| Abstract: |
Supermultiplier growth models show that higher autonomous spending leads to
stronger economic growth, implying that greater government spending can boost
economic activity (Freitas and Serrano, 2015). However, several authors
highlighted the limits of this strategy, arguing that increased spending might
lead to unsustainable debt accumulation patterns. This is particularly
important for small open economies, where growth requires imports that must be
paid with foreign currency, which can lead to growing external indebtedness
(Thirlwall, 1979; Nikiforos, 2018; Oreiro and Costa Santos, 2019). We build a
structuralist supermultiplier model for a small open economy with two sources
of autonomous demand, government expenditures and exports. We account for the
dynamics of external indebtedness (determined by economic activity), wage
growth (related to wage resistance) and the exchange rate (determined by the
Central Bank but limited by international reserves constraints). We find that,
in the long run, there is a limit for government spending: its growth rate
cannot exceed that of exports without generating an external crisis. However,
there is a strong role for public policy: there is nothing that automatically
leads the economy to its maximum growth rate compatible with the external
constraint to growth, and if government expenditures grow less than exports,
the economy will not completely exploit its external space. But the main
contribution of the paper is in the short-run analysis, where we find an
additional restriction, related to income distribution. Since higher wages
increase consumption and economic activity, they also require more imports,
potentially leading to unsustainable debt growth. Therefore, there is a
maximum real wage compatible with external equilibrium (Canitrot, 1983). If
unions’ demand wages are lower than the external equilibrium wage, the
economy will be stable, but will also achieve unnecessarily low output and
real wages. On the contrary, if target wages exceed those compatible with
external equilibrium, the economy displays economic cycles between capacity
utilisation, income distribution and indebtedness, marked by permanent
inflation. We show that, in the short run, the government can optimize fiscal
and monetary policies to maximise output given the external space, but that in
the long run, economic growth requires not only domestic spending but also
increasing exports to be sustainable. |