The effect of OFW remittances in today’s crisis – small or large?

Cielito Habito suggests that OFW transfers account for more than 10% of GDP. His calculation is as follows:

“Last year’s $16.4 billion in remittances translated to about P800 billion in the pockets of Filipinos. This is 10.7 percent of our total GDP of P7.5 trillion last year. Roughly, this means that remittances funded one out of every ten pesos spent on the goods and services produced in our economy. Without those remittances fueling Filipinos’ spending, our economy would have shrunk by 6 percent instead of growing 4.5 percent as reported by government statistics.”

I think there is an error in Prof. Habito’s arithmetic. Not all the OFW remittances translate into domestic production because some of that money is spent on imports. If half of OFW remittances were spent on imports, then only about 5% of domestic product was due to the flow of such remittances. Of course, where there is unemployment, as is the case here, the multiplier is greater than one, so the induced GDP could well be much higher than 5%.

If 2009 OFW remittances were to fall by, say, 20% (a pessimistic scenario), and again, assuming that half of that would have been spent on imports, what is the impact on domestic production, all other things kept constant? With a multiplier of one, the impact is a drop of GDP of P80 billion, a little over 1% (negative) of GDP. With a multiplier of two, the impact is to reduce GDP by 2%. This doesn’t seem like much, on its own.

But if the fall in OFW remittances triggers confidence effects, then there would be further “sympathetic” downward shifts in consumption and investment. If local firms with pricing power raise prices, rather than reduce them, this also triggers a further downward shift in consumption. The overall effect could well be up to 5% of GDP. This is large, as it would be as though we did not receive any OFW remittances at all.

All the above is based on official statistics. There is the possibility that OFW and similar transfers are actually much higher than officially reported. Taking this into account, the economy would seem to be at an even greater risk.

This is not a forecast or prediction of GDP in 2009. Other things are happening, such as the stimulus package of the government (which some say is weak, but could well be strong if it were focused on tax cuts), and the underlying growth of the economy because the factors of production (capital and labor) are growing, and because of productivity growth. I have always been skeptical of pronouncements, official or unofficial, purporting to forecast GDP. Until such forecasts are made with a transparent explanation of how they are made, I would take them with a grain of salt (and no pepper).

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