Development Watch
by Tarron Khemraj
Several commentators have recently expressed the view that remittances are important for Guyana’s economic development. Indeed, one pro-government commentator noted remittances are “pivotal to development” (Misir 2009). Of course, the latter view is not altogether unfounded as there are several cross-country regression studies and reports from international organizations that tend to support that view. However, I am not convinced by these cross-country studies and will explain why it is misleading to extrapolate the conclusions of these studies to the Guyana context. I frame my arguments by taking into consideration the underlying structural characteristics of the Guyana economy. These structures mitigate the long-term positive effects remittances could have in our context. The key argument of this column is remittances are not pivotal to Guyana’s development but rather are engendered by our perpetual underdevelopment.
Confusing the long-term with the short-term
One of the misconceptions emanating from pro-government letter writers is they constantly fail to grasp the difference between long-term growth strategies and short-term stabilisation policies or mechanisms. As a result, remittances – which certainly have a favourable short-term effect by stabilising the local foreign exchange market – are seen as a positive for creating long-term growth and development. I would outline below how one can make erroneous conclusions when only focusing on the short-term.
Human capital and development
Guyana is considered to be one of the highest exporters in percentage terms of its skilled workforce. This outward migration depreciates the human capital base of the country. It is now a truism in economics that human capital is critical for the growth of the aggregate productivity of a nation. It is this growth in aggregate productivity that causes per capita GDP (real GDP divided by population) to grow over time. Moreover, it is the growth of aggregate productivity that enables a country to circumvent the diminishing production returns from sectors that have passed their productive prime decades ago. Some examples of sectors susceptible to diminishing production returns (per unit of labour and capital employed) in the Guyana context would be sugar, timber, rice and minimally processed bauxite – the core of the economy.
Human capital is also important for building suitable institutions that are critical for long-term growth (in economics institutions are things that reduce transaction costs and minimise societal inefficiencies; for instance, institutions can be laws, rules and the system of government). That institutions are critical for development is now conventional wisdom in economics. Talented home grown individuals, who understand the domestic circumstances (and not necessarily super-salaried foreign consultants), are required to run schools and hospitals, become university professors and researchers, supervise building infrastructures, conduct research relevant to the private sector, conduct analysis for government, run banks, etc.
Entrepreneurs are needed to build new productive sectors and take the economy away from the diminishing returns or low productivity sectors. These people are critical for changing the industrial landscape and breaking into new markets. Talents are required in private business to employ the researchers at the university level to seek solutions and new ways and techniques of production.
We can continue to enumerate the fundamental role human capital plays. But the key point is remittances are not enough to compensate for the immediate loss of human capital. The critical point, moreover, is if Guyana’s productivity continues to stagnate (as several studies have shown), then the perpetual status of underdevelopment will continue. Thus, while remittances may ease short-term foreign exchange constraints, the country is hurt at greater levels in the long-term by the dearth of entrepreneurs, innovators, researchers and administrators. In other words, the talents are not there to even optimally utilise the remittances.
Structure of production and multiplier effect
Professor Clive Thomas has long ago noted that Guyana imports a significant percentage of what it consumes, although this percentage has fallen over time. For instance, if we consult the Bank of Guyana statistics we will see the percentage of end-use consumer goods imports relative to the private consumption component of GDP to be 40% as at 2008. One has to be careful here, however, as imports cannot be part of Guyana’s GDP. But the point is the country continues to import a significant percentage of consumer goods that could probably be produced at home. The same conclusion can be made with respect to the imports of fuel and lubricants, which amount to 22.8% of GDP at end 2008. On the other hand, capital goods imports – things that go into the production process and stuff which the country cannot stop importing – amounts to 14.3% of GDP.
The reasons for citing these percentages are two-fold. First, a significant multiplier effect from remittances does not accumulate in the domestic economy but rather leaks out as imports of consumer goods and fuel. Therefore, remittances assuage short-term foreign exchange bottlenecks and furthermore furnish a false sense of success. Second, if government really has a long-term industrial strategy the country could save significantly from importing food and fuels that can be made at home. As it relates to fuel, I would argue for a renewable energy industrial policy framework utilising wind energy, ethanol and bagasse (the latter has already been in use in Skeldon but there is potential to generate many more MWs as Mauritius has shown) in the interim before hydro-electricity can come on stream. But then again the country would need the human capital and private entrepreneurs to pull this off as Mauritius has done.
Savings or investment constraint?
Several economists at the international stage have argued that remittances can increase domestic savings and promote financial deepening and intermediation in developing countries. However, I am quite sceptical of this view in the Guyana context. Indeed, I have noted in the past that remittances can contribute to the increase of bank deposits, excess bank reserves and domestic savings. But the latter does not imply the savings are channelled to investment projects with high rates of return. The main reason why an increase in domestic financial savings really does not matter has to do with the fact that business demand for investment rather than savings is likely to be the binding constraint (Rodrik and Subramanian 2009). Because investment demand is constrained, higher savings are just not intermediated or channelled into high productivity investments. As a result, we tend to see the society’s savings being channelled into foreign assets, excess liquidity and low productivity but safe traditional production sectors (Khemraj 2008).
