South African Journal

of Economics
South African Journal of Economics Vol. 0:July 2018

IS THE RELATIONSHIP BETWEEN REMITTANCES AND

POLITICAL INSTITUTIONS MONOTONIC? EVIDENCE
FROM DEVELOPING COUNTRIES
KEVIN WILLIAMS*

Abstract
Remittances have become one of the most important sources of household income in developing
countries, empowering recipients to be more politically independent. Using a dynamic estimator
and panel data for 84 developing countries over the 1982–2011 period, this paper investigates the
effect that remittances have on political institutions. Controlling for country and time fixed effects
and using an exogenous source of variation to instrument remittances, the baseline results show
that remittances start having a positive effect on democratic institutions when remittances reach
22% of GDP. This evidence suggests that remittances can influence the relationship between
recipients and political elites, providing incentives for recipient households to hold their political
representatives more accountable.
JEL Classification:  F24, F2, D72
Keywords:  Remittances, democratic institutions, system‐GMM

1. INTRODUCTION

This paper investigates the effect that the large and persistent inflows of migrant
remittances have on political institutions in developing countries. Remittances, finan-
cial resources sent by migrant residents from abroad, have increased significantly over
the past three decades, from US$47 billion in 1980 to US$426.40 billion in 2013 and
are p­ rojected to reach US$429 billion in 2016 (World Bank, 2017). These large capital
inflows are a stable source of foreign income for developing countries and they have
­important effects on political institutions, but also on recipient households’ welfare.
At the household level, Acosta et al. (2008) and Gupta et al. (2009) demonstrate that
remittances reduce poverty in Latin America and Sub‐Saharan Africa (SSA), respectively.
Although the evidence is mixed, on the macroeconomic front, remittances can improve
economic growth (Giuliano and Ruiz‐Arranz, 2009; Ahamada and Coulibaly, 2011;
Hassan et al., 2016) and financial development in developing countries (Williams, 2016).

*Corresponding author: Lecturer, Department of Economics, The University of the West

Indies, St. Augustine, Trinidad and Tobago. E-mail: Kevin.Williams@sta.uwi.edu or
Kev_Williams2000@yahoo.com

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On the political level, the heart of this paper, international migrants are increas-
ingly using their remittances to influence political reforms in their country of origin
(O’Mahony, 2013). They do so by funding legitimate political parties that support dem-
ocratic institutions or by funding irregular forces with the aim of replacing autocratic
incumbent (Collier and Hoeffler, 2004; Mascarenhas and Sandler, 2014). Because of
the sizable financial resources available to international migrants, both opposition and
incumbent government compete for the support of their diaspora. Aware of the politi-
cal leverage that their remittances entail, international migrants are able to play a more
central role in domestic politics. For example, Mexicans residing in the U.S. can now
participate in presidential elections as absentee voters. They won this concession in part
because of the contribution of their remittances to the macroeconomy and to other social
programmes at the local level (Adida and Girod, 2011).
Motivated by the large inflows of migrant remittances (15% of GDP on average), there
is an ongoing debate in Jamaica whether members of the diaspora should have an elected
representative in the House of Parliament (Alleyne et al., 2008). In Jamaica the two
major political parties also compete for the financial backing of the diaspora community.
Given the key role that money plays in national elections in developing countries, inter-
national migrations can use their remittances to influence the outcome of an election.
Hence, through their remitted income, international migrants exert enormous influence
in domestic politics of their country of origin.
By investigating the impact that migrant remittances have on political institutions
in developing countries, this paper advances debate on the role of remittances in politi-
cal reforms. With their huge financial resources and experience in democracies abroad,
the impact of international migrants’ remittances on domestic politics sends a powerful
message that it does not require a foreign power using military intervention to transform
the political landscape in developing countries from an autocratic regime to a democratic
regime. Combining their political views with remittances, international migrants can
potentially shape the political culture of their country of origin.
However, developing countries have generally poor democratic institutions. The mod-
ernisation literature argues that per capita income is positively related to democratic
institutions (Barro, 1999). Since remittances are an alternative source of income, under-
standing the effect that remittances have on democratic institutions can create an avenue
to improve democratisation in developing countries. And because democratisation pro-
motes economic growth (Acemoglu et al., 2014), developing countries can possibly reap
this growth dividend.
To test the relationship between remittances and political institutions, the paper uses
five‐year panel data for 84 developing countries over the 1982–2011 period within a dy-
namic estimation setting. This panel data framework enables control for country fixed
effects, an important step towards identifying consistent estimates of the relationship
between remittances and political institutions. Country fixed effects control for time‐in-
variant country‐specific factors that jointly affect remittances and political institutions.
An issue with estimating the effect of remittances on political institutions is the pos-
sibility of political institutions themselves affecting remittances. For example, interna-
tional migrants may leave their country of origin because of poor political conditions
and in turn send money home to fund political parties that support democratic insti-
tutions. To address this endogeneity, the paper uses lagged real GDP per capita income

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gap between each country in the panel data and that of the U.S. as an instrument for
remittances (Chami et al., 2005; Feeny et al., 2014). As the income gap between remit-
tance‐receiving developing countries and that of the U.S. increases more remittances are
expected to flow to developing countries. This identification strategy is consistent with
the countercyclical feature of remittances (Frankel, 2011).
The main finding from the panel data analysis suggests that remittances have a statisti-
cally significant effect on democratic institutions in developing countries. The baseline es-
timates indicate a U‐shaped relationship between remittances and democratic institutions.
Specifically, remittances start yielding a positive effect on democratic institutions when re-
mittances research 22% of GDP. Importantly, this central finding is robust to controlling
for country and time fixed effects, alternative model specifications that control for a range
of confounders that other studies found to be correlated with democratic institutions,
different measures of democratic institutions, three‐year, five‐year and annual panel data.
A straightforward explanation of this U‐shaped relationship is that because remit-
tances are an independent source of foreign income that are used to improve house-
hold welfare, as they increase, recipients become less dependent on political patronage
(which tend to weaken democratic institutions). By providing a substitute for political
patronage, remittances empower recipients to demand better governance from political
elites. Notably, because remittance inflows weaken the clientelistic relationship between
political elites and remittance recipients (Pfutze, 2014), the cost (being removed from of-
fice) faced by governments for undermining democratic institutions will likely increase.
Given that governments want to remain in office, they consider this cost in their utility
function and thus work to improve political institutions.
The current paper is closely related to recent studies that examine the economic im-
pact of remittances. Hassan et al. (2016) estimate a growth model and also find a U‐
shaped relationship between remittances and economic growth in Bangladesh. Ajide et
al. (2017) use panel on 70 countries and the system Generalized Method of Moments
estimator and show that remittances reduce the volatility of investment and that in-
stitutions mediate the impact that remittances have on the volatility of investment. In
their contribution, Ssozi and Asongu (2016) use data on 31 sub‐Saharan African coun-
tries and document a positive effect of remittances on physical capital, human capital
and productivity, with heterogeneous effect across low‐ and middle‐income countries.
Unlike these studies, however, the current paper’s main contribution is to investigate the
political consequences of remittances and demonstrates that the effect of remittances on
political institutions is non‐monotonic.
The remainder of the paper is organised as follows. Section discusses related litera-
ture. Section discusses the econometric model and data. Section presents the economet-
ric results. Section presents further robustness checks. Section concludes. Descriptive
statistics, the list of countries used in the analysis and first differenced GMM estimates
are reported in the appendix.

