Journal of International Migration and Integration (2022) 23:383–402

https://doi.org/10.1007/s12134-021-00833-1

Effect of International Remittance on Economic

Growth: Empirical Evidence from Ethiopia

Debelo Bedada Yadeta 1 & Fetene Bogale Hunegnaw 1

Accepted: 5 April 2021 / Published online: 8 June 2021

# The Author(s), under exclusive licence to Springer Nature B.V. 2021

Abstract
Despite the increasing importance of remittances in total international capital flows in
Ethiopia, however, the short- and long-run relationships between remittances and
economic growth has not been adequately studied. Existing few studies also did not
resolve the nature of causality between remittances and economic growth. This study
attempted to resolve these problems by employing the ARDL model and Granger
causality test to investigate the short- and long-run effects and nature of causality of
remittances on real GDP respectively for the period 1980 to 2015. The main results are
as follows. First, remittance flow significantly improves real GDP in long run. Second,
the effect of remittances in the short-run is negative. Third, there is unidirectional
causality from remittances to economic growth. Fourth, short-run negative effect is
higher than the long-run positive effect. A 1% increase in remittances increases real
GDP by 1.13% in long run but reduces real GDP by 1.87% in the short run. This might
be due to the fact that in the short run, remittances are mainly used for consumption
smoothing and a high proportion of informal transfer of remittances. The policy
implication of the results is that the government can extract the economic benefit of
international remittance if it works on easing the remittance sending process and cost.
This can be achived through devising a competitive financial system and setting
coordination among government, banks, and migration offices. This can divert the
remittance flows from the informal to the formal sectors.

Keywords Remittances . Economic growth . Ethiopia

* Fetene Bogale Hunegnaw

fetene1984@gmail.com
Debelo Bedada Yadeta
debelomam@gmail.com

1
Adama Science and Technology University, P.O. Box 1888, Adama, Ethiopia
384 Bedada D., Hunegnaw F.B.

Introduction

Many developing countries are constrained by a lack of foreign exchange to finance the
increasing demand for imports associated with domestic investment requirements. For
many developing economies, international remittances constitute the largest source of
foreign exchange, exceeding export revenues, foreign direct investment (FDI), and
other private capital inflows (World Bank, 2017) with the exclusion of China. Accord-
ing to the World Bank (2017), remittances represent the largest source of foreign flows
to SSA after FDI. For instance, in 2017, Ethiopia occupied the 8th position among the
top 10 remittance recipients in Africa with $ 815 million (World Bank, 2018a, 2018b,
2018c). Remittance accounted for 6.9% of Ethiopia’s GDP on average from 1981 to
2018 (WDI, 2020), and remittance is an extremely important source of foreign ex-
change for Ethiopia, perhaps larger than the export earnings of the country in its foreign
exchange generation capacity. Between 2008 and 2017, remittance flows have steadily
grown from 386 million USD to 815 million USD (World Bank, 2018a, 2018b, 2018c).
Despite continuous impressive international remittances flow to developing coun-
tries, the effect on economic growth on these countries remains a contested subject
among scholars and policymakers. Findings, either at the country or cross-country
level, continue to be mixed. This can be attributed to the difference in methodological
and theoretical approaches employed to study the issue and challenges of accessing
reliable and credible data. In Ethiopia, despite the huge flow of remittances and its
increasing importance of remittances in total international capital flows, to the best of
our knowledge, specific studies to date that have examined the dynamic relationship
between remittances and economic growth for Ethiopia are rare. Moreover, the short-
and long-run relationship between remittances and economic growth has not been
adequately studies; instead, it has been studied from a reducing poverty and
inequality point of view. The few known available studies for Ethiopia are Tolcha
and Rao (2016) and Gebbisa (2019), and they come up with different results. These
studies also did not resolve the nature of causality (bidirectional or unidirectional)
between remittance and economic growth, and they failed to include variables like
money supply and government expenditure as proxies to monetary and fiscal policies
which are powerful in the analysis of growth and remittance relationship.
This study tried to fill the aforementioned gaps and focused on the following issues. First,
what is the nature of causality between remittance and economic growth (bidirectional or
unidirectional)? Second whether remittances promote or thwart growth both in the short run
and in long run? Third, are there any differences between the short run and long effect? To
answer these research questions, the study employed ARDL model and Granger causality
tests. The main findings of this study are as follows. First, remittance flows significantly
improve real GDP in long run. Second, the effect of remittances in short run is negative.
Third, there is a unidirectional causality that is remittances to accelerate economic growth.
Fourth, the short-run negative effect is higher than the long-run positive effect.

Literature Review: Remittances and Economic Growth

The available theoretical literature on the growth effects of remittances can be catego-
rized into in to the following main schools of thoughts (De Haas, 2007), namely,
Effect of International Remittance on Economic Growth: Empirical... 385

