J Knowl Econ DOI 10.1007/s13132-016-0377-5

Remittances, Institutions, and Economic Growth in North African Countries Nahed Zghidi 1 & Imen Mohamed Sghaier 2 & Zouheir Abida 3

Received: 20 October 2015 / Accepted: 8 March 2016 # Springer Science+Business Media New York 2016

Abstract This paper seeks to investigate the causal links between remittances, economic freedom, and economic growth on a panel of four North African countries, namely, Tunisia, Morocco, Algeria, and Egypt from 1980 to 2012. Using the system generalized method of moments (GMM) in a panel data analysis, we found strong evidence of a positive relationship between remittances and economic growth. We also found that economic freedom appears to be working as a complement to remittances and, that the effect of remittances is more pronounced in the presence of the economic freedom variable. Thus, to the extent that remittances have become a major source of external development finance, policies promoting greater freedom of economic activities benefit more from the presence of remittances. Keywords Remittances . Economic freedom index . Economic growth . Panel data JEL Classification F24 . O43 . C23

* Nahed Zghidi [email protected] Imen Mohamed Sghaier [email protected] Zouheir Abida [email protected]

1

Higher School of Commerce of Sfax, University of Sfax, Sfax, Tunisia

2

Higher Institute of Business Administration of Sfax, University of Sfax, Sfax, Tunisia

3

Faculty of Economics and Management of Sfax, University of Sfax, Sfax, Tunisia

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Introduction Migrant remittances constitute an important source of foreign exchange earnings for many households in the developing countries. According to the World Bank (2014), remittances in the developing countries are projected to grow by 5.0 % to reach US$435 billion in 2014 (accelerating from the 3.4 % expansion of 2013), and rise further by 4.4 % to US$454 billion in 2015. Global remittance flows, including those to higher-income countries, are expected to follow a similar pattern, rising from US$582 billion in 2014 to US$608 billion in 2015. In 2013, remittances were significantly higher than foreign direct investment for the developing countries (excluding China) and were three times as large as the official development assistance. They are also a more stable component of receipts in the current account, reliably bringing in foreign currency that helps sustain the balance of payments and dampen gyrations. In the extant literature, there is substantial disagreement as to what economic factors determine the inflow of remittances, as well as what impact, if any, these inflows have on economic growth. For example, Chami et al. (2005) found a negative relationship of remittance with economic growth in their study of 113 countries. Remittances were found to be counter-cyclical in nature: as income growth rises, remittances fall. Therefore, they demonstrated that remittances act like compensatory transfers and not like capital flows and hence do not contribute to economic growth. The study of Chami et al. (2005) was followed by many other studies searching the impact of remittances on economic growth. Giuliano and Ruiz-Arranz (2009) empirically investigated that remittances can promote economic growth in countries with less developed financial systems by being a substitute of financial development. Considering a panel model on annual data from 100 developing countries for the 1975–2002 period, they found that remittances are more growth-enhancing in countries with less developed financial systems. On the other hand, using panel framework on annual data from 25 Latin America and Caribbean (LAC) countries over the 1970–2002 period, Mundaca (2009) found evidence confirming its theoretical result that remittances tend to improve further economic growth if financial markets develop properly. It is equally important to outline that the causal link between remittances and economic growth has not received more systematic attention. In this context, few studies have recently started to be interested in investigating such causality relationship directly or through transmission channels (see Bettin et al. 2009; Siddique et al. 2010; Le 2011). Our motivation is to provide comprehensive evidence on the existence and the nature of the dynamic relationship between remittances and economic growth by including institutional variable as a specific channel through which remittances may have an impact on economic growth in the North African countries, namely, Tunisia, Morocco, Algeria, and Egypt over the 1980–2012 period. 1 The inclusion of this variable in the model can be motivated by the fact that remittances alone would not be strong enough to promote economic growth. In this context, many empirical studies have investigated the key channels of how remittances affect economic growth. Indeed, controlling for institutional variables as transmission channels in the analysis enhances 1

The choice of North African countries is motivated by the fact that the relationship between remittances and economic growth has been poorly examined in the literature for these countries, and that are important sources of expatriate workers.

