Thirlwall’s Law, External Debt Sustainability and the Balance of Payments Constrained Level and Growth Rates of Output

Thirlwall’s law, given by the ratio of the rate of growth of exports to the income elasticity of imports is a key result of Balance of Payments (BOP) constrained long run growth models with balanced trade. Some authors have extended the analysis to incorporate long run net capital flows. We provide a critical evaluation on these efforts and propose an alternative approach to deal with long run external debt sustainability, based on two key features. First, we treat the external debt to exports ratio as the relevant indicator for the analysis of external debt sustainability. Second, we include an external credit constraint in the form of a maximum acceptable level of this ratio. The main results that emerge are that sustainable long run capital flows can positively affect the long run level of output, but not the rate of growth compatible with the BOP constraint, as exports must ultimately tend to grow at the same rate as imports. Therefore, Thirlwall’s law still holds.

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