Criticisms and Defences of the Balance of Payments Constrained Growth Model: Some Old, Some New

This chapter assesses various critiques that have been levelled over the years against Thiriwall’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-share” 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 post-war period. Next, Krugman’s interpretation that the law (or what he terms the “45-degree rule”) which is at variance with the usual demand-oriented explanation is examined. The chapter 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.