Trade reforms, credibility, and development
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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- Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-557, June.
- Grossman, G.M. & Helpman, E., 1989.
"Growth And Welfare In A Small Open Economy,"
15-89, Tel Aviv.
- Gene M. Grossman & Elhanan Helpman, 1989. "Growth and Welfare in A Small Open Economy," NBER Working Papers 2970, National Bureau of Economic Research, Inc.
- Rodrik, Dani, 1989. "Promises, Promises: Credible Policy Reform via Signalling," Economic Journal, Royal Economic Society, vol. 99(397), pages 756-772, September.
- Dani Rodrik, 1988. "Promises, Promises: Credible Policy Reform via Signaling," NBER Working Papers 2600, National Bureau of Economic Research, Inc.
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