Trade and Investment under Policy Uncertainty: Theory and Firm Evidence
Kyle Handley and
Nuno Limão ()
No 8798, CEPR Discussion Papers from C.E.P.R. Discussion Papers
We provide theoretical and empirical evidence that policy uncertainty can significantly affect firm level investment and entry decisions in the context of international trade. When market entry costs are sunk, policy uncertainty can create a real option value of waiting to enter foreign markets until conditions improve or uncertainty is resolved. Using a dynamic, heterogeneous firms model we show that: (i) investment and entry into export markets is reduced when trade policy is uncertain, and (ii) preferential trade agreements (PTAs) are valuable to exporters even if applied trade barriers are currently low or zero. We derive a structural equation that predicts how firm entry responds to changes in applied tariffs and a theory-based measure of policy uncertainty. Our novel approach using observable trade policies allows us to estimate the impact of policy uncertainty and quantify its aggregate implications. We apply this method to Portugal's accession to the European Community in 1986 using new firm-level trade data. We find that (i) the trade policy reform accounted for a large fraction of the observed Portuguese exporting firms' entry and sales upon accession (ii) the accession removed uncertainty about future preferences and (iii) this uncertainty channel accounted for a large fraction of the predicted growth. These results have broader implications for other PTAs and our approach can be applied to analyze other sources of policy uncertainty.
Keywords: Investment; Policy; Trade; Uncertainty (search for similar items in EconPapers)
JEL-codes: D8 D92 E22 F02 F1 F5 H32 O24 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-int
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (48) Track citations by RSS feed
Downloads: (external link)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at email@example.com
Journal Article: Trade and Investment under Policy Uncertainty: Theory and Firm Evidence (2015)
Working Paper: Trade and Investment under Policy Uncertainty: Theory and Firm Evidence (2012)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:8798
Ordering information: This working paper can be ordered from
http://www.cepr.org/ ... ers/dp.php?dpno=8798
Access Statistics for this paper
More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ..
Series data maintained by (). This e-mail address is bad, please contact .