DP14832 Capital-Reallocation Frictions and Trade Shocks

Author(s):	Andrea Lanteri, Pamela Medina, Eugene Tan
Publication Date:	May 2020
Date Revised:	July 2020
Keyword(s):	capital reallocation, Firm Dynamics, Investment Irreversibility, Trade Shocks
JEL(s):
Programme Areas:	International Trade and Regional Economics, Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=14832

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.