Harrod-Domar Dilemma, Thirlwall’s Law and Green New Developmentalism

Dilema Harrod-Domar, Lei de Thirlwall e Novo Desenvolvimentismo Verde

ABSTRACT

The article aims to address the ecological transition into a model that integrates the Harrod-Domar Dilemma and the New Developmentalism according to a Green New Developmentalism perspective. To this end, this paper focuses on the green sides of the middle-income countries’ traps by introducing a novel concept of the ecologically sustainable output growth rate into the new developmentalism model developed by Oreiro (2023) to identify a balanced ecological growth path. Compensating for the price competitiveness losses produced by the exchange rate over-valuation, Ecological Structural Change and green finance allow for reversing the process of premature de-industrialization by improving the competitiveness of the manufacturing sector.

KEYWORDS:
Green New Developmentalism; ecological structural change; Harrod-Domar dilemma; Thirlwall’s law

RESUMO

O artigo pretende abordar a transição ecológica para um modelo que integre o Dilema Harrod-Domar e o Novo Desenvolvimentismo segundo uma perspectiva do Novo Desenvolvimentismo Verde. Para este fim, este artigo centra-se nos lados verdes das armadilhas dos países de rendimento médio, introduzindo um novo conceito de taxa de crescimento da produção ecologicamente sustentável no modelo do novo desenvolvimentismo desenvolvido por Oreiro (2023) para identificar uma trajetória de crescimento ecológico equilibrada. Compensando as perdas de competitividade de preços produzidas pela sobrevalorização da taxa de câmbio, a Mudança Ecológica Estrutural e o financiamento verde permitem inverter o processo de desindustrialização prematura, melhorando a competitividade do setor transformador.

PALAVRAS-CHAVE:
Novo Desenvolvimentismo Verde; mudança estrutural ecológica; dilema Harrod-Domar; lei de Thirlwall

1. INTRODUCTION

Lewis articulated that underdeveloped economies are characterized by a dual economic structure, which includes a modern or capitalist sector alongside a conventional or subsistence one. Kaldor posited that industrialization plays a pivotal role in economic development, asserting a causal linkage between the expansion of manufacturing output and the acceleration of both GDP and labor productivity growth. This relationship is underpinned by the principle of increasing returns associated with manufacturing activities, contrasted with diminishing returns in the agricultural sector. To identify the deep determinants of economic development, New Developmentalism theory focuses on structural change patterns from the primary sector based on the exploitation of natural resources to the modern sector, typically characterized by the manufacturing industry and its more significant potential for enhancing labour productivity due to an increasing productive sophistication or economic complexity (Bresser-Pereira et al., 2015). In particular, the nature of economic development is the accumulation of capital and the reallocation of labour from the subsistence sectors to the modern ones (Bresser-Pereira & Oreiro, 2023). However, the Harrod-Domar model argues that factors present in lower quantities, such as raw materials and energy, can limit the aggregate production capacity due to the imperfect substitutability among inputs. Moreover, the prevailing technological solutions for the problem of climate change rely on progressively diminishing non-renewable natural resources, pushing the economy towards an unsustainable development strategy.

Developing countries exhibit structural differences from advanced economies, which several factors can characterize. Firstly, they are technologically lagging, which can lead to a widening technological gap between developed and developing nations over time. Secondly, they often have large labour reserves in informal sectors, which can impact wage growth in advanced sectors, resulting in high unemployment rates and wage stagnation. Thirdly, they tend to have an unbalanced productive capacity even in the modern sector, so many intermediate and capital goods need to be imported, resulting in weak sectoral spillovers and huge balance of payment constraints. Lastly, their financial markets are illiquid and characterized by frequent credit rationing, particularly for the informal sector. “Exchange rates tend to be volatile, and firms and governments often have to rely on foreign exchange (FX)-denominated borrowing from abroad” (Stockhammer, 2023, p. 629). Consequently, many developing countries have not converged to the economic development levels of advanced economies due to their specialization in producing and exporting primary goods and low-tech manufacturing ones (Johnson & Papageorgiou, 2020).

Latin American countries have experienced a “process of premature de-industrialization, i.e., a reduction of the share of manufacturing industry in output and employment before the ‘Lewis’s point’ is reached” (Guarini & Oreiro, 2023, p. 2), which resulted from the trade liberalization made around 1990, which by reducing drastically the high import tariffs that neutralized the Dutch Disease, led the countries to a Liberalization Trap, not a Middle-Income Trap (Bresser-Pereira et al., 2020). Especially, a persistent real exchange rate over-valuation derived from the Dutch Disease and External Saving Strategy reverts the sophistication process of emerging economies (Oreiro et al., 2020). In the former, the exchange rate over-valuation generated by the production and the export of natural resources-intensive goods erodes the price competitiveness of the manufacturing sector, compromising investment profitability and increasing the technological gap. Since the industrial equilibrium exchange rate is higher than that compatible with the current account equilibrium exchange rate, sustainable economic development with catch-up requires a surplus in the current account in the long term (Oreiro et al., 2020). The External Savings Strategy, based on the Washington Consensus, forces policymakers to set a higher domestic interest rate and foreign capital inflows, generating a surplus in the capital account and real exchange rate appreciation with respect to the level of the current account balance.

