Remittances - private income transfers from migrants to family members in their home country - are good news for the families that receive them. Often sent a few hundred dollars at a time, they increase disposable income and are generally spent on consumption - food, clothing, medicine, shelter and electronic equipment.
Remittances help to lift huge numbers of people out of poverty by enabling them to consume more than they could otherwise. They also tend to help the recipients maintain a higher level of consumption during economic adversity.
Recent studies report that these flows allow households to work less, take on risky projects they would otherwise avoid or invest in the education and health care of the household. In other words, remittances are a boom for households.
But, what is good for an individual household isn't necessarily good for an entire economy. Whether remittances are also good for the economies that receive them is an important question. This is because remittances are currently one of the largest sources of financial flows into developing countries.
In 2012, workers sent home an estimated 401 billion dollars through official channels. It is likely that billions more were transferred through unofficial avenues. These flows are often large relative to the economies that receive them. In 2011, for example, remittances were at least one percent of the gross domestic product (GDP) for 108 countries and five percent or more of the GDP for 44 countries.
For 22 countries, remittances represented 10pc or more of the GDP. Moreover, remittance flows are typically stable and, from the perspective of the recipient, countercyclical - helping to offset a turn of bad luck.
Besides households, there is one other economic actor that benefits from remittances and whose actions are important to the economy - the government. Recently, it has been shown that remittances spent on the consumption of both domestically produced goods and imports increase the tax base. This, in turn, increases revenues from sales taxes, value-added taxes and import duties. In other words, remittances can provide much-needed fiscal space. This allows some countries to increase spending, lower taxes, or both, in order to fight the effects of the recent global recession.
The economic impact of remittances depends, in part, on how governments choose to use them. Governments can sustain higher levels of debt when the ratio of remittances to domestic income is high. This reduces the country's level of risk.
On the other hand, evidence shows that remittances hurt the quality of institutions in recipient countries. This is precisely because they increase the ability of governments to spend more or tax less. By expanding the tax base, remittances enable a government to appropriate more resources and distribute them to those in power.
At the same time, remittances mask the full cost of government actions. Remittances can give rise to a moral hazard, because they allow government corruption to be less costly for the households that receive such flows. Recipients are less likely to feel the need to hold the authorities accountable and, in turn, the authorities feel less compelled to justify their actions. This reduces the likelihood that the fiscal space created by remittances will be used for productive social investments.
The complex effect of remittances on the economy is also apparent when the business cycle is taken into account. Because remittances increase household consumption, fluctuations in remittance flows can cause changes in output in the short-term. But, a shock that reduces economic output is also likely to induce workers abroad to send more remittances home. This then has the effect of reducing output volatility. The increase in remittances, however, is also likely to weaken the incentive to work. This could lead to a more volatile business cycle.
So, again, the evidence is mixed. Remittances do stimulate consumption, which for some economies will help reduce the size of the swing between recession and growth by putting a floor under total demand. But, for other economies, remittances may increase the severity of business cycles, by inducing workers to stay at home when the economy takes a down turn, as well as by linking the business cycles of some developing economies more strongly to the business cycles of remittance-source countries.
The mixed evidence regarding the macroeconomic impact of remittances reflects a number of underlying truths about their role in an economy. They are unequivocally good for recipient households, as they alleviate poverty and provide insurance against economic adversity. But, there are many different paths through which remittances can impact an economy.
None of these paths is necessarily active at any given time - that is, many economic and social conditions determine whether any given path is active or significant. And, finally, many of these paths have opposing or conflicting economic effects.
These realities shape the challenge faced by policymakers who wish to maximise the development potential of remittances. To make the most of remittances, governments will have to strengthen or facilitate the channels through which remittances benefit the overall economy, while limiting or weakening others.
This task is challenging, not only because economists do not fully understand how remittances affect the economy, but also because this task may put policymakers in conflict with households, used to utilising remittances in a certain manner. Nonetheless, there are several promising approaches for policy.
Any country wishing to make better use of remittances must study how the recipients actually use them. This is essential in ensuring that policymakers understand the specific obstacles that prevent remittances from being used to facilitate development, and the kinds of development-friendly activities (such as education, business formation, or investment) remittance recipients would be most likely to engage in. Obstacles preventing the use of remittances for development are likely to vary with the particular economic, social and legal environment of each country.
Policymakers must take advantage of the fiscal space created by remittance flows by investing more in social institutions and public infrastructure. For example, the increased tax revenues that remittances generate can finance initiatives to increase the professionalism of civil servants and improve the enforcement of rules and regulations.
Likewise, the government can take advantage of its increased borrowing capacity to finance improvements in infrastructure. One potential use would be to upgrade a country's financial system at all levels, including improvements in the payment system, availability of banking services and financial literacy.
Policymakers must also design programs that are responsive to the needs of individual households and that give recipients the proper incentives to use remittances productively. Promoting the acceptance of remittance income as collateral for private loans, used to finance productive investments, is one way to direct remittance income into growth-enhancing activities.
In addition, governments could subsidise education or business loans for which remittances are pledged as collateral. Policymakers will have to work closely with remittance recipients - and senders - if they are to make these efforts work.
Increasing globalisation and demographic changes, such as the aging of the developed-economy workforces, means that remittances are likely to increase in size and importance in the future. It is clear that remittances improve the welfare of households that receive them and, as such, should be encouraged.
But, to be more helpful to recipient economies, governments must design policies that promote remittances and increase their benefits, while limiting or offsetting any counterproductive side effects. Getting the most value possible out of remittances requires significant, thoughtful effort from national governments, alongside the assistance of international organisations.
Connel Fullenkamp, Professor of Economics At Duke University, United States.