Capital Adjustment Costs: Implications for Domestic and Export Sales Dynamics
Theoretical and empirical work on export dynamics has generally assumed constant\nmarginal production cost and therefore ignored domestic product market conditions.\nHowever, recent studies have documented a negative correlation between firms' do-\nmestic and export sales growth, suggesting that firms can be capacity constrained in\nthe short run and face increasing marginal production cost. This paper develops and\nestimates a dynamic model of export behavior incorporating short-term capacity con-\nstraints and endogenous capital investment. Consistent with the empirical evidence,\nthe model features firms' sales substitutions across markets in the short term, and\ngenerates time-varying transition paths of firm responses through firms' capital adjust-\nments over time.\nThe model is fit to a panel of plant-level data for Colombian manufacturing indus-\ntries and used to simulate how firm responses transition following an exchange-rate\ndevaluation. The results indicate that incorporating capital adjustment costs is quan-\ntitatively important, as shown by the length of the transition period, and the difference\nbetween the short-run and long-run exchange rate elasticity of exports. Firms' expeca-\ntion on the permanence of the policy changes also matters.