Finance: Research, Policy and Anecdotes

In 2011, I published a paper with Sole Martinez Peria on the drivers of remittance costs across countries, with data on 119 corridors and for 2009. Thanks to amazing data collection effort of the World Bank on Remittance Prices Worldwide, Roland Kpodar, Mathilde Janfis and I expanded the previous exercise to a panel of corridors over time, even exploiting variation across different providers within a corridor, now published as IMF Working Paper as well as a summary on VoxEU.


We document a decline in remittance prices, with the median remittance fee decreasing from 7.7 percent in 2011 to 5.7 percent in 2020. Nevertheless, most of the corridors still have median remittance cost above 5 percent in 2020, far from the 2030 Sustainable Development Goal target of average fees of less than 3 per cent and no remittance corridors with costs higher than 5 per cent. The data also reveal significant variations in remittance fees within the same corridor (across firms), between the same sending country and different receiving countries, or between the same receiving country and different sending countries. Similarly, remittance fees vary with the payment instrument, the access point, and the speed of the transfer.


What factors explain the variation in remittance costs? Five results stand out:

  • Higher GDP per capita in the sending country and easier geographic access to financial institutions is associated with lower fees, especially for banks.
  • Scale economies matter: a larger market for remittances (as proxied by closer economic ties and a larger migrant population from the receiving in the sending country) is associated with lower costs as is a shorter distance between sending and receiving countries.
  • The market structure is important: banks charge higher fees than money transfer operators (MTOs), but a larger share of banks among remittance service providers is also associated with higher fees charged by MTOs. Unlike banks, MTOs’ fees react to competitive pressures, with more market players being associated with lower MTO but not bank remittance fees.
  • In corridors where the sending country has a pegged exchange rate, both banks and MTOs charge lower fees.
  • There is some evidence that cash payments attract higher fees, while payments over the Internet are charged lower fees. Nonetheless, there are no conclusive results regarding the impact of the regulatory framework, which leaves unsettled the debate that compliance to regulatory requirements (e.g., on AML/CFT issues) heightens the cost of remittance services.


Overall, these findings point to both cost- and risk-based constraints and market structure as barriers to lower remittance fees. Higher transaction costs as result of a more rural population in the sending country and lower scale can explain high remittance fees in some corridors. These factors are largely structural, implying a limit to the extent to which remittance fees can be lower with policy actions.


However, decisive policy actions are needed in areas that are directly under the control of policy makers and where the yield from reforms can quickly materialize. For instance, stronger competition through easing entry to the remittance market, especially for non-bank providers, and digitalization might help reduce remittance costs. Similarly, exchange rate stability (or better hedging possibilities) might contain remittance costs, more so because exchange rate margins (often not fully disclosed by remittance service providers) can make up a significant portion of the remittance fees in corridors where exchange risks are the highest. The one area where our analysis cannot really make any clear inferences (due to endogeneity concerns) is on the role of the regulatory framework in its direct effect on remittance costs.

A lot has been written about the Russian invasion of Ukraine, the reaction of the West, including the sanctions, and the reshaping of European and global geopolitics. I’d like to pick up on a few themes where I have strong views, given my own history of having grown up during the Cold War and as economist.


First, as powerful as the initial response of the West has been in terms of sanctions, it has become clear that this is far from sufficient.  And it is the German government, which has refused to take a more prominent role and has all but ruled out cutting its dependence on Russian gas in the short-term and providing the Ukrainian military with the necessary heavy arms to drive the Russian invaders out of Ukraine. One false argument is that as lesson of 20th century German history war should never be fuelled with German support. This is clearly a misinterpretation of German history as Ukraine’s fight is clearly defensive and Ukraine suffered disproportionately during World War II from the Nazi invasion. And if one takes the view that Putin should not be provoked further by supporting Ukraine too much with heavy arms, one clearly has not understood that Ukraine would not be the final stop for Putin. He has made it clear over and over again that he aims at restoring the old East bloc. So the political arguments are clearly fake and one has to look to economic reasons.


