# 1 Introduction

Trade policy causes some sectors to expand and others to shrink, creating winners and losers along the way. The magnitudes of these impacts depend on factor adjustments to shocks. If labor and capital react slowly and can only be imperfectly reallocated from shrinking to expanding sectors, then the negative eects of a trade policy shock can be amplied. To account for imperfect factor adjustments, early international trade research mostly focused on the capital adjustment process (Mussa, 1978). More recent research focused instead only on labor market adjustments (Davidson and Matusz, 2004; Davidson and Matusz, 2006; Artuc, Chaudhuri and McLaren, 2010). This paper oers a new analysis that incorporates both labor mobility costs and capital adjustment costs and assesses their signicance simultaneously. This allows for an accurate quantication of the impact of trade policy because we not only measure both mechanisms in a consistent framework, but we also account for interactions that occur when the labor adjustment process aects the capital adjustment process and vice versa.

We claim that capital adjustment can re-shape the short- to long-run transition of wages. After a tari cut, the wages in the aected sector typically decline in the short-run.<sup>1</sup> When rms can disinvest in response to the loss of protection, the capital stock sluggishly decreases, thus further reducing labor productivity and wages through time. The impacts on wages can consequently be magnied. If instead capital adjustment is ignored, as it is often the case in the trade literature on labor markets, the wage impact of the tari cuts will be eroded in the long-run as labor moves out of the de-protected sectors and the marginal product of labor thus increases.<sup>2</sup> To investigate these issues and the attendant patterns of labor market adjustment, we formulate a dynamic structural model of trade with worker's intersectoral choice and rm's capital accumulation decisions. Our framework combines the labor supply model with workers' mobility costs of Artuc, Chaudhuri and McLaren (2010), extended to include non-employment as in Caliendo, Dvorkin and Parro (2019), with the labor demand model with capital adjustment costs of Bloom (2009) and

> 1See Goldberg and Pavcnik (2005), Kovak (2013), Autor, Dorn and Hanson (2013), Autor, Dorn, Hanson, and Song (2014) and Hakobyan and McLaren (2016).

> 2The labor adjustment cost literature is abundant, including models with workers' moving costs across sectors (Artuc, Chaudhuri and McLaren, 2010; Artuc and McLaren, 2015; and Dix-Carneiro, 2014) and workers' sectorspecic experience (Cosar, 2013; Dix-Carneiro, 2014; Davidson and Matusz, 2004; Davidson and Matusz, 2006; Ritter, 2014). Another branch focuses on rm behavior and studies ring and hiring costs (Kambourov, 2009; DixCarneiro, 2014) and market search frictions (Cosar, 2013; and Cosar, Guner and Tybout, 2016). The treatment of capital adjustment costs is succinct in the related trade literature. Dix-Carneiro (2014) works out examples of ad-hoc capital adjustment costs and labor markets; Rho and Rodrigue (2016) analyze the interaction between investment and export costs.

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