A recent Bangladesh Bank study reports that remittance sent by expatriates is mostly used for consumption and in the “non-productive” sectors in the country. The survey conducted in 2011 found 90% of remittances were used for meeting basic needs. Seventy-five percent of households receiving remittance spent those on food, 42% on loan repayment, 65% on education, 57% on treatment, 49% on marriage and 4% on running legal battles (multiple responses allowed). Experts described these as failure of successive governments to act on diverting the remittances into “productive” sectors instead of consumption.
The criticism is flawed for several reasons. Remittances in Bangladesh are generally a contribution to the family budget, not capital flows. Given the socio-cultural and educational background of the majority of migrant households, they are generally ill-prepared to undertake risky activities. Evidence from some countries including Bangladesh shows that the pattern of expenditure is invariant between remittance-receiving and non-receiving households when controlled for income and socio-cultural differences.
Spending remittances on consumption often contributes to improved health, education and human capital, enhancing both private and public welfare. It may be that in many cases a significant part of the remittance-related investment increases stock of wealth of the migrant household in the form of land, housing and jewelry. But these have indirect macro-economic effects on development. They provide a monetary base for the supply of credit that can be used as investment capital. Whether or not the supply of additional credit will actually be used for investment purposes depends on the efficacy of the banking system, the government and, more generally, on the overall investment climate.
In Bangladesh as elsewhere, remittances have a related, but distinctive type of positive effect on the rural economy where lack of effective demand is often a serious constraint on economic growth. A large part of the remittances is almost invariably spent on locally produced goods and services. New demands for a variety of goods and services, largely from a class within society that had previously little purchasing power, have a powerful impact on production of both tradable and non-tradable labor-intensive goods and services, land markets, construction and spread of banking and commerce. The consequent stimulus given to local industry, through better utilization of installed capacity or creation of new productive units, far exceeds the value of the initial rounds of expenditure. By generating a multiplier effect they stimulate aggregate demand, output and income.
Analyses of the dynamic macro-economic impact of remittance induced expenditure show that its multiplier effect on GNP could be as high as 1:2 or 1:3. In other words, a remittance of $1 million could increase the country’s GNP by more than $2 to 3 million. Remittances in Bangladesh are estimated to have a multiplier effect of 1:2.1 on GNP in the long run.
Some caveats deserve mentioning. When remittances lead to increased trading of existing goods, such as houses and land, the expenditure may increase the stock of wealth and investment of the family, not the country. However, except in highly implausible cases where the supply of production inputs is completely inelastic and factors are immobile, increased demand due to remittance induced expenditure lead over time to increased growth and employment, even if it creates inflation in the short term. Nonetheless, the slow response of input supplies could well be a real problem, reducing the multiplier effect of remittance expenditure on income and output. This may be exacerbated if in the face of rising inflation at the local level the central bank adopts a tighter monetary policy, thus offsetting some of the local multiplier effect by stifling demand elsewhere in the economy.
The nature of linkages between the remittance-receiving localities and the national economy also influences the remittances’ multiplier effect on the overall economy. When remittances are concentrated in limited areas, as is the case in Bangladesh, the growth impulses of the multiplier are not likely to be transmitted to the national economy. However, to the extent that the remittance-receiving areas are integrated with the rest of the economy, a good part of the benefits of remittances tends to be passed on to other parts of the country. The overall development effect of remittances cannot be fully gauged by focusing on the remittance-receiving communities alone without accounting for the positive effect of remittances to the other parts of the economy.
Summing up, remittances can make a positive impact on output growth and overall economic performance under two economy-wide conditions. First, the economy has an integrated productive structure capable of responding positively to the stimuli of remittances from abroad. Second, the country has sound macro-economic policies, political stability, and an investment-friendly environment, including an efficient financial system and public administration. Remittances, by themselves, cannot create these conditions. Absent such conditions, remittance still increase welfare by supplementing budgets of the recipient households, providing the foreign exchange needed for financing imports related to domestic consumption and investment, and deepening the deposit base as well as the income sources of the domestic banking system.
-from WB Blog