Remittances are one of the most substantial financial flows to developing regions – in many countries, they surpass foreign aid and foreign direct investment. Although widely recognized to benefit recipient households through increased income and consequent improvements in living standards, such large inflows of currency can have broader economic impacts, which remain less understood. The Salter-Swan open economy model suggests that when large inflows of remittances increase aggregate demand, the price of non-tradables increases relative to tradables, since the latter can adjust to world price through imports. This leads to a shift in resources towards the more profitable non- tradables sector — leading to structural transformation. This study examines whether remittances lead to a shift in production towards services by looking at employment and firm formation in Nepal, a country where annual remittance inflows are equivalent to over 25% of GDP.

I analyze district- and year-level variation in remittances received and economic outcomes. I estimate district-level remittances using data on labour permit issuance; the Department of Foreign Employment maintains a record of number of labor permits issued by each district. I use five rounds of household surveys to measure sector of employment, and firm registration data to measure sector of firm formation. Using a machine learning algorithm, I classify firms into sectors based on their names.

Since remittances received by districts are likely endogenous to unobservable. characteristics, OLS estimates would not identify causal effects. Therefore, to capture exogenous variation in district-level remittances, I use an instrumental variable: proximity to depots used by the British army to recruit Nepali soldiers during the 17th century.

Regions closer to these depots sent more soldiers and the migration patterns persisted, leading these regions to now experience disproportionately higher migration. I find that remittances lead people to move out of employment in agriculture, but I find no effect on the probability of being employed in the service sector. However, I find strong results on service-sector firm formation – a 10% increase in remittances increases the formation of service-sector enterprises relative to agriculture-or manufacturing firms by 2.3%. These findings offer new evidence on the potential role of migration and remittances in developing countries.