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Policy Uncertainty and Private Investment in Developing Countries

  • Dani Rodrik

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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2999.

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Date of creation: Jun 1989
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Publication status: published as Journal of Development Economics, November 1991.
Handle: RePEc:nbr:nberwo:2999
Note: ITI IFM
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  13. Rudiger Dornbusch & Sebastian Edwards, 1991. "The Macroeconomics of Populism in Latin America," NBER Books, National Bureau of Economic Research, Inc, number dorn91-1.
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