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Trade Reforms, Credibility, and Development

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  • Joshua Aizenman

Abstract

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.

Suggested Citation

  • Joshua Aizenman, 1991. "Trade Reforms, Credibility, and Development," NBER Working Papers 3600, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3600
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    1. Grossman, Gene M. & Helpman, Elhanan, 1989. "Growth and Welfare in a Small Open Economy," Foerder Institute for Economic Research Working Papers 275466, Tel-Aviv University > Foerder Institute for Economic Research.
    2. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-557, June.
    3. Rodrik, Dani, 1989. "Promises, Promises: Credible Policy Reform via Signalling," Economic Journal, Royal Economic Society, vol. 99(397), pages 756-772, September.
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    Cited by:

    1. Richard Mash, 1999. "The Investment Response to Imperfectly Credible Trade Liberalisation with Endogenous Probability of Reversal," Economics Series Working Papers WPS/1998-13, University of Oxford, Department of Economics.
    2. Buffie, Edward F., 1995. "Trade liberalization, credibility and self-fulfilling failures," Journal of International Economics, Elsevier, vol. 38(1-2), pages 51-73, February.
    3. 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.
    4. Fatbardha Morina & Eglantina Hysa & Uğur Ergün & Mirela Panait & Marian Catalin Voica, 2020. "The Effect of Exchange Rate Volatility on Economic Growth: Case of the CEE Countries," JRFM, MDPI, vol. 13(8), pages 1-13, August.
    5. Marjit, Sugata & Mukherjee, Arijit & Kabiraj, Tarun, 2004. "Future technology, incomplete information and international joint venture," Research in Economics, Elsevier, vol. 58(3), pages 219-234, September.
    6. Yermakov, Yuri Y., 1997. "Credibility of economic reform and foreign direct investment in the former Soviet Union region," ISU General Staff Papers 1997010108000012835, Iowa State University, Department of Economics.
    7. Ibarra, Luis Alberto, 1995. "Credibility of trade policy reform and investment: the Mexican experience," Journal of Development Economics, Elsevier, vol. 47(1), pages 39-60, June.
    8. Chebbi, Ali, 2019. "How to enlarge the fiscal space and gain efficiency when adopting automatic fuel pricing mechanisms? The Tunisian case," The Quarterly Review of Economics and Finance, Elsevier, vol. 73(C), pages 34-43.
    9. WILLIAM C. Gruben, 1992. "North American Free Trade: Opportunities And Pitfalls," Contemporary Economic Policy, Western Economic Association International, vol. 10(4), pages 1-10, October.
    10. 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, vol. 2(2), pages 85-109.
    11. Kabiraj, Tarun & Yang, Chun-Lei, 2001. "Licensing vs. Innovation incentives under uncertain government policies," International Review of Economics & Finance, Elsevier, vol. 10(3), pages 247-261, July.

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