The role of remittances in economic development

BySam Ursu

The role of remittances in economic development

Every single day, tens of millions of people who are working abroad send money to their friends, relatives, and loved ones residing in their country of origin and these financial transactions are collectively known as “remittances”.

Although many people focus on the role that Official Development Assistance (ODA) and foreign direct investment (FDI) play in shaping the economies of developing nations, these sums are almost always dwarfed by the volume of inbound remittances. In 2022, the global aid flows amounted to a little over US$200 billion while remittances reached more than US$620 billion. In some countries, the volume of remittances can reach 50% of the Gross Domestic Product, as in the case of Tajikistan.

Furthermore, although most people sending money back to their home countries are primarily considering this in terms of how it will affect the immediate receiver, collectively these financial flows have broad implications for the economy, including influencing spending patterns and investment dynamics.

The economic impact of remittances

Every dollar sent home by an overseas worker has the direct result of stimulating household consumption by injecting a (usually) supplementary source of income into the recipient family’s budget. These additional or “extra” funds enable the recipients not only help to meet their immediate needs but also give them access to (more) discretionary spending. These financial flows, in the form of remittances, help to foster an environment whereby the recipient households are (better) able to engage in local markets, thus helping to drive demand for goods and services and thus contribute to the overall growth of the local economy.

In short, every dollar sent home from an overseas worker serves to increase the purchasing power of the recipient household. Not only does this influx of funds empower recipients to meet their essential needs but also to engage in so-called “discretionary spending” or spending above and beyond what is absolutely necessary to sustain life (food, medicine, and shelter). This “heightened” ability to engage in consumer spending has a ripple or knock-on effect as it spreads through the local community, leading to business growth, job creation, and a more vibrant and dynamic economy.

TOP 5 countries by received personal remittances, as % of GDP

Source: WorldBank

Although there are too many different channels for funds to be transferred internationally from one person to another person back home (remittances) for the total ever to be fully tracked and monitored, the World Bank estimates that the global flow of remittances in 2022 was over US$626 billion, compared to around US$200 billion in ODA. Thus, for every dollar transferred from wealthier governments to developing nations, overseas workers send home more than three dollars to their country of origin. However, this flow of money is spent in different ways – while aid is spent on macroeconomic programs, environmental, social, and other purposes, remittances are usually spent on household consumption and investments (such as small businesses or real estate).

See also: Global remittances see only modest gains in 2023

Investment and entrepreneurship

Remittances do not just allow recipients to meet their basic needs and engage in some discretionary spending. They also play a significant role in both the creation of small businesses and supporting existing small businesses in developing countries. The recipients of remittances, if properly motivated or advised, use the funds sent by their loved ones working overseas to engage in entrepreneurial activities, including investing, job creation, and opening a business, all of which collectively serve to stimulate economic development.

Indeed, successful entrepreneurial ventures that are funded, partially or wholly, by remittances demonstrate the transformative impact of migrants working abroad on the economies of their home countries. In developing nations, where the ability to access loans or credit can be challenging, the influx of remittances can give locals the ability to launch their own businesses, whether it is a small retail enterprise or a service-oriented venture. And, as these businesses grow and prosper, they not only generate income for the owners but also contribute to job creation, thus feeding a virtuous cycle of economic empowerment within the community.

In one compelling case study, a worker from the Philippines who worked abroad for several years was able to send sufficient funds for her family to start a thriving small-scale agricultural business in her hometown. The funds she was able to send were invested in acquiring arable land, buying seeds and tools, and implementing sustainable farming practices. Through her diligent efforts and those of her family, she was able to return home and enjoy financial independence for the first time while also serving as a catalyst for local economic development by creating job opportunities and improving agricultural productivity in her local community.

Another success story is that of a migrant worker from Moldova who spent ten years working in Italy. After remitting money home for several years amount, which was doubled by the local Government’s aid program, the man was able to launch a small family business and opened a pizzeria in the town he lived in. Thus, with the money earned abroad, the entrepreneur was able to procure the necessary equipment and launch a small restaurant.

Financial inclusion and access

Remittances do more than just improve the material well-being of recipients and help to stimulate and grow the economies of developing nations. They also play a key role in improving financial inclusion by connecting recipients with formal financial channels. When a migrant sends money back home, these transfers often serve as a way for the recipients to open a bank account or otherwise engage with regulated financial services providers. This not only encourages broader participation in the formal financial system but can also help recipients begin to establish a credit history, thus opening up the future possibility of taking out loans or borrowing funds on credit.

In some cases, this increased participation in the formal financial system also makes it easier for recipients to benefit from local government programs and even ODA from foreign donors and international organizations. Furthermore, as the recipients of remittances increasingly embrace participation in formal financial systems, this also has the effect of contributing to greater financial literacy. Thus, as recipients become more empowered to save, invest, and navigate the world of debts, grants, credits, and loans, they can further contribute to long-term economic stability and growth.

In conclusion, the multifaceted role that remittances play in economic development in lower-income countries must be acknowledged as a key driver in poverty reduction worldwide. Financial inflows in the form of remittances substantially contribute to household consumption, job creation, investment opportunities, and improved financial inclusion, thereby helping to propel the economies of developing countries towards a more prosperous future.