Are remittances a curse?

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.

Uganda and Nepal: Two different tracks in utilizing natural resources

Good news that Uganda is trying to harness its own natural resources to spur economic growth rather than relying on foreign aid and assistance. The country has allowed private companies to start produce electric plants and it is estimated that within one generation Uganda will become a middle income country and will be self reliant on energy and, importantly, export energy to neighboring countries. Currently, Uganda's GDP per capita is $360 and it aims to make it between $1000 to $6000 within one generation. Good news that the country is well in its path to its goal.

Resource rich poor countries like Nepal should be proactive in harnessing its natural resources to spur economic growth and reduce poverty. A case in point is the wrangling going on in the country regarding awarding contracts to companies. Corruption and petty political interests always come into foray and political leaders are not insulated from rent-seeking activities. Nepal should proactively award contract to credible and committed international companies or domestic companies to start generating hydropower electricity. It loses nothing but gains a lot of things. The country is already is reeling under 8 hours of load-shedding per day and is set to lose one-third of the estimated revenue due to factory closures and scaled down activities as a result of power shortage.

It is heartening to see that Nepali leaders are ignoring the importance of natural resources in spurring growth and they are increasing relying on foreign aid to bridge budget gaps. Meanwhile, in Uganda the leaders have realized the importance of natural resources and are set to exploit them to benefit its people. This way Uganda is well on track to becoming a middle income country, ceteris paribus, and unfortunately Nepal is way off track. It is not even thinking of raising per capita income. All the leaders are doing right now is wrangling on political modality for upcoming CA election, which has already been postponed two times. Nepali leaders should proactively award contracts to credible international and domestic companies so that the current of our raging running rivers is harnessed to lit not only the country but neighboring states of India.

Shanta on the effects of sub-prime crisis on South Asia

Shanta Deverajan argues that the US sub-prime crisis would have minimal impact on the South Asian economy because of "little exposure to US mortgage securities, availability of liquidity in the domestic markets, and the possibility that lower capital inflows could help countries such as India with macroeconomic management.".  He argues that the "impact will be mild because of the structure of the region’s trade and financial flows, and partly because of compensating effects". More from his blog.

Not all happy news though:

"The Indian IT industry, which derives about 65% of its revenues from the U.S. market, will also be adversely affected if the subprime crisis leads to a recession in the United States."

And given the scale of sub-prime crisis, rising oil prices, pessimism in the stock market, and receding consumer spending, a recession is more than likely in the US market. More here, here, and here.