The money workers send home to their families from abroad has become a critical part of many economies around the world. Based on the most recent data, remittances, as this money is called, will only grow in importance. Officially recorded remittances amounted to a record $529 billion in 2018, and are on track to reach $550 billion in 2019.

This money is flowing at about the same levels as foreign direct investment (FDI), but if China is excluded, they are the largest source of foreign exchange earnings in low- and middle-income countries, according to Migration and Remittances Brief 31, published by the World Bank Group and KNOMAD, the Global Knowledge Partnership on Migration and Development. In other words, if China is excluded from the analysis, remittances have already overtaken FDI as the biggest source of external financing.

Today, remittances equal or surpass 25% of GDP in five countries: Tonga, Kyrgyz Republic, Tajikistan, Haiti, and Nepal.

“Remittances are on track to become the most important game in town when it comes to financing development,” says Dilip Ratha, lead economist in Macro Economics and Fiscal Management at the Bank and the head of KNOMAD.

Today, they are more than three times larger than official development assistance (ODA), and FDI has been on a downward trend in recent years, notes the brief. “In five years, remittances will likely become larger than development assistance and FDI combined,” says Ratha. “The underlying factors driving remittances will continue to grow,” he added. “We could see remittances reach a trillion dollars in the foreseeable future.”

Factors driving remittances

The underlying factors driving migration and therefore remittances are big global trends that are already apparent. Ratha lists them as:

Income gaps — The average per capita income in a high-income country is $43,000, versus $795 in a low-income country – a ratio of 54-1.

Demographic imbalances — Between 2018 and 2030, the working age population will grow to 552 million in low- and middle-income countries. In high income countries, the working-age population will decrease by 40 million people.

Climate change – If no action is taken, by 2050 more than 143 million people will be displaced by climate change within their own countries across Sub-Saharan Africa, South Asia and Latin America.

Fragility, conflict and violence — A record 70.8 million people were forcibly displaced in 2018, including 25.9 million refugees seeking refuge in other countries.

Remittances are a lifeline to low- and middle-income countries, but sending them costs too much

Remittances are a lifeline to low- and middle-income countries and an effective way to alleviate poverty because they go directly to families; there is little waste, says Ratha. The United Nations has recognized the importance of remittances to development and to achieving the Sustainable Development Goals.

But the benefits of remittances are reduced by the generally high cost of sending the money, which averages 7% on a money transfer of $200. Banks were the costliest channel for transferring remittances, at 10.9%. In Sub-Saharan Africa the cost of sending money is higher than the average at 9.3%.

For the five most expensive remittances-sending corridors, the average cost is dramatically higher — 18.7%. That’s almost three times higher than the global average and six times higher than the SDG target.

The SDGs call for reducing the cost of sending remittances to 3% of the value of the money transfer. Digital currency or cryptocurrency could expand access to credit and eliminate many fees, argue proponents. New research estimates that international digital remittances will exceed $300 billion globally by 2021, about 44% of total formal international remittances.

Diaspora bonds offer an opportunity for impact

Another way to maximize the power of remittances is to encourage migrant workers to invest in their home countries in a more formal way, such as through a diaspora bond. Diaspora bonds can be a tool to make remittances more productive and are “perfect for financing development,” says Ratha.

Migrant workers save about $500 billion a year as well as send money home, says Ratha. If a 10th of their savings could be mobilized, that could be an additional $50 billion for development finance, he says.

Ratha is preparing a diaspora bond for the state of Kerala in India as part of a World Bank Group project.

For more on the potential of remittances to reduce poverty, watch Dilip Ratha’s TED talk.