Challenging the Supply-side Vision of the Long Run
Edited by Mark Setterfield
Chapter 7: Pitfalls in the Theory of Growth: An Application to the Balance-of-Payments-Constrained Growth Model
7. Pitfalls in the theory of growth: an application to the balance-ofpayments-constrained growth model Thomas I. Palley INTRODUCTION Over the last decade, under the banner of new endogenous growth theory, there has been a revival of interest in the theory of economic growth. Though endogenizing steady-state growth, the new theory persists with the claim that growth is a purely supply-side phenomenon. This is at odds with Keynesian economics that emphasizes the demand-side dimension of the growth process. However, the Keynesian paradigm has, itself, fallen into the pitfall of failing to properly account for the supply side. In the long run, there is a requirement that the rates of demand and supply growth be equal. Absent this, there will either be growing excess capacity or excess demand. If potential output growth is subject to influences other than those acting on the demand side, or if it does not respond one-for-one to changes in the rate of demand growth, this requires mechanisms that equilibrate the two. This study presents a short treatment of the demand- and supply-growth problem, and then applies it to balance-of-payments-constrained (BOPC) growth theory (Thirlwall, 1979). In its simplest form, the BOPC model is a pure demand-constrained model of growth. A Verdoorn law equation can be added to describe the supply side, but this introduces problems of reconciling supply growth with the BOPC rate of demand growth. Building on Palley (1996), the study suggests how this inconsistency can be reconciled. THE PROBLEM OF BALANCING DEMAND AND SUPPLY GROWTH Neoclassical...
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