productive infrastructures.

The policy and institutional environment seem to be either a pull or a push factor for remittances; there is a two-way relationship. In the SSA region, pull factors are a development-friendly and conducive environment that attracts remittances for productive investments. Push factors are policies and an institutional environment that are not development oriented, encourage brain drain and discourage the productive use of remittances to affect development. For instance, in the NELM theory, structural challenges and the failure of policies and institutions encourage households to opt for migration as a household strategy to deal with miseries caused by the side effects of policy and institutional failures in the region (side effects such as poverty, unemployment, brain drain, etc). On the other hand, an effective policy and institutional environment encourages and induces remittance inflows and channeling of these inflows into productive investment that spurs growth and development. Therefore, policies and institutions play a causal and determining role in the remittance-development outcomes. However, in SSA countries, we observe variations in terms of policy and institutional environments, their applications and affects. Issues of policy and institutional frameworks and their effects are thus country specific.

This study contributes to the above identified theoretical and empirical gaps by adopting a nested analytical framework in the context of the SSA region and Rwanda in particular. I adopt both a cross-country analysis of the SSA region and an in-country analysis of Rwanda to comprehensively examine the development impact of remittances and the mediating effect of institutional and development factors in SSA countries. The comprehensive and systematic conceptual framework (informed by the above theoretical approaches) in my thesis, based on the pluralist view, considers the broader view of development. The framework focuses on the neglected aspects of development in the literature and on the context, that is, the country-specific factors such as the institutional and policy framework and how these factors

(4)

condition the productive use of remittance inflows to affect development outcomes. How do the institutions and policies in place induce remittance inflows, the choices of people to deploy remittances into productive investments which affect micro outcomes, and, ultimately, aggregate outcomes? Rwanda is a typical case for operationalizing such a conceptual framework. Immediately after the genocide against Tutsi, the country exhibited impressive economic growth and development and developed an effective institutional and policy environment, structural reforms, and an aggressive policy of engaging its diaspora for national development (contrary to the previous regime), among other changes. All these developments influenced a turn-around in the attitudes, sentiments and interests of the Rwandan Diaspora and encouraged them to contribute to the development back home. As a result, in recent years, there has been a surge inflows of remittances and they have had a growing effect on the socio-economic development in the country.

These developments, coupled with my professional experience serving the Rwandan Government and working closely with the diaspora, motivated the adoption of the comprehensive and systematic conceptual framework used in this thesis. To operationalize the framework, I employ an empirical strategy looking at the broader view of development to examine both the micro and macroeconomic outcomes of remittances in Rwanda and the conditional role of the local institutional and policy framework in the country. I also examine how the development effect of remittances plays out differently among different socio-economic layers of recipient households in Rwanda. Rigorous empirical strategies are employed to suit the data and respond to the research questions. The availability of extensive country data, both at the macro and the micro level, allows me to respond to the objectives of this study using the available data.

3.1 Novelty

This thesis answers research questions about the contribution of remittance inflows to development outcomes and how best to measure and explain the development effects of remittance inflows. Under what conditions do remittances affect development outcomes? To answer these questions, this study applies a systematic analytical approach grounded in the three dominant theoretical approaches (the national account model, the endogenous growth model and the NELM theory). It examines the causal path between remittance inflows, agents and both micro and macro effects (of remittances), each causally conditioned by the prevailing institutional and development factors. The study considers the fact that remittance inflows are personal private transfers from a migrant to the recipient household/individual,

(5)

mediated by the prevailing institutions and policy environment. This thesis is based on the proposition that the immediate remittance effects are micro effects, which aggregate to macro effects. The macro effects are produced by the micro processes and the interaction of households with remittances and institutions in the local economy. Therefore, this study seeks to understand what causes these micro and macro outcomes. The study investigates how the diaspora and remittance-recipient households utilize remittances, the choices they make and how these choices are influenced by the policy and institutional dynamics in the country. I not only study the channels through which these inflows are utilized, but also which choices allow remittances to improve the overall development outcomes.

