Recent years have seen an impressive surge in official remittance flows to Central America. The Inter-American Development Bank (IADB) estimates the region received US$7.8 billion through official channels in 2004, a 17 percent increase from the 2003 figure of US$6.7 billion.
Although a huge portion of remittance flows to Latin America and the Caribbean (LAC) still goes to countries outside of Central America — almost 60 percent reportedly just to Mexico, Brazil, and Colombia — Central America's slice of the remittance pie has nonetheless been growing. It now accounts for 17 percent of the official flow to LAC, up from just 15 percent in 2001 according to IADB.
Reporting almost US$2.7 billion in official flows in 2004, Guatemala topped the list, followed closely by El Salvador, with US$2.5 billion (see Table 1). These two countries, which account for nearly two-thirds of the two million Central Americans counted in the 2000 US census, receive almost 64 percent of total remittance flows to Central America, and they are the fourth- and fifth-largest remittance-receiving countries in LAC. Remittance growth in Guatemala tripled from 2001 to 2004.
Honduras and Nicaragua followed at some distance, at around the US$1 billion mark, while Panama, Costa Rica, and Belize trailed with less than US$325 million in remittances in 2004. The low levels of the latter three reflect the fact that they have relatively few emigrants in the United States.
Not surprisingly, the dominant source of these remittance flows is the United States. A good proportion, however, is also believed to be sent from other LAC countries. Despite the attention given to remittances from developed countries, particularly the United States in the case of Latin America, these so-called South-South remittance flows are far from negligible.
A 2003 study of Costa Rica and Nicaragua suggests that about one-third of remittances received in Nicaragua are actually sent from Costa Rica. Given that Mexico is the second-largest destination of Guatemalan workers after the United States, it can also be assumed that at least some of the remittances going to Guatemala are coming from Mexico. Indeed, research conducted for IADB estimated that, in 2002, about US$1.5 billion of the US$32 billion remitted to LAC were actually interregional.
Table 1. Remittances to Central American Countries in Millions of U.S. Dollars, 2001 to 2004
In interpreting these numbers, it is critical to realize they are official estimates and, thus, do not take into account remittances flowing through informal channels, such as those hand carried by migrants on visits home. Given the predominance of informal transfer mechanisms in Central America, it is safe to assume these figures are, more probably than not, underestimates.
Indeed, evidence from household surveys suggests widespread use of informal remittance channels to Central America, as in many other regions. The World Bank estimates, for example, that informal remittances account for about five percent of the actual remittance flow to Guatemala and almost 15 percent to El Salvador.
Remittances and the Macroeconomy
The importance of these huge remittance flows to the economies of Central America becomes very visible once they are compared to key economic aggregates such as gross domestic product (GDP), foreign direct investment (FDI), official development assistance (ODA), and exports.
In all but three Central American countries, remittances are equivalent to at least 10 percent of GDP, suggesting a heavy dependence on remittances as an engine of economic activity. Figures from Nicaragua, El Salvador, and Honduras are particularly high (see Table 2).
Table 2. Remittances to Central America as a Percentage of GDP, FDI, ODA, and Tourism Receipts (2004)
Except in Costa Rica and Panama, remittances also far outweigh both private capital flows and official development assistance. Particularly remarkable in this regard is Guatemala, where remittances are 21 times greater than FDI and 30 times greater than ODA.
Figures from the rest of Central America are no less striking. As share of FDI and ODA, remittances also scored very high in El Salvador, Honduras, and Nicaragua. Interestingly, Belize's remittance flows, although low in absolute value, are two and a half times greater than FDI and 15 times greater than ODA. Indeed, in Guatemala, El Salvador, Honduras, and Belize, remittances are far larger than ODA and FDI combined.
Remittances also made up for the shortfall in exports of some traditional products, dwarfing coffee exports in Guatemala, El Salvador, and Nicaragua, and banana exports in Honduras and Panama. Remittances, again with the exception of Costa Rica, Panama, and Belize, are also at least three times greater than tourism receipts.
For political scientist Manuel Orozco, a long-time analyst of remittances, this dominance of remittance flows over traditional export receipts signals that Central American countries are in the midst of a transition away from "agro-exporting economies" and toward "transnationally integrated households" that are mainly exporting labor to the United States.
Remittances and Development
Despite remittances increasing in magnitude and importance for the majority of Central American countries today, it is interesting to note that their impact on development is far from clear. For decades now, the perception has lingered that remittances are used mostly for consumption by individual households and rarely, if at all, invested in productive enterprises. Thus the developmental potential of remittances is generally thought to be low. In fact, it has been argued that remittances lead not to long-term economic growth but to a passive and dangerous dependency.