Development and migration optimism (before 1973), Development and migration

pessimism (1973–1990), Pluralist perspectives (1990–2001), and Resurgence of mi-
gration and development optimism (After 2001).
According to Development and migration optimism (before 1973), for example,
functionalist and neo-classical school of thought, there are positive direct and indirect
growth effects of remittances on economic growth. This view emerged during the
1950s and 1960s in development theory. Some prominent scholars who subscribe to
the optimistic view include Kindleberger (1965), Todaro (1969), and Beijer (1970).
According to optimistic school of thought, economic remittance increases economic
growth through direct and indirect economic channels such as increased saving,
investment in physical and human capital (such as education and health), technological
progress and reduce credit constraints of unbanked households in poor rural areas and
facilitate asset accumulation and business investments (Ahortor & Adenutsi, 2010).
Development and migration pessimism (1973–1990; e.g., structuralist and Neo-
Marxist school of thought), on the other hand, argue that remittances have either
negative or no effect on economic growth. The pessimistic view emerged in the
1970s and argued that migration and remittances create underdevelopment in migrants’
countries of origin (Olufemi & Ayandibu, 2014). Scholars associated with this view are
Lipton (1980), Rubenstein (1992), Russell (1992), and Binford (2003). Remittances
negatively affect economic growth through increasing inflation; reducing labor supply
and creating a culture of dependency, increasing consumption of no tradable goods,
raising tradable goods prices, appreciating the real exchange rate, decreasing
exports, and damaging the receiving country’s competitiveness in world markets
(Adams Jr. & Cuecuecha, 2013; Amuedo-Dorantes & Pozo, 2014; Sami & Mohamed,
2012). Remittances also increase the risk of corruption in the recipient country (Abdih
et al., 2012). Remittances change the household’s spending behavior in a way that is
less beneficial for development (Amuedo-Dorantes & Pozo, 2014). As indicated by
Chami et al. (2003) migrant household’s save/ invest a smaller proportion of their
income, are more likely to spend on ‘status-oriented’ consumption, and the kind of
investment that is done, is often not productive to the economy as a whole (e.g.
housing, jewelers). According to Bettin and Zazzaro (2012) also, whether remittances
promote or thwart growth will depend “on the expenditures they fund (investment
versus consumption; traded versus non-traded goods) and the activity they stimulate
(work versus leisure). If remittances fund consumption (investments), the effect on
growth may be negative (positive); if they fund the production of durable (nondurable)
goods, the effect on growth will be positive (negative); and if remittances instill a work
ethic (leisure), the effect on growth will be positive (negative).
Pluralist perspectives (1990–2001): most empirical work from the late 1980s and
1990s increasingly acknowledged the heterogeneous, non-deterministic nature of mi-
gration impacts on development. This corresponded with a general paradigm shift in
contemporary social theory, away from grand theories towards more pluralist, hybrid
approaches, which simultaneously take into account agency and structure. In the 1980s
and 1990s, the new economics of labor migration (NELM) emerged as a critical
response to neo-classical migration theory (Massey & Parrado, 1994). NELM suggests
that migration and remittances decisions are best viewed not as individual decisions but
as household strategies (Stark, 1991). This approach integrates motives other than
individual income maximization that plays a role in migration decision-making.
386 Bedada D., Hunegnaw F.B.

Migration is perceived as a household response to income risks since migrant remit-

tances serve as income insurance for households of origin (Lucas & Stark, 1985). The
fundamental question is, therefore, not whether migration has either positive or nega-
tive developmental impacts but why migration has contributed to development in some
communities and much less, or even negatively, in others, and what factors explain this
differentiation.
Migration and development optimism resurgence (After 2001): Boom in research, in
particular on remittances and generally positive views. Resurgence of migration and
development optimism under influence of remittance boom, and a sudden turnaround
of views considered remittances, brain gain, diaspora involvement as vital development
tools. The emergence of the livelihood concept has meant a departure from rather rigid
and theoretically deductive historical-structuralist views towards more empirical ap-
proaches. This went along with the insight that people—generally, but all the more in
the prevailing circumstances of economic, political, and environmental uncertainty and
hardship—organize their livelihoods not individually but within wider social contexts,
such as households, village communities, and ethnic groups (McDowell & de Haan,
1997). In this context, migration has been increasingly recognized as one of the main
elements of the strategies households employ to diversify, secure, and, potentially,
durably improve their livelihoods. This is often combined with other strategies, such as
agricultural intensification and local non-farm activities (Bebbington, 1999; Ellis, 2000;
McDowell & de Haan, 1997). Empirically, many studies have been conducted to
investigate the effect of remittance on economic growth in developing countries, and
the results are mixed. This is evident in the studies carried out on a specific country or
across countries. Empirically, some studies identified a positive relationship between
remittances and economic growth in developing countries. These studies include
Fayissa and Nsiah (2012) for 36 SSA countries; Tchantchane et al. (2013) for the
Philippines; Ozurumba (2013) for South Africa, Ghana, and Nigeria; Oshota and
Badejo (2014) for Nigeria; Kratou and Gazdar (2016) for the Middle East and North
Africa countries; Hasan and Shakur (2017) for Bangladesh; Bangake et al. (2019) for
developing countries; Olayungbo and Quadri (2019) for SSA countries; and Sutradhar
(2020 ) for Bangladesh, Pakistan, and Sri Lanka. On the other hand, some other studies
found that remittances retard economic growth: Davis and Carr (2010) for Guatemala;
Abdullaev (2011) for selected Asian developing countries; Justino and Shemyakina for
Tajikistan; Kumar (2012) for Sub-Saharan Africa; Alkhathlan (2013) for Saudi Arabia;
Sobiech (2015) for 54 developing countries; Vadean et al. (2019) for developing
countries; and Sutradhar (2020) for India. According to Lubambu (2014), remittances
have proven to be a more sustainable source of foreign currency for developing
countries than other capital inflows such as foreign direct investment, public debt, or
official development assistance. However, the nexus between remittances and devel-
opment remains complex, especially with regards to the movement of people, which
contributes to the spread of global interdependence at all levels—social, economic, and
political.
In Ethiopia, despite the increasing importance of remittances in total international
capital flows, however, the effect of remittance has not been adequately studied. The
existing few studies also did not resolve the nature of causality (bidirectional or
unidirectional) between remittance and economic growth. Moreover, they failed to
include variables like money supply and government expenditure which are powerful
Effect of International Remittance on Economic Growth: Empirical... 387

in the analysis of growth and remittance relationship. The few available studies for
Ethiopia are Tolcha and Rao (2016) and Gebbisa (2019), and they come up with
different results. Tolcha and Rao (2016) found that remittance has a significant effect
on economic growth in the short run whereas it has an adverse effect in the long run. As
long as the findings of this paper is concerned, the main factors that contribute to the
negative impact of remittances for economic growth, in the long run, are problems
related to moral hazard and a large share of remittance spent for daily consumption
purposes. Gebbisa (2019) found positive and statically significant long-run growth
while a positive but statically insignificant effect in short runs.

