Terms of Trade, Debt and Economic Growth

Abstract

The goal of this paper is to analyze the effects of the increase in international prices on the reallocation of resources and the economic growth of a small and open economy. To do this, two adjustment mechanisms are introduced in a two-sector economic growth model, one for labor and the other for the debt-capital ratio.

We show that the direction of migration between wages is completely determined by the proportion of total labor employed in the sector of natural resources; and that the external loan decisions, at any instant of time, is a percentage of the net debt stock, the speed of which is the proportional discrepancy of the adjustment of external capital and the expected marginal product and the world interest rate, thereby we find a growth path (within the stable manifold) that allows the optimal growth path.