2.  RELATED LITERATURE

On the empirical front, Tyburski (2012) employs data from Mexico and finds that remittances
enable recipients to bring democratic pressures on state officials to reduce corruption and in turn
improve governance. Historically, the autocratic Institutional Revolutionary Party dominates

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state power in Mexico. It does so by distributing public resources as political patronage to it sup-
porters. Recent evidence, however, shows that this control mechanism has been broken by remit-
tances. For example, Pfutze (2012) presents evidence that in Mexico, municipalities with higher
share of migrant households tend to improve democratisation by voting against the entrenched
Institutional Revolutionary Party. One explanation offered by Pfutze (2012) is that remittances
undermine the clientelistic–state relationship by making it more costly for remittance recipients
to be captured by political elites. Using a large panel data comprising 133 developing coun-
tries, Deonanan and Williams (2017) show that remittances improve democratic institutions.
Additionally, the authors demonstrate that the impact of remittances is stronger when govern-
ment spending is low.
Counterbalancing the above studies, the literature also points to the possibility that
remittances can make developing countries less democratic. The reason is that by aug-
menting household income, remittance recipients could decide to purchase public goods
and services through private markets, which eliminates the political pressures for govern-
ments to provide these public goods and services. This lack of political pressures creates
incentives for political elites to undermine democratic institutions through, for example,
wasteful expenditures on public infrastructure and patronage employment. Abdih et al.
(2012) develop a theoretical framework illustrating that remittances harm democratic in-
stitutions. They confirm this theoretical prediction in a large sample of countries. Using
a more robust instrumental variables approach in a dynamic setting, Ahmed (2012,
2013) also show that remittances impede democratic institutions.
Although some of the above papers use similar econometric approach and panel data
(Abdih et al., 2012; Ahmed, 2012, 2013; Deonanan and Williams, 2017), this paper
is the first attempt to provide empirical evidence on the non‐monotonic relationship
between remittances and political institutions in developing countries. This approach
provides an important contribution to the literature that examines the effect that remit-
tances have on democratic institutions. Failure to take account of the non‐monotonic
effect of remittances on political institutions may possibly explain the divergent evidence
in the literature.
This study further contributes to another strand of the literature that examines the
macroeconomic effects of remittances. The macroeconomic effects of remittances are the
subject of a voluminous literature. Here, this paper discusses the most recent contribu-
tions. There is much controversy in the literature whether remittances promote economic
growth. Theoretically, there are plausible reasons to expect remittances to enhance eco-
nomic growth in developing countries: they expand aggregate demand through higher
consumption levels; they enable a larger pool of savings to be available for investment;
and they allow recipients to invest in education and access better health care, improving
their human capital. Some recent studies using different econometric approaches and
different samples and time‐periods find that remittances are positively associated with
economic growth (Catrinescu et al., 2009; Feeny et al., 2014; Jawaid and Raza, 2016;
Lartey, 2017; Williams, 2017).
In contrast, there are also several reasons why it should not be surprising if remittances
are not significantly associated with economic growth in developing countries: much of
the increased flows of remittances arise from better ways of capturing remittances and
not actual increases in remittances; conventional statistical techniques are not powerful
to detect any significant effect of remittances; and the negative effect of out‐migration

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in developing countries offset the growth effect of remittances (Clemens and McKenzie,
2014). Chami et al. (2005) and Barajas et al. (2009) are two widely cited studies that
find no significant link between remittances and growth. In addition to differences in
questions and using a more robust econometric technique, the current paper conducts
a battery of sensitivity checks that confirms a concave effect of remittances on political
institutions.
The finding of a significant relationship between remittances and democratic insti-
tutions makes this paper also related to the modernisation literature. The key feature
of this literature, that as countries become richer they develop stronger democracy, is
highlighted in important contributions (Dahl, 1971; Huntington, 1991). Cross‐coun-
try evidence presented by Barro (1999) supports the positive link between income per
capita and democratisation. Using a more robust estimator, Acemoglu et al. (2008) cast
doubt on this cross‐country evidence. While the modernisation literature emphasises
the impact of income per capita, this paper sheds novel light on the effect of remittances
on democratic institutions. The paper follows closely the models in Barro (1999) and
Acemoglu et al. (2008), but what sets the current paper apart is that it focuses on the
effect of remittances instead of per capita income.

