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Japan’s remarkable economic progress was in part underpinned by the rapid expansion of its export sector, especially between 1950 to 1970. The history was closely related to an exchange rate system that worked as follows. In 1949, a fixed exchange rate system began working at a rate of JY360 per US dollar. In August 1971, a floating exchange rate system was introduced. However, in December 1971 the system returned to a fixed exchange rate at JY208 per US dollar in order to prevent sudden yen appreciation. Although international trade and investment proceeded smoothly under the fixed system, in February 1973 the system was moved back again to a floating rate, and has continued like this ever since. In the two decades up to 1993, owing to inexpensive labor costs and a favorable exchange rate in Japan, exports strengthened the balance of payments and GDP. Consequently, corporations reinvested profits in equipment.

One of the architects of a major reorganisation of the Treasury, and chosen by Prime Minister Harold Macmillan as a new broom, Armstrong was the first permanent secretary to be fully at home with the analytical framework of contemporary economic policy and demand management. He was involved in all the economic issues of the 1960s, particularly the balance of payments crises that eventually led to devaluation of the pound in 1967. He also worked to hold the Whitehall machine together following the change of government in 1964, including the issues raised by Labour’s creation of the Department of Economic Affairs.

After outlining the main characteristics of the literature on the role of the USA in the world economy since WWII, mostly focused on the postwar era, this section points to the decades of the 1960s and 1970s to provide an introduction to the history of the US foreign financial and monetary policies within the framework of changing international oil markets and capital markets developments reconstructed in this study. It outlines the main historical issues that such investigation tackles and illustrates the worthiness of exploring continuities and pathbreaking changes in the US strategies to resurrect the dollar in exchange markets and to restore US balance of payments equilibrium. It rounds off by pointing out the very end of the 1970s as a watershed in the history of both US foreign economic policy and the role of international economic institutions set up at the Bretton Woods conference. In charting the history of US foreign economic policy since the teetering of Bretton Woods’ stability in exchange rates and commodity prices, this work aims to detect the historical dynamics that lay at the origins of such a pathbreaking turn at the end of the 1970s.

This chapter investigates the US attempt to resort to the financial investments of the OPEC oil producing countries into the Eurocurrency markets to finance both the recasting of the supply side in the US and most advanced industrial economies, and the international payments position of the non–oil producing Least Developed Countries (LDCs) that suffered the most from both the increase in commodity prices, and the cost of money triggered by the oil crisis and by capital markets developments. Then, the chapter explores the American debate on the implications of the OPEC countries’ short-term investments on inflation, Eurocurrency markets, and the US international payments position. It charts the twin US strategy to reduce the balance of payments deficit and to restore stability in international trade through the multilateral institutional arrangements set off to recycle the funds of OPEC into long-term investments through the involvement of both the largest US commercial banks and the IMF. Finally, the chapter investigates the ways in which the leading OPEC countries (Saudi Arabia, Kuwait and Iran) reacted to this US strategy to make the oil producers shift from short-term inflation-sensitive placements to long-term investments. In so doing, the recycling mechanism is a test case to assess the course of bilateral economic and financial relations between each of these countries and the US. In contrast to the US approach––the chapter suggests––they went their own way in providing development finance assistance to the non-oil LDCs.

This chapter pinpoints the US strategies to restore balance of payments equilibrium and the dollar’s strength in foreign exchange markets from the late 1950s through to the 1960s, and its linkage to the US gold policies. After a late 1950s unsuccessful attempt to restore international payments equilibrium focused on the capital account position that included high interest rates, credit restraint policies, and the squeezing of the money supply, the Kennedy administration turned its attention to the current account component. Against this backdrop the chapter pinpoints Washington’s commitment to reduce overseas US military expenditures and to increase foreign military sales, as well as pressures on capital-surplus European partners for early repayments of outstanding debts and to have them embark upon a string of trade liberalizations. All of these measures were aimed at reducing foreign holdings of dollars and convertible foreign currencies, and at averting the international run on US gold stocks and its harmful effects on the dollar’s convertibility into gold and its stability in foreign markets.

