Trade Openness and Investment Instability

In the presence of lumpy investment cost of adjustment, globalization may have non-conventional effects on the level of investment and its cyclical behavior. Trade openness may lead to a discrete 'jump' in the level of investment, as it may trigger a discrete change in the terms of trade. Such a shift creates a sizeable boost in aggregate investment. But trade openness may also lead to boom-bust cycles of investment (namely, multiple equilibrium) supported by self-validating expectations. In this sense globalization destabilizes the economy. There can be substantial gains from globalization in the investment-boom equilibrium. However, gains could be small, or negative, in the investment-bust equilibrium.