A principal agent model of remittances and

investment in human capital

SRIYA SINHA
QE2313

April 2024
Indian Statistical Institute,Kolkata
1 Abstract
Remittances from migrant labourers in foreign countries to their families that
are left behind in their home country have been an important source of additional
income for millions of families in low and middle income countries across the
world. With globalisation, as the number of migrant labourers has reached sev-
eral millions, amount of remittances has also grown steeply. How remittances
influence educational outcome has become a hotly debated issue in recent years.
In this paper, we try to model the impact of remittances on investment in human
capital as a manager-firm owner problem where the migrant acts as the owner
of the asset called remittances and the family acts as the manager who may
spend the remittances it receives on consumption or invest it in human capital
formation.

2 Introduction
International migration has long been an important issue in economics, in
terms of skill transfer, cultural assimilation, development of both host and home
countries, trade and specialisation, social justice,and so on.Based on numbers
from the World Migration Report, there were about 281 million international
migrants in 2021, making up about 3.6% of the world population.

Remittances are money transfers from citizens working abroad to support

their families.They are an important source of revenue for many developing
countries, especially because they remain unaffected by economic downturns of
the home country and therefore provide a very stable source of income.In poorer
households, remittances may finance the purchase of basic consumption goods,
housing, and children’s education and health care. In richer households, they
may provide capital for small businesses and entrepreneurial activities. Since
2015, remittances have been the largest source of external finance flows to low-
and middle-income countries (LMICs) other than China.Over the last 20 years,
remittance flows have grown in value five-fold. Migrant workers send on average
US$200 to US$300 home every one to two months.(IMF,Remittances: Funds for
the Folks Back Home).

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Figure 1: Growth in remittances for some countries, taken from
https://www.migrationpolicy.org/programs/migration-data-hub

The New Economics of Labor Migration views migration as a contractual

arrangement between the migrant and his family, where, in the first stage, the
family supports the development of the migrant and, in the second stage, the
latter provides support to his family (e.g., Stark and Levhari (1982), Stark and
Bloom (1985), Lucas and Stark (1985), and Stark and Lucas (1988)). From this
viewpoint, migrants send remittances not only out of pure altruism, the amount
of remittances being sent can enhance their social status, increase the likelihood
of them inheriting their parent’s wealth; remittances may also be sent to acquire
assets in the home country and ensure their maintenance. The family left in
home country receiving remittances may choose how to invest it. How remit-
tances are used can therefore influence the well-being of the family in several
ways - the education of children, the health of family members, improvement
in living conditions, social empowerment of the family in the town or village,
and so on. Ivlevs(2019) while doing a comprehensive study on the impact of
remittances on the well-being of the family members left behind, found that re-
ceiving remittances is linked with significant increases in evaluative well-being,
especially in poorer families worldwide. However, the paper also found that hav-
ing household members abroad is linked with increased stress and depression,
which may not be offset by remittances, although it is observed to be somewhat

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less traumatic in countries where migration is more common. In essence, the
impact of remittances on the family well-being is a topic which needs to be more
rigorously investigated.

We shall focus on the impact of remittances on human capital development.

Increase in remittances imply an increase in the household disposable incomes,
which may be used to enhance the family’s stock of human capital. The empir-
ical evidence gives mixed results; sometimes remittances are used for funding
consumption and at other times they are used for investing in human capital
such as education, vocational training and health.

Here, we model the family as the principal agent and the migrant as the
owner of assets who sends remittances to the family expecting them to invest
some portion of it in the education of the children. While he can observe or
verify the educational outcomes (through report cards, or calls from relatives
in the home town or village), he might not know if the money he sent is being
invested in education or not. We will see that, if the migrant can somehow
monitor the amount the family is investing in human capital, he can ensure
that the maximum possible investment in education. However, in case he cannot
observe the exact investment being made, the investment in education will be
less; however, education levels can still increase if remittances increase according
to the educational outcomes. Moreover, we will also find that the amount that
a family decides to invest on education depends heavily on the opportunity cost
of investing in education, and the risk averseness of the family.