The chapter first points to the reaction of the OPEC countries to the US attempt to cause a shift in their investment patterns from short-term highly liquid placements to long-term investments aimed at recasting the supply side of the business cycle since shortly after the first oil shock. In the framework of the OPEC countries’ investment diversifications and bilateral assistance to the LDCs, and their direct and portfolio investments in the US, Washington’s strategy to direct the recasting of the US balance of payments on the capital account proved to be unsuccessful. Against this backdrop, the early Ford administration turned to improve the current account position through an increase in US export to the oil producers by means of technical and industrial cooperation. Thereafter, the Carter administration strove to draw on the OPEC surplus capital to promote demand management policies in support for a restructuring of the business cycle on the demand side in both the US and other advanced industrial nations. The last part of the chapter highlights the failure of such strategies as a result of multiple causes, which included the persistent weakening of the dollar in international exchange markets and the consequent diverging views between Washington and its leading Western partners (Germany and Japan), worsening financial and economic relations between the US and Iran and Saudi Arabia, through to the outbreak of the Iranian Revolution. It rounds off by pointing to the path-breaking new US monetary tightening inaugurated by the new Chairman of the Federal Reserve Paul A. Volcker in late 1979 as the endpoint in the demand side policy implemented by Carter, and its financial path-dependence strategy on the oil producers.

China's financial system has been insulated from international markets by capital controls. These capital controls restrict international portfolio flows, that is, investment flows other than direct investment, into and out of China. As part of its financial reforms, China plans to relax these controls to allow capital to flow more freely into and out of the country. Such reforms are often dubbed capital account liberalization as the capital account is the part of the balance of payments that deals with international investment flows.

Distinct winners and losers have emerged in the world economic scene in which the manufacturing sector, through a combination of positive externalities and higher productivity growth, has played a decisive role in the countries’ inclusive growth path and the process of structural transformation. Manufacturing has played a crucial role in achieving the commanding heights in the growth of the successful entrepreneurial economies. One important motivation for the focus on manufacturing has been its potential to absorb labor from the agricultural sector. This is reflected by the gains registered by East Asian economies and others such as Israel, Spain, and the countries that made up the former Yugoslavia. A globally competitive manufacturing sector creates a sustainable economic ecosystem, encourages domestic and foreign investment, and improves a country’s balance of payments; not only does it create jobs within the sector but its effects also spill over into areas such as financial services, infrastructure development and maintenance, customer support, logistics, information systems, healthcare, education and training, and real estate. A strong manufacturing sector boosts a country’s intellectual capital and levels of innovation, underwriting research and development, pushing the technological envelop and driving the growth in demand for highly skilled workers and scientists.

This chapter engages with a number of macro-economic, micro-economic, geographic, geological and institutional conditions that affect LC policy development in each of the case countries and co-determine the degree to which LC policies enable sectoral and/or economy-wide catching up. Variations in these conditions influence the necessary trade-offs between competing objectives relating, more narrowly, to LC, and wider objectives relating to the balance of payments (BoP), demand-side management and monetary policy. It also structures the trade-offs between state control over downstream development/supply-chain operations and IOCs’ access to rent and operational autonomy. Finally, the chapter analyses the role of LC policy in generating wider social and economic benefits through the respective NIS’s ability and capacity to deliver innovation-driven growth and economic diversification.

India experienced unprecedented economic growth since economic reforms were launched in 1991 in the wake of India’s balance of payment crisis. These economic reforms adopted the free market philosophy and aimed to eradicate the License Raj. Although the Indian economy has improved significantly since the reforms, India still remains a difficult place to start and run a business. In a report titled ‘Doing Business’ by the World Bank, India ranked 142nd out of 189 countries in the favorable institutional business environment (World Bank Report, 2014). India is ranked even lower (156th out of 189 countries) when it comes to the ‘starting business’ indices of this report. Similarly, India’s arduous business climate is echoed in its low ranking on the Global Entrepreneurship Development Index (75th out of 120 countries), which examines the entrepreneurship ecosystems (mix of attitudes, resources, and infrastructure) of countries across the globe.