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the impact of remittances on economic growth. In this context, Bjuggren et al. (2010) estimated a model based on a panel of 79 countries over the 1995–2005 period to point out that remittances positively affect investment in the presence of a high quality institutional system and well developed credit market. While there are backward and forward linkages in investment activities, Jongwanich (2007) showed that in the context of improving returns and based on developing Asia-Pacific countries, an increase in investment of one household could generate an increase in income to another household. As development aid, economic environment, and good investment climate could play an important role in the effectiveness of remittances on economic growth. These above arguments support the fact that institutional development is an important channel through which remittances influences economic growth. The main objective of this paper is then to investigate the role of economic freedom in mediating the impact of remittances on economic growth in the North African region. Our dynamic panel regression analyses show that remittances have a positive and significant effect on economic growth in the region, and that the impact is more pronounced when institutional variable is included in the model. Moreover, we found that countries with sounder institutions will realize a net payoff from remittances on economic growth. This paper then contributes to the related literature in three main aspects. First, there is still little empirical evidence on how remittances affect economic growth and vice versa directly or through other channels as institutional development although the remittances-growth nexus has been the subject of several empirical works. 2 Second, in terms of policy implications, the results of this research will guide policy makers in designing policies aimed at better directing external capital, such as remittances, towards sectors with the highest effect on economic growth. Third, compared to previous studies, this paper employs a more advanced dynamic panel econometric technique that formally addresses country specific effects and simultaneity bias. This method relies on the system GMM estimator, which has a number of advantages over the cross-section estimator. This paper is organized as follows: The BLiterature Review^ section reviews some of the voluminous extant literature. The BTrend and Remittances in North Africa^ section presents an account of evolution of remittances to North Africa over the 1980–2012 period. The BData and Empirical Methodology^ section describes the data and the empirical methodology. The empirical results are presented in the BEmpirical Results^ section. The BConclusion^ section draws conclusions based on the results.

Literature Review The literature on remittances to the developing countries has developed rapidly in recent years. Many empirical studies concentrate on the impact of remittance inflows on the living standards of recipient households. In this context, Abdih et al. (2012) 2

This allows us to study, in addition, the link between remittances and institutional development since it remains quite poorly debated in the literature. The better understanding of this relationship is important given the massive empirical studies focusing on the economic growth enhancing and poverty reducing impacts of institutional development.

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noted that remittances help lift huge numbers of people out of poverty by enabling them to consume more than they could have. According to Chami et al. (2012), remittances also tend to help the recipients maintain a higher level of consumption during economic adversity. Recent studies reported that these inflows allow households to work less, take on risky projects they would avoid if they did not receive this additional source of income, or invest in education, and health care of the household. In other words, remittances are a boon for households. Others focus on the short run macroeconomic impact of remittances, typically finding a positive relationship with aggregate income, investments, and employment. In this context, Glytsos (2002) modeled the direct and indirect impacts of remittances on income and hence on investment in seven Mediterranean countries, and found that investment rises with remittances in six out of the seven countries. Additionally, the results of the analysis conducted by LeónLedesma and Piracha (2004) for 11 transition economies of Eastern Europe over the period 1990–1999 showed support for the view that remittances have a positive impact on productivity and employment both directly and indirectly through their effect on investment.3 Using panel unit root and cointegration techniques, Ramirez and Sharma (2008) found that remittances have a positive and significant effect on economic growth of selected upper and lower income LAC countries. Vargas-Silva et al. (2009) found positive effects of remittances on economic growth for 26 Asian countries. Eltayeb Mohamed (2009) showed that remittances have a positive impact on economic growth both directly and indirectly through their interactions with financial and institutional channels for 7 Middle East and North African (MENA) countries. Fayissa and Nsiah (2010) found a significant positive impact of remittances on economic growth. Using annual panel data of 36 African countries between 1980 and 2004, they found that remittance inflows increased economic growth, providing an alternative way of financing investments and overcoming liquidity constraints. Similarly, using a panel of 66 developing countries, including Guyana, over the 1991–2005 period, Bettin and Zazzaro (2012) showed that an efficient banking system complements the positive effect of remittances on GDP growth. Moreover, using the system GMM estimator, Ben Mim and Ben Ali (2012) found a significant effect of remittances on GDP growth in 15 MENA countries with human capital formation being the main channel. Similar results are reported by Nsiah and Fayissa (2013), who found that remittances had a positive and significant effect on economic growth in Africa, Asia, and Latin American-Caribbean countries over the 1985–2007 period. Imai et al. (2014) investigated the empirical link between remittances, economic growth, and poverty using annual panel data for 24 Asian and Pacific countries. They found that remittances promote economic growth and reduce poverty in the region. More recently, Salahuddin and Gow (2015) have investigated the relationship between remittances and economic growth using the error correction model with panel data ranging from 1977 to 2012 in India, Bangladesh, Philippines, and Pakistan. Their study confirmed that remittances have a positive impact on economic growth in the long run. Jouini (2015) examined the causality between remittances and economic growth in Tunisia using auto-regressive distributed lag with time series data from 1970 to 2010. The study revealed that the two variables under study were cointegrated, characterized 3

Also see Le (2011) and Dzansi (2013).