Data and Methodology

Data

This study used time series data ranging from 1980 to 2015. The choice of data length is
based on the availability of data for all the variables and the unprecedented increase in size
remittances received during the period. All data for this study come from the World Bank
development indicators. All explanatory variables are in percentage of GDP.

Model Framework

Considering the mixed claims in the literature about the remittance-growth nexus, the
researcher opts for an optimistic view by hypothesizing that remittances positively
affect the economic growth in the long run in Ethiopia during the period of study. To
answer the research questions, the analytical framework of this study is embedded in
the debate between the two dominant theoretical approaches about the remittance-
growth effect: the national account and the endogenous growth model approach. The
national theory demonstrates two effects of remittances (positive and negative) on the
macroeconomic behavior of the recipient economy. These effects depend on how
remittances are utilized in the recipient economy. For instance, if used for consumption,
this has an adverse effect on macroeconomic outcomes. If spent on capital goods, there
will be a spillover effect on investments and savings, and the remittances can stimulate
local production and exports. The endogenous growth model, on the other hand, claims
that the remittance-growth effect works via an alternative but not incompatible mech-
anisms: human capital development, total factor productivity, technological diffusion,
and physical investments. Remittances interact with these factors of production to
stimulate growth and development in the recipient economy.
Our empirical model started with Solow (1956) national growth model. Y = f (A, L,
K), where Y is the real gross domestic product, L is the total labor force, and K is the
capital stock. Variable A captures the total factor productivity effect. Romer (1986) has
extended this model to include human capital. According to this endogenous growth
theory, total factor productivity (A) is affected by the human capital and finds that the
stock of human capital in an economy is a determinant of the rate of growth. Thus, the
effect of remittances on economic growth can also be formulated within the
endogenous growth model setup. If the remittance is spent on investment,
particularly on human capital, investment promotes economic growth. The argument
388 Bedada D., Hunegnaw F.B.

is that whenever families who earn remittance income spend on education, it

accelerates the pace of economic growth through enhancing human capital and hence
productivity. The World Bank survey (2010) shows that 29% of remittance income is
spent on education and 60% of the remittance is spent on daily expenses which can
contribute to better nutrition and health of the individual. As a positive externality,
remittance-receiving families has informational advantage over non-remittance re-
ceivers, thus the probability of sending their children to school is high. This implies
that remittance income could contribute to economic growth indirectly through affect-
ing human capital. Remittances may also affect total factor productivity through
physical investment efficiency and the size of dynamic production externalities
(Barajas et al., 2009). By improving the quality of financial intermediation, remittances
may also improve the efficiency of domestic investment. For example, if recipient
family members invest on behalf of the remitter, then the efficiency of investment is
affected to the extent that the family member possesses some informational advantage
relative to formal domestic financial intermediaries. Similarly, since remittances expand
the quantity of funds flowing through the banking system, remittance flows may affect
the ability of the recipient economy’s financial system to allocate capital by creating
economies of scale (Aggarwal et al., 2011).
Based on the arguments mentioned above, TFP can be formulated simply as A = f
(H) and H=f(R), which implies that A= f(R) and where H refers to human capital and R
refers to remittances. Then our model can be defined as:

β1 β2
Y ¼ AK L ð1Þ

Taking the natural logarithm transformation of the equation of both sides and
expanding it to the time dimension give:

lnY ¼ lnA þ β1lnK þ β2lnL ð2Þ

t t t t

Total factor productivity (A) can be defined as a function of the stock of human capital
(H) and remittance income (R) with a natural logarithm.

lnA ¼ β þ β lnH þ β lnR ð3Þ

t 0 3 t 4 t

Substituting Eq. (3) into Eq. (2);

lnY ¼β þ β1lnK þ β2lnL þ β lnH þ β lnR ð4Þ

t 0 t t 3 t 4 t

In addition to human capital, physical capital, labor, and remittance, Barro and Sala-i-
Martin (2004) have identified different additional variables that affect the growth rate of
output. Therefore, it is vital to incorporate these additional variables to determine valid
results. By extending Eq. (4), our empirical model can be written as follows:
Effect of International Remittance on Economic Growth: Empirical... 389

lnRGDP ¼ β þ β1lnGFCF þ β2lnLF þ β lnHC þ β lnREM

t 0 t t 3 t 4 t

þ β lnGCE þ β lnM2 þ e ð5Þ

5 t 6 t t

where e t is the idiosyncratic error, which is assumed to be independently and

identically, distributed with mean zero and variance σ 2 and β 1; β 2; ; β 3; β
4 ; β 5 ; and β 6 are the elasticity coefficients with respect to GFCF, LF, HC,
REM, GCE, and M2, respectively. lnGDP t; lnGFCF t; lnHC t; lnREM t ;
lnGCE; lnLF t; and lnM2 t, represent the log of real GDP, log gross fixed capital
formation as a percentage of GDP, log of human capital (tertiary school enrolment as
a percentage of gross enrollment), logarithm of the total remittance income received
as a percentage of GDP, log of government consumption expenditure (general
government consumption expenditure as a percentage of GDP), log of the total
amount of labor force, and the logarithm of the money supply as a percentage of
GDP (currency plus demand and interest-bearing liabilities), respectively. Tertiary
school enrolment as a percentage of gross enrollment has been used in this study
because the World Bank (2010) survey on remittance receivers in Ethiopia where the
majority of this income is used for covering tuition fees for university education. The
relation between remittance and economic growth is indeterminate. It is expected
that capital formation and human capital positively affect economic growth. Gov-
ernment consumption expenditure is an expected negative effect on economic
growth because it distorts private decisions (Barro & Sala-i-Martin, 2004). The
expected sign of money supply on growth is indeterminate.

