13 - Growth with Limited Supplies of Foreign Exchange: A Reappraisal of the Two-Gap Model

Abstract

This chapter discusses growth with the limited supplies of foreign exchange. Practical orthodoxy seems unable to understand a simple but important message of the two-gap model: from the accounting identity S - I = X - M - R plus the observation of a current account deficit in the balance of payments, one cannot derive the conclusion that a particular developing country is living beyond its means. The conclusion follows only if net exports are restricted by excess domestic demand. It is not correct when net exports are conditioned by insufficient demand in world markets. The possibility of a foreign-exchange restriction cannot be assumed away in the 1980s merely because of the existence of a competitive world capital market. First, developing countries have to pass an export performance test before entitling themselves to enter the world credit market and the performance criteria required may be too stringent for the poorest developing countries. Second, credit rationing is an important characteristic of these markets and the country credit limits established by international banks may be too low, under given export opportunities, to free individual developing countries from the foreign-exchange bind.