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by the feedback effect in the short run and long run unidirectional causality running from remittances to economic growth. Similarly, Marzovilla and Mele (2015) examined the effects of remittances on the Moroccan economic growth and their implications for economic policy choices, with particular attention to those relating to the exchange rate regime. They showed that remittances have been a fundamental engine of economic growth, pro-cyclic, and constant in time. Investigating the impact of remittances on economic growth using the autoregressive distributive lag bounds procedure with annual data from 1979 to 2012, Kumar and Stauvermann (2014) also showed that personal remittances, output, and capital per worker were cointegrated in Bangladesh. The same study noted the existence of a unidirectional causality relationship running from personal remittances to output per worker thus supporting the remittance-led growth hypothesis. This was buttressed by Kumar (2014) who used augmented Solow framework and found the unidirectional causation from remittances to output per worker; and from output per worker to tourism in Kenya over the 1978–2010 period. Some studies investigated the potential negative impact of remittances on economic growth through the Dutch disease effect. One such study by Amuedo-Dorantes and Pozo (2004), where they examined the impact of workers’ remittances on the real exchange rate of 13 LAC countries, concluded that remittances did reduced international competitiveness through the appreciation of the real exchange rate. In addition, using data for El Salvador and employing Bayesian techniques, Acosta et al. (2009) estimated a two-sector dynamic stochastic general equilibrium model and also found that remittances lead to a Dutch disease effect. Recently, Guha (2013) showed that remittances might cause the real exchange rate appreciation, which leads to reallocation of sectoral production. He also indicated that several shocks in the remitting process might lead a country’s economy towards a negative economic growth path from the weakening of the traded sector. Barajas et al. (2009) examined the impact of remittances on economic growth in 84 host countries based on annual observations over the 1970–2004 period and found a negative effect on economic growth. Furthermore, the findings of Rahman (2009) on Bangladesh, Pakistan, India, and Sri Lanka appeared inconclusive. In a discussion paper, Siddique et al. (2010) investigated the causality relationship between remittances and economic growth in Bangladesh, India, and Sri Lanka, for the 1975–2006 period. They found that there was no causal link between economic growth and remittances in India, but there was a two-way relationship between remittances and economic growth in Sri Lanka. However, these remittances did not lead to economic growth in Bangladesh. In a study conducted by International Monetary Fund (2005) about the impact of remittances on growth over an extended period (1970–2003) for 101 developing countries found no statistical link between remittances and per capita output growth, or between remittances and other variables such as education or investment rates. However, this inconclusive result attributed to measurement difficulties arising from the fact that remittances may behave countercyclical with respect to growth. Dhungel (2014) observed that the impact of remittances on gross domestic product was very weak thereby showing that the greater portion of remittances flowing into Nepal is consumed and not invested in the productive sector. The same study noted that gross domestic product Granger caused remittances in Nepal both in the long and short run. Similarly, Ruiz and Vargas-Silva (2014) revealed that the

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relationship between remittances and output was not stable in Mexico in the long run. During certain time periods, remittances had a pro-cyclical effect on output and counter-cyclical impact on output in other periods. More recently, Lim and Simmons (2015) have investigated the economic importance of remittance flows to the Caribbean Community and Common Market (CARICOM) during the 1975–2010 period. Using panel cointegration tests, they showed that there is no evidence of a long-run relationship between remittances and real GDP per capita or investment but some evidence of a long-run relationship between remittances and consumption. This suggests that remittance inflows to the CARICOM region are used for consumption purposes rather than for productivity improving spending. The above discussion about the empirics on remittances and economic growth unfolds the fact that the effect of remittances on economic growth is mixed. Part of explanations for these distinct findings may be that the studies suffer from an omitted variable bias: the role of institutions. There are strong arguments, based on the analysis of Knack and Keefer (1995) and Acemoglu et al. (2001) for example, the belief that the economic growth impact of remittances ultimately depends greatly on the underlying institutions and government policies in the host country. The quality of institutions might play an important role in determining the exact impact of remittances on economic growth, because institutions exert substantial influence on the volume and efficiency of private investment. There is some limited empirical work suggesting that institutions play a role in the impact of remittances on economic growth. Faini (2002), for instance, found that the impact of remittances on economic growth is positive. He interpreted the positive coefficient on the policy variable as a signal that, for full impact of remittances to be realized, a sound policy environment is needed. That is, an environment that does not foster macroeconomic uncertainty and supports the build-up of social and productive infrastructures. Barajas et al. (2009) also argued that their findings that remittances have had, at best, no impact on economic growth may suggest that many countries do not yet have the right institutions and infrastructure in place. However, they do not investigate this claim empirically. Ratha (2003), in a less systematic analysis, found that during 1996–2000, remittances averaged 0.5 % of GDP in countries with a higher-than-median level of corruption compared to 1.9 % in countries with lower-than-median corruption, giving an indication that corruption has an effect on the level of income generated from remittances. The quality of political institutions may therefore, affect the flow of remittances. Moreover, one of the most important determinants of remittances is the cost of transactions in the destination country. Conceivably, an improvement in economic institutions that facilitate economic freedom would serve to reduce such costs, and affect both the volume and value of remittances. In this context, the quality of economic institutions in general, could be an important determinant of remittances in the developing countries. Rodrik (2004) pointed out that there is now a widespread agreement among economists that institutional quality holds the key to prevailing patterns of prosperity across countries. He argued that rich countries attract investors because of the presence of effective property rights, the rule of law, and the existence of monetary and fiscal policies that are grounded in solid macroeconomic institutions. However, poor countries are those where these arrangements are absent or ill-formed. He also indicated that

