Criticisms and defences of the balance-of-payments constrained growth model: some old, some new

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.