Remittances, transaction costs, and informality ☆ Caroline Freund a, ⁎ , Nikola Spatafora b a World Bank, United States b IMF, United States Received 14 October 2005; received in revised form 11 September 2007; accepted 12 September 2007 Abstract Recorded workers' remittances to developing countries reached $167 billion in 2005, bringing increasing attention to these flows as a potential tool for development. In this paper, we explore the determinants of remittances and their associated transaction costs. We find that recorded remittances depend positively on the stock of migrants and negatively on transfer costs and exchange rate restrictions. In turn, transfer costs are lower when financial systems are more developed and exchange rates less volatile. The negative impact of transactions costs on remittances suggests that migrants either refrain from sending money home or else remit through informal channels when costs are high. We provide evidence from household surveys supportive of a sizeable informal sector. © 2007 Published by Elsevier B.V. JEL classification: F21; F22; F30 Keywords: Remittances; Migration; Money transfer fees 1. Introduction Recorded flows of workers' remittances to develop- ing countries have grown from about $70 billion in 2000 to more than $150 billion in 2005 (World Bank, 2006). Such high levels and rapid growth rates have brought increasing attention to remittances as a potential tool for development. Understanding the determinants of remit- tances is important because these flows reduce poverty, allow recipients to smooth consumption, and are also used for investment purposes (World Bank, 2006, Chapter 4). In times of severe economic distress, remit- tances may be the primary source of income for many families, as in Zimbabwe today (Wines, 2007). The main motivation of this study is to explore the determinants of remittances. We find that the number of migrants is the primary determinant of official remit- tances: an increase in the stock of migrants residing in OECD countries leads to a roughly proportionate increase in recorded remittances. We also find that high transaction costs significantly reduce recorded remit- tances: a one percentage point reduction in transaction costs raises recorded remittances by 14–23%. Our analysis offers three contributions. First, in ex- ploring the determinants of remittances, we improve on the previous literature by including migrant stocks and transaction costs in the estimation. Previous work by Aggarwal and Spatafora (2005) and Sayan (2006) Journal of Development Economics 86 (2008) 356 – 366 www.elsevier.com/locate/econbase ☆ We are grateful to Irena Omelaniuk for providing us with IOM studies of remittances in several countries and for helpful discussions, to Dean Yang for generously providing data and summary statistics on the mode of remittance transfer in the Philippines, and to Angela Espiritu for outstanding research assistance. We are also grateful to Gordon Hanson, Dilip Ratha, Dean Yang, participants at a World Bank seminar, and two anonymous referees for comments. ⁎ Corresponding author. E-mail addresses: cfreund@worldbank.org (C. Freund), nspatafora@imf.org (N. Spatafora). 0304-3878/$ - see front matter © 2007 Published by Elsevier B.V. doi:10.1016/j.jdeveco.2007.09.002