3.  ECONOMETRIC MODEL AND DATA

This section presents the data and the empirical model used to examine the effect that remit-
tances have on democratic institutions. The paper estimates the following reduced form dynamic
panel data model
2 �
di ,t = 𝛼di ,t −1 + 𝛾yi, t −1+ 𝜙Ri , t −1+ 𝛿R
i , t −1
+ xi, t −1 𝛽 + 𝜇t + 𝜎i + ui , ,t
(1)

where di,t is democracy score of country i at time t. The lagged dependent variable
di,t–1 captures persistence and mean‐reverting dynamics, that is, the democracy score for
country i will converge to some equilibrium value. The variable yi,t–1 is the lagged value
of log income per capita (constant 2000 US$) and is the key variable in the moderni-
sation hypothesis, which argues that rich countries are likely to be more democratic in
comparison to poor countries. The modernisation control variables are included in the
vector xi,t‐l : the sum of imports and exports as a percentage of GDP; the percentage of
the total population living in urban areas; life expectancy at birth; and education at the
secondary level.
Barro (1999) and Acemoglu et al. (2008) use different variants of equation (1) to
examine the impact of per capita income on political institutions, the modernisation
hypothesis. Barro (1999) shows that high‐income countries tend to be more democratic.
Barro’s (1999) cross‐country finding was overturned by Acemoglu et al. (2008) when
country fixed effects were introduced in the model. This paper builds on their models by
including remittances share of GDP in equation (1).
To capture the effect of remittances on democratic institutions, the paper includes in
equation (1) lagged remittances share of GDP Ri,t–1. The paper also includes in equa-
tion (1) lagged remittances squared R 2i,t–1, to examine whether the relationship between
remittances and democratic institutions is non‐monotonic. Arcand et al. (2015) use a

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similar approach to estimate the non‐linear effect of financial deepening on economic

growth, as well as Easterly et al. (2000) and Kose et al. (2003) who investigate the effect
of financial openness on macroeconomic volatility. Remittances are the sum of workers’
remittances and compensation of employees divided by GDP. The time fixed effects μt
control for time‐specific shocks that affect all countries, such as global business cycles
and other political events such as the fall of the Berlin Wall. Country fixed effects 𝜎i
control for differences across countries in ethnicity, geography and other time‐invariant
country‐specific factors. Omitted factors and transitory shocks to democracy are con-
tained in the error term ui,t. The modernisation control variables and workers’ remit-
tances are from the World Bank (2014), World Development Indicators.
The paper follows the literature and uses the Freedom House Political Rights Index
as the main measure of democratic institutions. The Political Rights Index is one of the
most readily available and widely used measures of democratic institutions (Barro, 1999;
Acemoglu et al., 2008; Deonanan and Williams, 2017). The Freedom House Political
Rights Index is based on a 1–7 scale; one is the highest Political Rights Index score.
Countries score high when they have free and fair elections; when candidates who are
elected actually rule; when political parties are competitive; when opposition parties are
allowed to function; and when minority groups have reasonable self‐government or can
participate in the government through informal consensus.
For ease of interpretation, the paper follows Barro (1999) and normalises the Freedom
House Political Rights Index to range from zero to one, with higher values indicat-
ing stronger democratic institutions. The key advantage of using the Freedom House
Political Rights Index (as the main measure) over the Polity2 Index, another widely used
measure of democratic institutions, is that it provides information on a larger number of
countries. The Polity2 Index does not provide information on countries with population
below 5000, in particular Small Island Developing States, though the main result does
not depend on the choice of the democratic institutions measure.
The empirical analysis uses five‐year unbalanced panel data covering 84 developing
countries, representing all regions of the world, over the period 1982–2011.1 As robust-
ness check against five‐year data, the paper also uses three‐year panel data. The paper
uses non‐overlapping five‐year and three‐year intervals because averaged data introduced
serial correlation in the estimation, making inferences problematic (Acemoglu et al.,
2008, 2014).2 Five‐year and three‐year data smooth cyclical fluctuations associated with
annual data. Tables 1A and 2B in the appendix present descriptive statistics for three‐
year and five‐year panel data and the list of countries, respectively.
To obtain unbiased estimates of the effect of remittances on democratic institutions
requires an estimator that models the dynamics of democratic institutions (that is, lagged
democratic institutions di,t–1) and also addresses potential endogeneity arising from re-
verse causality between democratic institutions and all the control variables, including
remittances. Using observational data from the World Bank, least squares estimator is
unlikely to produce unbiased estimates of the relationship between remittances and
democratic institutions.
1 
The analysis begins in 1982 because of limited data for remittances for most countries.
2
 Acemoglu et al. (2014) showed that five‐year averaged data introduced additional serial
­correlation in panel data.

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The paper therefore employs the Arellano and Bover (1995) and Blundell and Bond
(1998) system Generalized Method of Moments (GMM) dynamic panel estimator to
estimate equation (1). The system GMM3 models the dynamics of democratic institu-
tions and controls for potential endogeneity of other regressors using lags as instruments
for these regressors.4 In particular, remittances could be influenced by political condi-
tions in the country of origin. For example, migrants may leave their home countries
because of unstable political conditions (or because they do not support a regime) and in
turn send money home to influence political outcomes. The system GMM dynamic
panel estimator uses lagged first differences of remittances to instrument the equation in
levels and lagged levels of remittances to instrument the equation in first differences.
The system GMM therefore alleviates concerns that lagged remittances are reacting to
democratic institutions.
However, the system GMM has one important problem. The additional orthogonal-
ity conditions tend to increase the instrument count and, as a result, can weaken the
diagnostic tests. To tackle this issue, the paper limits the number of instruments to three
lags (Roodman, 2009).5 The paper also presents estimates using “external instrument” in
the system GMM6 to instrument remittances. Robust standard errors are computed with
the Windmeijer (2005) finite sample correction. Notice that by including country fixed
effects in equation (1), the effect of remittances on democratic institutions is identified
from within‐country variations in the data.

4.  EMPIRICAL RESULTS

In this section, the paper starts the analysis by reporting, in Appendix Table 3C, estimates using
the first differenced GMM. Looking across model specifications, the estimated coefficients on
lagged democracy and lagged income are generally statistically insignificant. Likewise, the remit-
tances variables are statistically insignificant. These estimates must be interpreted with caution.
The first differenced GMM uses lagged levels as instruments in the first differenced model. As
noted above, the system GMM, however, combines in a system the model in first differences
with the model in levels and uses lagged levels as instruments in the first differences model and
lagged differences as instruments in the model in levels. The system GMM asymptotically pro-
duces more reliable estimates (Wooldridge, 2010; Baltagi, 2013). In the rest of this section, the
paper presents estimates using the more efficient system GMM estimator.
Table 1 presents the baseline estimates using the Freedom House Political Rights
Index as the dependent variable and remittances Ri,t–1 and remittances squared R 2i,t–1 as

3 
Nickell (1981) shows that as T>15 the bias of the lagged dependent variable goes to 0. The sys-
tem GMM is appropriate for large N. I thank the anonymous associate editor for this
suggestion.
4 
An advantage of using the system GMM over traditional IV estimator is that it enables to treat
all independent variables as endogenous, though the paper lagged all right‐hand side variables
one period, that is, 5‐year and 3‐year lags. Importantly, the system GMM allows to exploit the
time‐series dimension of the data.
5 
The number of instruments should not exceed the number of cross‐section (Roodman, 2009).
6 
The system GMM does not address measurement errors arising from unofficial flows of remit-
tances. A large share of remittances passes through unofficial channels.

