Policy Uncertainty and Private Investment in Developing Countries, Issue 2999
A resurgence in private investment is a necessary ingredient of a sustainable recovery in heavily-indebted developing countries. Policy reforms in these countries involve a serious dilemma, especially when they include structural and microeconomic features. On the one hand, entrepreneurs, workers, and farmers must respond to the signals generated by the reform for the new policies to be successful. On the other hand, rational behavior by the private sector calls for withholding investment until much of the residual uncertainty regarding the eventual success of the reform is eliminated. This paper shows that even moderate amounts of policy uncertainty can act as a hefty tax on investment, and that otherwise sensible reforms may prove damaging if they induce doubts as to their permanence. A simple model is developed to link policy uncertainty to the private investment response.
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1050 Massachusetts Avenue 5/89 Stock Volatility aggregate investment Andrew behavior Bureau of Economic Business Cycle capital flight capital irreversibilities Conway Dani Rodrik decreasing function developing countries discussion distortion Dornbusch Econometric Economic Research entrepreneurs entry and exit entry costs equilibrium ex-ante probability exchange-rate exit costs export external balance fiscal deficit Fischer Black instability INVESTMENT IN DEVELOPING investment incentive investment subsidy investors large number literature on hysteresis macroeconomic stabilization magnitude measures multiple equilibria National Bureau negative relationship opportunity cost otherwise sensible reform Paul Krugman percent percentage points policy reform policy reversal policy uncertainty probability of collapse probability of reversal real exchange rate real interest rate regression RELATIONS/PACIFIC STUDIES LIBRARY resurgence in private return to capital small reversal statistically insignificant Stiglitz STUDIES LIBRARY UNIVERSITY subjective probability sunk costs Suppose tax on investment trade liberalization trade policy UNCERTAINTY AND PRIVATE unit of capital unsustainability Wijnbergen William Schwert World Bank