Remittances, Human Capital and Poverty: A System Approach

The international remittances sent back home by migrant workers have a profound impact on the developing countries of Asia, Africa, Latin America, and the Middle East. According to World Bank, official international remittances sent home by migrant workers represent the second most important source of external funding in developing countries. Estimated official international remittances are around $440 billion in 2015 and are about twice as large as the level of official aid-related inflows to developing countries. While estimating the effects of remittances on economic growth tend to be rather difficult and controversial, measuring their welfare effects are less so. Remittances have been found to have poverty reducing impact in many studies. The usual methods used in these studies to gauge the effect of remittances on poverty have been OLS or instrumental variable (IV) regression. While these are valid approaches, one of their shortcomings is to overlook that remittances and poverty are both endogenous and jointly determined in a system. This paper estimates the effect of remittances on poverty in an unbalanced panel of 37 economies using a system of equations framework. Although there are some earlier studies that recommend the use of system approach, they tend to impose i.i.d condition on the error term. This paper relaxes the i.i.d. error assumption and adopts the multiple equation generalized method of moments (GMM) estimator because it produces consistent and efficient estimates when non-i.i.d. errors are present. The obtained results show that remittances significantly reduce poverty in the sample of a remittances dependent countries. The point estimates provide a robust estimation of remittances-poverty nexus and are consistent with those found in the literature. Furthermore, since it is likely that poverty itself can be a significant determinant of remittances flows, the estimated elasticities are measured on the basis when both remittances and poverty are jointly determined. The results also suggest that the dynamics of remittances is related to the overall level of human capital of the general population as well as to those living under poverty. Specifically, we find that the flows of remittances decline with improvement in the health factor of the general population but increase as health conditions of the poor people tend to improve. Likewise, there is also some evidence that remittances tend to rise with increases in educational attainments of the general population, but more likely to fall as the poor people become more educated. As a poverty reduction strategy, a stable macroeconomic environment is required so that the migrants are assured of the safety of the use of their money sent back home.