Second, an interesting and, in my opinion, very valid comparison has been made by Thomas Philippon on Germany’s reaction to the crises in euro periphery countries a decade ago and its behaviour during the current crisis. During the eurodebt crisis, German politicians were quick in telling Ireland, Greece and Italy that austerity policies were the necessary consequence of private and government overborrowing during the previous decade and thus to rectify macroeconomic policy mistakes by these countries. The same argument can be made now about Germany, which has increased its energy dependence from Russia substantially over the past decades, a decision that many criticised even before the current conflict and that is now indefensible. However, Germany is not really accepting the consequences of this wrong decision, which would require to cut itself off from Russian energy, even if this implies a heavy economic cost. As much as euro periphery countries imposed costs on the whole euro areas with imprudent macro policies, Germany has imposed security costs on all of Europe with its imprudent energy policies!


Third, this brings me to the important debate among German economists on the predicted economic damage that such an Russian energy import ban would imply. The first study, by Ruediger Bachmann and others has shown that there would be economic damage, but would be most likely to be limited to 3% of GDP. A lot depends on the assumption of elasticities of substitution and adjustment speeds.  However, a lot also depends on the complementary policy actions taken by the government; importantly, keeping fossil energy prices high (rather than subsidise them) while focusing on income subsidies for poorer households.  As much as this initial study has been criticised by other German economists, other studies have more or less confirmed this assessment.  This makes the aggressive dismissal of these estimates by Olaf Scholz as “being theoretical” even more embarrassing.  It is elected politicians who are to take such decisions, but dismissing serious research contrary to one’s priors is embarrassing and ultimately damaging for the political discourse and informed policymaking. At this stage it seems that the German government is listening primarily to industry lobbyists who refuse to internalise the costs that energy dependence from Russia imposes on German and European security. And pointing to economic costs in the light of ongoing Russian aggression and war crimes and the clear threat to European security and peace seems a rather cheap excuse anyway.  In spring 2020 lockdown decisions were taken before any economic cost scenarios could be completed; why the hesitancy now?


Finally, the hesitancy of the German government to address the challenges immediately will simply kick the can down the road and increase the costs in the future. The longer Russia can rely on energy payments, the longer it can finance its aggression against Ukraine and the bigger the human and economic damage. Cutting off Russian energy keeps the West in control, waiting until Putin might decide to cut off energy supplies to the West leaves the West at his mercy. And not to speak of the long-run international reputation costs that Germany is currently incurring because of its hesitancy. Time for German leadership not hesitancy! Time to be on the right side of history! 

There is currently a discussion on how Russia went from an almost ‘normal’ country to an authoritarian kleptocratic regime that is about to slip into a totalitarian dictatorship. Some argue that the reform shock therapy in the late 1980s and 1990s is at the core of this development, having caused significant socio-economic upheaval if not chaos, impoverishing large parts of the population, while at the same time allowing the emergence of oligarchs.  When Putin came to power in 2000, his promise of stability was welcomed by many if not most Russians, which ultimately allowed his shift towards an authoritarian kleptocracy. So have the Chicago boys lost Russia for the democratic world? I am not convinced, as I will argue in the following.


There were two major schools of economic thinking about the optimal transition process in the late 1980s and early 1990s – the gradualist approach and the shock-therapy approach.  The former has focused on a step-wise approach to the transition from a planned to a market economy, allowing for institutional experimenting and proper sequencing. Shock therapy, on the other hand, involves sudden and rapid introduction of market reforms, including ending price controls, stopping government subsidies and moving state owned industries to the private sector, with the objective of getting beyond the point of no return and overcoming entrenched opposition to reforms. Both Russia and Poland undertook reforms in the spirit of a shock therapy, while Hungary and China are often quoted as examples for the gradualist approach.  Have different approaches to economic policy reforms resulted in significantly different economic and political outcomes? The examples above suggest that no and I am not aware of any academic evidence to this effect (happy to be contradicted, though!).


Enter the ”institutionalists” who argue that it is not about specific policies but about the quality of the underlying institutions that determine the consequences of economic reforms for economic and political development. So, for example, privatisation by vouchers can have very different long-term effects, as the experience of Russia, Slovenia and Czech Republic show (independent of the question whether this is per se the optimal form of privatisation or not). The transition started with the rapid destruction of the institutions supporting socialism in all transition economies. The building of new institutions supporting a broad-based market economy, however, varied significantly across transition economies, with societies taking sharply different paths during the first decade of transition and ultimately political and economic development.


In a paper with Luc Laeven, published back in 2006, we provide evidence for the institutional theory in explaining variation in growth across transition economies during the first decade after the fall of socialism.  We also find no evidence for any significant impact of policy reforms for this sample of countries and time period, nor for a positive impact of future EU membership (although future EU membership helped the development of institutions during the 1990s and thus indirectly economic growth).


