Optimal Growth and Borrowing with Non-convex Technology

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This paper employs a simple intertemporal optimization model to analyze the optimal growth and borrowing for a small open economy with non-­convex technology that imports intermediate inputs for production. Unlike other papers in the literature, this paper concludes that there is only one path for an open economy to achieve optimal growth: namely, the pursuit of the highest possible steady-state capital-labor ratio. Thus, a country in a region of low capital intensity can achieve high long run economic growth by putting itself on a locally unstable path. By setting a high marginal opportunity cost of investment, a country can achieve higher long run output. An economy cannot become a creditor if it starts as a net debtor. Moreover, if an unanticipated permanent deterioration in the terms of trade occurs, the economy should decrease investments in order to improve its current accounts.