The balance of payments constrained growth rate and the natural rate of growth: new empirical evidence

Lanzafame, Matteo (2011): The balance of payments constrained growth rate and the natural rate of growth: new empirical evidence.

Abstract

This paper implements a panel approach to investigate the empirical relevance of ‘Thirlwall’s Law’, which states that long-run growth must be consistent with balance of payments (BOP) equilibrium and is, thus, determined on the demand side. Building on ARDL modelling, mean-group and pooled mean-group estimation methods, we use annual data over the 1960-2010 years for a panel of 22 OECD countries and find significant support for the ‘Law’. Next, we also explore empirically the hypothesis that the BOP-constrained growth rate (yb) must equal the natural (or potential) rate of growth (yn) and find that the data do not reject this hypothesis. Finally, we adopt a new approach, based on panel Granger-causality methods, to explore the direction of causality between yb and yn. The results indicate the existence of unidirectional long-run causality from yb to yn , thus reinforcing the view, embodied in the ‘Law’, that long-run growth is demand-determined and constrained by the BOP.

• Item Type: MPRA Paper
• Language: English
• Keywords: Balance of payments; endogenous growth; panel cointegration; pooled mean-group estimation; panel Granger-causality
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C23 - Panel Data Models ; Spatio-temporal Models; O - Economic Development, Innovation, Technological Change, and Growth > O5 - Economywide Country Studies > O57 - Comparative Studies of Countries; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O40 - General; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F43 - Economic Growth of Open Economies

References

Alonso, J.A. 1999. Growth and the external constraint: lessons from the Spanish case, Applied Economics, vol. 2, 245-253

Arellano, M. and Bond, S. 1991. Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations, Review of Economic Studies, vol. 58, 277–297

Attanasio, O.P., Picci, L. and Scorcu, A.E. 2000. Saving, growth, and investment: a macroeconomic analysis using a panel of countries, Review of Economics and Statistics, vol. 82, 182–211

Bagnai, A. 2010. Structural changes, cointegration and the empirics of Thirlwall’s Law, Applied Economics, vol. 42, 1315-1329

Bairam, E. 1993. Static versus dynamic specifications and the Harrod foreign trade multiplier, Applied Economics, vol. 25, 739-742

Blundell, R. and Bond, S. 1998. Initial conditions and moment restrictions in dynamic panel data models, Journal of Econometrics, vol. 87, 115-143

Bruno, G.S.F. 2005. Approximating the bias of the LSDV estimator for dynamic unbalanced panel data models, Economics Letters, vol. 87, 361-365

Dray, M. and Thirlwall, A.P. 2011. The endogeneity of the natural rate of growth for a selection of Asian countries, Journal of Post Keynesian Economics, vol. 33, 451-468

Granger, C.W.J. 1969. Investigating causal relations by econometric models and cross-spectral methods, Econometrica, vol. 37, 424–438

Gutierrez, L. 2003. One the power of panel cointegration tests: a Monte Carlo comparison, Economics Letters, vol. 80, 105-111

Hartwig, J. 2010. Is health capital formation good for long-term economic growth? – Panel Granger-causality evidence for OECD countries, Journal of Macroeconomics, vol. 32, 314-325

Holtz-Eakin, D., Newey, W. and Rosen, H.S. 1988. Estimating vector autoregressions with panel data, Econometrica, vol. 56, 1371–1395

Judson, R.A. and Owen A.L. 1999. Estimating dynamic panel data models: a guide for macroeconomists, Economics Letters, vol. 65, 9-15

Karlsson, S. and Löthgren, M. 2000. On the power and interpretation of panel unit root tests, Economics Letters, vol. 66, 249-255

Kim, B-H., Min, H-G., Hwang, Y-S. and McDonald, J.A. 2009. Are Asian countries’ current accounts sustainable? Deficits, even when associated with high investment, are not costless, Journal of Policy Modeling, vol. 31, 163-179

Kiviet, J.F. 1995. On bias, inconsistency, and efficiency of various estimators in dynamic panel data models, Journal of Econometrics, vol. 68, 53–78

Kiviet, J.F. 1999. Expectation of expansions for estimators in a dynamic panel data model: some results for weakly exogenous regressors, in Hsiao, C., Lahiri, K., Lee, L.-F. and Pesaran, M.H. (eds), Analysis of Panel Data and Limited Dependent Variables, Cambridge, Cambridge University Press

