Capital-Reallocation Frictions and Trade Shocks

What are the short- and medium-run aggregate effects of an international-trade shock that increases competition for domestic manufacturing industries? In this paper, we address this question by combining detailed firm-level investment data from several manufacturing industries in Peru, data on the import penetration of Chinese manufacturing goods in Peru, and a quantitative general-equilibrium model of trade with heterogeneous firms subject to idiosyncratic shocks. We find evidence of large frictions in disinvestment (i.e., capital reallocation), that induce high persistence of low returns from capital at the firm level, and dampen the empirical response of reallocation to Chinese import competition. In our calibrated model, these frictions play a key role in the dynamic response of the economy to an import-competition shock, inducing slow transitional dynamics and several years of low aggregate productivity, while the distribution of firm-level capital and productivity adjusts to the new steady state.