The existing theoretical approaches only partially provide the mechanisms through which remittances affect development outcomes. At the micro level, there is still a gap. The NELM approach explicitly explains migration (as a household strategy), its determinants, and remittances as a return on the migration investment. It also explains behaviors influencing remittance transfers. But it does not inform us of the micro level processes and mechanisms through which these inflows are productively utilized to affect development outcomes. In particular, the theory does not theorize about micro and macro development outcomes. The endogenous growth theory does theorize about the remittance-growth nexus (through the interactive effect of remittances with human capital development), focusing on macro-level effects. This theory, however, does not explain why the remittance-growth effect works in one context but not in the other or how the macro effects are aggregated by the micro interactions between agents and the institutional framework. This is a gap the endogenous growth model shares with other theoretical approaches (such as the national account model and the NELM).

Moreover, the national account model only addresses the macroeconomic implications of remittances (as discussed in the previous chapter). In none of these three theories, the mechanisms (mostly the micro ones) through which remittances interact with local institutions to affect development outcomes are considered. Development outcomes are conditioned by the existing policy and institutional environment faced by households and remitters. Several previous empirical findings have argued for the negative effects of remittances, based on conspicuous consumption claims, without investigating the mediating role of the policy and institutional environment in this development process. Besides encouraging remittance inflows, a conducive and productive institutional environment positively affects the choices of recipients on where to channel their inflows. The issue is thus not only the volume of remittances transferred, but the productive use of these inflows

(6)

influenced by the institutional environment in place. For instance, if there are no schools, hospital, or access to functional financial institutions, remittances would probably do a lot less development work (instead being spent on conspicuous consumption). Unfortunately, although the national account model and the NELM theory do shed some light on these mechanisms, they do not tell us what people do with remittances and what influences their choices. In other words, they miss the micro part. As discussed above, the endogenous growth theory tries to explain the interaction of remittances, remitters, households and institutions to some extent. For this reason, this model is adopted in the current thesis and extended to examine the development impact of remittances at the cross-country and country level. The NELM theory informs the nested analytical framework adopted in this study and different empirical strategies adopted.

At the cross-country level, the study examines the economic growth impact of remittances in SSA countries and how the remittance-growth effect plays out between Rwanda and the other SSA countries. In the same analytical framework, the study examines the conditional effect of institutional and development variables in the region and how institutions influence the growth effect of remittances in the region. However, we know that the contextual aspect matters. Therefore, I contextualize the analysis by conducting an in-depth analysis of Rwanda as a case study. In Rwanda, I conduct an extensive analysis of how remittances affect development outcomes. I provide an extensive description of how policies and the institutional environment causally influence the mechanisms through which remittances are productively utilized to affect micro and macro outcomes in the country. Accordingly, I examine the channels through which remittances affect poverty and other development outcomes and how remittances affect development outcomes among different socio-economic layers of recipient households. I also investigate the growth effect of remittances in the country. The next section discusses the conceptual framework of this thesis.

3.2 Conceptual Framework

This thesis examines how remittance inflows contribute to the economic development in SSA countries, with a particular focus on Rwanda over the period between 1980 and 2014. In particular, this thesis seeks to understand the contribution of remittance inflows to the development outcomes, how the development effects of remittance inflows can best be measured and explained, and under what conditions remittances affect development outcomes. It attempts to address the poorly understood interaction among micro and macro outcomes by adopting a comprehensive analytical framework to analyze

(7)

remittance-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

development outcomes. Second, it seeks to understand the institutional and development factors mediating the remittance-development impact in developing countries. These factors are the mechanisms through which agents (remitters, recipient households, and local institutions and policies) interact to deploy remittances productively to affect micro and macro development outcomes. Third, at the micro level, this thesis studies how the development outcomes play out differently among different socio-economic layers of recipient households.

