Economic Growth in an Open Developing Economy: The Role of Structure and Demand – by A.P. (Tony) Thirlwall

Trade

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Why do the economic structure of countries and constraints on demand in an open economy matter for the economic performance of nations? Tony Thirlwall challenges the orthodox neoclassical approach to the analysis of economic growth and explains why he hopes that his latest book – Economic Growth in an Open Developing Economy – will encourage economists who teach the topic of growth and development to take a more realistic approach.

 

This new book is a sequel to my earlier book published in 2002 entitled The Nature of Economic Growth: An Alternative Approach to Understanding the Performance of Nations, and is based on lectures given to students and staff at the National Polytechnic Institute in Mexico City in 2008 and 2011. What I set out to do is to challenge the way that orthodox growth theory is taught in most Universities across the world which ignores the structure of production and the demand for output, and which assumes that the factors of production, labour and capital, and technical progress, are exogenous to demand. And the background to my concern is that faster growth is vital to poverty reduction in developing countries and that my alternative approach to understanding growth performance has important policy implications.

On the question of the structure of production, we know from empirical research that GDP growth is much more closely related to the growth of manufacturing industry than it is to the growth of primary production and service activities. That is why the so-called newly industrialising countries (the NICs) are the fastest growing. The reason is that manufacturing generates increasing returns and positive spill-overs to other activities which raises productivity growth compared with land-based activities and most services. Developing countries need structural change in favour of manufacturing if they are to grow faster and reduce poverty.

On the question of the role of demand, we know from basic Keynesian theory that it is demand that determines output, but there may be severe constraints on demand relating to inflation; government budget deficits and, in the open economy, to the balance of payments position of countries. In many developing countries, demand constraints bite long before capacity output is reached. There are vast reserves of unemployed and under-employed labour, and capital lies idle a lot of the time.

We also know from empirical research that supply responds to demand; that labour force growth and investment are endogenous to demand – not exogenously determined as in neoclassical theory. In other words, if constraints on demand can be lifted, countries will grow faster. This has different policy implications from the purely supply-side policy recommendations of neoclassical theory.

In many non-oil exporting countries, a particularly binding demand constraint is the balance of payments, and I present a lot of empirical evidence to show that many countries’ long run growth performance can be approximated by a country’s growth of exports relative to its income elasticity of demand for imports. The purpose of trade liberalisation should be to raise export growth relative to import growth, but this has not happened in many poor countries. I argue, in general, that trade liberalisation has not delivered the benefits expected.

What I hope from this book is that economists who teach the topic of growth and development to students will take a more realistic approach to the analysis of growth than the conventional one-good, orthodox, supply-side model, and recognise that what countries produce and export is of prime importance, and that economic policy should focus as much on demand constraints on output as well as potential supply constraints to maximise the growth performance of countries.

Finally, economic growth is too important to be left to the free market alone. With regard to the use of domestic resources and to foreign trade, there is an important role for government activity. This is the lesson of history, and from the successful fast-growing countries of China and South East Asia.

I would welcome any comments.

Tony ThirlwallTony Thirlwall is professor of Applied Economics at the University of Kent at Canterbury, UK.  He has written a number of other books published by Edward Elgar: The Economics Of Growth And Development (1995); Macroeconomic Issues From A Keynesian Perspective (1997); The Nature Of Economic Growth (2002); Trade, The Balance Of Payments And Exchange Rate Policy In Developing Countries (2003); and Trade Liberalisation And The Poverty Of Nations (2008). He also serves on the Board of Patrons for the Review of Keynesian Economics.


Economic Growth in an Open Developing EconomyAlso available as an eBook for subscribing libraries on

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