Essays in Honour of A.P. Thirlwall
Edited by Philip Arestis, John S.L. McCombie and Roger Vickerman
Chapter 2: Thirlwall’s Law and Palley’s Pitfalls: A Reconsideration
Mark Setterfield 1. Introduction Thirlwall’s Law, together with the idea that the potential rate of growth – Harrod’s natural rate – is endogenous to the demand-determined actual rate of growth, rank amongst the most important of Tony Thirlwall’s many contributions to the economics of growth and development. This chapter draws and expands on these contributions, paying particular attention to the ‘pitfalls’ in contemporary growth theory identified by Palley (2002). These pitfalls are associated with the common failure of both supply- and demand-led theories of growth to explicitly attend to the reconciliation of the actual and potential growth rates when employing steady state growth frameworks. The remainder of the chapter is organized as follows. Section 2 briefly describes Thirlwall’s Law and the balance-of-payments-constrained (BPC) growth model with which it is associated, whilst section 3 introduces ‘Palley’s pitfalls’ and identifies their potentially damaging implications for the BPC growth model – even when the endogeneity of the natural rate of growth is taken into account. Section 4 then discusses different channels through which the actual and potential rates of growth might be reconciled in the BPC growth model. Palley’s (2002) preferred solution is shown to involve quasi-supply-determined growth, and this is contrasted with an approach that results in a model of fully-demanddetermined growth. Finally, section 5 offers some conclusions and suggestions for further research. 2. Thirlwall’s Law The essence of Thirlwall’s Law (Thirlwall, 1979) is that absent the ability to attract a permanent net inflow of capital from abroad, the rate of growth of an economy...
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