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Table 1.  The effect of remittances on democratic institutions. Dependent variable: Freedom
House Political Rights Index
(1) (2) (3) (4) (5) (6)
Democracyt–1 0.703*** 0.730*** 0.813*** 0.811*** 0.734*** 0.895***
(0.071) (0.071) (0.092) (0.083) (0.072) (0.055)
Log Income t–1 0.064** 0.055* 0.036 0.041 0.075*** 0.010
(0.031) (0.031) (0.036) (0.038) (0.027) (0.018)
Remittancest–1 0.001 −0.018** 0.003** −0.005*
(0.003) (0.009) (0.001) * (0.002)
Remittances 2t–1 0.0004**
(0.000)
0.0001***
(0.000)
Panel data Five‐year Five‐year Five‐year Three‐year Five‐year Three‐year
Time fixed effect Yes Yes Yes Yes Yes Yes
Country fixed effect Yes Yes Yes Yes Yes Yes
Hansen test 0.96 0.60 0.57 0.48 0.90 0.71
(p‐value)
AR (1) (p‐value) 0.00 0.00 0.00 0.00 0.00 0.00
AR (2) (p‐value) 0.22 0.11 0.12 0.83 0.57 0.47
Number of 417 354 290 747 639 513
observations

Notes: The method of estimation is system GMM. Numbers in parentheses are robust standard
errors.
2
*, **, and *** denote significance at 10%, 5% and 1%, respectively. All regressors are treated as
endogenous across five‐year and three‐year panels. System GMM uses maximum 3 lags as in-
struments. Standard errors are computed with the Windmeijer (2005) finite‐sample correction.
Hansen test is the p‐value for the null hypothesis of instrument validity. AR (1) and AR (2) are
p‐values for first‐ and second‐order autocorrelated disturbances in the differenced equation.
Five‐year is observation every fifth year and three‐year is observation every three years.

the key independent variables. Columns 1–3 use five‐year panel data and columns 4–6
use three‐year panel data as robustness check against columns 1–3. The results show that
the estimated coefficient on the lagged dependent variable di,t–1 is positive and statisti-
cally significant at conventional levels, indicating that the history of democratic insti-
tutions matters for current democratic institutions. The estimated coefficient on lagged
income yi,t–1 has a significant positive effect on democratic institutions, contradicting the
evidence documented in Acemoglu et al. (2008) when country fixed effects are included
in their regressions. In columns 2 and 5, the estimated coefficient on remittances is posi-
tively associated with democratic institutions, but statistically significant at conventional
levels in column 5 only.
Columns 3 and 6 of Table 1 explore the non‐monotonic effect of remittances on dem-
ocratic institutions by including the quadratic term R 2i,t–1 in the model specifications.
Remittances and remittances squared are both statistically significant at conventional
levels. The sign on the linear term Ri,t–1 is negative and the sign on the quadratic term
R 2i,t–1 is positive, together suggesting a U‐shaped relationship between remittances and

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democratic institutions. The quantitative magnitude of these estimates implies that with
five‐year panel data remittances start having a positive effect on democratic institutions
when remittances reach 22.5% of GDP.
To put this estimate into perspective, only about 7% of the sample approaches this
threshold. Majority of the sample lies on the left side of the U‐shaped impact of remit-
tances. For these countries, remittances can have a negative effect on democratic institu-
tions. In 2006, Honduras remittances share of GDP was 22% and it had political rights
score of 0.667 on a scale of 0–1(1 indicates the highest political rights). In 2011, Lesotho,
a country that is highly dependent on remittances, had remittance inflows of 26% of
GDP. In the same year, Lesotho was highly democratic, a political rights score of 0.667.
Although Jordan is less democratic, a score of 0.5 on the political rights index in 1997, its
remittance inflows were 25% of GDP. Some countries that lie on the left side of the U‐
shaped effect of remittances also have strong democratic institutions. For example,
Jamaica, Botswana, and Cape Verde do not exceed the 22% threshold, notwithstanding
they enjoy extensive political rights. However, there are countries with low remittance
inflows that also have low political rights score, for example, Algeria, Burkina Faso, and
Burundi.7
The main finding is robust to using three‐year panel data, which yields a significant
positive effect on democratic institutions when remittances reach 25% of GDP. We can
therefore reject the hypothesis that remittances are not significantly associated with dem-
ocratic institutions in developing countries. Notice the slight difference in the quanti-
tative magnitudes of the U‐shaped effect of remittances across the two panel data. This
difference may be explained by the different panel intervals. The row with the Hansen
test reports p‐values for instrument validity.
In all model specifications the null hypothesis of instrument validity is not rejected.
The AR (1) and AR (2) p‐values are first‐ and second‐order autocorrelated disturbances
in the first differenced equation, respectively. There is first order autocorrelation, as ex-
pected, but no‐second‐order autocorrelation. The p‐value for the Hansen test and the
p‐value for the test of no‐second‐order autocorrelation in the first differenced equation
suggest that the estimates are not affected by misspecification bias. Additionally, the esti-
mates are not biased due to the unit root process, a key assumption for the system GMM
to produce consistent estimates. It is noteworthy that across all model specifications in
Table 1 the estimated coefficient on lagged democratic institutions di,t–1 is below one,
suggesting that the econometric model is not misspecified. This continues to be the case
for all model specifications in this paper.
The main conclusion from the baseline estimates in Table 1 is that the within‐country
effect of remittances on democratic institutions becomes positive, depending on the
panel interval, at 22.5% or 25% of GDP.8 To ensure the results are not driven by the
five‐year or three‐year panel data, Table 2 presents estimates using annual panel data.

7 
I thank the anonymous associate editor for suggesting this analysis.
8
  The paper re‐estimates the model specifications in Table 1 using dynamic fixed effect estima-
tor and static cross section OLS estimator. In all cases the remittance variables are statistically
insignificant. These estimators suffer from the Nickell (1981) bias and endogeneity arising from
reverse causality. Results are available from the author upon request.

