The Effects of Internal and External Imbalances on Italy´s Economic Growth. A Balance of Payments Approach with Relative Prices No Neutral

Recently, Soukiazis E., Cerqueira P., and Antunes M. (2013) developed a model – hereafter the SCA model - that takes into account both internal and external imbalances and where relative prices are not neutral in the pace economic growth. The SCA model can be considered as an extension of the well known Thirlwall´s Law (Thirlwall, 1979) stating that growth can be constrained by the balance-of-payments when the current account is in permanent deficit. However, Thirlwall´s 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 in the peripheral countries shows that when internal imbalances are out of control they can constrain growth and domestic demand in a severe way. The aim of this paper is to implement the more complete SCA model in Italy and check its accuracy for explaining the growth path in this country. Our empirical analysis shows mainly that Italy grew less than its potential capacity due to supply constraints. A scenarios analysis shows that improving external trade performance is the most effective way to achieve higher growth in Italy.