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institutions exert a very strong effect on economic growth, such that poor countries that strengthen property rights of entrepreneurs and investors would likely experience a lasting increase in productive capacity. Ashby (2007) noted that the variation in economic freedom across the contiguous US states helps explain the overall rates of migration. He showed that states with higher relative economic freedom experience greater migration inflow through its direct impact on income and employment growth. He also argued that individuals are more likely to migrate to states with higher government expenditure and transfers, fewer labor market impediments, and lower taxes. Similarly, Clark and Pearson (2007) considered two hypotheses. First, economic growth is highly dependent on the level of economic freedom and entrepreneurship. Second, migration inflows are increasing in the levels of economic freedom and entrepreneurship. They found that economic freedom and entrepreneurship are positively correlated with economic growth. In a related study, Freund and Spatafora (2008) investigated the determinants of remittances and their associated transaction costs. They found a negative and statistically significant impact of transaction costs on remittances to suggest that, when costs are high, migrants either refrain from sending money home or else remit through informal channels. The study concluded that one percentage reduction in transaction costs would increase money transfer through formal channels by 14–23 %. The same conclusion is drawn by Ratha (2013) who surveyed numerous empirical studies to show that the extent to which countries benefit from remittances is closely related to the strength of domestic institutions and the macroeconomic environment. Catrinescu et al. (2009) extended the approach of Chami et al. (2005) to include policy and institutional variables and estimate a panel using the Anderson-Hsiao estimator. They found some significantly positive results for the impact of remittances on economic growth, which are more robust when interaction terms with institutional indicators are included. They argued that a sound institutional environment affects the volume and efficiency of investment; hence in the presence of good institutions, remittances could be channeled more efficiently, ultimately leading to higher output. Le (2009) examined the determinants of economic growth in developing countries, and attempts to check whether institutions, trade openness, and remittances are complements or competitors in economic growth. He concluded that trade, institutions, and remittances impact economic growth. Singh et al. (2010) used a homogeneous panel model on annual data from 36 Sub-Saharan African countries over the 1990–2008 period and found that remittances have a negative impact on economic growth; this impact being mitigated in countries with well developed financial system or more stable political environment. Abdih et al. (2012), on the other hand, showed that remittances affect the incentives faced by governments, and may therefore have important impact on the quality of domestic governance. They argued that access to remittance income makes government corruption less costly for domestic households to bear and the government engages in more corruption. Similarly, Yaseen (2012) found that remittances affect economic growth through institutions and financial development in eight MENA countries. More recently, Bang et al. (2015) have also examined the impact of financial liberalization on the remittance inflows to 84 countries over the 1990–2005 period. They found that various dimensions of financial reform impact remittances differently. In their study, increased economic freedom in the financial sector, as captured by

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absence of direct government control over the allocation of credit, has a positive and immediate impact. However, the improved robustness of financial markets, as captured by the development of security markets, improvement in the quality of banking supervision, and removal of stringent restrictions on interest rates and international capital, has a negative and lagged effect. They conclude that the net combined effect suggests that financial liberalization may have a modest negative impact on remittances in the long run. Given that remittances are a major source of external development finance, the quality of institutions in the host countries can be expected to affect remittances, particularly in the case where they are driven by a portfolio choice motive and where migrants seek to exploit investment opportunities as a means to allocate their savings optimally between origin and destination countries. The presence of high quality institutions that favor foreign investments would, therefore, serve to attract remittances towards investment opportunities in the host country. Much of the literature that focuses on institutions tries to find a direct link between institutional quality and economic growth. This paper seeks to extend this literature by examining the importance of institutional quality in the North African countries, in order to determine whether there are interaction effects with remittances.

