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Trade Reforms, Credibility, and Development


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  • Joshua Aizenman


This paper analyzes the role of investment policies in regimes undergoing trade liberalization with policy makers of uncertain credibility. We consider an economy producing exportable and importable goods. The economy is liberalized, and tariffs are eliminated. The public views the reform credibility as questionable, and expects the possibility of future policy reversal. The policy maker sets policies and public investment as to maximize the expected utility of a risk averse representative agent. We identify the need to tax private investment in the importable sector, and to subsidize private investment in the outward-oriented sector. We show that the signaling effect of public investment nay generate a positive externality for public investment in the outward sector, and a negative externality for public investment in the inward-oriented activity. We demonstrate that the elimination of sectorial private investment policies call for a rise in the public/private capital ratio in the outward-oriented activities, and a drop in that ratio in the inward-oriented activities. In the presence of an external credit ceiling, a higher degree of risk aversion increases the magnitude (without changing the nature) of the policies.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3600.

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Date of creation: Jan 1991
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Publication status: published as Journal of Development Economics Volume 39, pp. 163-187, 1992
Handle: RePEc:nbr:nberwo:3600

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  1. Grossman, G.M. & Helpman, E., 1989. "Growth And Welfare In A Small Open Economy," Papers, Tel Aviv 15-89, Tel Aviv.
  2. Rodrik, Dani, 1989. "Promises, Promises: Credible Policy Reform via Signalling," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 99(397), pages 756-72, September.
  3. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(3), pages 541-57, June.
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Cited by:
  1. Ibarra, Luis Alberto, 1995. "Credibility of trade policy reform and investment: the Mexican experience," Journal of Development Economics, Elsevier, Elsevier, vol. 47(1), pages 39-60, June.
  2. Marjit, Sugata & Mukherjee, Arijit & Kabiraj, Tarun, 2004. "Future technology, incomplete information and international joint venture," Research in Economics, Elsevier, Elsevier, vol. 58(3), pages 219-234, September.
  3. Muhammad Jamil & Erich W. Streissler & Robert M. Kunst, 2012. "Exchange Rate Volatility and its Impact on Industrial Production, Before and After the Introduction of Common Currency in Europe," International Journal of Economics and Financial Issues, Econjournals, Econjournals, vol. 2(2), pages 85-109.
  4. Buffie, Edward F., 1995. "Trade liberalization, credibility and self-fulfilling failures," Journal of International Economics, Elsevier, Elsevier, vol. 38(1-2), pages 51-73, February.
  5. Richard Mash, 1999. "The Investment Response to Imperfectly Credible Trade Liberalisation with Endogenous Probability of Reversal," Economics Series Working Papers, University of Oxford, Department of Economics WPS/1998-13, University of Oxford, Department of Economics.
  6. Azam, Muhammad & Khan, Hashim & Hunjra, Ahmed Imran & Ahmad, H. Mushtaq & Chani, Muhammad Irfan, 2011. "Institutions, macroeconomic policy and foreign direct investment: South Asian countries case," MPRA Paper 32480, University Library of Munich, Germany.
  7. Kabiraj, Tarun & Yang, Chun-Lei, 2001. "Licensing vs. Innovation incentives under uncertain government policies," International Review of Economics & Finance, Elsevier, Elsevier, vol. 10(3), pages 247-261, July.
  8. William C. Gruben, 1992. "On the future erosion of the North American Free Trade Agreement," Research Paper, Federal Reserve Bank of Dallas 9208, Federal Reserve Bank of Dallas.


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