Given that the exports of developing economies are predominantly of low or medium technological intensity, their growth trajectory tends to be less robust compared to that of advanced economy exports. This pattern implies that disparities in income may be perpetuated by the dynamics of international trade (Stockhammer, 2023). An over-valued real exchange rate can result in diminished economic growth, reduced exports, heightened susceptibility to currency crises, and increased vulnerability to political instability (Ambaw et al., 2023). Therefore, the “realignment of the real exchange rate and trade openness” is essential for accele­rating technological innovation and enhancing their economic performance (Xiao et al., 2022).

From an environmental perspective, the shift towards a carbon-neutral economy presents a significant challenge for nations heavily dependent on exploiting natural resources as their primary source of net exports. The environmental quality can be considerably compromised by economic growth, high energy consumption, and open trade in the long term (Usman & Jahanger, 2021). The New Developmentalism model considers the real exchange rate over-valuation as the fundamental barrier to long-term economic growth. A competitive exchange rate may have two opposite effects on CO ₂ emissions. On the one hand, a competitive exchange rate will stimulate industrial production and exports and raise energy consumption and CO₂ emissions (Shah et al., 2022). On the other hand, to achieve a competitive exchange rate in countries with abundant natural resources, it is necessary either to impose an export tax on primary goods or to set import taxes on manufactured goods, although nowadays, the degrees of freedom to impose import taxes are severely limited by the rules of World Trade Organization. Some capital controls are also required since an important share of FDI and portfolio investment in countries with abundant natural resources are directed to finance the exploitation of such resources (Botta, 2017; Gabriel & Oreiro, 2008). Such measures will reduce the profit rate of activities related with the exploitation of natural resources so diminishing the economic incentive to convert forests into agricultural and grazing lands. This reduction in land conversion rates consequently lowers deforestation levels, thereby preserving the capacity of CO₂ capture by the environmental system. Moreover, a competitive real exchange rate is positively related to economic complexity, which has a negative effect on CO₂ emissions (Grazini & Guarini, 2023; Romero & Gramkow, 2021). To resolve the dilemma between economic growth and the reduction of greenhouse emissions effectively, an ecological transition based on Ecological Technological Progress and Ecological Structural Change (ESC hereafter) is needed.

Presenting a formal New Developmentalism model, Oreiro (2023) demonstrates that Thirlwall’s Balance of Payments Constrained Growth model is not a limit for the long-run growth of middle-income countries, which is instead hindered by the exchange rate over-valuation caused by Dutch Disease and External Saving Strategy. Starting from Oreiro (2023), this paper introduces an ecological sustainable growth rate of real output to develop a Green New Developmentalist model to identify a possible balanced ecological growth path. An imbalance in the real exchange rate can result in diminished economic growth, reduced exports, heightened susceptibility to currency crises, and increased vulnerability to political instability (Ambaw et al., 2023). To examine the ecological transition, this paper focuses on the green sides of the two middle-income countries’ traps. Compensating for the price competitiveness losses produced by the exchange rate over-valuation, ESC and green finance allow for reversing the process of premature de-industrialization (Bresser-Pereira et al., 2015) by reducing the inputs and product costs and improving the competitiveness of the manufacturing sector. Increasing environmental efficiency has a positive impact on domestic prices, real wages and external trade equilibrium (Althouse et al., 2020), thus opening new export opportunities and pushing the economy towards a sustainable development path.

