International capital, multiple equilibria and finance-led dynamics in a BoPconstrained growth model

In this paper, we present a Balance-of-Payments (BoP)-constrained center-periphery growth model extended for the inclusion of international finance and the accumulation of external debt. With respect to previous works in this stream of literature, we show how the long-run BoP-constrained growth rate changes endogenously alongside the evolution of periphery’s external position. We describe a complex non-linear system that may feature multiple equilibria with different stability properties. A stable equilibrium characterized by high long-run BoP-constrained growth and low external indebtedness is paired with a saddle-path unstable one in which a more fragile external position associates with lower growth. We also show that periods of (temporary) financial “bonanza”, i.e., surges in foreign capital pouring into the economy, may modify the long-run growth trajectory of the periphery and its overall macro stability. Financial bonanza can boost economic growth in the short term. However, it can also give rise to tougher debt service payments and possibly lead to cases of premature de-industrialization. Despite short-term benefits, the periphery may well get worse off in the long run. If the financial boom is strong and protracted enough, it can even generate radical instability driving the periphery towards default on external debt. In the final part of the paper, we discuss the policy implications of the model, namely the role of capital controls as part of a broader development strategy aimed at taming finance-led instability and boosting structural change in the periphery.