ABSTRACT
Thirlwall (1979) proposes a model explaining that rates of economic growth differ between countries because of different balance of payments constraints, that is, because of the different income elasticities of exports and imports. In Thirlwall’s world, the exports of one country are imperfect substitutes for the exports of another country, and the labor supply is not constraining, in the long run. Thus, relative prices and the adjustment in the exchange rate, that is, price competitiveness, become irrelevant to growth. The solution of the model provides a formula of surprising simplicity and of
appealing interpretive capacity. In fact, it has been extended in several directions (Cimoli and Soete, 1992; Fagerberg, 1988; Padoan, 1993), and it has been favorably tested to capture the stylized fact that relative growth rates differ in the same proportion as the export/import elasticity ratio.1 The model has also been challenged both theoretically and empirically by McGregor and Swales (1985, 1986, 1991), while Krugman (1989a) suggests an alternative explanation for the same stylized fact. McCombie and Thirlwall (1994) collect contributions to the debate, together with their replies, and provide further material for discussion, while McCombie (1996) and McCombie and Thirlwall (1997a) refine the model. However, neither the original model nor its subsequent developments spell
out the underlying structure necessary to explain dynamic stability. Thirlwall’s model in fact provides only a steady-state solution, where all the variables grow at the same constant rate. Most important, the model predicts a steady growth disregarding both the size, rather than the changes, in the deficit or surplus of the balance of payments, and the gap in the levels, rather than in the changes, of domestic and foreign competitive prices. Hence, the model fails to explain the working of the external constraint on economic growth. Overcoming this failure is the main aim of the present chapter. It presents a sub-
stantial extension of the original model, by drawing on Thirlwall andMcCombie’s verbal arguments, discussions, and, sometimes, hints. In particular, treatment of the labor market becomes necessary, and the adoption of the short-run Phillips curve becomes difficult to avoid. As a consequence, a short-run case emerges
where the Thirlwall growth formula does not apply, and where, for very slow adjustments, the growth path assumes a Goodwinian cyclical pattern. A further extension of Thirlwall’s model concerns the possibility of a flexible exchange rate. This allows study of a further price-mechanism for the adjustment of the balance of payments.
