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This paper develops a formal model that accounts for the net effect of an exchange rate devaluation on the long-term balance-of-payments constrained growth rate. Such a model investigates how a currency devaluation impacts on the home country non-price competitiveness via changes in income distribution and the rate of technological innovation. The model is built upon two plausible hypotheses. First, it is assumed that the rate of technological innovation is directly related to the income elasticity of demand for exports and inversely related to the income elasticity of demand for imports. Second, it is assumed that a redistribution of income between labour and capital has an ambiguous direct impact on the income elasticities ratio. The model shows that the net impact of a currency devaluation on growth can go either way depending on the institutional framework of the economy.

Purpose-This paper seeks to contribute to the literature on demand-driven Keynesian growth in open economies by developing a formal model that combines Dixon and Thirlwall's (1975) export-led growth model and Thirlwall's (1979) balance-of-payments constrained growth models into a more general specification. Then, based on the model developed in this paper, we analyse more broadly some important issues concerning the net impact of currency depreciation on the short-run growth. Design/methodology/approach-We build upon Dixon and Thirlwall's (1975) export-led growth model and Thirlwall's (1979) balance-of-payments constrained growth models in order to develop our theoretical framework. We also run numerical simulations to illustrate the net impact of devaluation on the short-run growth rate in different scenarios. Findings-We demonstrate that the net impact of currency devaluation on growth can go either way, depending on some structural conditions such as the average share of imported intermediate inputs in prime costs of domestic firms and the institutional capacity of trade unions to set nominal wages through the bargaining process. The model also shows that the effectiveness of a competitive real exchange rate to promote growth is higher in countries where the share of labour in domestic income is also higher. Research limitations/implications-This paper provides a coherent formal starting-point for further theoretical developments on the interrelatedness between currency devaluation, income distribution and growth. These findings provide empirically testable hypothesis for future research. Originality/value-The present study proposes an alternative formal solution for the theoretical problem of imposing a balance-of-payments constraint on the process of cumulative causation often incorporated in Kaldorian growth models. In terms of policy, our framework sheds further light on the relevance of income distribution and the labour market institutional framework for the dynamics of the exchange rate pass-through mechanism and allows us to map out related conditions under which currency devaluation can promote growth. Keywords balance-of-payments constraint, exchange rate, income distribution.

Conventional view argues that devaluation increases the price competitiveness of domestic goods, thus allowing the economy to achieve a higher level of economic activity. However, these theoretical treatments largely neglect two important effects following devaluation: (i) the inflationary impact on the price of imported intermediate inputs which raises the prime costs of firms and deteriorates partially or totally their price competitiveness; and (ii) the redistribution of income from wages to profits which affects ambiguously the aggregate demand as workers and capitalists have different propensities to save. New structuralist economists have explored these stylised facts neglected by the orthodox literature and, by and large, conclude that devaluation has contractionary effects on growth and positive effects on the external balance. Given that empirical evidence on the correlation between devaluation and growth is quite mixed, we develop a more general Keynesian-Kaleckian model that takes into account both opposing views in order to analyse the net impact of currency depreciation on the short-run growth rate and the current account. We demonstrate that this impact can go either way, depending on several conditions such as the type of growth regime, that is, wage-led or profit-led, and the degree of international price competitiveness of domestic goods.