Recent household surveys do show that Central Americans who receive remittances mainly use them to cover basic necessities. According to the World Bank, about 77 percent of remittances, on average, are believed to be spent on immediate needs, such as food. At 84 percent of total expenditures, consumption spending is particularly high in El Salvador while Honduras (77 percent) and Guatemala (68 percent) are not far behind.
More recently, however, an increasing number of studies suggest a more positive developmental role for remittances. Although a big chunk of the literature on this topic is concentrated on other countries and regions, a relatively small number of studies focus on some Central American countries.
For example, economist Richard Adams found that, contrary to common perception, Guatemalan households receiving remittances actually spend slightly less, at the margin, on consumption — food and consumer goods and durables — than do households receiving no remittances. For Adams, this rather surprising result may be explained by Guatemalan households' tendency to view their remittances as a temporary stream of income thus precluding more spending on consumption.
Adams further found that although remittances only had a limited role in reducing the number of poor people in Guatemala, they do reduce the depth of poverty and are therefore particularly beneficial for the poorest of the poor. According to his calculations, remittances reduced extreme poverty by almost 22 percent.
A study on child schooling in El Salvador also found that remittances have a large and significant effect on school retention. From a development standpoint, this finding is clearly promising. Since the increased investments in education contribute to human capital formation, it is likely that remittances may benefit developing countries' long-term growth prospects.
Remittances have also been found to rise when the recipient economy suffers a downturn in activity or macroeconomic shocks due to financial crisis, natural disaster, or political conflict. By compensating for foreign-exchange losses due to these events, World Bank economist Dilip Ratha has found that remittances may smooth consumption and thus contribute to the stability of recipient economies. Indeed, emigration from Central America and the remittances that soon followed were mainly a response to the political turmoil of the 1980s and early 1990s as well as to natural disasters such as Hurricane Mitch in Honduras in 1998.
Very recently, the Economic Commission for Latin America and the Caribbean (ECLAC) released the findings of a comprehensive, region-wide study of the impact of remittances on poverty and inequality. This study included the top four remittance-receivers in Central America — Guatemala, El Salvador, Honduras, and Nicaragua. In this study, however, the results were mixed and prone to different interpretations.
On one hand, the ECLAC study reported that remittances' impact on poverty, indigence rates, and income distribution is very limited. The study revealed that remittances reduced poverty rates in Central America by only 2.2 percentage points. It is important to note that this average is skewed because of El Salvador, which registered a particularly high decline of 4.5 percentage points (see Table 3).
Remittances' impact on indigence is much higher but still limited to a 2.7 percentage-point reduction. This average is skewed, once again, by El Salvador, which registered a higher reduction of 5.4 percentage points.
Remittances' effect on income distribution, though perceptible, is also very limited. El Salvador registered the most significant improvement with an almost five percent reduction in the value of the Gini index, the most commonly used measure of inequality, while Guatemala and Nicaragua were at the far lower end of the scale. Remittances were associated with a small increase in inequality in El Salvador.
On the other hand, however, the study also found that if the analysis focused only on remittance-receiving households, remittances enabled many recipients to escape poverty. The Central American countries in the study recorded, on average, a 20 percent decline in poverty rates among these households. El Salvador registered the highest drop in Central America with a 39 percent poverty-rate reduction and was followed by Honduras, Guatemala, and Nicaragua.
The impact of remittances on indigence in receiving households is even more dramatic. ECLAC found that 64 percent of Salvadoran households receiving remittances were lifted out of extreme poverty. Corresponding figures for Guatemala (43 percent), Honduras (28 percent) and Nicaragua (27 percent), although smaller, are still very significant.
These numbers can mean different things to different people. They can affirm what skeptics have been pointing out for decades — that the benefits of remittances do not accrue beyond the households receiving them. They can even contribute to inequality, as the case of Honduras revealed.
Others, however, might look at the same numbers and emphasize the significant number of remittance-receiving households that managed to improve their living conditions and escape poverty. Further, it can be argued that the dismal impact of remittances on aggregate poverty and indigence figures stems from the fact that the number of households receiving these transfers is still small. In other words, if more households received remittances, then the impact on poverty would be much more pronounced.
The authors of the ECLAC study clearly take the latter view. They emphasize that remittances would lift 2.5 million Latin Americans above the poverty line. They further suggest that if, as they suspect, the data utilized in their study came from a source that underreported remittances received, then several million more persons in Latin America have been lifted out of poverty.
Ultimately, however, the developmental impact of remittances on Central American economies can only be ascertained from empirical studies based on more accurate data.
Migrant, Government, and Private Sector Initiatives
As the discussion on the costs and benefits of remittances occupy the academic literature and professional circles, key stakeholders have already launched initiatives aimed at maximizing the benefits of remittances. This is hardly surprising given that the ongoing debate on the impacts of remittances is occurring at a time when the perceived developmental potential of remittances has never been greater.
