ABSTRACT
The purpose of this chapter is to discuss and analyse how the balance of payments impinges on the growth performance of countries. This is important because mainstream growth theory still largely ignores the balance of payments. In classical growth theory, the balance of payments was assumed to look after itself through internal or external price adjustment, thereby severing any possible link between the state of the balance of payments and the use or accumulation of resources for economic growth. Harrod’s growth model (Harrod 1939) was a closed economy model, and so was the neoclassical growth model (see, for example, Solow 1956) with the added objection that the demand side of the economy was completely ignored. Savings determine investment and aggregate demand equals aggregate supply. ‘New’ growth theory, or endogenous growth theory (see Romer 1986; Lucas 1988) is also supply orientated and there are no demand constraints either internal or external. Many of the ‘new’ growth models are closed economy models, and in those which are not, the focus is on growth and trade, not on growth and the balance of payments. In the history of economic thought, the only school to have emphasised the importance of foreign exchange and a strong balance of payments for economic growth was the Mercantilists.