2. THE BOPG-NEW DEVELOPMENTALIST MODEL

Let us resume the BOPG-New Developmentalist proposed by Oreiro (2023). Proponents of demand-led growth have posited that autonomous demand growth is the primary driver of economic expansion. In the context of open economies, two principal components of autonomous demand are identified: exports and government spending. However, according to Harrod (1939), investment expenditures are not considered a part of autonomous demand due to the principle of the acceleration of investment theory. So, investment is primarily driven by entrepreneurs’ expectations regarding the future growth of production and sales rather than being an autonomous component of demand. Therefore, exports are the only exogenous source of demand in a small open economy (Oreiro et al., 2020). Indeed, Harrod’s foreign trade multiplier sustains that the country’s real output depends only on the quantity of goods exported. However, Thirlwall (2019) sustains that, in analysing the relationship between the warranted growth rate and the natural growth rate, one of the significant limits of the Harrod multiplier is the lack of recognition of “the dynamic analogue of his static foreign trade multiplier, and its implications”. The Thirlwall law highlights how “the long-run growth of countries [g _b ] is likely to be approximated by the growth of exports [x] relative to the income elasticity of demand for imports$\left[\pi \right]\left(g_b=\frac{x}{\pi }\right)$turned out to be the dynamic analogue of Harrod’s (1933) static foreign-trade multiplier result, Y=M/m, derived on the same assumptions as the dynamic result (where Y is the level of output, X is the level of exports and m is the marginal propensity to import)” (Thirlwall, 2019, p. 556). Within this framework, the long-term economic growth of developing countries is subject to two different constraints, where exports constitute the essential driver of development. The balance of payment equilibrium constraint expressed by the Thirlwall law represents the first. According to the New-Developmentalist approach, the exchange rate serves as a critical determinant of the anticipated profit rate and, consequently, influences the rate of investment, thereby playing a pivotal role in the growth trajectory of developing nations (Bresser-Pereira, 2019). Therefore, the income elasticity ratio is not constant but depends on the difference ­between the actual exchange rate (θ) and the industrial equilibrium exchange rate¹ (θ _IND ), influencing the balance of payments equilibrium growth rate. Any growth rate will be sustainable from the point of view of balance of payments equilibrium whether the actual exchange rate is aligned at the industrial equilibrium level, as expressed by Equation (1):

$\theta ={\theta }_{IND}$ (1)

The productive capacity represents the second constraint. In the Harrod-Domar model, the warranted growth rate (g _w ) is the rate of growth at which desired savings are equal to planned investment. Therefore, it depends on the rate of investments (I), which in turn depends on the animal spirits of firms, i.e., the willingness of capitalists to invest despite the uncertainty related to investment decisions. The warranted growth rate is the growth rate of output, which guarantees aggregate demand and productive capacity expand at the same rate, thereby maintaining the utilization of productive capacity at a normal long-term level. Along with the balanced growth path, the degree of capacity utilization must equal the capacity utilization level desired by firms, i.e., the normal capacity utilization level. Therefore, the warranted growth rate can be expressed as follows:

$g_w=u^{n}v\left[\frac{I}{Y}-\delta \right]$ (2)

Where $\frac{I}{Y}$ is the rate of investment, u ⁿ is the normal level of capacity utilization, v is the potential output-capital ratio, and δ is the depreciation rate of the capital stock.

According to Oreiro (2023), the income distribution between wages and profits relies upon the real exchange rate due to international competitive pressures. For example, a devaluation of the real exchange rate allows domestic firms to increase the mark-up on production costs and hence decrease real wages, improving their profit share in income, as well as an improvement of the profit rate, thus stimulating investment. Therefore, the share of investment in GDP (rate of investment) is positively related to the real exchange rate:

$\frac{I}{Y}=\vartheta \left[\theta ,R\left(\theta \right)-r\right]$ (3)

Substituting (3) in (2), we obtain the following warranted growth rate of real output:

$g_w=u^{n}v\left[\frac{I}{Y}-\delta \right]=u^{n}v\left\{\mu \left[\theta ,R\left(\theta \right)-r\right]-\delta \right\}$ (4)

Figure 1 represents both dynamic constraints and the long-run equilibrium.

Figure 1:
Balanced growth in the New-Developmentalist model

This representation of the BOPG-New Developmentalist Model developed by Oreiro (2023) does not concern the environmental constraint; thus, in the next paragraphs, we will explicitly introduce an Ecological Growth Rate of Output.

3. ECOLOGICAL SUSTAINABLE GROWTH RATE OF OUTPUT AND THE EXCHANGE RATE

Acknowledging the unsustainable trajectory of current economic growth, policymakers have explicitly established the objective of increasing the global average temperature to well below 2°C above pre-industrial levels and limiting the rise in global temperature to a maximum of 1.5°C above pre-industrial levels (Huang et al., 2017). According to Guarini & Oreiro (2022), trade globalization could be a driver of ESC through the so-called “ecologically unequal exchange”. The Ecological Sustainable Growth Rate (g _E ) can be defined as the growth rate of real output that allows a stabilization of the CO ₂ concentration in Earth’s Atmosphere at a level compatible with a maximum of 1.5°C increase in the average global temperature relative to the pre-industrial era. This objective assumes zero net CO ₂ emissions as a necessary condition, which means that gross emissions of CO ₂ due to the increase in the scale of global activity is compensated by CO ₂ capture.

Let us define H ^C as the concentration of CO ₂ in the atmosphere measured as part per million (ppm). The change in the CO ₂ concentration is defined by:

$H^C=\frac{d{H}^c}{dt}=H^{GE}-H^{CAP}$ (5)

where H ^GE is the gross CO ₂ emissions and H ^CAP is the capture of CO ₂.

