Market Liberalization, Regulatory Uncertainty, and Firm Investment

This paper analyzes the effects of regulatory uncertainty regarding labor costs on investment in a liberalized market. We distinguish between the external investment margin (market entry) and the internal investment margin (technology), and establish that regulatory uncertainty affects these margins differently, encouraging market entry, but discouraging technological investment. As a consequence, the impact of regulatory uncertainty on competition in liberalized markets is a combination of these two countervailing forces.