Uncertainty, Instability, and Irreversible Investment: Theory, Evidence, and Lessons for Africa

Abstract

Instability and uncertainty are important factors in Africa's poor investment record over the past two decades. A recent (but rapidly growing) literature has focused on how uncertainty and instability affect the adoption of fixed investment projects. That literature shows that if fixed investment projects are costly or impossible to reverse, uncertainty can become a powerful deterrent to investment.

Serven reviews the literature on irreversible investment to identify the implications for macroeconomic policy and to gauge the practical importance, especially for Sub-Saharan Africa, of the link between uncertainty and investment. He presents empirical evidence on the negative association between investment performance and measures of instability, using cross-section time-series data. That evidence suggests that instability and uncertainty are important factors in Africa's poor investment record over the last two decades.

This paper - a product of the Macroeconomics and Growth Division, Policy Research Department - is part of a larger effort in the department to understand the determinants of private investment.

JEL Classification: E22, D81