Working Paper: CEPR ID: DP4399
Authors: Murat Iyigun; Dani Rodrik
Abstract: We analyse the interplay of policy reform and entrepreneurship in a model where investment decisions and policy outcomes are both subject to uncertainty. The production costs of non-traditional activities are unknown and can only be discovered by entrepreneurs who make sunk investments. The policy-maker has access to two strategies: ?policy tinkering,? which corresponds to a new draw from a pre-existing policy regime, and ?institutional reform,? which corresponds to a draw from a different regime and imposes an adjustment cost on incumbent firms. Tinkering and institutional reform both have their respective advantages. Institutional reforms work best in settings where entrepreneurial activity is weak, while it is likely to produce disappointing outcomes where the cost discovery process is vibrant. We present cross-country evidence that strongly supports such a conditional relationship.
Keywords: growth
JEL Codes: O10; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| policy reforms (E69) | entrepreneurship (M13) |
| institutional reforms (O17) | economic activity (E20) |
| entrepreneurship is weak (L26) | economic activity (E20) |
| entrepreneurship is high (L26) | economic activity (E20) |
| cost discovery is low (D40) | entrepreneurship (M13) |
| cost discovery is intermediate (D40) | institutional reforms dominate policy tinkering (E69) |