One of the most well known of such initiatives started with the migrants themselves. Like their counterparts from the rest of LAC, Central Americans have organized hometown associations, or HTAs.
Members of these associations pool their financial resources and send money or goods back to their hometowns. These so-called collective remittances are used to finance infrastructure and social projects, such as remodeling churches and schools. Guatemalan HTAs, for example, have been involved in purchasing small fire trucks for their hometowns, mobilizing support for their country after the 1996 peace agreements, and even in raising money for crises such as Hurricane Mitch.
Although, at present, only one percent of all remittances in Central America come from HTAs, the International Fund for Agricultural Development recently estimated that their contribution could rise to between three and five percent in 10 years if their management and institutional capacity improves.
Central American governments have also taken initiatives to maximize the benefits from remittances. El Salvador is particularly noteworthy in this regard. Almost six years ago, it created an office that coordinates governmental outreach efforts to Salvadorans living abroad. El Salvador's decision in 2000 to adopt the U.S. dollar as its legal tender was also widely acknowledged to be related to the nation's heavy reliance on foreign exchange coming from remittances.
Taking its cue from Mexico, El Salvador also launched a $300,000 matching fund in 2003 to implement joint partnership activities with HTAs. This grant will act as an incentive for HTAs to start and/or broaden development initiatives for their hometowns. Unlike in Mexico, however, the Salvadoran government is offering a one-to-one match with HTA money. Interestingly, related initiatives in Guatemala reportedly fell short in gaining government support and never took off.
Members of civil society, including international organizations, have also taken an interest in remittances. Through its Multilateral Investment Fund (MIF), IADB has been particularly active in the region. One of its rallying cries — bank the unbanked — is especially important in Central America given that only two out of 10 Central American migrants have bank accounts. This figure is significantly lower than LAC's ratio of six out of 10.
Credit unions in El Salvador, Guatemala, Honduras, and Nicaragua were instrumental in the creation of the International Remittance Network (IRnet) in July 1999. The network, which facilitates remittance flows from the United States to Latin America, reportedly lowered remittance costs not only by generating competition but also through raising customer awareness of remittance fees.
The private sector has also become more involved. Notably, several banks in Central America have been able to raise relatively cheap and long-term financing from international capital markets via securitization of future remittance flows. The volume of remittance securitization has grown rapidly since Mexico made the first transaction in 1994.
These initiatives are just a sample of an increasing array of activities, programs, and policies different actors have taken to maximize the benefits of remittances. Unfortunately, the effectiveness of these initiatives is unknown because evaluations are either incomplete or unavailable for public consumption.
What is clear, however, is that remittances do play an increasingly significant role in Central America, a role that, given current remittance flow projections, will only increase in the years ahead. Whether remittances will be able to lift this region of almost 40 million people out of poverty is a question only time can truly answer. If empirical findings from other regions are indicative of what is happening in Central America, then the skeptics are bound to be disappointed.
Adams, Richard. 2006. "Remittances, Poverty and Investment in Guatemala." International Migration, Remittances, and the Brain Drain. Edited by Çaglar Özden and Maurice Schiff. Washington, DC: World Bank.
Cox-Edwards, Alejandro and Manuelita Ureta. 2003. "International Migration, Remittances, and Schooling: Evidence from El Salvador." Journal of Development Economics 72(2): 429–61.
Economic Commission for Latin America and the Caribbean (ECLAC). 2006. "Social Panorama of Latin America 2005: Preliminary Version." United Nations. Available online.
Inter-American Development Bank. 2005. "Transforming Labor Markets and Promoting Financial Democracy, Statistical Comparison.", November. Available online.
Fagen, Patricia and Micah N. Bump. 2006. " Remittances between Neighboring Countries in Latin America." Beyond Small Change, Making Migrant Remittances Work for Development. Edited by Donald Terry and Steven Wilson.Washington, DC: Inter-American Development Bank.
Orozco, Manuel. 2006. "Migration, Money and Markets: The New Realities for Central America" in Beyond Small Change, Making Migrant Remittances Work for Development, Edited by Donald Terry and Steven Wilson.Inter-American Development Bank Washington DC
Ratha, Dilip. 2006. "Trends, Determinants and Macroeconomic Effects of Remittance." Global Economic Prospects 2006: Economic Implications of Remittances and Migration Washington, DC: The International Bank for Reconstruction and Development / The World Bank.
Sander, Cerstin. 2003. "Migrant Remittances to Developing Countries: A Scoping Study: Overview and Introduction to Issues fro Pro-Poor Financial Services." Paper prepared for the UK Department of International Development (DFID). June.