Reversible reforms with irreversible capital: The investment response to imperfectly credible trade liberalisation

Richard Mash

No 1997-06, CSAE Working Paper Series from Centre for the Study of African Economies, University of Oxford

Abstract: The paper considers the irreversible investment response to trade liberalisation when agents perceive there to be a positive probability that the liberalisation may be reversed. It is shown that even with full credibility the aggregate investment response may be weak since investment will collapse in the unfavoured sector as a result of the change in domestic relative prices. Limited credibility reduces the investment response in the favoured sector and hence reduces aggregate investment. The effect is particularly strong if investment involves delivery lags before new capital becomes productive. The paper also demonstrates a new solution method for irreversible investment problems of this type.

Date: 1997
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