Trend of Remittances in North Africa Figure 1 shows the time profile of remittances to the countries in North Africa during the 1980–2012 period. From this figure, it is evident that remittances to North Africa during the early 1980s stood at approximately US$4.5 billion. This started to grow gradually at an average annual growth rate of 4.2 % reaching approximately US$7.2 billion. Growth during this period may have been sustained by a 28 and 33 % growth rates reported in 1983 and 1987, respectively. During the 1990s the remittances 35 30 25 20 15

Remiance inflows (US $ billion)

10 5 0

Source: World Bank. World Development Indicators.

Fig. 1 Evolution of remittances in North Africa: 1980–2012. Source: World Bank. World Development Indicators

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appeared to have stabilized at a level slightly above US$7.5 billion, with an average annual growth rate of 3.3 %. During the 2000s, the remittances appeared to have gained prominence as it stood at US$6.6 billion in 2000 rising rapidly at an average rate of 13.4 % during this period to stand at US$19.8 billion in 2008 before declining slightly by US$2.3 billion to stand at US$17.5 billion in 2009. The decline witnessed during this period may have been on account of the effects of the financial crisis which may have led to job losses for migrant workers thus occasioning reduced remittances to their mother countries. The reduction in remittance inflows during the financial crisis can be attributed to two factors: (1) Reduced ability of the Diaspora to send money home, and (2) Return migration as migrants lose jobs and are forced to return home. Until the financial crisis, remittances had proven to be a remarkably dependable source of foreign income for North African countries. As shown in Fig. 1, remittance to North Africa was on an increasing trend standing at US$4.5 billion in 1980 rising to US$13.9 billion in 2006, just before the global financial crisis set in. At the onset of the financial crisis in 2007, remittances to North Africa totaled US$18.2 billion and grew by 8.8 % to stand at US$19.8 billion in 2008. The effect of the crisis on remittance inflows was felt in 2009 when the total remittances to North Africa declined by 11.6 % to stand at US$17.5 billion. However, remittances are estimated to have reached US$31.5 billion in 2012. Overall, remittances to North Africa grew at an average rate of 9.8 % per annum during the period 1980–2012. While Fig. 1 shows the trend of the remittances to North Africa in general, Fig. 2 shows the quantum of remittances to the top destinations in North Africa in 2012. Among the North African countries Egypt was the leading recipient with US$20.5 billion. Other leading destinations in the region were Morocco (US$6.9 billion), Tunisia (US$2.2 billion), and Algeria (US$1.85 billion). On average, Egypt received US$4.8 billion annually. Although, Egypt has a large 25 20 15 Remiance inflows (US $ billion)

10 5 0 Egypt

Morocco

Tunisia

Algeria

Source: World Bank. World Development Indicators.

Fig. 2 Top remittance destinations in North Africa, 2012. Source: World Bank. World Development Indicators

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stock of highly skilled expatriates in the USA, the UK, and other Organization of Economic Cooperation and Development countries, about two-thirds of its migrants are working in MENA’s oil-rich countries, which are benefitting from robust oil prices. With about 80 % leaving immediate family in Egypt, migrants maintain strong links with Egypt, driven in part by the temporary nature of their employment in destination countries and geographical proximity to Egypt. As a result, remittances are a reliable source of revenue for migrant families, meeting as much as 40 % of household expenses (International Organization for Migration 2010). The impetus to make remittances is likely to have become stronger with the economic difficulties in Egypt, the robust economic performance of the destination countries in the Gulf Cooperation Council (GCC), and the return of large numbers of migrant workers from Libya who repatriated their assets at the same time. The GCC accounted for 50 % of the US$20 billion in REM to Egypt in 2012. For Algeria, Morocco, and Tunisia, however, it is the European countries that provide the majority of funds. In the Algerian case, 90 per cent of the US$1.8 billion of remittances that flowed into the country in 2012 came from Europe, with the vast majority of that coming from France. For Morocco, the equivalent figure was US$6.9 billion or 86 per cent, while for Tunisia, it was US$2.2 billion or 80 per cent. Figure 3 tries to compare the remittances as a share of GDP. In doing so, it will be possible to determine the countries that are heavily dependent on remittances. As shown in Fig. 3, it appears, on average, that Egypt is the highest recipient of remittances as a percentage of GDP at 8.11 % of GDP followed by Morocco with a value of 7.04 % in 2012. On the global scale (see World Bank 2014), as a share of GDP, smaller countries were the largest receipts of remittances in 2012: Tajikistan (49.25 %), Tonga (15.4 %), Lesotho (25.5 %), Nepal (27.2 %), and Moldova (24 %).

