Do Political institutions and financial development promote the effect of Remittances on Economic gr


Komlan Fiodendji1 & Afi Etonam Adetou

Abstract

1. Purpose: Over the past decades, remittance flows accelerated and have grown to become an increasingly prominent source of external funding for many countries. Despite the increasing importance of remittances in total international capital flows, the role of remittances in development and growth is still not well understood. To contribute to this growing debate, this paper tries to investigate the relationship between remittances and economic growth and studies one of the links between remittances and growth. In particular, this study examines how the local financial development and political institutions influence a country’s capacity to take advantage from remittances.

2. Methodology: Dynamic Panel Threshold Analysis: Following Bick et al. (2009), a dynamic panel threshold model that extends Hansen’s (1999) is applied. Specifically, we adopt the cross-sectional threshold model of Caner and Hansen (2004), where GMM type estimators are used to allow for endogeneity in the dynamic setting. From this econometric approach, we identify four states of the economy consistent with the results of the growth framework. Using these four states, we are able to estimate whether the relation between remittances and economic growth in nonlinear fashion in each state with respect to the deviation from financial development and the political institutions. The empirical analysis is based on a panel data set including ECOWAS countries during the period from 1985 to 2014.

3. Findings: This paper finds that political institutions and local financial development condition the effect of remittances on economic growth. These findings suggest that in order for remittances to contribute to economic growth, ECOWAS countries must possess a developed financial system and a strong institutional environment. Considering the political institutions, our results outlined that remittances are more effective in enhancing economic growth in countries with strong institutions. The interaction between remittances and the political institutions indicators was more important to growth than the interaction between remittances and financial development indicators. These results are robust to the threshold estimation. Therefore, policy interventions to improve the functioning of governance institutions, enforcing regulation and political stability, enhancing socioeconomic environment are also crucial for increasing the benefit effects of remittances.

4. Practical implications: Efforts to improve political institutions, and the support they provide for the financial system, in developing and ECOWAS

economies should therefore be a main priority for policy makers as there are gains to be made in terms of economic development. The implication of this finding is that different countries require different sets of institutions and financial development for ensuring long-term economic growth.

5. Originality/value: The crux of the analysis is that the institutions and finance development are indeed important in determining the long-term relationship between remittances and growth. One of main contributions of this paper is to successfully identify the conditions under which the remittances have a positive impact on economic growth. The study recommended the design of policies that would facilitate simultaneous improvements in the political institutions indicators and financial development indicators, a situation that has previously been ignored.


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