Kaldor’s paradox, industrial equilibrium exchange rate, and technological gap: a reconciliation of New Developmentalism with stylized facts

One of the main propositions of the newdevelopmentalist school is the idea the over-valued exchange rates − due to Dutch disease and the adoption of a growth model with foreign savings − hampers economic growth by reducing the manufacturing share in output, i.e. causing a process of deindustrialization and also provoking an unsustainable increase in the current account led by an increase in the manufacturing trade deficit that is not compensated by the increase in exports of primary goods due to their low income elasticity of demand (Bresser-Pereira et al., 2015). The problem with this proposition is its incompatibility with the so-called Kaldor’s paradox, the empirical regularity discovered by Kaldor (1978) and confirmed by the subsequent empirical literature (Boggio and Barbiere, 2016) that a country manufacturing share in world’s manufacturing exports exhibits a negative correlation with the relative unit labour costs, which means that exchange rate devaluations that are able to reduce the relative real wages are associated with a decrease, rather than an increase, of a country manufacturing share in world’s manufacturing exports. The main objective of this paper is to show that using the concept of industrial equilibrium exchange rate of Oreiro et al. (2020) paper in a macro-Schumpeterian model developed by Fagerberg (2007) the Kaldor’s paradox can be explained as the result of an appreciation of industrial equilibrium exchange rate due to a reduction in the level of technological gap. In such a framework an overvaluation of exchange rate − relative to industrial equilibrium − continues to be harmful for economic growth, but appreciation of the industrial equilibrium exchange rate does not have such an effect. JEL Classification: O11; O14; O3; O4.