3 Literature review
Why migrants remit has been long since a topic of discussion among economists.
Lucas and Stark(1985) suggested 3 motives for migrants remitting their fam-
ilies back home- “pure altruism”, “pure self-interest” and “tempered altruism
or enlightened self-interest”. According to Stark, ”pure altruism” was the main
motive - since the utility of migrants also depended on the consumption of
family members back home. For ”pure self interest”,migrant sends remittances
with the aspiration to inherit (the bequest motive), to make himself appear as a
good investment for the future or with the intent to return home. If a migrant
wants to invest at home, the household can be a trustworthy and well-informed
agent. If a migrant intends to return home, he may already invest in hous-
ing, livestock etc. and will ask the family to be the agent.(Hagen-Zanker,Siegel
2007).Stark(1991) also hypothesises that in developing countries, migration and
remittances are used as a strategy for risk diversification. There are also other
factors influencing remittances, such as maintaining social status and the rate
of assimilation within the host community (Sana 2005, Naiditch and Vranceanu
2011).On the basis of data on Mexican migrants working in the United States,
Sana(2005) argues that remittances are one type of transnational practice, and

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can be thought of as the fee that migrants pay to remain members of the transna-
tional community, may as a response to discrimination and to the migrant’s loss
of status in the host country.

Lucas and Stark(1988) first proposed that migrants and their family members
enter into a mutually beneficial contractual agreement which covers a series
of transactions that stretch over time. While the migrant faces high risks in
the initial periods after his migration (there is a high chance of him being
unemployed during this period or employed in low-paying jobs), as he establishes
himself and obtains more secure employment the risk diminishes.The family may
be interested in pursuing some risky venture as adopting some new technology,
and therefore looking for some sort of insurance. In that case, the family acts
as an insurer to the migrant in the initial period , while the roles are reversed
in the next period. Although none of the parties would have been able to bear
the risk of failure alone, the exchange of risks permits the parties to engage in
activities that are highly risky in the short run and which would not have been
undertaken usually.

Another interesting subject mentioned in Lucas and Stark(1988) is the power

of the head of the family regarding the family resources. In many families,
’with respect to disposition of family property the head of the family has the
last word’ - if we consider that the remittances sent by the migrant becomes a
family asset, it is quite reasonable to assume that how the remittance is used
becomes the decision of the family head. While the migrant may influence the
decision of the family head by controlling the flow of remittances, he cannot
force the family to invest the money he sends however he wants.

The impact of remittances on education has also been debated in several pa-
pers. While many papers argue that remittances have a significantly positive
impact on human capital development, the effects vary based on the income
level of the family receiving remittances, institutional framework of the home
country, which members of the household have migrated,etc. Buchela,Boheli
and Fontenla used the 2010 Ecuadorian Census to estimate the effect of re-
mittances on secondary school enrollment across four key dimensions: gender,
household wealth, rural vs. urban, and family migration status. They found
that the effects of remittances are either negative or non-significant for chil-
dren in wealthier households, while strong positive effects are for poorer, urban
males, while negative effects are observed for rural females. There are thus very
different implications based on the income bracket of the household, the gender
of the family member in question, as well as which parent has migrated.

Here we try to use the manager-firm owner model (as given in Snyder and
Nicholson 2008, pg. 649) to argue that families will increase investment in
education as the amount of remittances increases.

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4 The model
Suppose a migrant in a foreign country is deciding how much remittances he
should send to his family in his home country. He wishes for a part of the
remittances he sends to be used for investment in the education of the children of
his family (for eg, buying more books, hiring tutors, feeding more nutritious food
to the children,and so on).The migrant can observe the change in educational
outcome, which may happen even if the family does not invest in better quality
education. Let the observed educational outcome be given by
e = i + u, u ∼ W N (0, σ 2 ) (1)
where i is the amount being invested in education. The migrant sends an amount
of remittances R = R̄+r , where R̄ is the minimum amount he must send in order
to influence household decision-making, and r is the amount he strategically
chooses to maximise his welfare. Thus, U (R̄) can be seen as some kind of
reservation utility for the family decision-makers. The migrant’s utility depends
on the educational outcome of the family, which may be due to interaction with
the host country’s society and culture, or simply because of migrants with better
education finding better jobs. Let the migrant’s utility function be given by:
V = W − R + m ∗ e, m>1 (2)
W being the wage he earns and W > R̄.
Let the utility function of the family decision-makers be given by
U (Rd ) = −exp(−ARd ), A > 0 (3)
which exhibits constant risk aversion behavior. Here, Rd represents the portion
of remittances that is available for consumption of the family (here, consumption
specifically refers to unproductive consumption which will not lead to human
capital formation). For simplicity, we will assume that the remittances can only
be spent on education or consumption. Let us also assume that remittances fol-
low a normal probability distribution. In that case the expected utility function
of the family is given by
E(U (R, i)) = E(R − i) − A/2 ∗ V ar(R − i) − C(i)
(4)
= E(R) − A/2 ∗ V ar(R) − C(i) − i
Here, i represents the amount of money being invested in education, and C(i)
represents the opportunity cost of foregoing the consumption from that amount
today. Rd = R − i, since the amount spent on education will not be used for
consumption. C(i) is increasing and convex in i. For simplicity, we shall also
assume U (R̄) = R̄.

