Endogeneity of the elasticities and the real exchange rate in a balance of payments constrained growth model: cross-country empirical evidence

Renato S Campos,Gustavo Britto,Frederico Gonzaga Jayme Jr

doi:10.33834/bkr.v5i2.193

Renato S Campos, Gustavo Britto + Show 1 more

Open Access

https://doi.org/10.33834/bkr.v5i2.193

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Abstract

Balance of payments constrained growth models are notable for their longevity. This is especially true for the case of Thirlwall’s Law, which defines that a country’s sustainable growth rate is given by the ratio between the income elasticity of exports and that of imports. In light of this, the current paper explores the hypothesis that the income elasticities of this type of models are endogenous. The debate on the latter is resurgent in the literature. The results provide evidence that the ratio is, indeed, exogenous, and that the level of the real exchange rate influences economic growth as it determines such ratio. In other words, the real exchange rate is important for improving non-price competitiveness without, however, making the ratio between elasticities endogenous.

Highlights

Thirlwall»s (1979) seminal paper suggests that a country»s maximum sustainable growth rate is given by the equation that defines the growth rate compatible with balance of payments equilibrium
The results show that the per capita growth rate of a country is directly related to that of its exports and inversely related to the sectoral income elasticities of the demand for imports
This holds in spite of the fact that the endogeneity tests indicated that the hypothesis of endogenous elasticities is not valid

Summary

Introduction

Thirlwall»s (1979) seminal paper suggests that a country»s maximum sustainable growth rate is given by the equation that defines the growth rate compatible with balance of payments equilibrium. &'⁄$, where # is the growth rate of exports, $ is the income elasticity of the demand for imports, & is the income elasticity of the demand for exports and ' is the growth rate of world income This relationship came to be known as Thirlwall»s Law. As McCombie (2011) puts it, the rationality behind this “law” is that no country can grow faster than compatible with balance of payments equilibrium for long periods of time or its foreign debt, as a proportion of GDP, would rise to such a level that would cause international confidence to plummet, a decrease in the capacity of acquiring foreign credit and a currency crisis.

Growth-led models and endogenous elasticities

Conclusions