The conceptual framework of this study is informed by the theoretical and empirical approaches reviewed and by the impetus of addressing the broader view of development by considering contextual factors such as the local institutional and policy framework. It addresses how these factors causally condition the overall development impact of remittances. The framework explains the macro and microeconomic implications of remittances and the mediating effects of the institutional and development factors. The analytical framework is comprehensive and nested and informs the empirical analysis of this study in the SSA region and Rwanda in particular. At the cross-country level, the thesis examines how remittances affect economic growth in SSA countries and how the remittance-growth effect manifests in Rwanda in relation to other SSA countries. Again, I cater for institutional and development factors and examine how their respective (institutional and development) variables causally condition the remittance-growth effect in SSA countries. I also cater for the country context and customize the analysis to Rwanda. In Rwanda, I examine how remittances affect economic growth. I establish a close link between the micro and macro development outcomes of remittances in Rwanda. The rationale behind this macroeconomic framework is inspired by the extensive empirical debates about the influence of remittances on macroeconomic outcomes. It is empirically argued that remittance inflows affect macroeconomic outcomes by influencing GDP per capita, financial sector development, the national current account, the balance of payment, the exchange rate, inflation and the trade balance. It is known that the effects of remittances on the latter macroeconomic variables are influenced by the institutional and policy environment and the development factors in the recipient country, proxied by the level of development. Institutions provide channels through which remittances are transferred, but they also condition the process and mechanisms through which these inflows affect both micro and macroeconomic outcomes. Thus, it remains imperative to consider institutional variables in the remittance-growth model while analyzing the growth effect of remittances. In the analysis of the remittance-growth effect, GDP per capita (as a dependent variable) is used as a proxy

(8)

for economic growth. Other macroeconomic variables are employed as explanatory variables: foreign direct investments (FDI), gross capita formation (GCF), openness of the economy (OPEN), education (ENR which is the school enrollment rate, measured as secondary enrollments as a percentage of total (% of relevant age group), financial sector development measured as credit to private sector as percentage to GDP (CPS), and institutional indicators such as political stability and regulatory quality.

The micro-analytical framework is based on the empirical scholarship claiming that remittances are private transfers between migrant and recipient individual/household. Therefore, their impact is presumed to be manifested at the individual or household level and then aggregate to the observed macro outcomes. The mechanisms through which remittances are transferred and choices in the utilization of these inflows are strongly conditioned by the prevailing policy and institutional environment in the country. There is a causal path from institutional framework determining mechanisms and channels through which remittances are utilized by remitters and recipient households. In Rwanda’s case, this analytical framework examines this mediating relationship which informs the micro effects of remittances and ultimately aggregate outcomes. I empirically examine how remittances improve development outcomes by contributing to the socio-welfare of recipient households. Based on Rwanda household survey data, remittances contribute to the microeconomic outcomes by affecting poverty, household income, human capital development, savings, and physical investments of recipient households. This effect plays out differently among different socio-economic layers of remittance-recipient households.

It would be interesting to operationalize institutional variables at the household level, but this is not practical due to the nature of data used and the adopted analytical framework. It is however known that the prevailing institutional environment conditions the transfer and utilization of these inflows. This study provides different types of data (anecdotes and secondary data) to explain the mediating role of local institutions and the policy environment in influencing the remittance-development outcomes in Rwanda.

The use of the household as a unit of analysis allows the researcher to depict the effect of both formal and informal remittances based on the household survey data, because the household survey questionnaire asks the respondent (household member) whether she or he received remittances from someone from abroad in the 12 months prior to the survey. The survey also asks how these remittances are used. Hence, using household survey data provides enough and reliable data on remittance inflows and how there are utilized. This allows the investigator to capture the effect of informal remittances – those remittances which

(9)

are not captured and reported by formal institutions – as well as allowing for macroeconomic analysis. It has been documented that most remittances to SSA countries and Rwanda in particular are transferred through informal channels. The microeconomic analytical framework is designed in a way that allows the researcher to capture and depict the effect of both formal and informal remittances in Rwanda using the household survey data. This methodology cannot be realized at the cross-country level. The analytical framework of this thesis is graphically illustrated in Figure 3. 1 below.