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These estimates are qualitatively similar to those in Table 1: remittances start having a
significant positive effect on democratic institutions at 30% of GDP.
The model specifications in Table 1 do not control for the full set of time‐varying
variables that other studies show are correlated with democratic institutions. The mod-
ernisation literature argues that trade, urbanisation, life expectancy at birth and educa-
tion are determinants of democratic institutions (Barro, 1999; Acemoglu et al., 2008;
Berger et al., 2013). If these variables are determinants of democratic institutions, omit-
ting them from the regressions in Table 1 would bias the effect of remittances on dem-
ocratic institutions.
To address this potential omitted variable bias, in Table 3, the paper includes the full
set of modernisation control variables. The study adds in sequentially the modernisation
control variables to test the robustness of the U‐shaped relationship between remittances
and democratic institutions. The regressions in Table 1 use three lags of remittances to
control for potential endogeneity arising from reverse causality between remittances and
democratic institutions.
Other studies attempt to identify the exogenous variation of remittances using exter-
nal instruments. Unfortunately, there is no consensus in the economic literature on a
valid external instrument for remittances. Different studies use different instruments for
remittances. Moreover, when instrumenting for remittances these studies rarely consider
potential endogeneity of the other right‐hand side control variables. This paper builds
on these studies by addressing this potential bias by treating all right‐hand side variables
as endogenous in the system GMM dynamic panel estimator. A major advantage of

Table 2.  The effect of remittances on democratic institutions. Dependent variable: Freedom
House Political Rights Index. Annual panel estimates
(1) (2) (3)
Democracyt–1 0.972*** 0.887*** 0.884***
(0.033) (0.090) (0.086)
Log Incomet–1 0.007 0.028 0.033
(0.008) (0.024) (0.023)
Remittancest–1 0.001 −0.006***
(0.001) (0.002)
2
Remittances t–1 0.0001***
(0.000)
Time fixed effect Yes Yes Yes
Country fixed effect Yes Yes Yes
Hansen test (p‐value) 0.75 0.87 0.87
AR (1) (p‐value) 0.00 0.00 0.00
AR (2) (p‐value) 0.74 0.61 0.60
Number of observations 1416 1193 1193

Notes: The method of estimation is system GMM. Numbers in parentheses are robust standard
errors. *** denotes significance at the 1% level. All regressors are treated as endogenous. Standard
errors are computed with the Windmeijer (2005) finite‐sample correction. Hansen test is the p‐
value for the null hypothesis of instrument validity. AR (1) and AR (2) are p‐values for first‐ and
second‐order autocorrelated disturbances in the differenced equation.

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the system GMM dynamic panel estimator is that it enables to include external instru-
ments in the instrument set in addition to lags (internal instruments) of the independent
variables.
The paper follows Feeny et al. (2014)9 and uses lagged log GDP per capita income gap
between each country‐year observation in the panel data and that of the U.S. as an ex-
ternal instrument to instrument remittances. Chami et al. (2005) also use this instru-
ment to examine the effect of remittances on growth. Feeny et al. (2014) and Chami et
al. (2005) show that lagged log GDP per capita income gap between the U.S. and remit-
tance‐receiving developing countries is a suitable instrument for remittance flows to
developing countries. The paper’s aim in employing this instrument is to improve the
robustness of the estimated coefficient on the U‐shaped relationship between remit-
tances and democratic institutions.
The identification assumption of this external instrument is that one should expect
migrants to send more remittances home when home country income is relatively de-
pressed, which is consistent with the compensatory hypothesis of remittances. Further,
there is no reason to expect the income gap between remittance‐receiving developing
countries and remittance‐sending developed countries to directly affect democratic
institutions in remittance‐receiving developing countries, except through remittances
when recipients experiencing higher income may be empowered to refuse government
hand‐outs thus weaken clientelistic politics and, as a result, strengthen democratic in-
stitutions in developing countries. The paper checks the validity of this external instru-
ment with the Hansen test. Table 3 reports estimates using the system GMM estimator,
including the full set of modernisation control variables and the external instrument for
remittances.
As reported in Table 1, lagged democracy di,t–1 is a significant determinant of current
democracy di,t. Rich countries tend to be more democratic. The estimated coefficient
on lagged income yi,t–1 is positive and statistically significant at conventional levels. The
estimated coefficient on the linear remittances variable Ri,t–1 is consistently negative and
generally statistically significant across model specifications. The estimated coefficient
on remittances squared R 2i,t–1 is positive and statistically significant. The modernisa-
tion control variables are statistically insignificant and, quantitatively, they do not affect
the U‐shaped relationship between remittances and democratic institutions. Berger et
al. (2013) also find no evidence of a statistically significant effect of the modernisation
control variables on democratic institutions.
Columns 1 and 6 of Table 3 are similar to the baseline estimates in Table 1. The only
exception is that in Table 3 remittances are instrumented with lagged log income gap
between each country‐year observation and that of the U.S. With this external instru-
ment, the effect of remittances on democratic institutions is statistically significant in
model specifications 1 and 6. This continues to be the case even after including the full
set of control variables. Conditional on the modernisation control variables, remittances

9 
Feeny et al. (2014) also use the interest rate gap between the U.S. and their country sample.
They find that the interest rate gap and the income gap do not perform well in their IV regres-
sion. The paper uses the income gap between the U.S. and each country because it provides a
better instrument for remittances, perhaps because the paper uses a different estimator system
GMM and also treats all independent variables as endogenous.

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Table 3.  The effect of remittances on democratic institutions. Dependent variable: Freedom House Political Rights Index
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Democracy t–1 0.779*** 0.790*** 0.788*** 0.806*** 0.788*** 0.842*** 0.865*** 0.845*** 0.866*** 0.902***
(0.048) (0.049) (0.048) (0.049) (0.078) (0.028) (0.030) (0.032) (0.044) (0.063)
Log Incomet–1 0.035*** 0.035*** 0.046*** 0.032 0.007 0.028*** 0.029*** 0.041*** 0.005 0.053
(0.012) (0.010) (0.016) (0.026) (0.058) (0.006) (0.007) (0.012) (0.015) (0.061)
Remittancest‐– −0.018* −0.007* −0.008** −0.008* −0.016** −0.003* −0.002 −0.002 −0.004 −0.006
(0.010) (0.004) (0.004) (0.004) (0.007) (0.002) (0.002) (0.002) (0.003) (0.004)
Remittances 2t–1 0.0004** 0.0002** 0.0002*** 0.0002** 0.0004*** 0.0001*** 0.0001*** 0.0001*** 0.0001*** 0.0002***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
Tradet–1 −0.0003 −0.0003 −0.0002 −0.002 −0.0004 −0.0004 0.0003 −0.0003
(0.001) (0.001) (0.001) (0.001) (0.000) (0.000) (0.001) (0.001)

© 2018 Economic Society of South Africa. 

