Capital Adjustment Cost: Implications for Domestic and Export Sales Dynamics

Theoretical and empirical work on export dynamics has generally assumed constant marginal production cost, which implies separability of production decisions for export and domestic product markets. However, recent studies have documented a negative contemporaneous correlation between …rms’ domestic and export sales growth, suggesting that …rms could be capacity constrained in the short run and face increasing marginal production cost. This paper develops and structurally estimates a dynamic model of …rm export behavior incorporating short-term capacity constraints and endogenous capital investment. Consistent with the empirical evidence, the model features substitution of sales across markets in the short term, and generates di¤erent short- and long-term export responses. The model is …t to a panel of plant-level data for Colombian manufacturing industries and used to simulate …rm transitions in response to permanent and temporary exchange-rate devaluations. The results indicate that incorporating capital adjustment costs has quantitatively important implications for …rm-level responses. First, it takes more than …ve years for …rms to fully adjust to a permanent change of the exchangerate process. Second, the long-run exchange rate elasticity of exports is substantially higher than that in the short run. Firms’ expectation on the permanence of the policy change also matters. The failure to accurately anticipate the duration of the devaluation results in reduction in …rm-level pro…ts due to over- or under- investment in capital