Working Paper: NBER ID: w3600
Authors: 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.
Keywords: trade liberalization; investment policies; public investment; private investment; policy credibility
JEL Codes: F10; F13; O10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Public Investment (H54) | Private Investment (G31) |
| Public Investment in Outward-Oriented Sector (H54) | Private Investment in Outward-Oriented Sector (F21) |
| Public Investment in Outward-Oriented Sector (H54) | Reduced Likelihood of Perceived Policy Reversals (E61) |
| Public Investment in Inward-Oriented Sector (H54) | Negative Externality for Private Investment (D62) |
| Higher Risk Aversion (D81) | More Significant Policy Interventions (E65) |
| Need to Tax Private Investment in Importable Sector (F21) | Expected Tariff Hikes (F13) |
| Public-Private Capital Ratio Adjusts (H54) | Increasing in Outward-Oriented Activities (O36) |
| Public-Private Capital Ratio Adjusts (H54) | Decreasing in Inward-Oriented Activities (F69) |