Econometric Techniques

Unit Root Test

When dealing with time series data, it is necessary to assess whether the series is
stationary or not. The reason behind is that regression of a non-stationary series on
another non-stationary series leads to what is known as spurious regression. Several
tests are available, but the most commonly used are the Augmented Dickey-Fuller
(ADF) and Philip and Perron (PP) tests. The ADF test is used to test the null hypothesis
of the series y t is integrated order one against it is integrated of order zero. The test is
based on the estimation of a test regression which is stated below is a general form
where an intercept and trend is included.

P
Δy ¼ α t þ ϕy þ ∑ β Δy þe ð6Þ
t 1 t−1 j¼1 i t−j t

where y t is the variable in the model to be tested for stationarity, p refers to the
maximal lag length, Δ is the first difference operator, and e t is the error term.
The null hypothesis is ϕ=1 against an alternative hypothesis of ϕ< 0. A rejection
of the null hypothesis means that the time series is stationary, while accepting the
null indicates that the time series is non-stationary. The computed value will be
390 Bedada D., Hunegnaw F.B.

compared with MacKinnon (1996) critical values to determine whether the series
are stationary or not. An important issue to consider here is the selection of
optimal lag length (P). This is due to the fact that when too small P is chosen,
the remaining serial correlation in the error will bias the test, and when P is too
large it will affect the power of the test. Phillips and Perron’s (1988) test I also
applied and it is robust with respect to unspecified autocorrelation and
heteroscedasticity in the disturbance process of the test equation. The test also
makes a nonparametric correction to the t-test.

Long-run and Short-Run Model Specification

To test the existence of a long-run relationship between the dependent variable and the
set of regressors, the study used an autoregressive distributed lag bounds testing
approach (Pesaran et al., 2001a, 2001b). This approach is chosen because it has some
advantages over other methods. Firstly, as the name suggests, this approach will allow
both the dependent and independent variables to enter the model with lags; secondly,
this method will be applicable irrespective of whether the regressor is I (1) and I (0).
Thirdly, it solves the endogeneity and serial correlation problems that exist in many
empirical studies. Finally, this method is also relatively more efficient in the case of a
small sample size. The ARDL approach requires three steps. The first step is to check the
existence of a long-run relationship among the variables of interest. The second step
requires the estimation of long-run relationships and to determine their values, thereafter
the short-run elasticity of the variables with error correction representation of the ARDL
model.
Based on Pesaran et al. (2001a, 2001b), the ECM-ARDL representation of Eq. (5)
can be written as follows in Eq. (7)

k k k
ΔlnRGDP ¼ β þ ∑ β ΔlnRGDP þ ∑ β ΔlnHC þ ∑ β ΔlnREM
0 i¼1 1 t−i i¼1 2 t−i i¼1 3 t−i
k k k
þ∑ki¼1 β ΔlnGFCF þ ∑ β ΔlnLF þ ∑ β ΔlnGCE þ ∑ β ΔlnM2 þ λECT
4 t−i i¼1 5 t−i i¼1 6 t−i i¼1 7 t−i t−1
k k k k
þ ∑ a lnRGDP þ ∑ a lnHC þ ∑ a lnREM þ ∑ki¼1 a lnGFCF þ ∑ a lnLF
i¼1 1 t−i i¼1 2 t−i i¼1 3 t−i 4 t−i i¼1 5 t−i
k k
þ ∑ a lnGCE þ ∑ a lnM2
i¼1 6 t−i i¼1 7 t−i
ð7Þ

where β 1; β 2; β 3; β 4; β 5; β 6; and β 7 represent the coefficients of the short-

run dynamics of the model, whereas α 1; α 2; α 3; α 4; α 5; α 6; and α 7 are
coefficients of long-run relationship and ε is an error term; parameter λ represents the
coefficient on ECT t−1 or speed of adjustment to restore equilibrium in the dynamics model
(how quickly the variables converge to equilibrium). It is expected to be negative and
statistically significant.
The null hypothesis for the test of long-run cointegration is stated as follows:
H 0 : α 1 ¼ α 2 ¼ α 3 ¼ α 4 ¼ α 5 ¼ α 6 ¼ α 7 ¼ 0 ðcointegration
does not exist among variables)
H 1 : α 1≠α 2≠α 3≠α 4≠α 5≠α 6≠α 7≠0 (cointegration exists among
variables)
Effect of International Remittance on Economic Growth: Empirical... 391

Testing Causality

The presence of cointegration alone does not indicate the direction of causality. Hence
we need to test whether the relationship between the remittance (LREM) and real GDP
(LRGDP) is unidirectional or bidirectional. The test proceeds in estimating the follow-
ing two equations.

k k
LRGDP ¼ β þ ∑ β ΔLRGDP þ ∑ β ΔLREM þε ð8Þ
t 0 i¼1 1 t−i j¼1 1 t−j 1t

k k
LREMG ¼ α þ ∑ α LREM þ ∑ α LRGDP þε ð9Þ
t 0 i¼1 1 t−i j¼1 1 t− j 2t

The null hypothesis (for Eq. (8)) is that:

