THE BALANCE OF PAYMENTS CONSTRAINT, CAPITAL FLOWS AND GROWTH RATE DIFFERENCES BETWEEN DEVELOPING COUNTRIES *

Abstract

THIS paper starts from the proposition that for most countries the major constraint on the rate of growth of output is likely to be the balance of payments position because this sets the limit to the growth of demand to which supply can adapt. Most countries, apart from the oil producing countries of the Middle East, can absorb foreign exchange without difficulty; and most cannot earn enough. It is true, of course, that the world as a whole cannot be balance of payments constrained, but it only requires one country or bloc of countries not to be constrained, for all the rest to be so. There cannot be many less developed countries that could not utilise resources more fully given the greater availability of foreign exchange. In a previous paper (Thirlwa]l, 1979) it was shown how closely the actual growth experience of several developed countries over the post-war period has approximated to the rate of growth of export volume (x) divided by the income elasticity of demand for imports (Xr). This ratio defines the balance of payments constrained growth rate on the assumptions that balance of payments equilibrium on current account is preserved and that the real terms of trade remain unchanged. The fact that the growth rate of so many advanced countries seemed to approximate to this simple rule suggested that for most countries capital flows are relatively unimportant in contributing to deviations of a country's growth rate from that consistent with current account equilibrium, and that relative price changes between countries measured in a common currency play only a minor role in balance of payments adjustment and in relaxing the balance of payments constraint on growth. It is largely real income (and employment) that adjusts to bring the value of imports and exports into line with one another to preserve balance of payments equilibrium. The simple growth rule, that growth approximates to y x/ir in the long run, is the dynamic analogue of the Harrod trade multiplier (Harrod, 1933), which has been recently revived by Kaldor (1975), and the workings of which have been explored by Kennedy and Thirlwall (1979). The empirical evidence suggests, therefore, that the Harrod trade multiplier works, at least for a range of advanced countries. The original Harrod trade multiplier assumes that the terms of trade are constant; that there is no saving and investment, and no government activity. Output or income is generated by the production of consumption goods (C) and exports (X), and all income is