Trade Adjustment Costs in Developing Countries: - World Bank ...

Reallocation and Adjustment in the Manufacturing Sector in Uruguay 696. CONCLUSIONS AND DIRECTIONS FOR FUTURE RESEARCHAll in all, our micro data evidence supports some regularities present in previousliterature on adjustment functions. Investment and job creation are not the resultof smooth and continuous microeconomic decisions. Individual adjustmentconstraints depart significantly from those implied by quadratic adjustment costs,and there are several sources of irreversibilities (technological, market-induced,increasing returns in the adjustment technology). The evidence provided seemsto confirm a pattern that has important nonlinear features, and hence is consistentwith such constraints. This impacts the use of all factors of production, particularlyemployment.Adjustment costs faced by capital, white and blue collar labor are non trivialin the Uruguayan manufacturing sector, which has consequences in terms of factorunemployment and economic efficiency. The size of adjustment costs mayreduce factor reallocation and dampen productivity gains.Our main results confirmed the asymmetric nature of firms’ adjustment process.Large shortages of one factor lead to less responsiveness in adjustment in thecreation side of other factors and to larger adjustment in the destruction side.We also assessed the effects of protection and trade liberalization on firms’ adjustmentprocess. The constraints arising from adjustment cost functions may becomean important part of policy analysis. Our results point to a significant shift inadjustment functions for all production factors associated with increased liberalizationafter the Mercosur Treaty. Specifically, trade policy variables measured by tariffslevels and reductions in tariffs significantly shifted adjustment functions. Firmsin less protected sectors have shown higher adjustment fractions in the creation sideand lower in the destruction side, particularly for blue collar labor. Sectors facinglarger tariff changes adjusted less in the creation side, particularly for blue collars,and more on the destruction side. In the context of tariff reductions of Mercosur,more highly protected sectors were probably those that faced the largest tariff reductions.Overall the impact of higher international exposure on factors of productionis stronger for blue collar workers than for white collar workers.Though our work does not provide an empirical identification strategy to pinpointthe causal relationship between trade openness and adjustment costs, webelieve our estimation results provide a powerful descriptive insight and valuablesuggestions for the mechanisms behind observed firm behavior.Our analysis also showed that adjustment costs faced by firms subject to strongChinese and Indian competition seemed to be particularly large for firms thatwould like to reduce their levels of white collar workers. For firms experiencingfactor shortages, however, adjustment costs seem to be smaller when subject toimport competition from China and India (except perhaps for small shortages ofskilled labor when subject to import competition from India).Finally, policies should be based on a wide look at the economy. Inference fromthe manufacturing sector may not be extendable to other sector of production.As new panel data on service sectors become available we should extend our empiricalwork to cover all sectors of activity.