Macroeconomics – Capital Accumulation and Growth

Imagine you’re named an Economic Advisor to the president of a very poor and backward country (Sandokistan). The President asks your advice on where they should use their very limited resources so that they can help escape the poverty trap. Should they invest in existing, traditional tools (think tractors, computers, known manufacturing techniques) or should they invest in cutting edge research where they might become a market leader? Please explain why you selected the option you did. Conversely, why didn’t you select the other option? How does the option picked fit with the theory learned this chapter?

Note: In a world of trade offs, you can pick only one. I won’t accept an answer that says they are both important. This is a topic where near universal agreement exists on “best strategy” as outlined in this chapter.

Bonus: Economic theory suggests that the investment would get the greatest return where capital is scarce. After all, adding another tractor to a field that already has modern technology isn’t likely to increase output, whereas adding a tractor to a location that is currently capital starved would have the potential to add a substantially more to output. This means we would expect capital to move from “capital rich” regions to “capital poor” regions when all else is equal (Ceteris Paribus). This is NOT what we see in the real world (and it is known as the “Lucas Paradox”). Without researching, why do you suppose we actually observe capital moving from poor to rich rather than from rich to poor as the theory would suggest?