The gross CO ₂ emissions (H ^GE ) can be defined as:

$H^{GE}=\frac{H^{GE}}{E}E=\gamma E$ (6)

where γ is the gross CO ₂ by one unit of energy produced (E), representing the pollution or carbon intensity of energy. In particular, energy production is a function of the level of economic activity as measured by real output (Y):

$E=\frac{E}{Y}Y=\beta Y$ (7)

where β indicates the energy intensity of the productive structure.

Replacing (7) into (6), we can express the gross CO ₂ emissions as a function of carbon and energy intensity of the economic system:

$H^{GE}=\gamma \beta Y$ (8)

Taking logs and time derivatives of Equation (8), we obtain the growth rate of the gross CO ₂ emissions $\widehat{H^{GE}}$:

$\widehat{H^{GE}}=\hat{\gamma }+\hat{\beta }+g_y$ (9)

where g _y is the growth rate of real output, $\hat{\beta }$ is the growth rate of the energy intensity and $\hat{\gamma }$ is the growth rate of the carbon intensity of the economic system.

Net greenhouse gas emissions depend not only on the carbon intensity but also on the absorption capacity of the ecosystem due to deforestation generating 20% of global CO₂ emissions (Valdecantos, 2023). In particular, forest ecosystems represent the most substantial terrestrial carbon sink, annually sequestering approximately 2 billion tons of carbon dioxide (UN, 2021). The case of Brazil can highlight the essential role of forests: Brazil has experienced a negative land cover structural change. To increase the extraordinarily profitable but land-intensive production of soybeans and cattle, producers chose to put down the Amazon forest, significantly reducing an important carbon sink (Guarini & Oreiro, 2023). The cessation of ongoing deforestation, coupled with reforestation efforts and the enhancement of carbon sequestration in soils through innovative agricultural practices, is thus imperative for the mitigation of carbon emissions (Eyraud et al., 2013). In this perspective, the capture of CO₂ (H ^CAP ) can be defined as:

$H^{CAP}=\alpha F$ (10)

Where α is the H ^CAP per unit of forests (F).

Taking logs and time derivatives of Equation (10), we obtain the growth rate of CO₂ captured by forests ($\widehat{H^{CAP}}$):

$\widehat{H^{CAP}}=\hat{\alpha }+\hat{F}$ (11)

A weak ecological sustainability condition requires:

$\widehat{H^{GE}}=\widehat{H^{CAP}}$ (12)

Substituting (9) and (11) in (12), the condition of weak ecological sustainability requires that:

$\hat{\gamma }+\hat{\beta }+g_y=\hat{\alpha }+\hat{F}$ (13)

So, the ecological sustainable growth rate of real output (g _E ), namely, the growth rate of real output that satisfies the Equation (13), is given by:

$g_E=\left[\hat{\alpha }+\hat{F}\right]-\left[\hat{\gamma }+\hat{\beta }\right]$ (14)

Both the terms $\left(\hat{\gamma }+\hat{\beta }\right)$ and $\hat{F}$ are related to both ESC and ecological technological progress.

In Equation (14), $\hat{F}$ is the growth rate of reforestation, which is defined as follows:

$\hat{F}=f_0+f_1\left({\theta }_{cc}-{\theta }_{ind}\right)$ (15)

Where f ₁ represents the reaction of $\hat{F}$ respect changes in the real exchange rate. It indicates how much the environmental issue depends on changes in the exchange rate in an economy. The forest transition, i.e., the shift from a phase of net deforestation to a phase of net reforestation, has been observed in high-income economies and is progressively becoming more prevalent in developing nations. International openness may exert a significant influence on land-use decisions pertaining to forests, driven by the export demands for forest-derived products as well as agricultural goods, which could potentially incentivise further exploitation and conversion of forested areas (Barbier et al., 2017). According to Culas (2012), African and Latin American countries have not achieved the needed level of development to decouple it from deforestation. In this case, we assume that if $\left({\theta }_{cc}-{\theta }_{ind}\right)<0$, the current account equilibrium real exchange rate (θ _cc ) is lower than the industrial equilibrium exchange rate (θ _ind ), meaning that the exploitation of natural resources such as mining and grazing cattle is expanding in terms of occupying new lands, thereby causing deforestation. The growth rate of forestation is negatively affected by exchange rate over-valuation due to Dutch Disease. The rate of reforestation depends partially on the economic incentives regarding the use of land. Our basic assumption is that the use of land for mining and grazing cattle depends on the strength of the Dutch Disease, which is measured by the difference between the two equilibrium levels for the real exchange rate. Thus, substituting (15) in (14), we obtain the following ecological sustainable growth rate of real output (g _E ):

