An Empirical Model of Factor Adjustment Dynamics

This paper investigates how firms dynamically adjust their use of capital, labor, energy, and materials using the Colombian Census of Manufacturing. This Census contains data at the establishment level and provides evidence of a mix of smooth and lumpy adjustments and of interrelated factor adjustments. Based on this evidence, I propose a dynamic firm model that incorporates five key features: disruption of the production process and reallocation of internal resources when firms adjust capital and labor; partial irreversibility of investment; fixed costs of installing capital and creating or discontinuing a job vacancy; 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. As result, when firms are hit by demand or productivity shocks, they decide to adjust either capital or labor alone or both, depending on the initial capital to labor ratio and on the magnitude of the shocks. 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. JEL CODES: E22, E24, J23, D24, L60, D92, C23