An interesting, and surprising, paper from the IMF shows that remittances have a negative effect on the quality of institutions. It is pretty surprising to see that "a higher ratio of remittances to GDP is associated with lower indices of control of corruption, government effectiveness, and rule of law." I am interested in knowing the mechanism through which this negative effect works. Additionally, I would like to know policy implications of this conclusion.
This paper addresses the complex and overlooked relationship between the receipt of workers' remittances and institutional quality in the recipient country. Using a simple model, we show how an increase in remittance inflows can lead to deterioration of institutional quality - specifically, to an increase in the share of funds diverted by the government for its own purposes. Empirical testing of this proposition is complicated by the likelihood of reverse causality. In a cross section of 111 countries we document a negative impact of the ratio of remittance inflows to GDP on domestic institutional quality, even after controlling for potential reverse causality. We find that a higher ratio of remittances to GDP is associated with lower indices of control of corruption, government effectiveness, and rule of law.
A cursory look at the paper hints that the authors start with a mistrust in government, especially by assuming that remittances act as a buffer between government and the people, and the former finds that corruption is less costly for individual households. This assumption is not too realistic, at least for me, because even if households become purchasers of public good (again, I do not totally concur with this idea) due to increased income from remittances, it is not guaranteed that they would not seek accountability and transparency in government's expenditure and activities. Moreover, how can one assume that the public would be purchasers of public goods when household income rises due to remittances. Why won't the public enjoy the commons, I.e. public goods, when they get it for free. Household would not like to pay for public goods if it is provided free, irrespective of the change in income.
The authors also find that remittances have no robust effect on economic growth. However, I would like to know why Nepal experienced decrease in poverty and increase in household income between 1994-2001? The WB says that this effect was brought about by remittances. And, the IMF says something different; the only difference is technical definition of economic growth and poverty reduction.