CGD Podcast: Remittances for Development with Manuel Orozco

Helen Dempster: Hello, and welcome to the CGD Podcast. My name is Helen Dempster, and I'm a policy fellow at CGD and Deputy Director of our migration and displacement program. Today, we're here to talk about remittances, money that migrants send back to friends and family in their home countries. Remittances are underrecognized yet crucial financial flows. In 2023, they were worth over $650 billion to lower-middle-income countries.

They're currently with more than aid and foreign direct investment combined, and around one in nine people globally depend on remittances, predominantly to fund basic needs such as food, shelter, healthcare, and education. It's therefore extremely concerning to see that the US administration has recently passed their big beautiful bill, which contains a 1% tax on all remittances sent by US and non-US citizens.

CGD’s recent analysis looked into the impact that this tax will have worldwide. Obviously, countries such as Mexico stand to lose the most in absolute terms, but many smaller, poorer countries are more reliant on remittances and will be hit hard. This is also coming off the back of large aid cuts affecting many of these same countries, aid cuts, which have made remittances even more important for families struggling to meet basic needs.

My guest today is Manuel Orozco, a director at the Inter-American Dialogue and an expert on remittances, financial inclusion, and diaspora engagement. We're going to delve into why remittances are important, the tax itself, and how remittances could be better supported and harnessed at all levels. Thank you very much for joining me, Manuel.

Manuel Orozco: Thank you very much.

Helen: I wanted to start with a broader discussion on the intersection between migration, remittances, and development. Could you tell me a little bit more about this intersection? How do you think about remittances being connected to migration flows?

Manuel: There are different economic activities that might have been formed. Sending money home is one, consuming home country products is another one, we call it nostalgic trade, participating in philanthropic activities, donating funds is another economic activity, at least 20% of migrants volunteer donate funds to their homeland, 80% of migrant adults send money back home, and 90% of adults consume from consequence.

There are other economic activities like making phone calls, investing back home, at least 5%, one in 20 migrants invest on a regular basis in their property or other economic opportunities in their homeland. When it comes to remittance, the flow of money that migrants send basically has an impact in the household that receives it, but it also has a macroeconomic impact and an impact on financial integration on the household level. One way to look at it is that they increase this possible income for those who receive it.

The increase in disposable income, typically, it's somewhere around 60% of total household income. If your income is $200 and you just send $300, and you have an increase, the effect of that increase is basically you're able to increase your spending, but also you're able to save. That's the most significant impact that the flow has on the immediate level. It helps you build savings. When you formalize those savings, you have even a greater impact in the local economy because you strengthen the financial ecosystem.

That's why, from a development policy standpoint, we aim at focusing on formalizing savings of remittances recipients. There is an indirect effect that remittances have through savings formalization. We have found that basically, those who save their money have a lower propensity or a lower intention to migrate. Those have a development impact or overall, because you're building assets, you're investing in the local community, and your opportunity cost of migrating or not change depending on how much you are saving.

The intersection between migration and developing is a complex one, but when it comes to remittances, the financial component is really a significant one, it's a strong one. I've been working on this for more than 30 years, and one significant impact of the flows of remittances is the effect on strengthening global financial networks.

The sending of money has created a motivation in the financial industry to develop real-time transfers, and they have helped even trade to use the rails of money transfer mechanisms in order to exercise a more seamlessly on payment of the three settlements. This is a significant impact. Pintex has been organizing themselves along the lines of body transfers. The revenue per transaction that the remittance makes is significantly higher than the revenue per transaction for a regular digital payment.

You do have significant impacts in the financial ecosystem, in the household level, and the macroeconomic level. You basically increase private consumption. In some countries like those of Central America, for example, remittances represent between 20% and 30% of private consumption, and private consumption is basically 80% or more or national income. They do have a significant impact.

Helen: Thank you very much, Manuel. That was fascinating, particularly to hear about some of the other indirect effects from remittance transfers. I think the discussion is just so focused on how they use for consumption that we tend to ignore the investment effect of remittances, as you were talking about, increasing resilience for things like climate change and other shocks that may increase some of these propensity to migrate in the long run.

Also, as you say, it creates a linkage between countries, between communities, between diaspora that can be built on for other purposes, including trade and other forms of investment. I really don't think that they should be underestimated. On that note, I think it's time we turn to speak about the new remittance tax in the US. As you know, the Trump administration just passed their big beautiful bill, which includes, among many, many other things, a 1% tax on remittances.

We've reported on the fact that business tax has gone through many iterations in its time. It started as a 5% tax, then went down to 3.5%. It was applied to many different types of people, undocumented migrants, non-US citizens, now, applying to everyone. I'd be really interested to get your take on this tax. You've been following its development very closely, especially exploring its implications for countries in Central and South America. Could you tell me a little bit more about which countries are likely to be most affected by this new tax?

