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Trade Reforms, Credibility, and Development

  • 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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File URL: http://www.nber.org/papers/w3600.pdf
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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
Date of revision:
Publication status: published as Journal of Development Economics Volume 39, pp. 163-187, 1992
Handle: RePEc:nbr:nberwo:3600
Note: ITI IFM
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Web page: http://www.nber.org
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  1. Dani Rodrik, 1988. "Promises, Promises: Credible Policy Reform via Signaling," NBER Working Papers 2600, National Bureau of Economic Research, Inc.
  2. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June.
  3. Grossman, G.M. & Helpman, E., 1989. "Growth And Welfare In A Small Open Economy," Papers 15-89, Tel Aviv.
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