Economic Volatility and Inequality: Do Aid and Remittances Matter?

by | Jun 4, 2016 | Uncategorised | 0 comments

Lisa Chauvet, Marin Ferry, Patrick Guillaumont, Sylviane Guillaumont Jeanneney, Sampawende J.-A. Tapsoba, Laurent Wagner

FERDI Working Paper Number 158, July 2016

The adverse impact of volatility on developing countries’ performance has been documented at length. This paper examines empirically the specific nexus of aid-inequality and remittances-inequality using a panel of 142 countries over 1973-2012. It studies whether foreign aid and remittances can mitigate the adverse effect of macroeconomic volatility on inequality.

Aid, Remittances, and Inequality

After several decades of analysis of the impact of export instability in developing countries, income volatility has been shown to have a negative impact on economic growth (Ramey and Ramey, 1995; Hnatkovska and Loayza, 2005). Economic volatility increases income inequality, making growth less favourable to the poor. In many developing countries, foreign aid and remittances are the main sources of international financial inflows. As such, the aid-inequality and remittances-inequality nexus is examined through the lens of the potential stabilizing role of aid and remittances.

The authors proceed with their econometric analyses in two steps. First, they estimate the impact of macroeconomic volatility on inequality, measured either using the Gini coefficient or the income shares by quintiles. They then add foreign aid and an interaction term of aid with volatility and alternately remittances and an interaction term of remittances with volatility. In a second step, they investigate the channels through which aid manages to reduce inequalities, by estimating the impact of aid on income volatility, accounting for different level of exports and external volatility.

Findings

The key results are as follows:

  • Output volatility has an adverse effect on income distribution and poverty,
  • Aid tends to dampen this adverse effect of output volatility and simultaneously to dampen its positive impact on inequality (or negative impact on the poor).
  • The effect of remittances is more uncertain as their mitigating action seems to occur only when volatility is high.

Policy Lessons

As income growth is a major factor in poverty reduction, income volatility hurts the poor through its negative effect on income growth. If macroeconomic volatility generates inequality and if aid or remittances have a stabilizing impact, it should be expected that due to this impact, they contribute to poverty reduction not only by increasing the rate of growth but also by making this growth less volatile.Given that robust evidence is found that aid helps to dampen the negative effects of volatility on the distribution of income, while remittances do not, there may be potential benefits of using aid in addressing income inequality in developing economies.

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