Discussion Paper Details

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Title: Capital-Reallocation Frictions and Trade Shocks

Author(s): Andrea Lanteri, Pamela Medina and Eugene Tan

Publication Date: May 2020

Keyword(s): capital reallocation, Firm Dynamics, Investment Irreversibility and Trade Shocks

Programme Area(s): International Trade and Regional Economics and Monetary Economics and Fluctuations

Abstract: What are the short- and medium-term effects of an import-competition shock on firm dynamics and aggregate productivity? We address this question by combining detailed data on investment dynamics of Peruvian manufacturing firms, data on trade flows from China, and a quantitative general-equilibrium model with heterogeneous firms subject to idiosyncratic shocks. In the data, we find evidence of substantial frictions that slow capital reallocation, by rendering disinvestment and firm exit costly. In our model, these frictions shape the transitional dynamics after a trade shock. On impact, a drop in output prices due to import competition induces a spike in inaction, and exit of some productive firms, consistent with our empirical evidence. These effects expand the aggregate productivity wedge relative to a frictionless benchmark. Overall, productivity gains materialize slowly over time, whereas welfare gains emerge early in the transition.

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Bibliographic Reference

Lanteri, A, Medina, P and Tan, E. 2020. 'Capital-Reallocation Frictions and Trade Shocks'. London, Centre for Economic Policy Research.