H 0 : β 11 ¼ β 12 ¼ ::… ¼ β 1 j ¼ 0; implying lnREM does not Granger
cause lnRGDPH 1 : β 11≠β 12≠…≠β 1 j≠0, implying lnREM does Granger
cause lnRDGP
The null hypothesis (for Eq. (9)) can be stated as:
H 0 : α 11 ¼ α 12 ¼ ……:: ¼ α 1j ¼ 0, implying lnRGDP does not Grang-
er cause LREM
H 1 : α 11≠α 12≠…::……:≠α 1j≠0, implying lnRGDP does Granger cause
LREM
The decision if the null hypothesis: H 0 : β 11 ¼ β 12 ¼ … ¼ β 1j ¼ 0 is
rejected, then there is causality from remittance to economic growth. Similarly, if the
null hypothesis: H 0 : α 11 ¼ α 12 ¼ … ¼ α 1 j ¼ 0 is rejected, then there is
causality from economic growth to remittance.

Results and Discussion

Unit Root Test Result

Augmented Dickey-Fuller (ADF) and the Philip and Perron (PP) tests were used to test
the stationarity of the variables; these tests were carried out using none, intercept, and
intercept with the trend.
As Table 1 above indicates, the null hypothesis of no stationarity cannot be
rejected for all variables in level except for lnLF and lnGCE which are stationary
at 5% level of significance with intercept and without intercept, respectively.
However, every variable becomes stationary either with the trend or without trend
once they are first differenced since the absolute value of the ADF test is greater than
Mackinnon’s (1996) critical value. The study had also applied the PP test for unit
root, which is another common way of testing the stationarity of time series vari-
ables. Table 2 presents the results for the PP test of unit root for the variables used in
this model.
392 Bedada D., Hunegnaw F.B.

Table 1 Results of ADF test

Variables ADF t-statistic at level I (0) ADF t-statistic at first differ- Order of
ence I (1) integration

Intercept Intercept None Intercept Intercept

(C) and trend (C) and trend
(C&T) (C&T)

lnRGDP −2.49 (0) −2.41 (0) −0.12 (0) −6.30 6.24 (0)*** (1)
(0)***
lnREM −0.01 (1) −1.71 [1] 0.34 [1] −4.18 −4.12 [0]** I (1)
[0]***
lnHC −0.10 (0) −1.48 [0] 0.91 [0] −6.12 −6.41 [0]*** I (1)
[0]***
LGCE 0.82 (9) −1.68 [5] 2.06 [9]** −2.98 [5]** −7.04 [0]*** I (1)
lnLF −3.50 −1.41 [0] 0.73 [0] −5.72 −4.03 [9]*** I (0)
(7)** [0]***
lnGCE −2.24 (0) −1.07 [0] 1.32 [0] −5.08 −5.61 [0]*** I (1)
[0]***
lnM2 −1.16 (0) −2.96 [1] −1.34 [0] −4.80 −4.71 [2]*** I (1)
[2]***
Mackinnon (1996) critical values
Intercept Intercept and None Significance
trend
Mackinnon 1% −3.63 −4.24 −2.63 ***
critical 5% −2.95 −3.54 −1.95 **
values
10% −2.61 −3.20 −1.61 *

Source: Authors’ computation based on the data from WDI using Eview 9 software where *, **, and ***
imply statistical significance at 10%, 5%, and 1% level of significance, respectively, and number in the
brackets () shows optimum or maximum lag selected for each variables by default during stationarity test.

Table 2 Results for the PP test

Variables PP t-statistic at level I (0) PP t-statistic at first difference I (1) IO

Intercept Intercept and trend None Intercept Intercept and trend None

lnRGDP −2.52 −2.44 −0.12 −6.30*** −6.25*** −6.40*** I (1)

lnREM 0.46 −1.64 0.84 −4.14*** −4.12** −3.40*** I (1)
lnHC −0.10 −1.39 0.93 −6.11*** −6.44*** −5.97*** I (1)
lnGFCF −2.67* −3.98** 12.93*** −6.03*** −6.91*** −0.69 I (0)
lnLF −1.86 −1.35 0.74 −5.71*** −5.84*** −5.70*** I (1)
lnGCE −2.25 −1.08 1.32 −5.08*** −5.61*** −4.87*** I (1)
lnM2 −0.99 −2.49 −1.28 −9.196*** −9.084*** −6.01*** I (1)

Source: Authors’ computation based on the data from WDI using Eview 9 software where *, **, and ***
imply statistical significance at 10%, 5%, and 1% level of significance, respectively
Effect of International Remittance on Economic Growth: Empirical... 393

The PP test for unit root had come up with the same result as the previous ADF test
except lnGCE. However, all the variables used in the model become stationary after
they are first differenced. In other words, the variables used in the model are a mixture
of I (0) and I (1), and none of the variables are integrated of order two (I (2)). As a
result, the autoregressive distributed lag approach to cointegration is the right technique
to apply in this scenario.

Bounds Test for Long-Run Relationship

One of the main purposes of estimating an ARDL model is to use it as the basis for
applying the “bounds test.” In this ARDL approach to cointegration, the first
step is to test the presence of cointegration or long-run relationships among the
variables. This test for the long-run relationship is done using the F-statistic.
The F-statistic will then be compared with the lower and upper bounds of
critical values bounds, of the ARDL bounds test (Table 3).
As we observe from Table 3, the F-statistic from ARDL Bound Tests is 4.16 which
is higher than the upper bound critical value both at 5percent and 10percent level of
significance. Accordingly, we reject the null hypothesis of “no long-run relationship.”
In other words, the result implies that the variables are co-integrated in the long run.

