How Do Firms Adjust When Trade Stops?

We investigate how _rms adjust to the introduction of sudden, unanticipated and eventually long-lasting economic sanctions. We explore a unique event when, due to political reasons, unrelated to the underlying economic conditions, the exporters completely lost access to a major foreign market. In particular, in 2014 Russia introduced sanctions on imports from Europe, which caused an abrupt negative shock to the food production sector in Lithuania. We find that part-time employment is used as the first shock absorber, followed by investment and full-time employment. At the same time, firms dampen shock effects by expanding to other export markets. To rationalize this firm behavior, we provide a theoretical mechanism where forward-looking firms face nonconvexities in the labor market along with heterogeneous variable trade costs.