ABSTRACT
Anumber of recent studies have dealtwith the 45◦-rule (also referred to asHarrod’s foreign trademultiplier or Thirlwall’s Law)which compares actual demand (or real output) growth (ddˆi)with a warranted rate (ddˆ∗) defined so as to keep the external current account in equilibrium without changes in the real effective exchange rate. Thirlwall (1979) uses a rank correlation test between ddˆi and ddˆ∗ and finds a significant value. McCombie (1989) relies on a more indirect test by comparing import elasticities obtained from time-series regressionswith the import elasticities required to keep the current account in balance. For the period 1954-73 he finds that for 11 out of 15 countries the two elasticities are not significantly different, and Bairam (1990), applying the same test to 15 low-income countries for the period 1961-85, finds the 45◦-rule confirmed except for 4 oil exporting countries. Krugman (1989) compares ddˆi with ddˆ∗ in a cross-country regression for 13 countries over the period 1955-65 and finds an R2 of 0.75, with most observations closely clustered around a 45◦-line. However, whenKrugman repeats this exercise for the period 1970-86 on the basis of revised elasticity estimates and a smaller country sample, the R2 falls to only 0.32. McGregor and Swales (1991) obtain a rather higher R2 for the same period using a sample of 19 countries, but the regression coefficient is significantly below the expected value of unity and the intercept term is significant. By suppressing the latter Bairam (1988) estimates a regression coefficient near unity but only when the calculation of ddˆ∗ is based on actual rather than estimated values for exports. These last results suggest that while the 45◦-rule is useful as a condition for bal-
anced growth, it is less useful in describing actual developments, especially under a regime of flexible exchange rates. Indeed, external imbalances inmany countries are non-stationary or show a distinct time trend (Andersen, 1990) and it is well known that real exchange rates have not been constant. Moreover, most of the elasticities presented in the literature are based onmerchandise trade only (or confined to manufactured goods), whereas total trade flows include a rising share of
services and non-factor payments. It might also be argued that some of the earlier samples were rather small and that the results proved very sensitive to the inclusion (or exclusion) of extreme observations, usually the United States and Japan. The purpose of this chapter is to provide a more up-to-date and extensive
evaluation of the 45◦-rule. To achieve this, export and import equations for 16 industrial countries were estimated using annual national accounts data for the period 1960-90, and then the income elasticities were applied to calculate warranted growth rates for various subperiods, and assess changes in countries’ external positions.
