Do Remittances Reduce Aid Dependency?

Abstract

Aid has been for decades an important source of financing for developing countries, but more recently remittance flows have increased rapidly and are beginning to dwarf aid flows. This paper investigates how remittances affect aid flows, and how this relationship varies depending on the channel of transmission from remittances to aid. Buoyant remittances could reduce aid needs when human capital improves and private investment takes off. Absent these, aid flows could still drop as remittances may dampen donors' incentive to scale up aid. Concurrently, remittances could be positively associated with aid if migrants can influence aid policy in donor countries. Using an instrumental variable approach with panel data for a sample of developing countries from 1975-2005, the baseline results show that remittances actually increase aid dependency. However, a refined model controlling for the channels of transmission from remittances to aid reveals that remittances lead to lower aid dependency when they are invested in human and physical capital rather than consumed. JEL Classification Numbers: F35, F24, O10

Breaking the Negative Feedback Loop of Disaster, Conflict, and Fragility: Analyzing Development Aid by Japan and South Korea

“…In this study, we expect that donors allocate more aid to reward countries for the good quality of their economic policies, in particular their trade liberalization policies. Lastly, a number of past studies analyzed the relationship between aid and remittances, and found that development aid acts as a complement to remittances [18,89,90]. By improving household capacity to invest in education and healthcare, remittance does improve the recipient country's absorption capacity, the lack of which has been often pointed out as a bottleneck to aid scaling up.…”