On Optimal Capacity Expansion for Domestic Processing of an Exhaustible, Natural Resource,

The issue of optimal capacity expansion for domestic processing of exhaustible, natural resource exports in a small open economy is analyzed in the context of non-malleable capital. A complete qualitative characterization of the optimal dynamic paths for resource extraction, domestic processing, and capacity expansion is obtained. It is shown that the presence of capital-stock adjustment costs, which vary directly with the rate of capacity expansion in the resource-processing sector, implies a presumption in favor of a policy of domestic processing, and that the optimal pattern of capacity expansion is of the front-end loading variety