What you need to know:
- Hippolyte Fofack argues that the shift in remittances from informal to formal channels has been crucial to increasing cross-border flows and bodes well for future growth.
When former Indian Prime Minister Rajiv Gandhi was asked about the risks of “brain drain” – the large-scale and sustained migration of well-trained citizens from lower-income to higher-income countries offering better opportunities – he allegedly responded, “Better a brain drain than a brain in the drain.”
Back then, in the 1980s, India’s universities were already churning out far more graduates than the country’s labor market could absorb, and developed economies, especially the United States, that sought to strengthen their comparative advantage in skill-intensive manufacturing welcomed these highly educated migrants with open arms.
Gandhi’s assessment proved prescient: many of these workers, from India and elsewhere, helped shape the modern digital economy, which is poised to extend the organisational and geographical fragmentation of work into new realms. A recent study found that highly skilled immigrants account for 36 percent of innovation in the US and also contribute significantly to the exchange of ideas across borders, given that they are more likely to rely on foreign technologies and collaborate with foreign inventors.
Buttressed by the contributions of qualified foreign labour, digitalisation has expanded the potential of remittances. The cost of sending money to family members back home – a process that migrant workers of all skill levels know well – has traditionally been high. But new digital business models have achieved faster payments, greater transparency, and lower costs for users, increasing the cross-border flow of money in support of welfare improvement and macroeconomic stability.
The growth of digital remittances cannot be overstated. The amount of money sent by migrant workers to family members in low- and middle-income countries (LMICs) has increased more than fivefold over the last two decades, reaching $647 billion in 2022.
Remittances now exceed more than a quarter of GDP in several countries, supplementing threadbare social safety nets. Over half of remittances go to people in rural areas, and around 75 percent are used to meet basic needs such as food, housing, medical costs, and school fees.
These inflows also have enormous benefits in terms of growth and macroeconomic management. In a growing number of LMICs, remittances have overtaken both foreign direct investment and official development aid (ODA) as the largest source of external funds. They are financing investments and mitigating the risk of sudden stops and capital-flow reversals, which are especially important as ODA declines and many LMICs confront balance-of-payments pressures and currency gyrations.
Even during the COVID-19 pandemic, which upended the world economy, migrants continued to send money home, with flows to Latin America and the Caribbean increasing by 6.5 percent in 2020. And despite broad-based growth deceleration in 2022, remittances to LMICs grew by an estimated 8 percent. This partly reflects the tight labor markets in advanced economies, many of which implemented large fiscal and monetary stimulus measures to sustain incomes during the pandemic. Moreover, the dollar’s sharp appreciation in 2022 increased the value of inflows to LMICs.
The resilience of remittances is also the result of international migration, which has helped shield high-income countries with low fertility rates from demographic headwinds, as well as the effectiveness of quantitative-easing policies after the 2008 financial crisis and in the years leading up to the pandemic. In the era of hyper-globalization, which sustained downward pressure on prices, these policies boosted output expansion to drive wage growth.
Likewise, the shift in remittances from informal to formal channels, together with the decline in transfer costs that followed the normalisation of digital payments, has been crucial to increasing cross-border flows and bodes well for future growth.
A study by the GSMA, the global trade association of mobile operators, found that mobile technology halves remittance costs, while research from PayPal and Xoom shows that the average cost of transferring money back home has fallen to 3.93% – nearly half that of traditional fees. According to the International Monetary Fund, cost reductions have a short-term positive impact on remittances and could even generate an additional $32 billion in inflows, if the target of 3% set by the United Nations Sustainable Development Goals is reached.
The relatively low procyclicality and volatility of remittance inflows, coupled with greater cost reductions and increased operational efficiency, will ultimately benefit LMICs.
Many of these countries are facing mounting debt-service costs, especially in view of widening spreads and tighter global financial conditions, as well as rising poverty levels exacerbated by food-price inflation. The projected growth of remittances will shore up these countries’ foreign-currency reserves, which could help avert a debt crisis.
Remittances can also reduce the risk of a financial crisis. Studies have shown that the impact of a sharp decrease in international reserves on current-account reversals becomes less severe when remittances to a country exceed 3 percent of GDP.
More than 43 percent of LMICs – 76 countries – have surpassed that threshold, and more countries look set to join them. Meanwhile remittances can also stabilize the balance of payments by keeping current-account deficits under control in countries with a negative trade balance. Such inflows can thus help promote macroeconomic stability as operating environments become more challenging in an age of “polycrisis.” Is a brain drain better than a brain in the drain? Given the current state of the world economy, the answer is a resounding yes.
For low-income households that depend on remittances for basic consumption goods, and for LMICs contending with twin deficits and currency risk, it has helped prevent social unrest and balance-of-payments crises. For high-income countries contending with low fertility rates, international migration has alleviated demographic headwinds and the risk of secular stagnation.
The growth of digital remittances may not fully compensate for the loss of skilled workers and the decline in human capital in LMICs. But the gains associated with brain drain and international migration have been momentous, driving innovation and financing development globally.
Hippolyte Fofack is Chief Economist and Director of Research at the African Export-Import Bank (Afreximbank).
Copyright: Project Syndicate, 2023.