Reforms in Indian economic management started in 1985 took a different shape in 1991–2. Faced with acute balance of payments deficits, due mainly to two international factors beyond India’s control, demise of the Soviet Union and the war against Iraq, India had accepted loans from the IMF. India received a massive loan from the World Bank to help turn India into a capitalist economy, abandoning its planning system. Domestic factors behind the crisis were excessive government consumptions financed by debts starting from 1985. The collapse of the Soviet Union had wiped out about 20 per cent of India’s export market and an important source of imports. Imports from the Soviet Union had been paid for with India’s own currency and with very long-term interest free credit terms, therefore avoiding foreign exchange rates.

The mainstream view on the causes of the Eurozone crisis is that it is a fiscal crisis that emanated partly from the incompetence of the peripheral EU states to collect taxes, partly from their own states’ profligacy with a huge and uneconomic public sector, and partly from the ‘fact’ that these societies are not working as hard as their northern neighbours. This mainstream view has been defeated by original work carried out in the past few years not only by Marxisant scholars and heterodox economists, but also by important financial commentators and journalists, such as Martin Wolf of the Financial Times. The Eurozone crisis, this winning approach argued, is a balance of payments crisis that is bound up with Germany’s anti-inflationary, low wage, export-led growth creating permanent surpluses for itself and permanent deficits for the periphery. This chapter aims at going a step further. Following a ‘global fault-lines’ approach1, it produces a historical reading of the Greek social and political economy, bringing into context not just economic indicators but also geopolitical and security ones. Thus, readers will become aware that periphery social formations, especially Greece, are connected with some inextricable historical and structural contradictions and fault-lines that go well beyond the country’s entry into the EMU in 2001 and refer to the country’s geostrategic and geopolitical location in the Eastern Mediterranean and the Balkans

Egypt has had fluctuating economic fortunes for the last two decades. Due to the rapid increases in the international price of petroleum, Egypt’s balance of payments situation has eased over the last few years. Prior to 1986, these oil prices had been the source of Egypt’s rapid ten-year growth. Since 1986, the country has had serious balance of payments problems; as a result of which its foreign debt has grown, with severe macroeconomic imbalances. Between 1986 and 1992 the per capita income of Egypt grew only by 10 per cent and, in the early 1990s, the country began to undertake a serious macroeconomic stabilization programme. Fiscal stringency and privatization were undertaken in some areas and foreign investment flows increased. Rate of growth of real GDP also increased, from 1.9 per cent in 1991–2 to about 5 per cent in 1995–6. During the same period, inflation fell from 21.1 per cent to 7.2 per cent. The fiscal balance, foreign reserves and external debt also improved (Table 6.1).

For a large number of countries, exhaustible natural resources are very essential inputs for domestic productions. These are also very important parts of the export earnings and import needs. From planning perspectives it is important to relate domestic investment planning to the external sector. The external sector imposes a constraint on the economy in the form of balance of payments, and in most cases the country concerned has very little influence on the terms of trade. However, it can regulate the volumes of exports and imports.

