The dynamic response to trade policy: evidence from the US textile and clothing industries

I study the behavior of textile and clothing makers in the U.S. as they were exposed to a large, uncertainly anticipated increase in foreign competition through the removal of import quotas. I find a large secular decline in capital investment in the industries that are likely to have been the most vulnerable to such competition. The decline is significant beginning immediately after announcement of the policy–nine years before the scheduled liberalization date. The investment decline is interrupted by a large, short-lived increase when the policy uncertainty is resolved. I show that each of these features of the data is predicted by a model of optimal industry investment in the presence of capital adjustment costs, under an anticipated but uncertain demand shock that mimics this liberalization. Using industry-level panel data, I examine other developments in the output and capital markets for these industries, and I find that they too are consistent with the model’s predictions. Calibration to fit the observed investment path yields parameter values that are close to directly estimated values. These findings demonstrate that considering capital adjustment costs and policy uncertainty can be critical in understanding industry behavior, even over a relatively long time horizon.