25 20 15

Algeria Egypt

10

Morocco Tunisia

5

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

0

Source: World Bank. World Development Indicators.

Fig. 3 Top destinations—remittances as percent of GDP, 1980–2012. Source: World Bank. World Development Indicators

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Data and Empirical Methodology Data This section describes the data used in the empirical analysis, specifically the measures of economic growth and a number of controlling variables used in growth regressions. Our sample consists of four countries from North Africa, namely, Tunisia, Morocco, Algeria, and Egypt with annual data for the 1980–2012 period. The choice of the selected countries for this study is primarily dictated by the availability of reliable data over the sample period. The dependent variable is economic growth measured as the growth rate of real GDP per capita at 2005 USD Prices. With the exception of the institutional variable (EFI), the main variable of interest (remittances as a ratio of GDP) and the other control variables are obtained from the World Development Indicators database (World Bank 2015).The Index of EF is taken from (Gwartney et al. 2014). The broader measure records remittances as the sum of three aggregates: first, workers’ remittance record current transfers to nonresidents by migrants who are employed in, and considered a resident of, the countries that host them. The category of employee compensation is composed of wages, salaries, and other benefits earned by individuals in countries other than those in which they are residents for work performed for and paid for by residents of those countries. Finally, migrants’ transfers are contraentries to the flow of goods and changes in financial items that arise from individuals’ change of residence from one country to another, such as the movement of accumulated savings when a migrant returns permanently to the home country. In most research on remittances, all three types of transfers are summed and labeled Bremittances.^ The extended model will also include the following institutional variable 4: the economic freedom index (EFI) from the Fraser Institute. The EFI measures the degree of economic freedom present in five major areas: 1. Size of government—indicates to what extent the allocation of resources in the economy is driven by market forces and shows the role of the public sector in the production of goods and services. 2. Legal system and property rights—the central element of economic freedom, which shows how successful the state, is in this regard. 3. Sound money—the ease of access to money (domestic and foreign) and its cost is assessed. 4. Freedom to trade internationally—the components in this area measure the impact of various restrictions on international trade exchange. 5. Regulation—assesses regulations that restrict the freedom of contract in the labor, credit, and product market, as well as hinder competition and freedom of economic activity. The index has a scale that ranges from 1 to 10, where a score of 10 represents the highest attainable level of economic freedom. Higher indexes are associated with smaller governments, stronger legal structure, and security of property rights, access 4

There is an extensive literature on the effects of institutions on economic growth. See, among others, Acemoglu et al. (2001, 2003), Glaeser et al. (2004), and Catrinescu et al. (2009).

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to sound money, greater freedom to exchange with foreigners, and more flexible regulations of credit, labor, and business. According to the survey of De Haan et al. (2006), which focused on the empirical studies that used this economic freedom indicator of the Fraser Institute, greater EF stimulates economic growth. Thus, a positive coefficient is expected. Our baseline model includes the explanatory variables common to most growth regressions found in the literature: &

& & &

Initial GDP per capita was included to control for economic convergence in our regressions. Several studies pointed out that per capita income could serve as a good proxy for the general development and sophistication of institutions (La Porta et al. 1998). A negative coefficient is expected, indicating the existence of conditional convergence between countries; Investment ratio (INV) is defined as the ratio of gross fixed capital formation to GDP. A positive coefficient is expected, as greater investment shares have been shown to be positively related to economic growth (Mankiw et al. 1992); Primary school enrollment (PSE). Greater enrollment ratios lead to greater human capital, which should be positively related to economic growth (Gemmel 1996). Population growth (PG). Everything else remaining the same, greater population growth leads to lower GDP per capita growth (Solow 1956). Thus, a negative coefficient is expected.

Empirical Methodology Assess the remittance influence on economic growth in a formal extended growth model. The empirical studies on economic growth provide evidence of conditional convergence on factors some of which are related to institutions. Our specification is based on earlier empirical works of Mankiw et al. (1992). As a starting exercise, we look at the direct effect of remittances on economic growth and estimate the following equation using the system GMM: GDPi;t ¼ α0 þ α1  GDPi;t−1 þ α2  REMi;t þ α3  X i;t þ μt þ ηi þ εi;t