China is the world’s largest international holder, having amassed about US$ 2 trillion of international reserves by the end of 2008 (Figure 1.1), rising to US$ 3 trillion by 2010.1 The rapid accumulation of reserves by China has generated several controversies. One concern is whether this continuing balance of payments (BOP) surplus signals the need for a substantial revaluation or appreciation of the Chinese Yuan (CNY) to protect China both from the inflationary consequences of the liquidity buildup and a misallocation of resources2 as well as to help ease global imbalances. An alternative view, particularly associated with McKinnon and Schnabl (2003a,b; 2004), argues that a fixed exchange rate is an optimal policy for China and the larger Asian region both on the grounds of macroeconomic stability and rapid economic development. The global monetarist approach of McKinnon is based on the assumption of little or no sterilisation of reserve accumulation, so that any BOP imbalance is temporary. However, many other commentators have suggested that the Chinese government’s concern with inflation has led the People’s Bank of China (PBC) to heavily sterilise these reserve inflows.3

This chapter discusses the characteristics, R&D expenditures, patents, and globalization of the ICT sector in Korea. Korea’s strength in the ICT manufacturing sector, R&D inputs, and quantitative R&D output shows a stark contrast to its weakness in the software sector, qualitative R&D output, and globalization of the ICT sector. Various statistics for the ICT sector such as R&D expenditure, the patent impact index, technological strength, the technology balance of payments, inward and outward FDI, and the R&D outsourcing index are provided and cross-country or crossindustry comparison is given. Firm-level analysis of R&D activities in the ICT sector is given and statistics such as CR5 and CR10 for ICT R&D expenditures and R&D intensity are provided. Detailed explanations of the R&D activities of the two most renowned ICT manufactuing firms in Korea – Samsung Electronics and LG Electronics – are given. The need for Korea to break away from a large company-oriented, HW-centric, less globalized ICT innovation system to one that is SME focused, SW centric, and more globalized is emphasized.

The optimal level of reserves has been a controversial issue from the times of fixed exchange rate regimes to the recent times of exchange rate flexibility. Earlier literature such as that of Heller (1966) points out that reserve accumulation has been driven by a precautionary motive against balance of payments imbalances. Similarly, Clark (1970) notes that even in the presence of a temporary deterioration of the balance of payments, international reserves enable a country to follow its domestic policy goals and reserves are beneficial because they provide a country with leeway to adopt suitable policies in the event of a permanent deterioration. Amongst others in recent times, Lee (2004) mentions that international reserves may mitigate international liquidity constraints encountered by a country. Yet again in recent times, reserve accumulation has been considered to be motivated by a need to insure a country against balance of payments risks. This is evident in the view of using reserves as an insurance mechanism against sudden stops. For example, Jeanne and Ranciere (2006) argue that reserves can smooth domestic absorption in the event of a sudden stop when debt is not rolled over and instead reserves can be used to repay the debt. In a similar perspective, such a possibility and theoretical construct is outlined by Aizenman and Lee (2007) where long-term investment projects are financed using foreign assets and, in the event of sudden stops and capital flight, international reserves can help long-term investment projects to continue rather than be liquidated.

As is well known, the Brazilian economy moved from a situation of stagflation (low economic growth and high inflation) and fiscal and external vulnerabilities in the 1990s and until 2002, to another characterized by “higher” economic growth, low inflation and improved macroeconomic fundamentals, that is, fiscal budget balance, sustainable public debt, and balance of payments equilibrium, from 2003 to 2012. Table 4.1 shows that, in the latter period, under leftist governments: (i) GDP grew by an average of around 3.8 percent per year, (ii) annual inflation averaged 5.8 percent, (iii) net public debt dropped from 52.4 percent to approximately 35.0 percent of GDP, and (iv) the external situation became comfortable, with foreign reserves increasing almost 657.0 percent from 2003 to 2012 to reach a total US$373.2 billion in 2012 (and, as a result, Brazil becoming a net creditor on the international financial market). Of course, these figures are modest in comparison with other emerging economies, such as China and India, but they are a remarkable change for Brazil. Moreover, since 2003, Brazil has displayed a healthy combination of macroeconomic resilience, sustained job creation, income redistribution and poverty reduction.

