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

In this paper, we present a Balance-of-Payments-constrained center-periphery growth model including international finance and the accumulation of external debt. In a setting of unbalanced trade, we show that the BoP-constrained growth rate changes endogenously alongside the evolution of the periphery’s external position. We describe a complex non-linear system that may feature multiple equilibria. A stable equilibrium characterized by high long-run growth and low external debt is paired with a saddle-path unstable one in which a more fragile external position associates with lower growth. We show that temporary surges in capital inflows can modify periphery’s long-run growth trajectory and overall macro stability. Periods of financial bonanza can initially boost economic growth. However, they also raise the debt service burden and possibly cause premature deindustrialization. Despite short-term benefits, peripheral countries may well get worse off in the long run. If the financial boom is strong and protracted enough, it could even generate radical instability driving peripheral countries towards default on external debt. We conclude by discussing policy implications of this 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.