Firms in low-income countries operate in an uncertain environment and frequently face risk and resource shortages (Kang et al. 2014). Uncertainty can have significant negative effects on investment, particularly when investment involves large irreversible costs and investors can delay the decision to invest until they have further information (Dixit and Pindyck 1994).
A stable policy environment provides an enabling environment for the private sector to invest, by ensuring that there are no policy reversals that cannot be justified on economic grounds, and no flip-flops due to political pressures (Rodrik 1991, Harriss 2006). For example, if the government levies a high (but not unreasonable) rate of corporate tax on the private sector, keeps its stable, and uses the proceeds to finance high quality public goods (such as efficient administration and infrastructure), the predictability of this tax policy would be more effective in encouraging investment than tax reductions that are variable and unpredictable (Cali and Sen 2012).
- Cali, M. & Sen, K. (2012). Do effective state business relations matter for economic growth? Evidence from Indian states. World Development, 39(9), 1542-1557. See document online
- Dixit, A., & Pindyck, R. (1994). Investment under uncertainty. Princeton, Princeton University Press.
- Harriss, J. (2006). Institutions and state-business relations: Improving institutions for pro-poor growth (IPPG Briefing Note 2). Manchester: IPPG. See document online
- Kang, W., Lee, K., & Ratti, R. (2014). Economic policy uncertainty and firm-level investment. Journal of Macroeconomics, 39, 42-53. See document online
- Rodrik, D. (1991). Policy uncertainty and private investment in developing countries. Journal of Development Economics, 36(2), 229-243. See document online