By late 1954, inflationary pressures had become well established after the quick recovery from the slowdown of 1952 and the rapid domestic demand growth of 1953 and 1954 (Chapter 4), and despite a considerable improvement in the public finances (Figure A2). These pressures continued into 1955. Domestic demand growth was unabated in the first half of the year, the labour market continued to tighten, retail price inflation continued to rise (Figure A3), and the current account of the balance of payments went into deficit (Table A1). Moreover, the Churchill administration was notably accommodating of wage demands. Butler commented that ‘Churchill … with unhappy memories of the General Strike to live down, was determined to pursue a policy of industrial appeasement, even at the cost of highly inflationary wage settlements’.1 Such a policy, combined with a commitment to high employment, was likely to have inflationary results.

With a rise of emerging market economies such as China, India, and Brazil, the distribution of global capabilities is shifting. In 2011, a newly inaugurated World Bank annual report, Global Development Horizons 2011, began with the following bold assertions: The inaugural edition of GDH addresses the broad trend toward multipolarity in the global economy … By 2025, the most probable global currency scenario will be a multipolar one centered around the dollar, euro, and renminbi … [In the postwar era,] in exchange for the United States assuming the responsibilities of system maintenance, serving as the open market of last resort, and issuing the most widely used international reserve currency, its key partners, Western European countries and Japan, acquiesced to the special privileges enjoyed by the United States — seiniorage gains, domestic macroeconomic policy autonomy, and balance of payments flexibility … [Today] three conventional pillars [of global economic governance] need to be reappraised: the link between economic power concentration and stability, the North-South axis of capital flows, and the centrality of the U.S. dollar in the global monetary system. (World Bank 2011: xi–xii; 2) This is quite striking language from the World Bank, suggesting as it does that global inequality might be a source of economic volatility, that major emerging powers might become senders rather than recipients of international investment, and that the U.S. dollar could gradually yield its position as the anchor currency for the world economy.

A number of economists have pointed out the key role of international capital flows and current account deficits in the formation of the crises in the periphery of the Euro Zone and have also mentioned their similarities with the crises in emerging market economies (for instance, Krugman 2011; Mansori 2011; and Wolf 2011). They characterize those events as “balance of payments crises”, in contrast to “public debt crises”. Other economists have adopted the same perspective and have produced papers with detailed data and persuasive arguments on the role and effects of capital inflows after the launching of the euro (for instance, Cesaratto and Stirati 2011; Bibow 2012). More recently, Cesaratto (2012) and Bagnai (2012) have developed analyses of the Euro Zone crises making use of our description of the macroeconomic dynamics that precedes the crises in emerging markets (as presented in Frenkel and Rapetti 2009). On the other hand, I became very interested in the comparison between the macroeconomic performances of the Euro Zone and the emerging market countries in early 2010, when the Greek sovereign risk premium began to rise. In a short paper (Frenkel 2010) I discussed the similarities and differences in the country risk premiums applied to each of the sets of countries.

Almost all of the financial centres considered in this book have developed since the 1960s in response to the globalization of capital markets and wealth generation. They have also benefited from restrictions imposed to limit international capital flows and to improve balance of payments in the host countries. Particularly prevalent in the US, the relevant policy actions included greater reserve requirements for banks, binding interest rate ceilings, and restrictions on the range of products and services that banks could offer.1 More generally, several developed countries, most notably the UK, implemented tax hikes in 1960s and early 1970s, especially on corporate income and investment earnings. These developments led financial institutions and businesses to look for alternative venues, to conduct their transactions elsewhere.

The UK entered 1977 with a hotchpotch of economic targets. There was the broad money supply target, reconstituted in 1975 as an adjunct to incomes policy, and announced in 1976 to placate the markets. There were the Public Sector Borrowing Requirement (PSBR) and Domestic Credit Expansion (DCE) ceilings, agreed with the International Monetary Fund (IMF), and published in the December 1976 Letter of Intent. There was an informal agreement with the Fund that sterling would be held down to encourage the balance of payments. There also emerged a Bank target for the foreign exchange reserves. But at the heart of the Labour government’s economic policy in 1977 was the target of lower inflation. While monetary and fiscal policy would play supporting roles, this was to be achieved primarily through incomes policy.