$g_E=\left[\hat{\alpha }+f_0+f_1\left({\theta }_{cc}-{\theta }_{ind}\right)\right]-\left[\hat{\gamma }+\hat{\beta }\right]$ (16)

The ecological sustainable growth rate of real output is an increasing function of the real exchange rate, depending on the value of $f_1\left({\theta }_{cc}-{\theta }_{ind}\right)$. In particular, making an incomplete structural change, Dutch Disease not only endangers economic development but also threatens the environmental sustainability of growth paths, as highlighted by Equation (16). Causing premature de-industrialization of the economy and increasing the production of primary commodities, such as timber and agricultural products characterized by high utilization of trees and extensive land use (Wunder, 1997), Dutch Disease can negatively affect the carbon absorption capacity of the ecosystem, enhancing deforestation. Due to Dutch Disease negatively affecting the rate of reforestation, is a negative function of the size of this phenomenon.

4. A BOPG-NEW DEVELOPMENTALIST MODEL WITH THE ECOLOGICAL SUSTAINABLE GROWTH RATE OF OUTPUT

4.1. The baseline model

In the previous section, we defined an ecologically sustainable growth rate of real output, along which it is possible to maintain the increase of the global average temperature to well below 2°C above pre-industrial levels. Therefore, by integrating the Thirlwall-New Developmentalism model with the Ecological Sustainable Growth Rate, we want to carry out a Green New Developmentalism model. We start by composing the following system of equations:

$g_w=u^{n}v\left\{\mu \left[\theta ,R\left(\theta \right)-r\right]-\delta \right\}warrantedgrowthrate$ (4)

$\theta ={\theta }_{IND}balanceofpaymentconstraint$ (1)

$g_E=\left[\hat{\alpha }+f_0+f_1\left(\theta -{\theta }_{ind}\right)\right]-\left[\hat{\gamma }+\hat{\beta }\right]ecologicalsustainablegrowthrate$ (16)

Figure 2 shows the sustainable, balanced growth path. For a balanced growth path to exist, the warranted growth rate must be equal to the ecological sustainable growth rate and also to the industrial equilibrium exchange rate, as in point 1, which identifies the growth rates of real output and the real exchange rate for which the expansion of productive capacity aligns with the growth of aggregate demand. This equilibrium ensures that the utilization of productive capacity remains steady and corresponds to the normal level. This equilibrium condition implies that the economy is growing at a rate that neither overextends nor underutilizes its productive capacity, maintaining a consistent level of economic activity and structure, as well as ensuring the environmental sustainability of the productive structure. We can have two different “equilibrium” situations:

$g_w>g_E\leftrightarrow g_w>g$ (17)

Figure 2:
The sustainable, balanced growth path

In the first scenario, there will be a decline in capacity utilization, which will consequently lead to a decrease in the rate of investment. This reduction in investment will necessitate a downward adjustment in the warranted rate of economic growth.

$g_E>g_w\leftrightarrow g_w<g$ (18)

In the second scenario, the utilization of capacity is set to escalate, which in turn propels the rate of investment, thereby inducing an augmentation in the warranted growth rate.

Suppose the exchange rate is overvalued and is lower than the industrial equilibrium rate. Given that production costs in primary sectors are substantially lower than those in manufacturing, the real exchange rate that aligns with ‘normal profits’ falls below the industrial equilibrium (Bresser-Pereira et al., 2015). The deviation between θ _CC and θ _IND interrupts the process of productive sophistication and generates a reprimarization of exports, reducing investments, eroding the price competitiveness of the manufacturing sector, increasing the technological gap, and concentrating productive structure on natural resources-intensive and low value-added goods (Oreiro, 2023). At the same time, the increase in imported components in production and the relative decrease in exports of manufactured goods in terms of value-added reduce the income elasticity ratio because the manufacturing sector is no longer competitive in international markets (Palley, 2021). In that case, we have an unsustainable development strategy because the ecological sustainable growth rate of real output is lower than the warranted growth rate. On the contrary, if the real exchange rate is undervalued on the right of the industrial equilibrium rate, we have a sustainable development strategy. To address the problem of balancing economic expansion with the imperative to curtail greenhouse gas emissions, it is essential to embark on an ecological transition based on Ecological Technological Progress and ESC, which are crucial for addressing environmental concerns comprehensively and effectively.

