Investment in new activities and the welfare cost of uncertainty

Joshua Aizenman

Research output: Contribution to journalArticlepeer-review

10 Scopus citations


Recent literature has shown that trade distortions are associated with first-order costs stemming from the induced drop in the formation of new activities. We demonstrate that uncertainty may induce similar welfare costs, and that these costs apply also to a closed economy. This argument is illustrated in Romer's model of a dependent economy, where foreign direct investment is needed to enable the importation of capital goods and intermediate products used in domestic production. We show that Knightian uncertainty inhibits the formation of new activities, leading to first-order losses, whereas risk aversion alone leads to second-order losses.

Original languageEnglish
Pages (from-to)259-277
Number of pages19
JournalJournal of Development Economics
Issue number2
StatePublished - 1 Jan 1997
Externally publishedYes


  • Foreign direct investment
  • Knightian uncertainty
  • New activities
  • Risk

ASJC Scopus subject areas

  • Development
  • Economics and Econometrics


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