Argentina’s economic performance, since the beginning of the new millennium, has been an object of analysis and intense debate. This is not surprising. The period began with a severe financial and debt crisis. In December 2001, the government announced the largest default on public debt in global financial history. The economy had also sunk into a deep depression: GDP contracted by more than 20% compared to its previous peak in mid-1998, unemployment reached almost 22% of the labor force and half of the population became poor. Rather unexpectedly for most observers, the economy began a rapid and strong recovery in mid-2002, which then turned into rapid and strong economic growth. During this process, employment grew very fast, many tradable services, manufacturing and agricultural activities boomed and non-traditional exports expanded at an unseeing pace. The impact of the global financial crisis of 2008–09 was short-lived and not as severe as in other emerging markets. However, by late 2011, despite the very favorable external context of low interest rates and high terms of trade, the economy started to be constrained by the lack of foreign exchange. In early 2014, it finally faced a balance of payments crisis. As a result, inflation accelerated and output and employment contracted. The full resolution and consequences of this crisis are — at the time we write these lines — still to be seen.

Title of this chapter indicates that the US and the heavily indebted countries in the Euro zone have a dual debt problem: a balance of payment deficit, engendering the need to borrow from other countries, and a sovereign debt problem, engendering a need to borrow from anywhere. The chapter discusses the nature and the order of magnitude as well as the possible solutions of the dual debt problem of the United States and the case of Greece and Italy to illustrate the situation in Europe and the Euro zone. The thrust of the argument is that there is need for both fiscal correction and for sustained growth, and for improving the competitive position of the indebted deficit countries on both sides of the Atlantic.

Commercial considerations have been an ingredient in most donor country aid programmes since they began. They are best dealt with in two parts. First, most donors’ bilateral aid programmes, albeit usually provided on highly concessional terms, have for the most part been tied to the procurement of goods and services from their own countries. However misplaced, donor governments believed that tied aid benefited the balance of payments and created employment. It has been generally believed that in political terms there would be stronger public support for aid if it were thought to be mutually beneficial.

The present work analyses the pattern of economic growth prevailing in Brazil from 1970 to 2005. The analytical framework for this investigation is based on the classical supermultiplier demand-led growth model combined with the hypothesis that the balance of payments was the main potential (and often the most effective) constraint for the expansion of the Brazilian economy during the period in focus. We adopt a demand- led growth accounting methodology to analyse the Brazilian economy, based on a multi-source database compiled for this investigation.

In November 1965 the British Government made a decision that significantly changed the military framework on which Britain’s policy in the Persian Gulf was based, when it agreed to give up the military base in Aden by 1968.1 This decision was taken in the context of the Defence Review that was being conducted by the Cabinet Defence and Oversea Policy Committee as a result of the Chequers conference of November 1964. During his election campaign, the new Labour prime minister, Harold Wilson, had stressed that a government under his leadership would maintain Britain’s military presence East of Suez,2 and, once elected, he assured the House of Commons that Britain could not afford to relinquish its world role.3 However, it soon turned out that it would not be easy for him to keep this promise, given the grave financial difficulties that the Labour Cabinet had inherited from its Conservative predecessors. Faced with a balance of payments deficit of £800 million, Wilson scheduled a meeting with all senior ministers who were concerned with defence issues, and they gathered at Chequers on 21 and 22 November 1964 to discuss Britain’s defence expenditure and commitments. During this conference, Wilson accepted the warnings of the Treasury and the newly created Department of Economic Affairs that because of the precarious financial situation, the British defence budget could not be allowed to continue increasing at the present rate.

