Remittances and the informal economy

• Published in: Journal of development economics 2018-07, Vol.133, p.66-83
• Main Authors: Chatterjee, Santanu, Turnovsky, Stephen J.
• Format: Article
• Language: English
• Subjects: Capital mobility; Collateral effect; Dutch disease; Informal sector; Labor mobility; Real exchange rate; Remittances
• ISSN: 0304-3878; 1872-6089
• DOI: 10.1016/j.jdeveco.2018.02.002

Many developing countries are characterized by a large informal sector, and are also often heavily dependent on remittance inflows from abroad. We develop a general equilibrium framework to understand better the dynamic absorption of remittances in a two-sector small open economy, by incorporating many of the stylized features of the informal sector. Calibrating the model to yield a long-run equilibrium consistent with sample averages for 56 developing countries for the period 1990–2014, we show that the effect of remittances depends critically on how they impinge on the recipient economy, i.e., whether these inflows are (i) permanent or temporary, (ii) associated with a collateral effect to securitize borrowing, and (iii) exogenous or countercyclical. We also identify the conditions under which remittances are associated with an expansion of the informal sector, as well as the Dutch Disease effect. •The effects of remittances in the presence of an informal sector is analyzed.•The use of remittances as collateral to securitize debt is examined.•We identify conditions under which remittances lead to a Dutch Disease effect.•Impact depends on whether remittances are exogenous or countercyclical.•Countercylical remittances amplify the safety-net feature of self-employment in the informal sector.