Structural Heterogeneity and Endogeneity of Elasticities on the Balance of Payments Constrained Growth Model

The aim of this chapter is to demonstrate that, especially in developing countries, changes in the real exchange rate affect both the structure of production and the income elasticities of the demand for imports and exports — and, as a result, the balance of payments constraint to growth*. If the latter is weakened, then these countries are able to reach a higher long-term growth rate. Thus, following Dosi, Pavitt and Soete (1990), we show how a devaluation of the real exchange rate affects an economy’s productive heterogeneity, by reducing its real wages. In addition, we demonstrate that the elasticities are endogenous, based on the argument that maintaining an undervalued exchange rate encourages research and innovation. This is due to its positive impact on self-financing conditions and on the access to credit, making it possible to modernise and diversify the structure of production. In the long term, this implies an expansion of the export capacity and a reduction of the dependence on imports. Furthermore, based on Kaldor and Mirrlees (1962), we present a model that formalises the endogeneity of the elasticities by making them dependent on the average age of the capital stock of the economy. Lastly, we show how the approach suggested in this article is an improvement on the Structural Economic Dynamics (SED) approach, by demonstrating how variations in the real exchange rate alter the sectoral composition of the economy.