4.1 The First Best Contract (full-information case)

In this case the migrant can observe the amount being invested by the family
in education, he will only remit an amount R̄ + r∗ if the family is investing

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a first best amount i* and nothing otherwise. The expected utility from the
remittance must exceed the reservation utility of the family.Since here E(R) =
R̄ + r∗ , V ar(R̄ + r∗ ) = 0 therefore:

R̄+r∗ −i∗ −C(i∗ ) ≥ U (R̄) =⇒ R̄+r∗ −i∗ −C(i∗ ) ≥ R̄ =⇒ r∗ −i∗ −C(i∗ ) ≥ 0 (5)

This is the participation constraint. Since the migrant would like to maximise
his utility, he will provide r* such that the equality constraint exactly holds in
equation(5); r* - i* - C(i*) = 0. In this case, the migrant’s exact utility is

E(V ) = W − r∗ + m ∗ i∗
= W − (i∗ + C(i∗ )) + m ∗ i∗ (6)
∗ ∗
= W − C(i ) + (m − 1) ∗ i

Maximising equation(6) we get

C ′ (i∗ ) = m − 1 (7)

We see that m > 1 is a necessary condition for this optimization, since C’ is

always positive.

4.2 The Second Best Contract (hidden-information case)

In this case, the migrant can observe the value of e but not i. The remittance
will therefore be conditioned on e.
Suppose the migrant remits according to the following rule:

R = R̄ + α.e + β, α > 1, β > 0 (8)

Then, expected utility of the family decision-makers is

E(U ) = E(R) − A/2 ∗ V ar(R) − C(i) − i

= E(R̄ + α.e + β) − A/2 ∗ V ar(R̄ + α.e + β) − C(i) − i
= E(R̄ + α.(i + u) + β) − A/2 ∗ V ar(R̄ + α.(i + u) + β) − C(i) − i (9)
A.α2 .σ 2
= R̄ + α.i − + β − C(i) − i
2
The first order condition for the utility maximisation of the family decision
makers, by differentiating (9) with respect to i is

α − 1 = C ′ (i) (10)

Now, the family members will only allow the migrant to influence decision mak-

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ing if E(U ) > U (R̄), so

A.α2 .σ 2
R̄ + β + α.i − − C(i) − i ≥ U (R̄)
2
A.α2 .σ 2
=⇒ R̄ + β + α.i − − C(i) − i ≥ R̄
2 (11)
2 2
A.α .σ
=⇒ α.i + β − − C(i) − i ≥ 0
2
A.α2 .σ 2
=⇒ β ≥ + C(i) − (α − 1).i
2
This acts as the participation constraint. Since the migrant has no incentive to
give the family a higher β, he will keep lowering the value of β until equation(11)
holds with equality. That is, the migrant lowers the incremental remittance
value until the family members are indifferent between investing in education
or not doing so.
The migrant’s utility function will now be

V = W − R + m.e
= W − R̄ − β − α.e + m.e
= W − R̄ − β − α.e + m.e
A.(C ′ (i) + 1)2 .σ 2
= W − R̄ − − C(i) + (α − 1).i − α.(i + u) + m.(i + u)
2
A.(C ′ (i) + 1)2 .σ 2
= W − R̄ − − C(i) − i − α.u + m.(i + u)
2
A.(C ′ (i) + 1)2 .σ 2
= W − R̄ − − C(i) − (α − m).u + (m − 1)i
2
A.(C ′ (i) + 1)2 .σ 2
=⇒ E(V ) = W − R̄ − − C(i) + (m − 1).i
2
(12)

Maximising (12) with respect to i, we get

m
C ′ (i) = −1
1 + A.C ′′ (i).σ 2
m (13)
=⇒ α =
1 + A.C ′′ (i).σ 2

Assuming that the RHS of equation(13) is positive, since C ′ (i) is positive we

infer that the amount being in education in the hidden information case is less
than the amount being invested in the full information case (given by equa-
tion 7). Therefore the amount of information available to the migrant is also
important in the family’s decision of how much to invest in education.

Another important thing to note here is equation (10). Since C’ is an increas-

ing function in i, if the value of α is increased, i will surely increase as well.

