Remittances and Financial Development in Caribbean Countries

Remittances to the Caribbean represent a significant source of inflows, following tourism and foreign direct investment. In terms of contribution to economic output, remittances are more important to the Caribbean than any other region around the world, and account for approximately 4% of GDP. The impact of remittances on Caribbean economies is also important because of the region’s close proximity to the US which represents the largest source of remittances and also where more than half the migrants emigrate. Panel data across several countries over four decades is used to explore the influence of workers’ remittances on financial development. Our approach is to identify the causal impact of remittances on various measures of financial development using a number of empirical strategies. It is found that remittances have a consistent and negative impact on various measures of financial development. This relationship appears causal within the Generalized Method of Moments and Instrumental Variable empirical frameworks. Based on our estimates, a one percentage point increase in remittances-to-GDP decreases the level of financial development in the range of 0.1 to 0.2 percentage points. These findings are robust to alternative measures of financial development and to a variety of estimation methods to addressing potential biases due to unobserved heterogeneity. There is suggestive evidence that the negative effects may be partly driven by the larger and more remittance-intensive countries, which also happen to be outside of a common currency area. Policy efforts designed to ensure the effectiveness of remittances in serving as complement (rather than substitute) will hinge on a more diversified and fully integrated financial system.