Manuel: Basically, the text of the tax amendment establishes that the 1% applies to cash transfers only. In that context, if we look at the US Latin America and Caribbean marketplace of money transfers, 50% of transactions right now, maybe a little bit more, are performed in cash. There is a person goes to send money to an agent location and uses cash to send the money. It's a practice that is more associated to social capital than economic capability or financial capability.

Somewhere around 70% of migrants own a bank account, so they could use their bank account to save money. Why have only lost the cash transfer, is because behavioral economics are typically shaped by emotions. One key motivation to go to an agent is that you can chat with other people, you can touch base with your neighbor or you can buy other stuff. There is a value added to it, it is mostly social.

The financial value added to it hasn't been as widespread when we look at it over the past 30 years. In that sense, if we were to look at those countries that have a higher propensity to perform cash transfers, more than the countries, the most affected will be the nationalities of migrants who send money. For example, we're looking at people from Honduras, from Nicaragua, from Haiti, who are more likely to use cash transfers to send money independently of their extent of financial inclusion or financial access in the United States.

Other nationalities, let's say Mexicans, at least close to 60% of US outbound transfers originated digitally online or to an account.

At the end of the day, the way to think about it is, my estimate is of $300 billion US outbound money transfers, $150 billion may be cash transfers. It's a $1.5 billion cost in the sending of money. Now, there are other elements to consider on this, and one is that the statistical evidence shows that Transaction costs have two effects on money transfers.

One is that people tend to send less in order to compensate for the costs. Two, is that people try to find an alternative way to send money to avoid the cost of that price. The 1% increase in cost reduces the amount remitted by $30. You may see that instead of sending $450, you're going to send $400. That's an added impact that then the remittance recipient's country will get the household that you serve will have an effect on it.

That depends on how many people choose to pay the tax but send less, or choose to go in a different direction, use a regulated financial mechanism that will basically have an effect also in using regulate rails.

Helen: That's really interesting, particularly the statistic on the financial inclusion of different migrant populations, and whether they have any illegal alternatives to send money through different channels to avoid the tax. Which brings me onto a question around whether the tax is going to have the impact that the Trump administration as stated.

They've put out many different rationales for this tax, including deterring the sending of remittances, but also encouraging, particularly undocumented migrants to return home, as well as deterring future flows of irregular migrants. Why do you think the tax was created? Do you think it's going to have those intended effects?

Manuel: The amendment is part of a whole set of initiatives that were introduced by the Freedom Caucus in order to introduce measures that were basically shaped by an assumption of punitive purpose and cost-cutting strategies to mostly vulnerable communities. It's not only migrants, the ones that are affected by the broader tax reform, but in the case of migrants, the impact basically may have the adverse effect. I think the Senate was conscious of the purpose of the amendment and how to reconcile and how to compromise with that political objective.

They settled with the 1% of cash transactions with the assumption that the undocumented people are the ones who make a transaction. The assumption is not exactly correct because people on unauthorized legal status actually send cash transfers. It's somewhat counter-intuitive, the imposition of a tax on a discretionary reason. Again, it's hard to determine if people would actually use unregulated channels.

The whole purpose of the Patriot Act, for example, which is a landmark law that has prevented financial crimes over the past 20-plus years, has been basically to determine who sends money and how and to whom. The more you integrate people in a financial ecosystem where you can actually monitor and scrutinize transactions, the more secure the system becomes.

By encouraging people to deal with alternative mechanisms, you may actually have an unintended effect, moving transactions to places where criminal activity might be prone to take advantage of individuals who send that money. I have my doubts, but again, migrants, for the most part, tend to be very diligent on paying their taxes using their ITIN. This is an important issue because whether you are privatized or not, whether you're authorized to do through the US or not, you're actually paying an income tax.

In doing so, it's the first thing they do after January 2nd of every year. They do file their taxes, they want to make sure that they are clean in what they owe. They are actually law-abiding individuals. The whole purpose of this, or to discourage migration is not correlated actually to the root causes of migration, especially on this point in time, where migration is very much correlated to state fragility.

When we look at the arrival at the US-Mexican border, it was 16 nationalities that represented 90% of all migration. These were countries that come from politically difficult places, Russia, Ukraine, Venezuela, Nicaragua, Cuba, Haiti, Honduras, Guatemala, and El Salvador. More people migrated from El Salvador during the Bukele administration than in the past 30 years. The correlation is obvious. This is a foreign policy problem, and yet they want to address it from a punitive approach that is disconnected from the facts.

Helen: As you previously mentioned, remittances are used to increase resilience to the impacts of state fragility. If you remove the ability of families to be able to weather those shocks, there's every reason why you may see migration increase.

Manuel: Yes, and a good example is Haiti. When you look at the conditions in Haiti, there is an interesting development going on there. On the one hand, you have basically state failure. It's not just state fragility. The collapse of the Haitian state is practically evident. Even in the midst of violence and with the significant outflow of migration that occurs during these few years, this year we expect 60,000 homicides resulting from gang violence in Haiti.

