TY  - JOUR
AU  - Aizenman,Joshua
TI  - New Activities, the Welfare Cost of Uncertainty and Investment Policies
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 5825
PY  - 1996
Y2  - November 1996
UR  - http://www.nber.org/papers/w5825
L1  - http://www.nber.org/papers/w5825.pdf
N1  - Author contact info:
Joshua Aizenman
Economics and SIR
USC
University Park
Los Angeles, CA 90089-0043
Tel: 213-740-4066
E-Mail: aizenman@usc.edu
AB  - This paper studies the effect of policy uncertainty on the formation of new activities in Romer's (1994) type of an economy, where productivity of labor increases with the number of capital goods.  Adding a new capital good requires a capital specific set-up cost, invested prior to using the capital good.  Agents are disappointment averse, putting greater utility weight on downside risk [as modeled by Gul (1991)].  Policy uncertainty is induced by the Disappointment aversion implies that investment, labor and capitalists' income drop at a rate proportional to the standard deviation of the tax rate.  Hence, policy uncertainty induces first-order adverse effects, whereas policy uncertainty leads to second-order effects when consumers maximize the conventional expected utility.  The adverse effects of policy uncertainty can be partially overcome by a proper investment policy.  The paper interprets the tax concessions granted to multinationals as a commitment device that helps overcoming the adverse implications of policy uncertainty.
ER  -