Using a multi-country generalization of Thirlwall’s law, we investigate the contribution to the growth performance of Sub-Saharan Africa (SSA) countries of trade with the low and lower-middle income countries in SSA and South Asia in the last two decades.* Unlike previous multi-country extensions of Thirlwall’s law, our model allows us to measure the contribution to the balance of payments constrained growth of the partner countries’ growth rates, the bilateral terms of trade, and the bilateral market shares (for imports and exports). This degree of detail provides useful insights on the functioning of the BoP constraint in a multi-country setting. The generalized law is estimated using a panel cointegration approach on a sample of 20 developing SSA countries, using annual data from 1990 to 2008 and considering three partner areas: SSA itself, developing Asia, and the rest of the world. Our generalized law is found to perform better than other versions of the law. Moreover, the empirical analysis shows that although each partner area has contributed to the relaxation of SSA countries’ BoP constraint, these contributions have occurred through different channels of transmission. On average, the main contribution of other SSA countries occurs through the real growth effect, that of developing Asia through the market share effect, and that of the rest of the world through the terms of trade effect.

This paper assesses various critiques that have been levelled over the years against Thirlwall’s Law and the balance-of-payments constrained growth model. It starts by assessing the criticisms that the law is largely capturing an identity; that the law of one price renders the model incoherent; and that statistical testing using cross-country data rejects the hypothesis that the actual and the balance-of-payments equilibrium growth rates are the same. It goes on to consider the argument that calculations of the “constant-market-shares” income elasticities of demand for exports demonstrate that the UK (and by implication other advanced countries) could not have been balance-of-payments constrained in the early postwar period. Next Krugman’s interpretation of the law (or what he terms the “45-degree rule”), which is at variance with the usual demand-oriented explanation, is examined. The paper next assesses attempts to reconcile the demand and supply side of the model and examines whether or not the balance-of-payments constrained growth model is subject to the fallacy of composition. It concludes that none of these criticisms invalidate the model, which remains a powerful explanation of why growth rates differ. JEL Codes: E12, O41

Thirlwall’s Law considers that growth can be constrained by the balance of payments when the current account is in permanent deficit.* The law focuses on external imbalances as impediments to growth and does not consider the case where internal imbalances (budget deficits or public debt) can also constrain growth. The recent European public debt crisis shows that when internal imbalances are out of control they can constrain growth and domestic demand in a severe way. The aim of this chapter is to fill this gap by developing a growth model in line with Thirlwall’s Law that takes into account both internal and external imbalances. The model is tested for Portugal, which in 2010 fell into a public debt crisis with serious negative consequences on growth. The empirical analysis shows that the growth rate in Portugal is in fact balance of payments constrained and the main drawback is the high import elasticity of the components of demand and in particular that of exports.

Thirlwall’s 1979 balance of payments constrained growth model predicts that a country’s long run growth of GDP can be approximated by the ratio of the growth of real exports to the income elasticity of demand for imports assuming negligible effects from real exchange rate movements. The paper surveys developments of the model since then, allowing for capital flows, interest payments on debt, terms of trade movements, and disaggregation of the model by commodities and trading partners. Various tests of the model are discussed, and an extensive list of papers that have examined the model is presented. JEL Codes: F32, F40, F43

Rapid growth takes place in economies which are competitive in world markets and start with the advantage of costs at least as low as their competitors’ (preferably lower). This advantage, by enabling them to expand exports without suffering excessive import penetration, provides them with opportunities to increase their share of world trade and to grow without the constraint of balance of payments problems. Internal demand can then be kept at a high and rising level, without undue inflationary pressures developing. These conditions were established and maintained for the USA during the nineteenth century and some of the first half of the twentieth, albeit behind high tariff barriers which had other disadvantages. They applied to most of the rest of western Europe — excluding Britain, which grew much more slowly — during the quarter of a century after World War II ended. The same conditions are to be found now in the fast-growing economies in the Far East. The reason why such sustained growth has been achieved, why living standards much more than doubled in the course of less than two decades, why inflation has in nearly all cases been relatively low and stable, is that the macroeconomic conditions have been right.