ð1Þ

where GDPi,t − 1 denotes the (logarithm of) level of GDP per capita of country i at the end of period t, REMi,t refers to the log of remittances as a percentage of GDP, Xi,t is the matrix of control variables described in the previous section; μt is a time specific effect, ηi is an unobserved country specific fixed effect and εi,t is the error term. 5 We are interested in testing whether the marginal impact of remittances on growth, α2, is statistically significant. While remittances have the potential to affect economic activity through a host of channels, in a second set of regressions, we examine one specific relationship between remittances and economic growth, specifically the one working through EFI. The 5

Note that Eq. (1) can be alternatively written with the growth rate as dependent variable as: Growthi,t = GDPi,t − GDPi,t − 1 = α0 + (α1 − 1) × GDPi,t − 1 + α2 × REMi,t + α3 × Xi,t + μt + ηi + εi,t where (α1 − 1) is the convergence coefficient.

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hypothesis we would like to test is whether the level of EFI in the host country affects remittances on economic growth. To this end, we add an interaction term constructed as the product of remittances and the EFI (i.e., REM × EFI) to Eq. (2) as an additional explanatory variable, apart from the standard variables used in the economic growth equation. A positive interaction term indicates that remittances and the quality of institutions are complementary and that the growth effects of remittances are enhanced in good policy environments. On the other hand, a negative interaction term reveals that remittances and institutional quality are used as substitutes to promote economic growth. This study estimated Eq. (2) 6 with an interaction term between remittances and the EFI variable to determine whether these variables are complements or substitutes. The regression to be estimated is the following: GDPi;t ¼ α0 þ α1  GDPi;t−1 þ α2  REMi;t þ α3  E FIi;t þ α4  REMi;t  E FIi;t þα5 *X i;t þ μt þ ηi þ εi;t




ð2Þ

Our estimation technique addresses issues of endogeneity and unobserved country characteristics. Therefore, to account for endogeneity and country specific unobserved characteristics, we used the system GMM dynamic panel estimation method. The option to use system GMM is based on the argument that the existence of weak instruments implies asymptotically that the variance of the coefficient increases and in small samples the coefficients can be biased. To reduce the potential bias and inaccuracy associated with the use of difference GMM Arellano and Bond (1991), Arellano and Bover (1995) and Blundell and Bond (1998) developed a system of regressions in differences and levels. The instruments for the regression in differences are the lagged levels of the explanatory variables and the instruments for the regression in levels are the lagged differences of explanatory variables. These are considered as appropriate instruments under the assumption that, although there may be a correlation between the levels of the explanatory variables and the country specific effect, there is no correlation between those variables in differences and the country specific effect. The consistency of the system GMM estimator depends on both the validity of the assumption that the error term does not show serial correlation and the validity of the instruments. By construction, the test for the null hypothesis of no first-order serial correlation should be rejected under the identifying assumption that the error is not serially correlated; but the test for the null hypothesis of no second-order serial correlation, should not be rejected. We use two diagnostic tests proposed by Arellano and Bover (1995) and Blundell and Bond (1998), the Sargan test of over-identifying restrictions, and whether the differenced residuals are second-order serially correlated. If the null hypothesis of both tests cannot be rejected, this would indicate that the model is adequately specified and the instruments are valid. The results from this estimation procedure are reported in Table 1.

6

This equation has been used by Catrinescu et al. (2009) who examined the link between remittances and economic growth specifically working through the institutions of a country.

J Knowl Econ Table 1 Remittances, economic freedom, and economic growth (1)

(2)

Initial GDP per capita

−0.0346***

−0.0345***

REM

0.0036*

EFI

0.0136**

PG

−0.009*

−0.0088*

PSE

0.0091*

0.0081*

INV

0.0147**

0.015**

REM*EFI

–

0.0006*

Constant

−0.134*

R-squared

0.51

0.55

AR(1) test

0.00

0.00

AR(2) test

0.71

0.75

P value Sargan test

0.73

0.69

0.0064* 0.0146**

−0.137*

Dependent variable is real GDP per capita growth *, **, and *** indicate statistical significance at 10, 5, and 1 % levels, respectively

