Trade Openness and Investment Instability
28 Pages Posted: 11 Apr 2002
Date Written: March 2002
In the presence of lumpy adjustment costs of investment, globalization may have non-conventional effects on the level of investment and its cyclical behaviour. Free trade may lead to a discrete 'jump' in the level of investment, as it triggers discrete terms-of-trade changes which either appreciate or depreciate the setup cost of investment. As a result, the economy may alternate between 'optimistic' and 'pessimistic' expectations and self-validating boom and bust investment cycles. There could be substantial gains from globalization in the investment-boom equilibrium and meager, or negative, gains in the investment-bust equilibrium.
Keywords: Lumpy adjustment cost, multiple equilibrium, boom-bust investment cycles
JEL Classification: F10, H10
Suggested Citation: Suggested Citation