Policy commitment and credibility are important for inducing agents to make costly, irreversible investments. Policy uncertainty can delay investment and reduce the response to policy change. I provide theoretical and novel quantitative evidence for these effects by focusing on trade policy, a ubiquitous but often overlooked source of uncertainty, when a firm's cost of export market entry is sunk. While an explicit purpose of the World Trade Organization (WTO) and preferential trade agreements (PTAs) is to secure long term market access, little theoretical and empirical work analyzes the value of these agreements for reducing uncertainty to prospective ex-
Using a dynamic, heterogeneous firms model with sunk costs of exporting we show that: (i) investment and entry into export markets is reduced when trade policy is uncertain and (ii) credible preferential trade agreements (PTAs) increase trade even if applied trade barriers are currently low. We structurally estimate the effect of policy uncertainty on firm entry following Portugal's accession to the European Community in 1986 and find that (i) the trade policy reform accounted for a large fraction of the observed Portuguese exporting firms' entry and sales (ii) the accession removed uncertainty about future EC trade policies and (iii) this uncertainty channel accounted for a large fraction of the predicted growth. These results have broader implications for other PTAs and our approach can be applied to analyze other sources of policy uncertainty.JEL classification: D8, D92, E22, F02, F1, F5, H32, O24.
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