Does institutional quality in developing countries affect remittances?

There is some empirical evidence showing that remittances, on average, were about 0.5 percent of GDP in countries with a corruption index higher than the median level, compared to 1.9 percent in countries with a level of corruption lower than the median. It is also arguable, that an improvement in economic institutions would facilitate economic freedom and in turn, reduce the costs of transactions associated with remittances in recipient countries. The quality of institutions in developing countries therefore, could be an important determinant of remittances, which are now considered an essential source of external finance in these countries. Thus, this paper explores the role of institutions in driving the flow of remittances to developing countries. The study uses a sample of 90 countries, and data from the World development Indicators (WDI) and Economic Freedom of the World (EFW) indicators databases. The paper estimates both static and dynamic representations of a reduced form model for the determinants of remittances. The static panel models are estimated using the fixed effects estimator, whereas the dynamic models, represented by autoregressive-distributed lag models, are estimated using a generalized method of moments (GMM) estimator. The results show that an improvement in the quality of institutions in charge of the conduct of monetary policy has a positive impact on remittances, and that this impact increases with the quality of such institutions. The estimates also show that an improvement in the operations of institutions of government leads to an increase in the inflow of remittances, which suggests that a decrease in direct government control or participation in the private sector has positive impact on remittances. Sound monetary policy and an effective government are critical to economic freedom, and these results seem to suggest that migrants tend to send remittances in order take advantage of macroeconomic environments that are favorable to better economic performance. Furthermore, the findings provide evidence, albeit a weak one, which suggests that an improvement in the legal system and property rights may be associated with an increase in remittances, but that the effect is lower for countries with an index value greater than the median level. Ergo, to the extent that remittances have become an important source of external finance, policies promoting sound and accountable local institutions should be a priority for policy makers in developing countries.