Costly Factor Reallocation and Reduced Productivity Effects in International Trade

Most models of international trade assume extremes of factor mobility between productive uses. From perfectly mobile factors in the Heckscher-Ohlin model, to fixed capital and mobile labor in the Ricardo-Viner-Jones model, factors are assumed to move costlessly or not at all. In reality, factors are neither perfectly mobile nor fixed. This paper considers costs of reallocating factors between industries, deriving a measure of adjustment costs due to factor specificity in a two-period model of a firm's input allocation decision. The degrees of specificity for labor and capital are then estimated based on data for 15 industries in 16 countries covering eight years. Estimating a system of nonlinear first-order conditions using a three-stage least squares technique, I find that recently reallocated factors are indeed less productive. Labor is 14% less productive in the period after reallocation, while capital productivity falls by 43%. Thereafter, capital, unlike labor, moves quickly toward full productivity