Urabanzsatio– t‐1 −0.001 −0.0002 −0.002 −0.001 −0.0002 −0.002*
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
Life expectancy t– 0.001 0.004* 0.003 −0.001
(0.002) (0.003) (0.002) (0.003)
Schoolingt–1 0.002 −0.002
(0.003) (0.003)
Panel data five‐year five‐year five‐year five‐year five‐year three‐year three‐year three‐year three‐year three‐year

12
Time fixed effect yes yes yes yes yes yes yes yes yes yes
Country fixed yes yes yes yes yes yes yes yes yes yes
effect
Hansen test 0.61 0.55 0.62 0.78 0.66 0.74 0.60 0.34 0.79 0.90
(p‐value)
South African Journal of Economics Vol. 0:July 2018

AR (1) (p‐value) 0.00 0.00 0.00 0.00 0.27 0.00 0.00 0.00 0.00 0.00
AR (2) (p‐value) 0.12 0.12 0.12 0.12 0.32 0.56 0.54 0.55 0.52 0.78
Observations 354 354 354 344 196 639 639 639 501 359
Notes: The method of estimation is system GMM. Numbers in parentheses are robust standard errors. *, **, and *** denote significance at 10%, 5% and
1%, respectively. All regressors are treated as endogenous across five‐year and three‐year panels. Lagged log GDP per capita income gap between home
country and that of the U.S. is used as external instrument for remittances. The system GMM uses three lags as instruments for independent variables.
Standard errors are computed with the Windmeijer (2005) finite‐sample correction. Hansen test is the p‐value for the null hypothesis of instrument
validity. AR (1) and AR (2) are p‐values for first‐ and second‐order autocorrelated disturbances in the differenced equation. Trade is the sum of imports
and exports as a percentage of GDP, urbanisation is the percentage of the population living in urban areas, life expectancy is life expectancy at birth and
schooling is gross secondary school enrolment. Five‐year is observation every fifth year and three‐year is observation every three years.
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South African Journal of Economics Vol. 0:July 2018

promote democratic institutions. Using model specification 5 in the five‐year panel data
as the preferred model specification, quantitatively, the effect of remittances on demo-
cratic institutions yields a positive impact at 20% of GDP. The size of this effect is close
to the baseline estimates in model specification 3 of Table 1 (22.5%). The model spec-
ification tests (AR (2) and Hansen) indicate no‐second‐order autocorrelation and the
instruments are valid across five‐year and three‐year panel data, evidence supporting the
external instrument for remittances.
The estimates in Table 3 show that the significant response of democratic institutions
to remittance inflows is not driven by omitted time‐varying variables that are correlated
with democratic institutions. Note that in the three‐year panel data most of the signifi-
cant response of democratic institutions to remittance inflows is on the right‐hand side
of the U‐shaped relationship.10
Table 4 explores whether the U‐shaped relationship between remittances and demo-
cratic institutions is heterogeneous across different regions. This analysis provides use-
ful insights into whether the effect that remittances have on democratic institutions is
different across regions. Furthermore, this exercise also checks the extent to which the
main results are robust to regional effects. To test for regional heterogeneity, the paper
interacts Region dummies for Latin America and the Caribbean (LAC), for sub‐Saharan
Africa (SSA), for the Middle East and North Africa (MENA) and for Asia (ASIA) with
the remittances variables. Results are presented in Table 4. The bottom of each column
shows the Region dummy that is interacted with the variables of interest, remittances
Ri,t–1 and remittances squared R 2i,t–1.
The modernisation control variables remain statistically insignificant across model
specifications. The interaction terms between remittances Ri,t–1 and the Asia dummy
and between remittances squared R 2i,t–1 and the Asian dummy suggest some evidence
of heterogeneity in the five‐year panel data (column 4). The corresponding interaction
terms for LAC, MENA and SSA are statistically insignificant, indicating that the U‐
shaped relationship between remittances and democratic institutions is not tied to any
region. Although the evidence is not as strong as in Table 3, the results in Table 4 still
point to a U‐shaped relationship (in general, the sign on the linear and on the squared
terms are consistent with a U‐shaped effect) between remittances and democratic insti-
tutions. Hence, the main conclusion from the estimates in Table 4 is that controlling for
regional effects does not significantly change the main finding of a U‐shaped effect of
remittances on democratic institutions.

5.  FURTHER ROBUSTNESS CHECK

Table 5 reports further robustness checks against the baseline results in Table 1. Table 5 uses
the Polity2 Index from the Polity IV Project as an alternative measure of democratic institu-
tions, to also confirm that the main finding of a U‐shaped relationship between remittances and
democratic institutions is not substantially affected by the choice of the democratic institutions
measure.

10
  The paper re‐estimates all model specifications in this paper, replacing remittances share of
GDP with real remittance per capita. The results are qualitatively similar and are available upon
request.

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Table 4.  Estimates on heterogeneity across regions. Dependent variable: Freedom House Political Rights Index
(1) (2) (3) (4) (5) (6) (7) (8)
Democracyt–1 0.789*** 0.988*** 0.868*** 0.926*** 0.818*** 0.690*** 0.482* 0.796***
(0.121) (0.128) (0.169) (0.120) (0.129) (0.153) (0.285) (0.125)
Log Incomet–1 0.004 −0.018 −0.029 −0.033 0.090 −0.008 0.006 0.068
(0.051) (0.045) (0.028) (0.069) (0.064) (0.071) (0.134) (0.066)
Remittancest–1 −0.021*** −0.033 −0.017** −0.021** −0.005 0.008 (0.016) −0.008 −0.001
(0.006) (0.031) (0.007) (0.008) (0.006) (0.007) (0.007)
Remittances 2t–1 0.0005*** 0.001 0.0005*** 0.0005*** 0.0001*** −0.0003 0.0001* 0.0001*
(0.000) (0.001) (0.000) (0.000) (0.000) (0.001) (0.000) (0.000)
Remittancest–1 × Region 0.008 0.002 0.065 −0.111** −0.007 −0.009 0.035 −0.048
(0.028) (0.031) (0.086) (0.046) (0.009) (0.016) (0.051) (0.044)
Remittances 2t–1 × Region −0.0002 −0.0005 −0.003 0.009*** 0.0003 0.0004 −0.003 0.005
(0.001) (0.001) (0.004) (0.003) (0.001) (0.001) (0.003) (0.004)

© 2018 Economic Society of South Africa. 

