Debating the assumptions of the Thirlwall Model: A VECM analysis of the Balance of Payments for Argentina, Brazil, Colombia, and Mexico
Danilo Spinola
#2020-001
This article challenges the main assumptions of the Balance of Payments
Constrained Model (BPCM, aka Thirlwall model) related to the long-run:
(1) equilibrium of the trade balance. (2) Stability of price-effects.
(3) Foreign income growth positively affecting domestic income. Some
authors raise the argument that the BP is rarely observed in equilibrium
(Alonso & Garcimartín, 1998); price effects, through the real exchange
rate, do affect the long-run (Rodrik, 2008); and foreign income has no
effect (or negative) on domestic income (Razmi, 2016). The BPCM is based
on its assumptions to defend the existence of a long-run growth rate
compatible with a stable growth of the balance of payments, in which the
effective growth rate converges to avoid external constrains (McCombie &
Thirlwall, 1994; Thirlwall, 1979). In order to challenge the assumptions
of the BPCM, we apply a time series co-integration Vector Error
Correction Model (VECM) using the BPCM related variables to Argentina,
Brazil, Colombia, and Mexico, the larger countries in Latin America. The
data source is the Penn World Tables (PWT) for 1950-2014. We apply
impulse-response and permanent shocks in selected variables, observing
their effects on Real Exchange Rate, GDP, and Trade Balance. The results
are compared to the assumptions raised in this research; we empirically
find that the BPCM assumptions are not empirically robust for the
selected countries. This offers an invitation to more empirical work
that can strength the arguments of the BPCM model.
Keywords: Balance of Payments Constrains, Latin America, Economic
Development
JEL Classification: O11, F41, E12