The one functioning infrastructure is the remittance payment network, and it's the true literal lifeline of many people in the current context. It's not just rhetoric, it's not just speech talking, it's facts that actually explain how remittances do have a development impact, but also an effect on resiliency in contexts where there is significant fragility.

Helen: Absolutely, and that's something CGD was involved in, trying to encourage more migration post the earthquake in Haiti to encourage more remittances to be channeled back into the country. As you say, there's such an integral link between these flows, and it's something that seems to be ignored.

I'd like to bring us out a little bit to think about the global outlook and how other countries engage with remittances. As far as we can tell, the US is the only country that has imposed a remittance tax. In fact, many countries that we work with, both migrant sending and receiving countries, are actually trying to increase remittance flows because they're better for development. Could you tell me a little bit about how other countries are trying to do this?

Manuel: I had a conversation with Michael Clemens right after the Haitian earthquake to introduce H-2B visas to Haitians in order to mitigate conditions in Haiti. It is a very important subject because some people in the labor department took seriously the idea of taking advantage of H-2B to supply labor in the high-level demands in the US economy, but also have an effect on the homelands.

One of the results of that has been different H-2B programs expansions in several countries, particularly in Central America, where H-2B visas were doubled, and among other things. It can make sense right now of what countries are trying to do is to use financial inclusion as a mechanism to better tap the legal system. The country that has taken more a step forward in this direction is Guatemala, where they have integrated what they call the NFIS, the National Financial Inclusion Strategy, is to look into how to tap more remittances by increasing savings in the local communities.

We do work with the Guatemalan government, but also we had different projects since 2006, formalizing savings as a way to increase economic opportunities, increase assets, and invest them into the local economy. That's one example. The financial sector is engaged, and then there are other experiences that we can look at.

For example, Philippines has a bank that basically tries to tap into local investments coming from migrants. Colombia has a program with the diaspora. There are some initiatives. I think there is a lot more to do. There is an almost widespread understanding that the best way to deal with remittances is to let them run through the formal economy. I think the policy outlook regarding financial inclusion should be a priority.

Helen: Great. That brings me really nicely onto my next question. You've already mentioned how a large number of potential remittance senders

bank accounts, and presumably the creation of more online-based, more mobile-based technologies, make it easier for people to send remittances as well as cheaper. What impact do you think some of these broader financial trends will have on the volume and shape of remittances, or do you not think they're going to have the effects that we keep touting?

Manuel: Technological modernization in finance is catching up on the economic behavior of individuals. One of the key things that behavioral economics of individuals points out is that they like to integrate a few financial transactions in one vehicle. One of the things that migrants are doing, for example, is increasing not only the origination of commitments transfers digitally, but also depositing transactions back home. For example, Mexico, right now, 50% of transactions are deposited into bank accounts.

Another example is El Salvador. Account deposits have increased from 10% to 30% in the past three years. This is a positive development because it increases the opportunity to save directly once you deposit the money to a bank account. These are developments that are likely to take place. There are other possibilities that will occur.

One of them is a more widespread integration of the transactions deposited into an account into payment networks that are fully integrated into a country. For example, SPE in Mexico, or Transfer365 in El Salvador, or Breve in Colombia. What you see basically is that financial transactions are taking on a global scale, but also in a holistic approach driven by economic behavioral bindings.

Helen: Absolutely. It'll be really fascinating to see how some of these forces play out over the next few years. I'm just coming to my final question. We ask all of the guests on the CGD podcast, if you could instantly change any one policy in the world, what would it be and why?

Manuel: It's a difficult question. I think my approach is to delve deeper into the relationship between the knowledge economy and investment in human capital. Foreign assistance and developing assistance and trade, and investment don't have a particular road map into the knowledge economy when it comes to developing countries. They make an assumption that most countries are poor because they are agricultural-based, and that's not going to change, but the reality is quite different. Most countries are actually not agricultural-based in the developing world.

They are basically more economists that don't function properly because there is not an investment in human capital. That investment in human capital will have an effect in deepening economic activities in the knowledge sector, in the digital economy. We need to align development strategies along the lines of the knowledge economy.

Helen: I completely agree. It's something we're seeing quite a lot in Sub-Saharan Africa, where we're doing some work on the intersection between skill-building and labor migration. Particularly, ministries of labor, but also ministries more broadly, are really starting to see human capital as an asset for economic development. I think starting to think more holistically about these issues. I agree we have a really long way to go.

Thank you so much, Manuel, for joining me, and to everyone for listening today. If you want to learn more about reminiscence and development, please check out Manuel's work at thedialogue.org and CGD's recent work on this topic at cgdev.org. Thank you so much again.

Manuel: Thank you.