Capital Adjustment Costs: Implications for Domestic and Export Sales Dynamics

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 correlation between firms' do- mestic 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 con- straints
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 adjust- ments over
time. The model is fit to a panel of plant-level data for Colombian
manufacturing indus- tries and used to simulate how firm responses
transition following an exchange-rate devaluation. The results
indicate that incorporating capital adjustment costs is quan-
titatively important, as shown by the length of the transition
period, and the difference between the short-run and long-run
exchange rate elasticity of exports. Firms' expeca- tion on the
permanence of the policy changes also matters.