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An Empirical Model of Factor Adjustment Dynamics

  • Contreras, Juan

This paper investigates how firms dynamically adjust their use of capital, labor, energy, and materials when there are both smooth and lumpy adjustment possibilities and interrelation among adjustments. The Colombian Annual Census of Manufacturing provides evidence of these kinds of adjustment. The innovation of this paper lies in three areas: in considering the joint adjustment and interrelation of labor and capital at the establishment level; in describing the dynamic adjustment of all the production factors; and in a rich description of adjustment costs, which includes disruption of the production process and reallocation of internal resources, and fixed costs of installing capital and creating or discontinuing a job vacancy. The model also includes both a convex cost component, aimed at capturing smooth adjustments, and congestion effects, which means that it is more costly for firms to adjust capital and labor at the same time than it is to adjust them separately. Using a simulated method of moments, the study finds empirical support for the existence of disruption costs for capital and labor, the existence of convex costs for capital but not for labor, and the existence of congestion effects. An important implication of the model is that, in response to shocks, firms decide to adjust either capital or labor alone or both, depending on the initial capital to labor ratio and the magnitude of the shocks.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 9797.

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Date of creation: Nov 2006
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Handle: RePEc:pra:mprapa:9797
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  1. Hamermesh, Daniel S. & Pfann, Gerard Antonie, 1996. "Adjustment Costs in Factor Demand," CEPR Discussion Papers 1371, C.E.P.R. Discussion Papers.
  2. Ricardo J. Caballero & Eduardo M.R.A. Engel & John Haltiwanger, 1995. "Aggregate Employment Dynamics: Building From Microeconomic Evidence," NBER Working Papers 5042, National Bureau of Economic Research, Inc.
  3. Eslava, Marcela & Haltiwanger, John C. & Kugler, Adriana & Kugler, Maurice, 2005. "Factor Adjustments after Deregulation: Panel Evidence from Colombian Plants," IZA Discussion Papers 1751, Institute for the Study of Labor (IZA).
  4. John Haltiwanger & Russell Cooper & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September.
  5. Klette, Tor Jakob & Griliches, Zvi, 1996. "The Inconsistency of Common Scale Estimators When Output Prices Are Unobserved and Endogenous," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(4), pages 343-61, July-Aug..
  6. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc.
  7. Chad Syverson, 2001. "Market Structure and Productivity: A Concrete Example," Working Papers 01-06, Center for Economic Studies, U.S. Census Bureau.
  8. Letterie, Wilko A. & Pfann, Gerard A. & Polder, J. Michael, 2004. "Factor adjustment spikes and interrelation: an empirical investigation," Economics Letters, Elsevier, vol. 85(2), pages 145-150, November.
  9. Matthew D. Shapiro, 1984. "The Dynamic Demand for Capital and Labor," Cowles Foundation Discussion Papers 735, Cowles Foundation for Research in Economics, Yale University.
  10. Ricardo J. Caballero & Eduardo M. R. A. Engel, 1999. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," Econometrica, Econometric Society, vol. 67(4), pages 783-826, July.
  11. Abel, Andrew B. & Eberly, Janice C., 1998. "The mix and scale of factors with irreversibility and fixed costs of investment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 48(1), pages 101-135, June.
  12. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932, June.
  13. Plutarchos Sakellaris, 2001. "Patterns of plant adjustment," Finance and Economics Discussion Series 2001-05, Board of Governors of the Federal Reserve System (U.S.).
  14. Ricardo J. Caballero & Eduardo M. R. A. Engel & John C. Haltiwanger, 1995. "Plant-Level Adjustment and Aggregate Investment Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 1-54.
  15. Rust, John, 1987. "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica, Econometric Society, vol. 55(5), pages 999-1033, September.
  16. Polder, Michael & Verick, Sher, 2004. "Dynamics of Labour and Capital Adjustment – A Comparison of Germany and the Netherlands," IZA Discussion Papers 1212, Institute for the Study of Labor (IZA).
  17. Daniel S. Hamermesh, 1988. "Labor Demand and the Structure of Adjustment Costs," NBER Working Papers 2572, National Bureau of Economic Research, Inc.
  18. Nick Bloom, 2006. "The Impact of Uncertainty Shocks: Firm Level Estimation and a 9/11 Simulation," CEP Discussion Papers dp0718, Centre for Economic Performance, LSE.
  19. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
  20. Robert E. Hall, 2004. "Measuring Factor Adjustment Costs," The Quarterly Journal of Economics, MIT Press, vol. 119(3), pages 899-927, August.
  21. Nadiri, M Ishaq & Rosen, Sherwin, 1969. "Interrelated Factor Demand Functions," American Economic Review, American Economic Association, vol. 59(4), pages 457-71, Part I Se.
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