The aim of this chapter is to demonstrate that, especially in developing countries, changes in the real exchange rate affect both the structure of production and the income elasticities of the demand for imports and exports — and, as a result, the balance of payments constraint to growth*. If the latter is weakened, then these countries are able to reach a higher long-term growth rate. Thus, following Dosi, Pavitt and Soete (1990), we show how a devaluation of the real exchange rate affects an economy’s productive heterogeneity, by reducing its real wages. In addition, we demonstrate that the elasticities are endogenous, based on the argument that maintaining an undervalued exchange rate encourages research and innovation. This is due to its positive impact on self-financing conditions and on the access to credit, making it possible to modernise and diversify the structure of production. In the long term, this implies an expansion of the export capacity and a reduction of the dependence on imports. Furthermore, based on Kaldor and Mirrlees (1962), we present a model that formalises the endogeneity of the elasticities by making them dependent on the average age of the capital stock of the economy. Lastly, we show how the approach suggested in this article is an improvement on the Structural Economic Dynamics (SED) approach, by demonstrating how variations in the real exchange rate alter the sectoral composition of the economy.

One of the main implications of the neoclassical approach to growth is the existence of convergence across economies — although not necessarily to the same steady states — as a consequence of decreasing returns to capital. But, according to the balance of payments constrained growth theory as developed by Thirlwall, international convergence cannot be taken for granted. Although convergence can indeed occur in Thirlwall’s framework, the conditions that backward countries must fulfil to converge toward the leaders have some puzzling implications. In particular, non-price competitiveness must be higher in the less advanced countries than in the leading countries. This chapter is aimed at solving this puzzle by developing a model that attempts to reconcile the balance of payments constraint hypothesis with the notion of convergence. This model is employed to analyse economic growth in a sample of eleven developed nations over recent decades.

The first half of the 1970s brought fundamental changes for the world economy that created difficulties for domestic and multilateral economic management. The suspension of dollar convertibility into gold in 1971 and the collapse of the Smithsonian agreement in 1973 saw the end of the par value system after fewer than 15 years operating as it had been intended, and the OPEC price increases at the beginning of the decade created massive structural imbalances in the international trade and payments system. Internationally, the problem of recycling oil revenues from surplus nations with insufficient capacity to spend them, to deficit nations that were reliant on petroleum products to fuel their industries, proved to be a controversial problem with no universally accepted solution. Domestically, the balance of payments deficits caused by increased oil prices and the inflationary impact that the rising cost of imports had on domestic prices posed state managers with two very real problems: the first was how the competitiveness of industries could be improved in order to bring the payments system back into balance, and the second was how the brakes could be put on inflation without requiring unbearable costs from the wider population that could escalate into a political crisis of legitimation. Given that the first problem would seem to require a rationalization involving lower wage costs and higher unemployment, and the second a reduction in disposable incomes to restrict wage-push inflationary pressures, the international context clearly resonates with the accumulation versus legitimation dilemma outlined in Chapter 2.

In the hundred years from 1914 to 2014, the century since the outbreak of the First World War, the United Kingdom will have declined from pre-eminent global superpower to developing country, or ‘emerging market’, part of the Global South. The symptoms of this vertiginous plunge in the world’s rankings are already starkly apparent: a chronic balance of payments deficit, a looming shortage of energy and food, a dysfunctional labour market, volatility in economic growth and a painful vulnerability to external events.

A testing approach developed in Kvedaras (2007) is applied to the case of Portugal to test for the statistical acceptability of model-implied restrictions in the cointegrated vector autoregression of export-led and balance of payments constrained growth, using yearly data 1970–2009.* A potential structural break is found in the vector autoregression in 1976–77. The growth-model implied restrictions — the number of cointegrating vectors and a set of (over-identifying) restrictions on parameters — are fully consistent with the data in the post-break period.