(10)

83 F igure 3.1 : Sche m atic Analysis of t h e Causal Re lationship between R em ittance Inf low s and Econom ic Develop m ent Source : Aut hor’s gr aphi ca l pre sen tat ion of s cope of study bas ed on hy po thes iz ed causa l re la tion ships among rela ted var iab les In stitutional Hu m an Dev`t In dica to rs P hy sical In ve st m en ts Sa vi ng s Re m ittances Bu si ne ss Mac roeconomic Outcom es -GD P Re m ittances FDI HCD -ENR In stitu tio na l in dica to rs Microe conomic Out comes -P ove rty Fo rmal Rem ittanc e Inf lows GCF OP ECONOMIC DE VE LOP M ENT IM PAC T In for mal Con su m pt io n

(11)

Figure 3.1 presents a systematic overview of the remittance-development nexus examined through the causal and mediating mechanisms. The remittance inflows affect the recipient economy in two ways; microeconomically and macroeconomically. This depends on how remittance receipts are used, the motives driving remittance inflows, and how the domestic institutional and policy environment influence the development impact of these inflows in the local economy. The prevailing local institutional and policy environment influences choices of recipients and remitters on how to utilize these inflows. We know that there are two channels of remittances inflows (formal and informal), both influenced by the existing institutional environment. The formal channels affect micro and macro outcomes at the household and national level, respectively. Informal remittances end up in the hands of recipient households, thus affecting their consumption and spending patterns and impacting micro outcomes. The proposition is that policies and the overall institutional environment influence the micro effects of both formal and informal remittances which aggregate to the macro outcomes (such as effects on GDP per capita, human capital development, savings, and consumption, to mention but few) we observe. This is however not a one-size-fits-all phenomenon across countries; instead the local context of the particular country matters in the analysis and understanding of the comprehensive effect of remittances. The mediating role of the institutional and policy environment thus needs to be integrated in the analysis.

The graphical conceptual framework in Figure 3.1 above illustrates how the development impact of remittances is empirically analyzed both at the cross-country and the Rwandan level. At the cross-country level, the thesis examines the impact of remittance on macroeconomic implications in SSA countries and in Rwanda in particular (as discussed above) for the period from 1980-2014. I use empirically recommended explanatory variables such as FDI, GCF, openness of the economy, education, financial sector development and institutional indicators such as political stability and regulatory quality.

At the country level of Rwanda, I conduct an in-depth analysis of how remittances affect micro and macro development outcomes. I examine how remittances affect economic growth in Rwanda over the same period of study, 1980-2014. Different empirical strategies are employed (discussed in Chapter Five). At the micro-level analysis, the study examines the effect of remittances on microeconomic outcomes of remittance-recipient households. It examines mechanisms through which remittances affect development outcomes and how policies and the institutional framework condition the micro outcomes of remittances in Rwanda.

(12)

The study investigates how remittances contribute to the microeconomic outcomes by affecting poverty, income, human capital development, savings, and physical investments of recipient households, using Rwanda household survey data. Operationally, the thesis examines how remittances affect consumption expenditure per adult, physical investments, savings, business and human capital development variables of remittance-recipient households. Furthermore, the thesis examines how remittances affect development outcomes among different socio-economic layers of recipient households (income distribution). To address these issues, the study employs data from micro datasets of the EICV4, which was conducted by the NISR in 2013-1014. A number of rigorous analytical techniques are employed to ensure the credibility and reliability of the findings of this thesis. The study employs the empirically recommended RCT technique specifically PSM technique to address the problem of endogeneity and selection bias that might affect the results. Prior to the application of PSM technique in the analysis, a baseline analysis is conducted using the OLS technique. The results of the OLS estimation are validated by the results of the PSM estimation technique. This analytical framework provides credible findings about the development impact of remittances in SSA countries and Rwanda in particular. The next chapter discusses remittance trends in SSA countries and Rwanda in particular and discusses the institutional and development factors that motivated the rationale of the selection of Rwanda as a case study.