Monday, November 4, 2013

Remittances in Nepal: Can a Good Thing Eventually Become Bad?

Can a good thing eventually become bad and is there such a point when it becomes too much? Thinking about Nepal’s development, remittances appear to be precisely such an ambiguous driver. Strikingly, despite the growing importance of remittances worldwide and its increasingly high level recognition, we are missing a consistent narrative of growth and development for highly remittance dependent countries (HRDCs – a new acronym, for once, may be needed) like Nepal.

While remittances have an unambiguous direct impact on household welfare, the evidence on how they affect macroeconomic variables is mixed. Moreover, their contribution to national well-being is often under-acknowledged in those very countries they support and mixed with a sense of collective shame and fear of dependence. Here, we deliberately leave aside the thorny issue of migrant rights, recently highlighted by a feature story in the Guardian (Qatar’s World Cup ‘Slaves’), and focus on the economic impact of remittance inflows.

Nepal is an interesting case study. It is part of a small league of countries that receive a significant proportion of their income via private transfers (equivalent to 25% of GDP) and the world leader among the ones with over 10 million people.

A bit of history. The migration of Nepalese workers has been taking place for centuries, particularly to India, with which Nepal shares deep cultural and historical ties. In the 19th century, a very specifically skilled subset of Nepalese – the Gurkhas – earned their country fame in the ranks of the British and Indian armies. However, a massive shift happened much later, starting in 2000, driven by both push (the Maoist insurgency in Nepal) and pull (economic boom in the Middle East and East Asia MICs) factors. In 1996, 6 workers left legally each day. By 2013 that number was multiplied by a factor of 200. Remittances followed suit rising from just 1% of GDP in 1996 to 25.5% today.

While the contribution of remittances to poverty reduction is well  documented (and striking in the case of Nepal - Figure 1), their macroeconomic impact remains under-conceptualized as well as the ways in which they could affect the long-term growth path of recipient economies.

Figure 1: Remittances and poverty

In Nepal the remittance boom has coincided with a sharp deterioration of the trade balance (with exports tanking as imports exploded), a significant shift in the composition of value added (with services taking up the space left by agriculture and a decline of industry), and high inflation. Structural transformation, at least of the type that made East Asian economies achieve massive development progress, is not happening and Nepal appears stuck in a low equilibrium growth trap (Figure2).

Figure 2: Are "labor exports" displacing tradable goods?

What do those deep structural shifts mean for developing countries like Nepal that are still struggling to come up with a consistent growth and development strategy for the future? Leaning against the tide of high and persistent inflows would be futile but simply learning to live with remittances and over-appreciated currencies is a lose proposition.  

To date, the prescriptions of the development community have been mostly adapted from the Dutch disease analogy, but these appear ill-fitting for HRDCs:

  • Fiscal contraction to avoid overheating may work in other countries facing short-lived shocks but would not help Nepal, which faces huge public infrastructure and social needs.
  • Sterilization of inflows has allowed China to maintain a competitive exchange rate; for Nepal it could be unsustainably costly given the magnitude and persistence of inflows. Likewise devaluation could spur unsustainable long term inflation.
  • Tax policies focusing more on consumption and less on income/tradables could hurt the poor.

More sensible responses emphasize structural transformation to make up for lost competitiveness, but they still appear half-baked: 

  • Labor market flexibility is particularly challenging because large outmigration may contribute to making domestic labor more rigid (low supply, high reservation wage). Is it a coincidence that Nepal has one of the highest average wage rates in the SAR region?
  • Trade liberalization may incentivize exports but could just as well annihilate import competing industries, exacerbate the negative spillovers to tradables production and increase consumption of remittance-backed imports. How else to interpret Nepal’s huge trade deficit?
  • Investment incentives may work when the economy is thriving but prove self-defeating if remittances themselves partly drive the poor investment climate (through both economic and governance spillovers). In Nepal, remittances have failed to translate into investment at both macro and micro levels, but they are surely behind the real estate bubble that drove the financial sector to near-collapse in 2011.

We need a new, fitting and consistent narrative. The framework of the Dutch disease (and its resource curse spinoff) only go so far because remittance inflows are more sustainable than resource booms, more countercyclical and less prone to the governance problems associated with state intermediation of revenues (including aid). What we need, in other words, is a “Nepali cure” tailored to the needs of HRDCs. Can you help us find it?

The views expressed are solely those of the authors and do not necessarily reflect the views of the institutions they are associated with.