We also show that institutional development is based on the behaviour and the incentives of the elite during the transition period. In some countries, the elite actively fostered a transition to a market economy with a broad base of participants in the economic and political life through the provision of basic property rights and rule of law. In other countries, the elite was mostly concerned with securing for themselves property rights in the formerly state-owned enterprises to extract economic rents and thus securing economic and political power in the post-transition society. We refer to these two opposite transition experiences as “catalytic transition” and “extractive transition.”  We conjecture that the behaviour of the elite during transition was largely determined by two main country characteristics: the endowment with natural resources and the entrenchment of the ruling elite during the socialist period.


First, given the surplus character of natural resources, the elite in resource-rich economies at the beginning of the transition period was most interested in securing the property rights over these resources that gave them a power base. It is generally easier to materialize short-term profits from natural resources than from fixed assets such as manufacturing plants, equipment and machinery, because proceeds from natural resources depend less on the creation of a functioning market economy, on human capital, and on R&D investments. This is a version of the natural resource curse, familiar to most economists. Second, one of the consequences of an extended time under socialism and the consequent centralization of power was the absence of any political opposition, or even civil society institutions and social networks, such as churches, political clubs, and trade unions to challenge the power of the political incumbents. These entrenched political elites are less inclined to share economic and political power during the transition process because they can use their political power to extract rents.


Interestingly, we used Belarus and Ukraine as example to illustrate this entrenchment: “Upon gaining independence, the communists remained in power in both countries. The Soviet economic and social structure had provided a social safety net, and the need for economic reforms was not apparent. Because of its strong historical link to Russia, Belarus remained a close ally of Russia and institutional development has been one of the lowest among all transition economies. Ukraine also made little progress in structural reform during the initial transition years and the business environment is still plagued by government interventions, weak property rights, onerous taxes, and corruption.”  Interestingly, both countries fare somewhat better in terms of natural resource reliance (well below Russia, other FSU countries and some Eastern European countries).  Obviously, time spent under socialism is not a permanent destiny as the difference between Belarus and Ukraine has shown over the past 8 years.


Returning to the initial topic, if economists have failed Russia it is not in providing wrong economic policy advice but not realising that without the proper institutional development participatory democracy and an open and competitive economy and society are not possible to develop. We are still trying to figure out how to overcome the curse of history and natural resources, but we know that institutional development is where the focus should be.  Put differently: economic reforms without the necessary institutional underpnning can easily go wrong.


These findings should also make us sceptical about a democratic future for Russia after Putin. Yes, countries can break out of the cycle of entrenched elites, rent-seeking and extractive institutions, but an exclusive focus on economic reforms is not sufficient. The building of inclusive institutions that can underpin both participatory democracy and an open and competitive market economy takes time, the right incentives and good leadership.  None of this has been in place in Russia over the past 30 years.

Following a virtual conference in September 2020, jointly organized by Asian Development Bank Institute (ADBI), the Journal of Banking & Finance, and the Singapore Management University’s Sim Kee Boon Institute for Financial Economics, we issued a call for papers on green and ethical finance, with five papers now published in a special issue.  The papers are discussed in more detail in this editorial, but below a quick run-down


Climate change poses new risks for financial intermediaries and an important question is to which extent these risks are being priced properly. Combining syndicated loan data with carbon intensity data (CO2 emissions relative to revenue) of borrowers across a wide range of industries, Torsten Ehlers , Frank Packer and Kathrin de Greiff  find a significant “carbon premium”, but only since the Paris agreement in 2015.  The question to which extent banks internalise climate risks in their loan pricing has been also explored in many other papers, as well as the question whether markets or banks are better in terms of addressing climate change (some of this discussed in my paper with Yung Chul Park).


What turns firms’ attention to ESG scores? Mark Shackleton, Jiali Yan, and Yaqiong Yao show that worse stock market performance increases firms’ efforts on environmental and social (ES) activities, using a panel vector autoregression to control for endogeneity. So, there seems to be a certain investor discipline!


Do retail investors really incorporate social considerations into their investment decisions? Philipp Kollenda analyzes 70,000 transactions by retail impact investors on a peer-to-peer lending platform that intermediates loans to firms in low-income countries and finds that financial returns significantly influence investors’ decisions, while expected social impact has no or limited influence on investors’ funding decisions.