Diagnostic and Stability Tests

The model is selected using the AIC method through selecting automatic lags selection
criteria and used maximum 2 lags for both dependent variables and regressors including
constant and trend. The most important step in any empirical study is testing the
soundness of the model. In this study, the researcher had conducted a stability test
and diagnostic tests. These tests include a test for serial correlation (Brush and God fray
LM test), a test for normality (Jaque Bera test), and a heteroscedasticity test.
As it is indicated in Table 4, using the Lagrange multiplier test of residual serial
correlation, the null hypothesis of no serial correlation (Breusch-Godfrey LM test) is
failed to be rejected because the p-value associated with the test statistic (0.51) is
greater than the standard significance level which is 0.05. Based on a test of skewness
and kurtosis of residuals, we cannot reject the null hypothesis which says that the
residuals are normally distributed because the Jarque-Bera normality test (0.67) is

Table 3 ARDL bounds test results

Test statistic Value K

F-statistic 4.16 6
Critical value bounds significance I (0)-low bound I (1)-upper bound
10% 2.53 3.59
5% 2.87 4
2.5% 3.19 4.38
1% 3.6 4.9

Source: Authors’ computation based on the data from WDI using Eview 9 software where k is number of
regressors
394 Bedada D., Hunegnaw F.B.

Table 4 Diagnostic test results for the long-run ARDL (1, 2, 2, 2, 2, 0, and 0)

Test statistics LM version F version

A: R-squared 0.87 (lag 1) 0.00 (lag 2)

B:Serial correlation CHSQ(2)= 1.33 [0.51] F(2,15)= 0.31 [0.74]
C:Normality CHSQ(2)= 0.79 [0.67] Not applicable
D:Heteroscedasticity CHSQ(16)= 20.09 [0.22] F(16, 17) = 1.54 [0.20]

Source: Authors’ computation based on the data from WDI using Eview 9 software where k is the number of
regressors

higher than 0.05. The null hypothesis of no heteroscedasticity is failed to be rejected at

5% significance level. This is because the calculated value (0.22) is greater than 0.05.
Thus, the diagnostic test results indicated that the model fulfilled the characteristics of
the best regression model in the ARDL model. Structural stability or presence of
structural break of the long run and short-run relationships for the sample period can
be better examined by cumulative sum (CUMSUM) and the cumulative sum of squares
(CUMSUMSQ) of the recursive residual tests (Pesaran,1997). In Figs. 1 and 2 in
Appendix, the graph plots both the cumulative sum and the 5% significant lines. If the
cumulative sum remains inside between the two critical lines or bounds back after it is
out of the boundary lines, the null hypothesis of the correct specification of the model
cannot be rejected. But, if the cumulative sum goes outside (never returns back)
between the two critical bounds, there exists a series parameter instability problem.
As the two plots clearly reveal the plots of CUMSUM and CUMSUMSQ stay within
the lines, therefore, this confirms the equation is correctly specified and the model is stable.
Furthermore, the result shows that there is no structural instability in the model during a
sample period. From this, the model appears to be robust in estimating short-run and long-
run relationship.

Table 5 Estimated long-run coefficient

Dependent variable: lnRGDP

Variable Coefficient Std. error t-statistic Prob.

lnREM 1.13 0.82 1.60 0.02

lnHC 6.52 1.90 3.42 0.00
lnGFCF 3.85 1.40 2.76 0.01
lnLF 4.74 2.03 2.33 0.03
lnGCE -8.19 11.19 -0.73 0.47
lnM2 0.01 0.23 0.05 0.96
C 136.19 182.50 0.75 0.47
With trend 0.47 0.40 1.18 0.02
Number of observations 34

Source: Authors’ computation based on the data from WDI using Eview 9 software for ARDL (1, 2, 2, 2, 2, 0,
and 0) model
Effect of International Remittance on Economic Growth: Empirical... 395

Long-Run ARDL Model Results

Given the existence of cointegration among variables, we estimated a long-run

relationship using the ARDL approach. Table 5 presents the long-run coeffi-
cients. The figures in the bracket are the number of lag chosen by the model for
each variable. Accordingly, estimated long-run coefficient for remittance (as a
share of GDP) shows that remittance has a positive and statistically significant
effect on economic growth during a study period (Table 5). This implies that a
1% increase in remittance income as a share of GDP leads to an average of
1.13% increase in real GDP. The finding suggested that in Ethiopia, a significant
portion of remittance inflows is directed to productive investments in the long
run. For instance, the World Bank’s (2010) survey on remittance receivers in
Ethiopia found that 29% of this income is used for covering tuition fees for
university education. Remittance income is also capable of inducing an increase
in aggregate demand, leading to a rise in national output and a subsequent
increase in real income growth. This notion stems from the fact that remittances
may not only provide much-needed finance for establishing micro-enterprises but
also stimulate economic growth by increasing the consumption capacity of
recipient households (World Bank, 2018a, 2018b, 2018c). It could also show
that many Ethiopian remittance receivers may impart a work ethic instead of
leisure. Moreover, remittances will provide the catalyst for the financial market
and monetary policy development, and remittances may improve credit con-
straints and thus accelerate economic growth. This result is consistent with
different theoretical arguments and empirical studies: Jawaid and Raza (2012),
in the case of Korea and Ikechi and Anayochukwu (2013) in the case of Nigeria,
Ghana, and South Africa.
This study also found that labor affects output positively and significantly. This is not
surprising given the dependence of the economy on agriculture and more than 80% of
the population lives in this sector. A 1% increase in the labor force contributes to about a
4.7% increase in output. Consistent with endogenous growth theory, the result of this
study indicated that human capital has a positive and statistically significant effect on
output. Figuratively, a 1% increase in tertiary enrollment increases output by 6.5%. This
can be explained by the fact that a highly skilled workforce promotes productivity and
efficiency which in turn increases output. The result is in line with the empirical study by
Driffield and Jonees (2013) where human capital is found to positively and significantly
affecting output. Another important variable in growth literature is capital investment; it
is found that investment in physical capital as measured by the gross fixed capital
formation as a percentage GDP shows a positive and statistically significant effect on the
real GDP. A 1% increase in gross fixed capital formation as a share of GDP leads to
3.8% rise in output. Although both government consumption expenditure and money
supply as a ratio of GDP are insignificant in long run, but they affect output negatively
and positively, respectively.

