Macroeconomic impacts of remittances: A two-country, two-sector model

We examine the impacts of remittances on foreign direct investment and the development of developing countries using a macro-dynamic model of two small open economies—an advanced economy and a developing country. We incorporate a two-sector framework for the latter: traditional non-traded and foreign capital dependent traded sectors while introducing a collateral effect of remittances. The most important feature of the model is that remittances come from two sources: temporary migrant workers and permanent immigrants, and they are allocated between consumption and domestic investment through the household’s utility maximization. The results from extensive calibration exercises show that remittances in the presence of labor migration hurt the traded sector of the developing economy, leading to a contraction in the aggregate output. Albeit to a lesser extent, the contraction persists even with the expansionary impacts of remittances through the collateral effect. In addition, the migration policy of the developing countries can weaken other development efforts, giving rise to a phenomenon known as a migration-remittance trap.