Investment demand can be constrained for several reasons. First, poor institutions – which the economics literature has indicated as poor specification of property rights protection, weak contract enforcement, and fear of expropriation of profits by the State or some other entity or individual – retard investment demand (Acemoglu et al 2001; Rodrik et al 2004). In the case of Guyana, however, the notion of institution has to be widened to include a Constitution that is not suited to the bi-communal ethnic nature of the population. In addition, our current titivated 1980 Burnham Constitution has made it possible for the ruling party’s democratic centralism to create a paramount ruling structure over the private sector. In other words, while the PNC once used the army and paramilitary to enforce its party paramountcy; the current PPP government uses the supposed legitimacy of the conflict-generating Burnham Constitution to sustain its paramountcy (of course there are now other clandestine operations that became clear after the Roger Khan trials). Second, investment demand is constrained by the scarcity of entrepreneurs and limited human capital base that we have noted above is weakened by outward migration.
Third, investment demand is constrained by high lending rates and interest rate mark-ups over the cost of fund. This stems from the oligopolistic nature of banking in small economies like Guyana. One of my studies has also indicated a stable relationship between the investment in foreign assets by financial institutions and the existence of surpluses and shortages of hard currencies in the domestic foreign exchange market (Khemraj 2009). Therefore, to the extent remittances are channelled into foreign assets by financial institutions, the much touted multiplier effect of remittances is diminished.
Fourth, investment demand is constrained by the appreciation of the real exchange rate (Rodrik and Subramanian 2009) owing to the inflows of capital whether from short-term hot money inflows or more stable and altruistic remittance inflows. As an aside, one study has shown that Guyana’s remittance inflows are derived from altruistic motives (Agarwal and Horowitz 2002). When the real exchange rate appreciates, it impedes the competitiveness of the export sector – particularly new sectors not dependent on preferential prices. However, published data on Guyana’s real effective exchange rate indicate this latter constraint might not be as serious in the Guyanese context.
Remittances cannot replace FDIs
Several pro-government letter writers have implied that because remittances have surpassed FDIs it should be seen as a critical source of development funds. But we need to get
perspectives straight. Although remittances aggregate to be larger than FDIs, they enter the economy in small units that go directly to families and individuals to prop up private consumption. We have already noted several reasons why the production multiplier effect of remittances is dampened. In other words, these micro quantities are never aggregated into a large high productivity investment project.
On the other hand, FDIs are lumpy and go directly to the production enterprise for which they are intended. FDIs engender direct job creation from which taxes are raised by the State. Remittances are not taxed directly and some economists have actually noted that these inflows could lead to an incentive to reduce work effort by people (in other words some people might prefer to wait on the next handout from abroad rather than seek work). FDIs can have a direct and profound positive effect on development if the government has a clearly defined industrial policy framework (see Lall 2004 for experiences around the world with integrating FDIs with an industrial policy framework). If the government really knows what it wants, FDIs could lead to technology transfers, bring in new management skills, and provide a direct boost for a renewable energy industrial strategy. The latter cannot be gained by the multiple small inflows of remittances as there is no existing mechanism that serves to pool together remittance inflows for large scale development projects.
Political economy issues
The local elites and friends of the ruling semi-oligarchy certainly would find remittances to be beneficial. Perhaps this explains why they have tended to conflate the long-term with the short-term when it comes to the true benefits. Remittances provide a stable source of foreign exchange, which enable those who are elected in an ethnically bi-communal society to be able to further divorce themselves from the public facilities. They are able to obtain immediate foreign exchange to send children to foreign universities; they can seek medical help from abroad; they can remit funds abroad; and overall divorce themselves from the local reality. Overall, remittances, provide a false sense of success given the stable and altruistic nature of the flows; and importantly these inflows could very well postpone the need for serious political reforms.
A better role for the Diaspora
Instead of viewing the Diaspora’s role as one of financing private consumption through remittances (and of course contributions at election time), it would be better for the government to come up with a comprehensive plan to engage the Diaspora. This can include knowledge transfer (brain gain or brain circulation), inward Diaspora investments and even special Diaspora financial products.
Conclusion
The remittance phenomenon is a reflection of Guyana’s perpetual underdevelopment rather than a cause of development. The poverty that remittances might reduce in the short-term is caused by Guyana’s production of things that are not important in the global continuum of products. As we have noted above, remittances cannot correct and transform this production structure without a clear and realistic development strategy by the government. Therefore, any short-term reduction in poverty via the subsidy on private consumption – without production transformation – is false success. Also, many government representatives see remittances as beneficial because they confuse short-term stabilisation with long-term production oriented policies.
References
Acemoglu, Daron; Simon Johnson and James A. Robinson. 2001. The colonial origins of comparative development: an empirical investigation. The American Economic Review 91 (5): 1369-1401.
Agarwal, Reena and Andrew Horowitz. 2002. Are international remittances altruism or insurance? Evidence from Guyana using multiple-migrant households. World Development 30 (11): 2033-2044.
Khemraj, Tarron. 2009. Excess liquidity and the foreign currency constraint: the case of monetary management in Guyana. Applied Economics 41 (16): 2073 – 2084.
Khemraj, Tarron. 2008. The missing link: the finance growth nexus and the Guyanese growth stagnation. Social and Economic Studies 57 (3&4): 105-129.
Lall, Sanjaya. 2004. Selective industrial and trade policies in developing countries: theoretical and empirical issues. In: S. Soludo; O. Ogbu and H. Chang (editors), The Politics of Trade and Industrial Policy in Africa: Forced Consensus? Trenton NJ: Africa World Press.
Misir, Prem. 2009. Remittances are pivotal to development. Kaieteur News, June 25, Letter Column.
Rodrik, Dani and Arvind Subramanian. 2009. Why did financial globalization disappoint? IMF Staff Papers 56 (2): 112-138.
Rodrik, Dani; Arvind Subramanian and Francesco Trebbi. 2004. Institutions rule: the primacy of institutions over geography and integration in economic development. Journal of Economic Growth 9: 131-165.