Short-Run and Error Correction Estimation Results

The next step that follows from the estimation of the long-run coefficients is the
estimation of the error correction model which is the error correction representation
396 Bedada D., Hunegnaw F.B.

of the long-run model. This representation shows the short-run dynamics of the model
along with the equilibrium of the model. Theoretically, the ECM term indicates the
speed of adjustment to restore equilibrium in the dynamic model, and the coefficient of
the ECM which should be both negative and statistically significant shows how quickly
the dependent variable converges to equilibrium.
As it is shown in Table 6, unlike the long-run model, the short-run remittance as a share
of GDP has a negative effect on real GDP for the period under consideration. A 1%
increase in remittances reduces real GDP by about 1.9%. The negative effect of remit-
tances on output is interesting, indicating that remittances are countercyclical flows in the
short run, i.e., remittances are mainly used for consumption smoothing in the short run, as
it is obvious that most of the remittance recipients’ families are known by their very nature
of consumption volatility. The study conducted by the World Bank (2010) in the case of
remittance receivers in Ethiopia also supports the result because about 60% of remittance
income received by households is meant for daily consumption. Also, investments in
human and physical capital may only be realized in the long term (Ratha, 2007) so that
remittance affects real GDP negatively in the short run. Finally, when, remittances are
received in challenging, Ethiopia’s under-developed contexts, the short effect becomes
negative, thus, negative result can be also explained by the nature of remittances transfer.
In Ethiopia lack of access to services in the send and receives markets, high direct and
indirect costs associated with formal channels, irregular migration, the existence of parallel
market exchange rates, and regulatory barriers for undocumented migrants contribute to
the high level of informal transfers. Because of these factors, Ethiopia’s remittances which
are estimated at around 78% flow through informal channel (Isaacs, 2018). These informal
flows may retard economic growth by reducing foreign exchange for the government and
also reducing the opportunities to encourage investment. The sign is consistent with the
study by Qayyum et al. (2008) in the case of Pakistan.
Table 6 reveals short-run and error correction estimation results, and the short-run
coefficients’ signs are consistent with the long-run estimates for human capital, labor
force, and physical capital formation. For instance, human capital (tertiary school

Table 6 Short-run and error correction estimation results

Dependent variable: RGDP

Variable Coefficient Std. error t-statistic Prob.

Δln(REM) −1.87 0.67 -2.81 0.01

Δ ln(HC) 3.36 1.68 2.01 0.06
Δln(GFCF) 2.89 1.28 2.25 0.04
Δln(LF) 2.58 1.48 1.74 0.10
Δln(GCE) −7.06 9.29 −0.76 0.46
Δln(M2) 0.01 0.20 0.05 0.96
@TREND 0.41 0.33 1.25 0.23
ECT(-1) −0.86 0.19 −4.63 0.00

Source: Authors’ computation based on the data from WDI using Eview 9 software for ARDL (1, 2, 2, 2, 2, 0,
0) model
Effect of International Remittance on Economic Growth: Empirical... 397

expenditure as a percentage of total enrollment) is found to be statistically significant

and positively affecting real GDP. An increase in the labor force also boosts output by
3.4% in the short run as compared to 4.7% in the long run. The reason for elasticity
difference could be due to the adaptation of workers towards the working set up or the
association of workers with physical capital gets better and better as time passes. In other
words, workers will learn more on how to work with machineries and increase their
productivity through time, which makes the long-run elasticity to be higher. Gross fixed
capital formation as a percentage of GDP shows a positive and statistically significant effect
on output. A 1% increase in the fixed capital formation increases real GDP by 2.9% in the
short run. Similarly, the money supply is statistically insignificant but positively affects
output. But, the short-run elasticity coefficient is less than long-run elasticity. The negative
and statistically insignificant coefficient of government consumption expenditure as a
percentage of GDP in the short run is consistent with the sign of the long-run result.
Table 6 further indicates that the error correction coefficient ECM (−1) has a
negative sign and statistically significant indicating that there is evidence of
cointegration. The estimated coefficient for the error correction term is −0.86 showing
that there is a relatively high speed of adjustment to the long-run equilibrium after the
short run shock has occurred. Therefore, almost 86% of the disequilibrium caused by
shocks in the previous period converges to the long-run equilibrium. The negative
magnitude of the error correction term implies that 86% of the deviations caused by the
previous year’s shocks converge back to the long-run equilibrium in the current year.