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Figure 2: Investment in education increases with incentives from the migrant

So for higher values of remittances, investment in education should increase as

well. However,we also note that the slope of the cost function has a significant
part to play on the amount of investment. If the marginal cost rises too quickly
with the rate of investment (i.e, C ′′ (i) is high), giving greater incentives to the
family members may not impact the educational outcomes significantly. We
can observe this from equation(13). For a very high value of C ′′ (i), the RHS of
equation(13) may be negative, so that there is no equilibrium and family mem-
bers will choose not to invest any part of the remittances in education, even if
incentives are high.

4.3 Results and Observations

From this principal-agent problem formulation , we can substantiate several
empirical findings on the impact of remittances on education. Remittances
are expected to have a strong impact on school education in countries where
the cost of education is low. Kifle(2007) found this to be true by examining
school children in Eritrea, where remittance-receiving households with school-
age children were observed spending a significant portion of the remittances on
child education.

On the other hand, the opportunity cost of investing in education should in-
crease steeply once mandatory level of schooling has been completed (Köllner,2013)
or one of the parents, especially the mother, has migrated (Hanson/Woodruff,

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2003). This would imply that the marginal cost rises very steeply in such cases.
So we expect that higher remittances will have little to no impact on education
levels in these situations.

The information available to the migrant and how risk averse the family
members are may also impact how much is invested in education. We observe
that for a high value of A, from equation (13), C ′ (i) is low, and therefore i
is also low. So for a risk averse family member, investing in human capital
(which is quite risky since it will not generate certain returns) may not be very
lucrative even with greater incentives. Examining data for Italian youth, Belzil
and Leonardi (2013) supports the claim that risk-aversion serves as a deterrent
to higher education; however, there are no empirical studies directly assessing
the relationship between risk aversion and the share of remittances invested
in education. Whether the availability of information to the migrant changes
the family’s decision regarding investment in education is also something which
remains to be empirically verified.

5 Conclusion
Remittances from migrants across the world provide a stable source of income
to their families left behind at home. Remittances provide the family with addi-
tional income, which may be used for food, healthcare, education, and housing
of the family and can also be used as source of capital for small businesses.
However, whether the family uses remittances for increasing consumption to-
day or invests the amount for capital accumulation (physical or human capital)
by foregoing current period consumption is the decision of the family members.
The migrant can influence this decision making by controlling the amount of
remittances being sent. This is the crux of our model, where the migrant acts
as the ’owner’ of the asset called remittances while the family acts like some
kind of ’manager’ who is directly controlling how the asset is being used.

We have used this principal-agent model to explain how an increase in remit-

tances can lead to increase in education levels. Secondly we have also proposed
that the opportunity cost of investing in education and the risk aversion of the
family members, and how closely the migrant can monitor the actual decisions
being taken by the family can have a significant impact on the amount of remit-
tances being used for education. The more responsively the ’cost’ of investing
in education increases with the actual investment, lesser will be the investment
in education; if the opportunity costs are too high, then family decision mak-
ers may choose not to invest in education at all. The degree of risk aversion
is also found to have a negative relationship with the amount being invested
for human capital formation, while increase in the information available to the
migrant should increase the amount being invested.

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 One of the very important issues that we have not discussed here is that
simply a parent migrating may impose a ’cost’ on the children being left in the
family. The children may be forced to take on the ’invisible’ work that was being
done by the parents (for eg., household chores) and therefore simply going to
school or taking extra tutions may have some ’opportunity cost’ which may not
be compensated by remittances. In such a case, simply investing in education
may not lead to increase in educational outcomes.

We also realise that this is hardly a general model, and several assumptions
can be modified to get a more realistic description of the arrangements between
a migrant and his family. However, the problem of the principal-agent where
the migrant and the family both maximise their respective utility functions is
something that should be considered deeply. There is also a need for further
research in this area since many of these results remain to be empirically verified.

6 References
1. Microeconomic Theory: Basic Principles and Extensions - Walter Nichol-
son and Christopher Snyder, Cengage Learning, 2010
2. Migration, remittances, and the family - O Stark, REB Lucas - Economic
Development and Cultural Change Volume 36, Number 3, April 1988

3. Remittances: Funds for the Folks Back Home - Dilip Ratha, www.imf.org
4. Buying membership in the transnational community: migrant remittances,
social status, and assimilation -M Sana, Population research and policy
review, 2005
5. Motivations to remit: Evidence from Botswana - REB Lucas, O Stark ,
Journal of political Economy, 1985
6. Mixed effects of remittances on child education - José R. Bucheli, Alok K.
Bohara and Matı́as Fontenla , IZA Journal of Development and Migration,
2018

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