Trade t–1 −0.002 −0.001 −0.002** −0.002 −0.0003 −0.0005 0.002 −0.001
(0.001) (0.001) (0.001) (0.001) (0.002) (0.002) (0.003) (0.002)
Urabanizationt–1 −0.001 −0.002 −0.001 −0.001 −0.002 −0.001 0.0003 −0.002
(0.001) (0.002) (0.001) (0.002) (0.001)* (0.002) (0.003) (0.002)
Life expectancyt–1 0.004 0.003 0.006 0.003 −0.0002 0.002 0.004 −0.003
(0.003) (0.004) (0.003)** (0.005) (0.004) (0.006) (0.004) (0.005)
Schoolingt–1 0.001 0.002 0.002 0.002 −0.003 0.004 0.002 0.0001
(0.002) (0.002) (0.002) (0.003) (0.003) (0.005) (0.006) (0.003)
Panel data five‐year five‐year five‐year five‐year three‐year three‐year three‐year three‐
year

14
Time fixed effect yes yes yes yes yes yes yes yes
Country fixed effect yes yes yes yes yes yes yes yes
Hansen test (p‐value) 0.78 0.48 0.91 0.40 0.61 0.21 0.17 0.87
AR (1) (p‐value) 0.36 0.39 0.23 0.33 0.00 0.00 0.05 0.00
AR (2) (p‐value) 0.31 0.29 0.34 0.30 0.92 0.82 0.85 0.96
South African Journal of Economics Vol. 0:July 2018

Observations 247 247 247 247 465 465 465 465

Regions LAC SSA MENA ASIA LAC SSA MENA ASIA
Notes: The method of estimation is system GMM. Numbers in parentheses are robust standard errors. *, **, and *** denote significance at 10%, 5%
and 1%, respectively. All regressors are treated as endogenous across five‐year and three‐year panels. Lagged log GDP per capita income gap between
home country and that of the U.S. is used as external instrument for remittances. The system GMM uses three lags as instruments for regressors.
Standard errors are computed with the Windmeijer (2005) finite‐sample correction. Hansen test is the p‐value for the null hypothesis of instrument
validity. AR (1) and AR (2) are p‐values for first‐ and second‐order autocorrelated disturbances in the differenced equation. Trade is the sum of
imports and exports as a percentage of GDP, urbanisation is the percentage of the population living in urban areas, life expectancy is life expectancy
at birth, and schooling is gross secondary school enrolment. Five‐year is observation every fifth year and three‐year is observation every three years.
Region dummies are not included in the regressions because they are absorbed in the fixed effects. Region is a dummy for LAC (columns 1 and 5),
SSA (columns 2 and 6), MENA (columns 3 and 7) and ASIA (columns 4 and 8) interacted with remittances squared Remittances 2t–1 × Region and
linear remittances Remittancest–1 × Region.
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South African Journal of Economics Vol. 0:July 2018

The Polity2 Index is a composite measure of democratic institutions, which is the dif-
ference between democracy and autocracy indices and ranges from −10 to 10 (10 being
the most democratic and −10 being the most autocratic). In the Polity2 Index database,
democracy is coded as constraints on the executive, the competitiveness of political par-
ticipation and the openness and competitiveness of executive recruitment. Autocracy is
also coded in a similar way: competitiveness of political participation, the regulation of
participation, the openness and competitiveness of executive recruitment and constraints
on the executive. The paper also normalises the Polity2 Index to range from zero to one,
with one being most democratic.
Table 5 presents estimates with the Polity2 Index as the dependent variable. Columns
1–3 use five‐year panel data and columns 4–6 use three‐year panel data. In columns 2
and 5, the estimated coefficient on remittances Ri,t–1 remains positive but statistically sig-
nificant in column 5 only. Columns 3 and 6 capture the U‐shaped relationship between
remittances and the Polity2 Index. Quantitatively, remittances start having a positive ef-
fect on the Polity2 Index at 20% of GDP in five‐year panel data. The size of this effect is
similar to the baseline estimate (22%) in column 3 of Table 1. The estimated coefficient
on lagged Polity2 Index is positive and statistically significant, indicating persistence in

Table 5.  The effect of remittances on democratic institutions. Dependent variable: Polity2
Index
(1) (2) (3) (4) (5) (6)
Polity Indext–1 0.754*** 0.983*** 0.849*** 0.851*** 0.862*** 0.865***
(0.054) (0.210) (0.085) (0.043) (0.038) (0.037)
Log Incomet–1 0.024 −0.003 0.004 0.003 0.014** 0.009
(0.025) (0.026) (0.011) (0.022) (0.007) (0.006)
Remittancest–1 0.002 −0.008** 0.002** −0.006**
(0.004) (0.004) (0.001) (0.002)
Remittances 2t–1 0.0002** 0.0001***
(0.000) (0.000)
Panel data five‐year five‐year five‐year three‐year five‐year three‐year
Time fixed effect yes yes yes yes yes yes
Country fixed effect yes yes yes yes yes yes
Hansen test (p‐value) 0.43 0.11 0.04 0.31 0.38 0.41
AR (1) (p‐value) 0.00 0.00 0.00 0.00 0.00 0.00
AR (2) (p‐value) 0.91 0.20 0.19 0.44 0.74 0.74
Number of 381 318 318 683 577 577
observations

Notes: The method of estimation is system GMM. Numbers in parentheses are robust standard
errors. ** and *** denote significance at 5% and 1%, respectively. All regressors are treated as
endogenous across five‐year and three‐year panels. System GMM uses maximum 3 lags as in-
struments. Lagged log GDP per capita income gap between home country and that of the U.S.
is used as external instrument for remittances. Standard errors are computed with the Windmeijer
(2005) finite‐sample correction. Hansen test is the p‐value for the null hypothesis of instrument
validity. AR(1) and AR(2) are p‐values for first‐ and second‐order autocorrelated disturbances in
the differenced equation. Five‐year is observation every fifth year and three‐year is observation
every three years.