Ann-Christine Brunen and Oliver Laubach gauge whether people behave consistently when it comes to sustainability, using a financially incentivized choice to study the non-investment-related sustainable behavior of the clients of three German robo advisors and relate it to their investment decisions with a digital wealth manager that offers both conventional and sustainable investments. They find that households with more sustainable consumption patterns are also more likely to choose a portfolio following a sustainable investment strategy, but that self-reported sustainable consumer behavior not backed up by pertinent actions is not significantly related to sustainable investment choices


Mikael Homanen gauges whether depositors react to negative non-financial and climate related information about their financial institutions, studying the case  of the highly controversial Dakota Access Pipeline and shows strong negative depositor reaction to the banks funding the pipeline.  I have discussed this paper before and given that Mikael was my PhD student, the paper was handled by a different editor.


These five papers show the importance of climate change and ESG concerns for firms, financial institutions and households, but also that there are limits to the extent to which these risks are properly priced.  Green finance is certainly a growth area in research and policy importance!

Putin’s invasion of Ukraine has redrawn geopolitical frontiers in Europe and beyond, but also within Western democracies. What according to an US intelligence report from 2011 was only the first step in restoring the old Soviet Union and Soviet bloc in Europe has finally revealed the true face of Putin and his imperialist ambitions.  It is also, as described by the courageous Carole Cadwalladr part of a 8-year long Great Information War that Putin has unleashed against the West, including misinformation campaigns through Russian media outlets and political interference, as in the Brexit campaign and the US elections of 2016. I will not dwell on Brexit here, but if anyone still doubts it, Putin certainly celebrated on 24 June 2016 when he saw the win of the Leave campaign not just as a personal win in the Great Information War but also as start of the decline of the European Union. Little did he know…


The European Union has taken a clear stance against Putin!  There are only two groups left that currently openly argue against such a clear stance. On the one hand, the intellectual children of the 1980s peace movement who think one can stop autocrats with roses and kind words.  Part of this group are also those who still think one can come to an agreement with Putin, like Chamberlain thought in 1938 in Munich. As described above, it is very naïve to think that Putin would be satisfied for long with any agreement in the Ukraine. It would not be before long that he would push further; next stop: Baltics!


On the other hand, there are the Putin apologists, like Nigel Farage and Yannis Varoufakis in Europe and Jair Bolsonaro and Donald Trump in the Americas. It is thus far more than a geopolitical conflict we are seeing emerge, it is a struggle between democratic liberalism and autocratic populism. What unites extreme left and right parties in Europe is their distaste for representative democracy and their love of autocratic populism a la Putin. And given that one of the two main parties in the US is still clearly aligned with autocratic populism, Europe certainly can no longer rely on assistance from the US, even with NATO links being strengthened.


And this is where the positive news comes in; Putin’s invasion has reinvigorated the European project. Rather than agreeing on the smallest common denominator, the 27 EU governments ultimately agreed on a rather strong package of sanctions, at least much stronger than initially expected by most observers. Even more surprising was the complete U-turn of the German government, which for the past 73 years has refused to play any leading role in European defence (even as part of NATO), had reduced their defence spending rather dramatically over the past 30 years and were (rightly) ridiculed for sending nothing but 5000 helmets to Ukraine. This U-turn towards substantially higher defence spending and modernisation of the German army (under a social democratic chancellor, in coalition with the Green party, child of the 1980s peace movement) is nothing but historic and will by itself change the geopolitical structure of Europe. For those who are afraid of a strong German military in the heart of Europe, one can only point to the close political and economic integration of Germany into Europe, courtesy of the peace project European Union.


As the former Finish PM (and my EUI colleague) Alex Stubb noted, this could be the 1989 moment for this generation. Back then, we all thought that democracy and the market-based societal order had won, there was a spirit of optimism across Europe.  Over the past decade, this has deteriorated significantly, with the rise of Orban in Hungary, the rise of Five-Star Movement and Lega in Italy, the rise of Marie Le Pen in France, and Brexit and Johnson in the UK; and all these movements funded and supported (with misinformation campaigns) by the Kremlin.  The courageous fight of the Ukrainians has shown us what is at stake. We can no longer take democracy as granted; it is not something assured for eternity but has to be defended by each generation. If we want to prolong the 75 years of peace, prosperity and freedom in the heart of Europe, we have to take a clear stance, both towards outside and inside threats!