Capital adjustment costs: implications for domestic and export sales dynamics

Yanping Liu

No 18-04, Working Papers from University of Mannheim, Department of Economics

Abstract: Theoretical and empirical work on export dynamics has generally assumed constant marginal production cost and therefore ignored domestic product market conditions. However, recent studies have documented a negative contemporaneous correlation between firms´domestic and export sales growth, suggesting that firms can be capacity constrained in the short run and face increasing marginal production cost. This paper develops and estimates a dynamic model of export behavior incorporating short-term capacity constraints and endogenous capital investment. Consistent with the empirical evidence, the model features firms´sales substitutions across markets in the short term, and generates time-varying transition paths of firm responses through firms´ capital adjustments over time. The model is fit to a panel of plant-level data for Colombian manufacturing industries and used to simulate how firm-responses transition following an exchange-rate devaluation. The results indicate that incorporating capital adjustment costs is quantitatively important. First, it takes more than five years for firms to fully adjust to a permanent change of the exchange-rate process. Second, the long-run exchange rate elasticity of exports is substantially higher than that in the short run. Firms´expectation on the permanence of the policy changes also matters. The failure to accurately anticipate the duration of the devaluation results in reduction in firms`profits due to over- or under-investment in capital.

Keywords: International trade; heterogeneous firms; capacity constraints; capital adjustment costs; firm dynamics; firm panel data (search for similar items in EconPapers)
JEL-codes: F12 F14 L11 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-int
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Citations: View citations in EconPapers (4)

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