4.2. A preliminary long-term analysis

We study the stability in the long term with a preliminary analysis of the steady-state values of the main variables. To this end, we integrate the model by inserting the following dynamic equations:

$\dot{g}=\beta \left(\theta -{\theta }_{ind}\right)=\beta \left[\left(\theta -{\theta }_{CC}\right)+\left({\theta }_{CC}-{\theta }_{ind}\right)\right]$ (19)

$\dot{\theta }=-\sigma \left[r-\left(\overline{r}+\rho \right)\right]$ (20)

$\dot{r}=\tau \left(g-g_w\right)+\omega \left(g-g_E\right)$ (21)

$\dot{h}=h\left(u-u^n\right)$ (22)

${\dot{g}}_w=u^{n}vh\left(u-u^n\right)$ (23)

$\dot{u}=-u\left(g_w-g\right)$ (24)

The New-Developmentalist model proposed by Oreiro (2023) shows the long-run economic growth of developing countries is not limited by the balance of payments constraint and the capacity one, but by the real exchange rate over-valuation caused by Dutch Disease and External Saving Strategy. Equation (19) related to the increase in the growth rate of real output ($\dot{g}$) is composed of two elements: $\left(\theta -{\theta }_{CC}\right)$ is the real exchange rate over-valuation due to growth with External Savings Strategy, while $\left({\theta }_{cc}-{\theta }_{ind}\right)$ is the real exchange rate over-valuation due to Dutch Disease. In the first case, foreign capital was believed to be an essential element in improving the investment rate and economic growth of developing countries in the long term due to their supposed complementarity with domestic savings². To stimulate foreign capital, policymakers had to set the domestic interest rate at a higher level than the sum of the international interest rate and the country’s risk premium (Oreiro et al., 2020). Consequently, the influx of additional capital determines a surplus in the capital account, causing an overvalued exchange rate with respect to its current account balance level over an extended period, even in the presence of a current account deficit. Furthermore, economic reliance on foreign savings can lead to foreign indebtedness, making countries vulnerable to foreign currency earnings deficits and impacting their debt servicing ability. An escalation in indebtedness can trigger economic repercussions like currency depreciation, capital flight, and inflation. In the context of an inflation-targeting framework, it could potentially exert a detrimental impact on economic output (Ferreira-Filho, 2023). Moreover, this financial burden may compel heavily indebted nations to adopt short-sighted strategies, such as escalating their logging exports and hastening the expansion of their agricultural exports (Wunder, 1997), increasing deforestation.

In the second case, the over-valuation of the real exchange rate generated by Dutch Disease adversely impacts the price competitiveness of manufacturing firms in both international and domestic markets, decreasing the profitability of investments and thereby exacerbating the technological gap between North and South (Guarini & Oreiro, 2023). The process of eco-friendly transformation of manufacturing activities could have substantial implications for bridging the technological divide and augmenting economic complexity. Viewed from this angle, the ecological structural transition, characterized by technological, social, and environmental sophistication, could serve as a potent strategy for these nations. This strategy could enhance the complexity of their economies and stimulate green growth by diversifying their production and export sectors (Grazini & Guarini, 2023).

According to Guarini & Oreiro (2023), ESC can solve Dutch Disease by generating an appreciation of the industrial equilibrium exchange rate. Therefore, green productive diversification, over an extended period, can bolster export capabilities and diminish reliance on imports. ESC bolsters environmental sustainability by curtailing CO₂ emissions, lessening dependence on fossil fuels, fostering industrial competitiveness via reduced energy consumption and operational expenses, and stimulating productivity and economic expansion (Nawaz et al., 2021; Wenlong et al., 2023). Moreover, the adoption of green technologies improves the intensity of the production system of natural resources and enhances environmental protection, pushing for reforestation and increasing the carbon capture capacity.

According to Equation (20), the growth rate of the real exchange rate depends on the international rate of interest $\overline{r}$, the country risk premium ρ, and the domestic interest rate r. Equation (21) represents a sort of Green Taylor Rule: ­authorities react to an unsustainable growth path both in economic terms $\tau \left(g-g_w\right)$ - as in traditional Taylor Rule³ - with parameter τ > 0, and in ecological terms $\omega \left(g-g_E\right)$ with parameter ω > 0, with condition ω + τ = 1. In Equation (22), the propensity to invest (h = I/Y) increases when the utilization capacity u higher than the natural one, u ⁿ , according to the flexible accelerator of investment (Dejuán, 2013; Freitas & Serrano, 2015). In Equation (23), the dynamic of the warranted growth rate follows that one of investment propensity, with v is the potential output-capital ratio. Finally, according to Equation (24), the capacity of utilization decreases when the warranted growth rate is higher than the effective growth rate.

