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Dynamic Adjustment to Trade Shocks

by Junyuan Chen, Carlos Goes, Marc-Andreas Muendler, and Fabian Trottner

Global trade flows and supply chains adjust gradually. The empirical disparity of trade elasticity estimates between the short and long run suggests substantive adjustment frictions in trade. We develop a tractable framework that provides microfoundations for dynamic trade adjustment. The model features staggered sourcing decisions, nests the Eaton-Kortum model as the limiting long-run case, and provides a quantitative framework that rationalizes reduced-form estimation of horizon-specific trade elasticities. We calibrate the model with horizon-specific trade elasticities under industry-specific input-output relations and use it to  quantify the welfare impact of the 2018 US-China trade war. Staggered sourcing decisions imply that the well-known static welfare formula based on observed domestic trade shares requires dynamic adjustment, so that predictions account for short-run distortions. Simulations suggest that the short-run welfare impact can be smaller than the long-run level for the United States but larger for China despite the same low short-run trade elasticity, while third countries such as Mexico and Vietnam may experience welfare losses in the short run but welfare gains in the long term.

Paper, July 2024 (PDF)