Why Remittances are Important for the Global Economy

Remittances are the hidden engine of the global economy, linking people across borders and forging networks of interdependence on a worldwide level. These remittances are powered by migrant workers sending money home to their countries of origin, with little to no involvement from governments or international organizations.

Billions of individual remittances sent each year amount to a massive movement of capital across the world’s borders. The impact is far-reaching and profound, with social, economic, and political implications.

According to the UN, the monetary value of global remittances is three times the amount of international aid. UN data from 2018 shows that during that year, 200 million migrant workers sent $689 billion to their home countries, of which developing countries received $529 billion.

Learn more about the effect of remittances on the world’s economy.

By Clement Lim September 15, 2021  •  6 min read
Mother and daughter planting rice

Remittances are cross-border transfers from workers in one country back to their home country, often in the form of payments to family members.

There are two main categories of remittance: 1) personal money transfers from residents of a country to non-residents; 2) the compensation of employees who work abroad for a limited period.

Migrant work is a significant feature of the global economy. Some migrants are seasonal workers who eventually return to their home countries. Other migrants work for extended periods in their host country, gaining settlement rights, and eventually full citizenship.

Migrants are very conscientious about sending money home to their families and continue to do so even after they have been settled in their home countries for many years.

There are three main categories of remittance channels.

  1. Formal remittance channels include financially regulated businesses such as banks and official money transfer organizations.
  2. Semi-formal remittance channels include organized businesses not subject to regulation.
  3. Informal remittance channels include personal and community networks.

Remittances pose a challenge for national governments and global institutions. They can be difficult to track and measure with any degree of accuracy when many transfers are conducted informally through the shadow economy and go unreported.

Nevertheless, it is indisputable that remittances have a significant effect on the global economy. Many studies have indicated that remittances play a major role in poverty reduction in recipient countries.

In contrast to development aid, remittances bypass bureaucratic organizations and go directly to the individuals and families in need to create an immediate impact.

Use of Remittances in Recipient Countries

The manner in which remittances are used by their recipients is a determining factor in their socioeconomic outcomes in the recipient country.

Evidence from Western Union reveals that a large proportion of remittances are used to meet the essential needs of families such as food, clothing, housing, transportation, and healthcare. This is especially true in some of the countries receiving the largest volume of remittances, such as the Philippines, Mexico, India, and Nigeria.

Education costs, in the form of school and college fees, books, and other materials, are another major need paid for by remittances. According to UNESCO, in 2019 international remittances increased educational spending by 35% across Asia and sub-Saharan Africa, and by 53% in Latin America.

Recipient households treat remittances differently than other sources of income. The findings show that households receiving remittances spend more on investment in health, housing, and education, and less on consumption such as consumer goods and durables.

It follows that remittances are a major contributor to the advancement of education and housing in developing countries, with significant and far-reaching socioeconomic impacts.

Increased expenditure on education represents an investment in human capital, resulting in greater productivity, higher income, and reduced social costs.

Spending money on housing is not only an improvement in living conditions for the recipients, but also a boost in local economic development creating new employment opportunities for both skilled and unskilled workers.

Related: How Pomelo Compares to Remittance Companies

Impact of Remittances on Economic Growth

Several major studies have found evidence of the positive impact of remittances on economic growth on a country’s consumptions, savings, or investment. The World Bank states remittances have overtaken foreign direct investment to become the largest source of external financing in developing countries.

Acosta et al. and World Bank argued that migrant remittances enhance economic growth in many developing countries by increasing savings, investment in human and physical capital, and consumption.

Remittances raise the consumption level in rural households leading to increased demand for domestically produced goods.

Other positive developmental effects of remittances include developing financial institutions that process remittance payments, increasing reserves of foreign exchange, and offering an alternative to debt in countries where micro-financing is not widely available.

Remittances often enhance the quality of funds flowing through the banking system, encouraging financial development. This leads to economic growth from one or both of the following: increased economies of scale in financial intermediation, and the creation of a larger constituency of depositors to pressure the government into undertaking constructive financial reform. (Barajas et al)

Iqbal and Sattar found that a lack of worker remittances will put a country’s exchange rate, monetary, and fiscal policies under pressure.

Some studies reveal that in certain low-income countries, remittances may be spent more on the consumption of foreign goods than on productive investments. However, this is overcome by integrating the local economy with world financial markets and developing the domestic financial system. When this is achieved, remittances will work to stimulate investment by relaxing credit constraints.

Hidden Costs of Remittances

Major international banks and money transfer organizations (such as Western Union, MoneyGram, or WorldRemit) typically charge a fixed transfer fee, typically hidden in the exchange rate.

Fixed transfer fees are not an issue for financial transactions made by international institutions for trade, investment, or development aid. Due to the larger sums involved, the fees are only a small percentage of the total amount.

However, for smaller transactions of under $200 sent by individuals, the fees can be as high as 15-20% of the amount sent. It follows that any reduction in transfer fees would make an enormous difference by leaving more money in the pockets of migrants and their families, thus raising the income levels of populations in poorer countries throughout the world.

“If the cost of sending remittances could be reduced by 5 percentage points relative to the value sent, remittance recipients in developing countries would receive over $16 billion dollars more each year than they do now.” (World Bank) This added income would encourage greater consumption, savings, and investment in local economies.

The United Nations has recognized the importance of reducing money transfer costs and has set a target of lowering the transaction costs of migrant remittances to less than 3% in its 2030 Agenda for Sustainable Development.

Excessive money transfer fees are a strain on low-income migrants who are already making substantial sacrifices. Migrants are already separated from their family and working long hours to earn enough money to send home and support themselves in the US.

Pomelo: A Promising Solution

Pomelo offers a promising solution for reducing the costs of sending remittances.

Unlike other money transfer organizations, Pomelo uses a credit card business model.

Migrant workers use Pomelo to extend lines of credit to family members back home for them to spend. At the end of each month, the migrant pays off the credit that the family members have accrued.

The Pomelo card offers a promising solution for reducing the costs of sending remittances.

Pomelo offers migrant workers and their families the benefits of premium U.S. credit cards like Amex Platinum or Chase Sapphire Preferred Card. They don’t have to meet the stringent eligibility criteria.

Most importantly, Pomelo eliminates transaction fees altogether and currency conversions use the bank’s foreign exchange (FX) rates.

By helping to meet the UN’s 2030 target of lowering money transfer costs to less than 3%, Pomelo ensures a greater proportion of remittances go where it has the most impact, namely poverty reduction, housing, and education.

Learn more about Pomelo.

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Read next: How Immigrants can Build Credit While Supporting Family Overseas

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