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South African Journal of Economics Vol. 0:July 2018

the Polity2 Index. Lagged income is statistically insignificant. Note that the Hansen
test of instrument relevance and the AR (2) test of second‐order serial correlation in the
differenced equation continue to support the external instrument. Overall, the finding
of a U‐shaped relationship between remittances and the Polity2 Index is consistent with
the corresponding baseline estimates in Table 1.

6.  CONCLUDING REMARKS

The impact of workers’ remittances in developing countries has been the subject of close scrutiny
by economists, policymakers and international institutions, because they are expected to improve
economic and political outcomes in developing countries. This foreign income goes straight
to recipient households without government’s intermediation, increasing incentives for recipient
households to be more politically demanding. This paper uses the system GMM dynamic esti-
mator and panel data covering 84 developing countries over the period 1982–2011 to estimate
the effect that remittances have on political institutions. The paper documents a U‐shaped effect
of remittances on democratic institutions. The baseline estimates suggest quantitatively that re-
mittances start improving democratic institutions when remittances reach 22% of GDP.
A central implication of this main finding is that for developing countries that do not
receive this 22% level of remittance inflows, remittances could impede democratic insti-
tutions. Policymakers in these developing countries will therefore have to identify strat-
egies to detect and counter any negative effect of remittances on democratic institutions
below this critical 22% point. Developing countries that have established ministries of
diaspora affairs that coordinate the inflows of remittances and engage with the diaspora
community such as Brazil, Mexico, the Philippines and Peru are better placed to tackle
any negative impact of remittances on democratic institutions. Finally, though this paper
takes an empirical approach, an important direction for future research is to build a
theoretical framework to underpin the U‐shaped relationship between remittances and
political institutions.

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APPENDIX 1
Table 1A. Variables: definition , sources and summary statistics

Variable Definition Source Mean St. Dev. Mean St. Dev.

Freedom House Political Based on a range of political rights including free and fair elections, candidate https://www.freedomhouse.org/ 0.54 0.33 0.53 0.33
Rights Index who are elected actually rule, political parties are competitive, the ratings/
opposition plays an important role and enjoys real power, minority groups
have reasonable self‐government or can participate in government through
informal consensus. Range 1, 2, 3, . . . , 7, transformed 0‐1.
Polity Index This composite index minus the autocracy score from the democracy score. https://www.systemicpeace.org/ 0.59 0.32 0.58 0.32
Range ‐10, ‐9, ‐8, . . . , 10, transformed 0‐1. polity/polity4.htm
Income GDP per capita (constant 2000 USD). World Bank 4.37 8.02 4.43 8.49
Remittances Workers’ remittances and compensation of employees as a percentage of GDP. World Bank

© 2018 Economic Society of South Africa. 

Trade Exports and imports as a percentage of GDP. World Bank 57.80 32.40 57.75 32.71
Urbanisation Urban population as a percentage of total population. World Bank 42.92 20.19 42.49 20.10
Life expectancy The number of years a newborn infant would live if prevailing patterns of World Bank 62.36 9.82 62.15 9.79
mortality at the time of its birth were to stay the same throughout its life.
Schooling Percentage of the population enrol in secondary school. World Bank 53.44 27.23 52.90 27.81
Income Gap (instrument) Each country’s GDP per capita minus US GDP per capita (in constant 2000 Author’s calculation 30543.02 4896.82 30201.90 4933.96
USD).
Panel data five‐year five‐year three‐ three‐year

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South African Journal of Economics Vol. 0:July 2018

Table 2B. List of countries

Algeria Ecuador Lesotho Sri Lanka
Argentina Egypt Madagascar St. Kitts
Bangladesh El Salvador Malawi St. Lucia
Barbados Equatorial Guinea Malaysia St. Vincent
Belize Ethiopia Mali Sudan
Bhutan Fiji Mauritius Suriname
Bolivia Gabon Mexico Swaziland
Botswana Gambia Mongolia Syria
Brazil Georgia Morocco Tanzania
Burkina Faso Ghana Mozambique Thailand
Burundi Grenada Nepal Togo
Cameroon Guatemala Nigeria Trinidad
Cape Verde Guinea‐Bissau Pakistan Tunisia
Central African Republic Guyana Panama Turkey
Chad Haiti Papua New Guinea Uganda
China Honduras Paraguay Uruguay
Colombia India Peru Zambia
Democratic Republic of Indonesia Philippines Zimbabwe
Congo
Costa Rica Iran Rwanda
Cote d’Ivoire Jamaica Senegal
Dominican Republic Jordan South Africa
Dominica Kenya South Korea

Table 3C. The effect of remittances on democratic institutions. Dependent variable: Freedom House
Political Rights Index. First-differenced GMM estimates
(1) (2) (3) (4) (5) (6)
Democracyt–1 0.289 (0.450) 0.202 (0.421) 0.785** (0.333) 0.415 (0.292) 0.125 (0.157) 0.151 (0.160)
Log Incomet–1 0.620 (1.620) 0.448 (1.280) 0.238 (0.752) 0.415 (0.605) ‐0.108 (0.317) ‐0.768 (0.456)
Remittancest–1 0.008 (0.008) −0.001 (0.025) 0.001 (0.002) ‐0.010 (0.015)
Remittances 2t–1 0.0003 (0.000) 0.0001 (0.000)
Panel data five‐year five‐year five‐year three‐year five‐year three‐year
Time fixed effect yes yes yes yes yes yes
Country fixed effect yes yes yes yes yes yes
Hansen test (p‐value) 0.99 0.32 0.44 0.72 0.94 0.89
AR (1) (p‐value) 0.73 0.54 0.06 0.11 0.13 0.15
AR (2) (p‐value) 0.13 0.67 0.33 0.61 0.50 0.93
Number of 251 207 207 582 493 493
observations

Notes: The method of estimation is first‐differenced GMM. Numbers in parentheses are robust
standard errors. ** denotes significance at the 5% level. All regressors are treated as endogenous
across five‐year and three‐year panels. Hansen test is the p‐value for the null hypothesis of instru-
ment validity. AR(1) and AR(2) are p‐values for first‐ and second‐order autocorrelated distur-
bances. Five‐year is observation every fifth year and three‐year is observation every three years.

© 2018 Economic Society of South Africa. 

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