Balance-constrained growth rates: Generalizing Thirlwall's law

A well-known approach to the relationship between the balance of payments and economic growth is due to A. P. Thirlwall [“The balance of payments constraint as an explanation of international growth rate differences”, Banca Nazionale del Lavoro Quarterly Review, vol. 32, March 1979, pp. 45-53]. According to this author, the balance of payments can act as a constraint on the rate of growth of output, since it puts a limit on the growth in the level of demand to which supply can adapt. From here, and assuming that the real exchange rate stays relatively constant, the concept of balance of payments-constrained growth rate follows, as the ratio of the rate of growth of exports to the income elasticity of the demand for imports. Only when the actual growth rate is lower than the balance of payments-constrained rate a country would be able to experience a sustained growth, on allowing equilibrium in the balance of payments. This rule is also known as Thirlwall’s law.

In this paper, we show how the concept of balance of payments-constrained growth rate developed by Thirlwall (1979) can be generalized as the growth rate constrained by the balance between any two economic variables. In particular, we derive two new concepts: the government balance-constrained growth rate, and the private balance-constrained growth rate. In addition, some extensions of the basic model have been also provided, namely, the cases in which the two variables depend on a set of possible determinants, and when there is no equilibrium between the two variables in the starting situation. To conclude, notice that the two new concepts might prove to be useful in empirical applications.