Balance‐of‐payment constrained growth: the case of China, 1979–2002

Abstract

The aim of this study is to empirically test the validity of Thirlwall’s Law in China during the reform period of 1979–2002. This study finds: (1) that for 1979–2002, the Chinese economy has grown on average as fast as Thirlwall’s Law predicts – the average actual growth rate and predicted growth rate were, respectively, 9.25 and 8.55, which are statistically identical; (2) that the growth of GDP and of exports are cointegrated. Both (1) and (2) provide strong support for Thirlwall’s Law in China during the reform period after 1978. The supportive result of Thirlwall’s Law implies the relevance of a demand‐side approach to the economic growth in China. For time series analyses, a bounds test approach is adopted.

Keywords:

• Chinese economy
• balance‐of‐payment constrained growth
• demand‐led growth
• bounds test for cointegration

JEL classifications:

• F14
• F43
• O53

Acknowledgement

I would like to thank Matias Vernengo for his comments on an earlier draft. I also thank the editor of this journal, Professor Malcolm Sawyer, for his kind suggestions and patience. However, any errors that might remain are my responsibility.

Notes

1. For a comprehensive discussion on the issues related to a demand‐oriented approach, see McCombie and Thirlwall (1994).

2. It is gratefully acknowledged that Tuck Cheung Tang, Monash University, Malaysia, collected from the World tables the data set for China and sent it to the author through personal correspondence.

3. It is worth noting that the notion of the binding constraint imposed on economic growth by the requirement in the foreign sector relies on the critical role of income elasticity of demand for imports and exports as the determinants of the volumes of imports and exports: if income elasticity of demand for import is big enough relative to that of exports, the requirement of balance‐of‐payment should be met by a reduction of income at home. In contrast, according to the stories of the supply‐oriented approach, economic growth is independent of the balance‐of‐payments constraint and supply‐determined because price should adjust in such a way that current accounts are always balanced. This means that price elasticity of demand for imports and exports are well greater than unity. As in our case here, however, almost all empirical studies on import and export demand functions have repeatedly rejected the key assumption of elastic price elasticity.

4. This is in sharp contrast to the results of preceding studies. To the present author’s knowledge, only a few studies (Senhadji 1998; Tang 2003) are submitted in the literature on an import demand function for China. The fact that price is inelastic of import demand in China is consistent with all the preceding works (Tang (2003) provides the results with various specifications). However, all studies report an inelastic income elasticity. Although the relevant specification and estimation technique is not a central issue in this paper, it should be worth mentioning the fact that all studies but the first model in Tang (2003) subtract export from domestic income, which makes their income elasticity not relevant to our purpose. Furthermore, to evaluate the results correctly, it must be considered that in China exports have caused imports (Liu, Wang and Wei 2001; Liu, Burridge and Sinclair, 2002).

5. The income elasticity implicit in the coefficient of 0.288 is 3.47 (1/0.288), which is much bigger than that in the import demand function in the above section. This may be explained by the fact that the estimate of 0.288 should embrace all the other factors, such as effects of change in terms of trade and of capital inflow, amplifying the income elasticity.

6. McCombie, Pugno and Soro (2002, 8–27) make a long and thorough list of empirical works on Verdoorn’s Law. The author also demonstrates that Verdoorn’s Law holds in China, suggesting the importance of demand‐side for the economic growth in China (Jeon 2007).