The steady-state general condition⁴ is:

$\dot{g}=\dot{\theta }=\dot{r}={\dot{g}}_w=\dot{u}=0$ (25)

From condition $\dot{u}=0$, we obtain g _w = g from Equation (24). Inserting this result in Equation (21) and being $\dot{r}=0$, we have g = g _E . By inserting the condition ${\dot{g}}_w=0$ into Equation (23), we obtain u = u _n . Given $\dot{\theta }=0$, we have $r=\left(\overline{r}+\rho \right)$ in Equation (20) and considering $\dot{g}=0$ from Equation (19), we obtain θ = θ_ind . These results give the final condition:

$g_E=g=g_w$ (26)

Equation (26) has two important implications. Firstly, by introducing g _E = g in the Equation (16), we obtain that:

$g=\left[\hat{\alpha }+f_0\right]-\left[\hat{\gamma }+\hat{\beta }\right]$ (27)

According to Equation (27), the long-run growth rate is determined by the ecological sustainable rate of growth: this means that the economic system adjusts itself to the rate of economic growth that is compatible with zero CO₂ emissions. ESC considers environmental and social innovations to push for a reallocation of resources and employment from brown sectors characterized by a high pollution intensity to green ones with greater environmental efficiency (Guarini & Oreiro, 2022). Therefore, ESC can support a re-industrialization process that is able to decouple economic development from environmental degradation. Green activities can generate double positive externalities related to environmental protection and local economic spillovers (Jones, 2018). Moreover, green innovation enhances the international competitiveness of businesses by facilitating the adoption of cleaner production technologies and optimizing the utilization of green resources (Hu et al., 2021). In particular, international competitiveness depends on both price and non-price factors (Blecker, 2016), which are positively influenced by green activities (Guarini & Porcile, 2016). The consequent reduction of unit production costs and the creation of new business opportunities support the price competitiveness of manufacturing industries (Gramkow, 2020). At the same time, higher environmental efficiency will be associated with improved non-price competitiveness, leading to an escalation in exports by facilitating the production of secondary raw materials, employment rates, and the rate of output growth (Albaladejo et al., 2021; Dávila-Fernández et al., 2023). Environmental friendly innovation can stimulate import substitution related to fossil fuel sources (Gramkow, 2020). In particular, the ESC can represent the winner’s strategy to escape from the Middle-Income Trap.

Secondly, by considering g _w = g _E in the Equation (2), we have that:

$g^E=u^{n}v\left(h-\delta \right)$ (28a)

and consequently:

$h=\frac{g_E}{u^{n}v}+\delta$ (28b)

The investment rate will be the adjusting variable that equalizes the actual growth rate with the ecological sustainable rate of growth, if there are no barriers for it to reach the required level expressed by Equation (28b), in particular, the barrier represented by the exchange rate populism (Bresser-Pereira, 2015, p. 349), which is endemic in Latin-America. Indeed, a persistent over-valuation of the exchange rate, when combined with a high marginal propensity to consume out of wages, enhances the purchasing power of wages, salaries, and also the income of rentiers, thereby stimulating consumption in the short run. However, it simultaneously acts as a deterrent to investment (Bresser-Pereira, 2020), compromising long-term growth. The increase of domestic interest rates above the international levels - required for the External Savings Strategy - can deter real investment due to the consequent appreciation of the national currency and the reduction of the firms’ profit share. This effect is particularly pronounced in the context of green investments, which typically present a higher degree of uncertainty and their returns are often realized over a longer time horizon (Guarini & Oreiro, 2023). Green investments are usually more susceptible to interest rate fluctuations compared to traditional investments due to factors such as higher upfront costs, extended payback periods, the risky nature of business projects, increased uncertainty, and greater technological complexity (Ghisetti et al., 2015; Mazzucato & Semieniuk, 2018).

A stable and competitive real exchange rate can stimulate investment through structural change, which subsequently influences the balance of payments constraint, enhancing short-term competitiveness and also stimulating long-term growth by encouraging investment and technological progress (Missio & Gabriel, 2016). According to New Developmentalism, one of the six essential conditions for growth is the presence of “finance to invest” (Bresser-Pereira, 2020). Reducing greenhouse emissions and achieving sustainable development in emerging countries needs a “rapid scaling up of finance” from public and private sources. Greening the production structure requires large investments in green technologies characterized by high upfront costs. Given the inherent uncertainties associated with investments in green industries, it is plausible to posit that the expected rate of return deemed “acceptable” for green industries would surpass that for brown industries. So, the perceived uncertainties necessitate a positive liquidity premium for investments in green sectors (Guarini & Oreiro, 2023).

International green finance could have a key role in mobilizing private capital to mitigate and adapt climate change actions (OECD, 2023), allowing escape from Dutch Disease and supporting ESC by reducing the cost of capital, in particular in the context of higher interest rates to attract foreign savings. Green technologies are characterized by a higher interest rate elasticity than traditional ones (Monnin, 2015), so an incentive that the government can give to make them more competitive is offering lower interest rates to compensate for the higher costs of green investment. As demonstrated by the research conducted by Chen et al. (2019), a reduced interest rate for green loans can stimulate an increase in the adoption of green innovation. If the production of environmentally friendly products can enhance corporate profitability and the manufacturing of such products can secure lower interest rates on loans, it increases the likelihood of firms undergoing a green transformation (Wang et al., 2023). If green finance allows us to reduce the cost of capital, the growth could be more ecologically sustainable.