Empirical Results To investigate the role of remittances and economic growth we present a range of results. We follow the approach of first estimating the growth model following the standard variables as shown in Table 1. Then, the proxy for institutional development is included. Further evidence of the importance of remittances to economic growth are shown in Table 1, where the institutional development indicator is introduced into the model, and it is found that the estimated coefficients are largely positive and significant at the conventional levels of testing. The results suggest that the main variable of interest, migrant remittances to GDP are positive and statistically significant in all the columns, suggesting that remittances contribute significantly to economic growth in North Africa. However, the impact is more pronounced when the institutional development variable is included. Column (1), for example, suggests that a 1 % increase in remittances leads to a 0.0036 % increase in the growth rate. A 1 % increase of migrant remittances leads to a 0.0064 % increase of economic growth in column (2). This conclusion is also consistent with previous empirical studies, such as, work of Ramirez (2013). The role of institutional development is shown in Table 1. In particular, we explore whether the institutional development of the recipient country influences the specific uses given to remittances and their capacity to influence growth. To this end, we estimate Eq. (2), which allows the impact of remittances on economic growth to vary across levels of institutional development in the recipient country. The EFI coefficient carries a positive sign and is statistically significant at conventional levels, implying that economic growth is stronger when EFI is high because it makes investment more productive. This finding is consistent with the survey conducted by Azman-Saini et al. (2010) and Ramirez (2013) who concluded that EFI is crucial for economic growth.

J Knowl Econ

Importantly, our results also confirm that the greater the EFI, the more it enhances the advantage of remittance inflows. Notice that the coefficients of the core variables considered in the equation enter the regression equation with the correct sign and are significant at 10 % significance level or better. Additionally, the estimated regression passed both specification tests. The null hypothesis of no second-order serial correlation cannot be rejected at the 5 % level. The regression is not plagued by simultaneity bias as the orthogonality conditions cannot be rejected at the 5 % level, as indicated by the Hansen test. 7 This suggests that the equation is adequately specified and the instruments employed in the analysis are valid. Column (2) displays the regression results based on interaction specification using an interaction term between remittances and the EFI (REM × EFI). In this specification, we relied on the interaction term to establish the contingency. If the term is positive and significant, this would imply that the effect of remittances on economic growth increases with EFI. The first thing to note is that the sign of the coefficient of the interaction term between remittances and the degree of economic freedom is positive, implying that remittances and the degree of economic freedom act as complements. This evidence supports the argument that the effect of remittances on economic growth depends on whether countries’ institutions are conducive to a productive use of remittances. This finding is consistent with the survey conducted by Catrinescu et al. (2009) who concluded that remittances will be more likely to promote economic growth in countries with higher quality of political and economic policies and institutions. We introduce the level of initial GDP per capita (the natural logarithm) as an independent variable according to the conditional convergence hypothesis. The initial GDP per capita coefficient is negative, meaning that the conditional convergence hypothesis is evidenced: holding constant other growth determinants, countries with lower GDP per capita tend to grow faster. The initial position of the economy is thus a significant determinant of economic growth, as recognized by the neoclassical theory. The initial income has a negative effect on economic growth which is coherent with the theoretical study and statistically significant at a 1 % level. The result corroborates the work of Barro and Sala-i-Martin (1997) and Easterly and Levine (1997). With regards to the effect of the other variables in the regression, they are all consistent with standard growth regression results. Investment and primary school enrollment ratios 8 have positive and statistically significant coefficients, indicating that greater investment and education promote economic growth. Finally, population growth has the expected negative coefficient.

Conclusion Several important conclusions emerge from this study. First, the system GMM estimates suggest that remittances have a positive and significant effect on economic growth in a panel of four countries of North Africa over the 1980–2012 period. 7

See Baltagi (2008) and Roodman (2009) for an extensive discussion. The results are virtually the same when secondary enrollment is used instead of primary enrollment. Since we have more observations for the latter, we opted to include it in the estimations reported in this paper.

8

J Knowl Econ

Second, this paper examined an institutional conduit via which remittances can affect economic growth, viz., the opportunity to invest remittances more productively because households have more secure property rights and greater freedom of exchange. The results suggest that, controlling for the degree of economic freedom as measured by the EFI; remittances have a positive and significant effect on economic growth. Finally, the positive interaction term between remittances and EFI suggests that remittances have a greater impact on economic growth when the level of institutional development is high. The results obtained in this paper could also have significant policy implications. A number of researchers have expressed skepticism regarding the ability of governments to affect the manner in which remittances are used. For example, Kapur (2003) echoes his argument that active government attempts to encourage or require investment of remittances are unlikely to have significant economic benefit. However, since institutions seem to matter in the manner in which remittances are used, the best way for the recipient country governments to ensure that remittances contribute to positive economic growth is to foster better quality of institutions. Indeed, a policy environment that promotes a well regulated use of monetary policy, and hence, a stable and low inflation rate, would attract more remittances. A better-functioning government that encourages privatization of industries and less government investment and enterprises, will also foster the inflow of remittances and their productive use, and thus provide additional source of external finance, which is key to the economic growth of the North African countries. Arguably, monetary policy and government institutions, in general, play a major role in these countries. This has many implications for other institutions; in that they affect economic freedom and therefore they should play an important role in these countries.

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