Granger Causality Test

Hence presence of cointegration or long-run relationships among variables necessarily

does not show causality among varibales, we need to test whether the causality between
the variables is unidirectional or bidirectional. Since the underlying series (LRGDP and
LREM) are integrated of the same order, the Granger causality test can be used to
perform causality tests.
From Table 7, the outcome of the pairwise granger causality test shows that there is
unidirectional causality from remittances to economic growth. Thus, we reject the null
hypothesis of lnREM does not Granger Cause lnRGDP at 1% level of significance.
However, since the probability (0.18) of LRGDP is greater than 0.05, we fail to reject the
null hypothesis of lnRGDP does not Granger Cause lnREM in the second scenario which
means that there is no causality which runs from lnRGDP to lnREM. This implies that
remittance leads to a greater output but not vice versa. More remittance inflow resulted in
output growth, but growth in output at home does not attract more remittances. The results
are similar to the one obtained by Siddique et al. (2012); Matuzeviciute and Butkus (2016);
Meyer and Shera (2017); and Golitsis et al. (2018). Higher remittance leads to higher

Table 7 Pairwise Granger causality test results

Null hypothesis Observation F-statistic Prob.

lnREM does not Granger Cause lnRGDP 34 6.11 0.01

lnRGDP does not Granger Cause lnREMG 1.80 0.18

Source: Authors’ computation based on the data from WDI using Eview 9 software
398 Bedada D., Hunegnaw F.B.

economic growth in long run through increasing human and physical capital and by solving
credit constraints. However, economic growth does not attract remittance. This might be the
fact that higher economic growth in the home is not accompanied with an attractive
investment environment and competitive financial system which can reduce remitting costs
in Ethiopia. Thus, remittances that flow to Ethiopia depend on individual migrant skills,
availability of jobs in the destination country, taxation system of the destination country, and
economic growth of a destination country; however, this seeks further studies.
Finally, different diagnostic tests conducted to test the estimated ARDL model evidence
of serial correlation, functional model misspecification, and heteroscedasticity effects were
not found in the model. The model also passed the normality and stability tests.

Conclusion

This study investigated the short- and long-run relationship and nature of causality
between remittances and economic growth in Ethiopia by using time series data from
1980 to 2015. The data for this study came from the World Bank development
indicators database. As it has been discussed in this study, despite the increasing
importance of remittances in total international capital flows in Ethiopia, however,
the short- and long-run relationship between remittances and economic growth has
not been adequately studied in Ethiopia. Existing few studies also did not resolve the
nature of causality (bidirectional or unidirectional) link between remittance and
economic growth. Thus, this study attempted to resolve these gaps by employing
more recently developed and more appropriate models. The study employed the
ARDL model to investigate the short- and long-run effects of remittances on real
GDP. Moreover, we applied the Granger causality test to investigate the nature of
causality between and economic growth.
ARDL result shows a positive long-run relationship between remittances and real
GDP. Granger causality result indicates that there is unidirectional causality from
economic growth to remittances. That is, remittances accelerate economic growth but
economic growth does not raise remittances. Human capital (proxy measure are tertiary
school enrolment) and labor supply are found the most influential variables in this study.
These variables found to be positive and statistically significant. A 1% increase in
tertiary school enrollment and labor supply increases real GDP by 6.5% and 4.7%
respectively in long run. Consistent with endogenous growth theory, the result of this
study indicated that human capital has a positive and statistically significant effect on
output. Another important variable is the gross fixed capital formation as a percentage of
GDP. It has a positive and statistically significant effect on the real GDP. However,
government consumption expenditure and money supply have no effect on real GDP.
In the short run, remittance as a percentage of GDP has a significant but negative
effect on output growth for the period under consideration. The magnitude of remit-
tances’ effect on real GDP in the short run is higher than its effect on the long-run
effect. The negative and higher effect of remittances on real GDP in the short-run is an
interesting scenario. The possible reasons are (i) countercyclical flows in the short run
(in short-run remittances are mainly used for consumption smoothing) and (ii) high
level of informal transfers. Informal transfers are high due to different barriers such as
lack of access to services in the receives markets, high direct and indirect costs
Effect of International Remittance on Economic Growth: Empirical... 399

associated with formal channels, irregular migration, the existence of parallel market
exchange rates, and regulatory barriers for undocumented migrants. Informal transfers
divert remittance capital from investment to money laundering and smuggling. Ac-
cording to Maimbo and Ratha (2005), informal transfers of remittance are likely areas
for tax evasion, terrorist funding, capital flight and smuggling. (iii) Remittance de-
velops dependency on households-leisure oriented. (iv) Finally, remittance on invest-
ments in human and physical capital may only be realized in the long run.
Consistent with long-run results, human capital, labor force, and physical capital boost
real GDP in short run, but money supply and government consumption expenditure are
statistically insignificant. The policy implications for this study are that to improve long-run
positive effect and to reverse the short-run negative effect of remittance on economic
growth; first, the government is recommended to devise a competitive financial system that
will reduce the cost of remittance by diverting the remittance flows from the informal sector
to the formal sector. Second, there should be coordination among government, banks,
migration offices, and remittance service providers in diverting the remittance flow through
the informal channel towards the formal so that the economy will be able to extract the
benefit of remittance to economic growth. When there is a good investment climate with a
well-developed financial system and institutions are functional and easily accessible so that
remittance receivers are more likely to invest in human and physical capital. Third, given
adverse effects of remittances on short run, government should be aware of the pitfalls
induced by the consumptive behaviors of recipients and put in place business incentives
that will foster investments, which in turn may yield greater economic growth.

Appendix

12
Plot of cumulative sum of square
8

-4

-8

-12
2000 2002 2004 2006 2008 2010 2012 2014

CUSUM 5% Significance

Fig. 1 Stability test examined by cumulative sum of square. Source: authors’ computation based on the data from
WDI, using Eview 9 software. Source: authors’ computation based on the data from WDI, using Eview 9 software.
400 Bedada D., Hunegnaw F.B.

1.6

plot of cumulative sum of square recursive residual

1.2

0.8

0.4

0.0

-0.4
2000 2002 2004 2006 2008 2010 2012 2014

CUSUM of Squares 5% Significance

Fig. 2 Stability test examined by cumulative sum square recursive residual. Source: authors’ computation
based on the data from WDI, using Eview 9 software. Source: authors’ computation based on the data from
WDI, using Eview 9 software.

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