ABSTRACT
The neo-classical approach to the question of why growth rates differ between countries, typified by the meticulous studies of Denison (1967), Denison and Chung (1976), and Maddison (1970, 1972) concentrates on the supply side of the economy using the concept of the production function. Having specified the functional form, the growth of output is apportioned between the growth of capital; the growth of labour, and the growth of total factor productivity obtained as a residual. By this approach, growth rate differences are ‘explained’ in terms of differences in the growth of factor supplies and productivity. While the approach is fruitful, interesting and mathematically precise, it does not tell us why the growth of factor supplies and productivity differs between countries. To answer this question, some would say that a more Keynesian approach is required which stresses demand. For the Keynesian, it is demand that ‘drives’ the economic system to which supply, within limits, adapts. Taking this approach, growth rates differ because the growth of demand differs between countries. The question then becomes why does demand grow at different rates between countries? One explanation may be the inability of economic agents, particularly governments, to expand demand. This explanation by itself, however, is not very satisfactory. The more probable explanation lies in constraints on demand. In an open economy, the dominant constraint is the balance of payments. In this chapter, it is shown how closely the growth experience of several developed countries approximates to the rate of growth of exports divided by the income elasticity of demand for imports, which, on certain assumptions, can be regarded as a measure of what I call the balance of payments equilibrium growth rate. In fact, the rate of growth of exports divided by the income elasticity of demand for imports gives such a good approximation to the actual growth experience of major developed countries since 1950 that a new economic law might almost be formulated. The importance of a healthy balance of payments for growth can be stated
quite succinctly. If a country gets into balance of payments difficulties as it expands demand before the short-term capacity growth rate is reached, then demandmust be curtailed; supply is never fully utilised; investment is discouraged;
technological progress is slowed down, and a country’s goods compared with foreign goods become less desirable so worsening the balance of payments still further, and so on. A vicious circle is started. By contrast, if a country is able to expand demand up to the level of existing productive capacity, without balance of payments difficulties arising, the pressure of demand upon capacity may well raise the capacity growth rate. There are a number of possible mechanisms through which this may happen: the encouragement to investment which would augment the capital stock and bring with it technological progress; the supply of labour may increase by the entry into the workforce of people previously outside or from abroad; the movement of factors of production from low productivity to high productivity sectors, and the ability to import more may increase capacity by making domestic resourcesmore productive. It is this argument that lies behind the advocacy of export-led growth, because it is only through the expansion of exports that the growth rate can be raised without the balance of payments deteriorating at the same time. Believers in export-led growth are really postulating a balance of payments constraint theory of why growth rates differ. It should be stressed, however, that the same rate of export growth in different countries will not necessarily permit the same rate of growth of output because the import requirements associated with growth will differ between countries, and thus some countries will have to constrain demand sooner than others for balance of payments equilibrium. The relation between a country’s growth rate and its rate of growth of imports is the income elasticity of demand for imports. The hypothesis we shall be testing, from the model to be outlined here, is that, if balance of payments equilibrium must be maintained, a country’s long-run growth rate will be determined by the ratio of its rate of growth of exports to its income elasticity of demand for imports.
Balance of payments equilibrium on current accountmeasured in units of the home currency may be expressed as