Kónya, L. 2006. Exports and growth: Granger-causality analysis on OECD countries with a panel data approach, Economic Modelling, vol. 23, 978–992

Lanzafame, M. 2009. Is regional growth in Italy endogenous?, Regional Studies, vol. 43, 1001-1013

Lanzafame, M. 2010. The endogeneity of the natural rate of growth in the regions of Italy, International Review of Applied Economics, vol. 24, 533-552

León-Ledesma, M. and Lanzafame, M. 2010. The endogenous nature of the 'natural' rate of growth, in Setterfield, M. (eds), Handbook of Alternative Theories of Economic Growth, Northampton, USA, Edward Elgar

León-Ledesma, M. and Thirlwall, A.P. 2002. The endogeneity of the natural rate of growth, Cambridge Journal of Economics, vol. 26, 441-459

Libânio, G.A. 2009. Aggregate demand and the endogeneity of the natural rate of growth: evidence from Latin American economies, Cambridge Journal of Economics, vol. 33, 967-984

Loayza, N. and Ranciere, R. 2006. Financial development, financial fragility and growth, Journal of Money, Credit and Banking, vol. 38, 1051-1076

Martínez-Zarzoso, I. and Bengochea-Morancho, A. 2004. Pooled mean group estimation of an environmental Kuznets curve for CO2, Economics Letters, vol. 82, 121-126

McCombie, J.S.L. 1989. Thirlwall’s Law and balance of payments constrained growth – A comment on the debate, Applied Economics, vol. 21, 611-629

McCombie, J.S.L. and Thirlwall, A.P. 2004. Essays on balance of payments constrained growth. Theory and evidence, London, Routledge

McGregor, P. and Swales, K. 1985. Professor Thirlwall and balance of payments constrained growth, Applied Economics, vol. 17, 17-32

Nair-Reichert, U. And Weinhold, D. 2001. Causality tests for cross-country panels: a new look at FDI and economic growth in developing countries, Oxford Bulletin of Economics and Statistics, vol. 63, 153–171

Ng, S. and Perron, P. 1995. Unit root tests in ARMA models with data-dependent methods for the selection for the truncation lag, Journal of the American Statistical Association, vol. 90, 268-281

Nickell, S. 1981. Biases in dynamic models with fixed effects, Econometrica, vol. 49, 1417–1426

Palley, T. 2003. Pitfalls in the theory of growth: an application to the balance of payments constrained growth model, Review of Political Economy, vol. 15, 75-84

Pedroni, P. 1999. Critical values for cointegration tests in heterogeneous panels with multiple regressors, Oxford Bulletin of Economics and Statistics, vol. 61, 653-660

Pedroni, P. 2001. Purchasing power parity tests in cointegrated panels, Review of Economics and Statistics, vol. 83, 727-731

Pedroni, P. 2004. Panel cointegration: Asymptotic and finite sample properties of pooled time series tests with an application to the PPP hypothesis, Econometric Theory, vol. 20, 597-625

Pesaran, M.H., Shin, Y. and Smith, R. 1997. Estimating long-run relationships in dynamic heterogeneous panels, DAE Working Papers Amalgamated Series 9721

Pesaran, M.H., Shin, Y. and Smith, R. 1999. Pooled mean group estimation of dynamic heterogeneous panels, Journal of the American Statistical Association, vol. 94, 621-634

Pesaran, M.H. and Smith, R. 1995. Estimating Long-run relationships from dynamic heterogeneous panels, Journal of Econometrics, vol. 68, 79–113

Setterfield, M. 2006. Thirlwall’s Law and Palley’s pitfalls: a reconsideration, in Arestis, P., McCombie, J.S.L. and Vickerman, R. (eds), Growth and Economic Development: Essays in Honour of A.P.Thirlwall, Cheltenham, Edward Elgar

Thirlwall, A.P. 1979. The balance of payments constraint as an explanation of international growth rate differences, Banca Nazionale del Lavoro Quarterly Review, vol. 128, 45-53

Vogel, L. 2009. The endogeneity of the natural rate of growth – an empirical study for Latin American countries, International Review of Applied Economics, vol. 23, 41-53

Westerlund, J. 2007. Testing for error correction in panel data, Oxford Bulletin of Economics and Statistics, vol. 69, 709-748