5. CONCLUDING REMARKS

Throughout this article, we argued that a sustainable growth path required both ecological sustainability - in the sense of reducing net greenhouse emissions to zero in the medium term - with balance of payments, capacity utilization, and sophistication of productive structure equilibrium. So, our first goal was to build a formal green new-developmentalist model where investment rate plays the role of adjustment variable among ecological sustainable growth rate, warranted growth rate and balance of payments equilibrium growth rates. For investment rate to play such a role, it is required that (i) domestic interest rates are set at a level compatible with international interest rate adjusted by the country risk premium and (ii) real exchange rate must be set at a level compatible with the industrial equilibrium exchange rate; otherwise, investment rate will not play this role. The model presented in this article showed that - under the required conditions - there is a level for investment rate that acts as an equilibrating device, assuring the sustainability of the growth path in the long run. For lack of space, however, we did not make the stability analysis of the dynamic system to analyse if the endogenous working of the model allowed the investment rate to achieve its required level. This analysis will be the goal of future research.

We also analyse the situations that can be a barrier to the investment rate acting as an equilibrating mechanism in the model. We argued that, mainly for developing countries, both domestic interest rate as well as real exchange rate can fail to achieve the right levels due to Dutch Disease and External Saving Strategy. Dutch Disease that results from an unbalanced productive structure - where domestic primary sector productivity levels are higher than the productivity level of the foreign primary sector as well as domestic manufacturing industry (Diamand, 1972; Oreiro, 2023) - creates an exchange rate over-valuation that is not only of the main causes of premature de-industrialization but also it stimulates deforestation and hence reduce the CO₂ capture capacity of the natural environment, thereby increasing net emissions of greenhouse gases. Moreover, premature de-industrialization is associated with an increase in the technological backwardness of a country, which raises the share of brown activities in productive structure, and also has negative effects on greenhouse emissions. External Savings Strategy - fuelled by exchange rate populism - is another cause of exchange rate over-valuation, but it is associated with fixing domestic interest rate at a level higher than the international level adjusted by the country risk premium. Higher levels of interest rates are harmful to investment decisions, mainly green investments required for a transition to a low-carbon economy. Since such factors are more present in developing countries than in developed countries, we can state that a transition to a green economy is even harder for developing countries than developed ones. Without a change in economic policy regime in developing countries, there is an enormous possibility that they will become pollution heavens in the near term.

In conclusion, our analysis presents an optimistic view about the possibility of humanity dealing with climate change. Our theoretical model shows that it is possible to have economic growth and reach the target of zero net emissions of greenhouse gases. Of course, there are a lot of political economy and international relations problems that we are not considering in our analysis. Our aim was a purely theoretical one, that is, to prove the existence of economic mechanisms that make economic growth sustainable in an ecological sense. This was an exercise similar to one developed by Harrod (1939) and Domar (1946) regarding the existence of a balanced growth path with full employment, which had shown that such a growth path is possible but unlikely in a laissez-faire type economy. This result became known as the Harrod-Domar dilemma. Kaldor (1957) and Pasinetti (1961) later showed that the income distribution between wages and profits could be the adjusting mechanism by which actual growth rates will converge to a balanced growth path in the long run, thus solving the Harrod-Domar dilemma in the growth theory. As Harrod and Domar, and Kaldor and Pasinetti, we made a purely theoretical exercise. For this theoretical possibility to become reality, a lot of other aspects of reality must be added to the analysis, and the dynamic properties of the model must be analysed in order to address the stability of the long-run growth path. This presents a huge agenda for future research.

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• 1
  The industrial equilibrium exchange rate is the level of real exchange rate “that makes those firms operating with the state of the art technology to be competitive in both domestic and international markets” (Oreiro et al., 2020, p. 31).
• 2
  For new-developmentalism, external and domestic savings are substitutes rather than complementary. See Breese-Pereira, Oreiro & Marconi (2015).
• 3
  The Taylor Rule guides central banks to adjust interest rates in response to economic indicators. When output or inflation exceeds targets, interest rates rise, slowing the economy and aiding inflation control, ensuring system stability through the bank’s countercyclical role (Gnos & Rochon, 2007).
• 4
  Due to this paper wants showing the existence of mechanisms that adjust the output growth rate to the sustainable growth rate, the analysis of the stability conditions of the final system will be held for further research.

• JEL Classification: E12; Q56; Q57; O11; O44.

Publication Dates

• Publication in this collection
  07 Oct 2024
• Date of issue
  2024

History

• Received
  16 Oct 2023
• Accepted
  27 Feb 2024