Production networks and structural transformation

We examine the aggregate effects of greater integration of traditional and modern services into national supply chains. Using international input–output data, we document substantial cross-country variation in the composition of intermediate goods and identify distinct sectoral patterns. That is, modern services are more prevalent in advanced economies and are becoming increasingly central within production networks. To evaluate the implications, we construct a multisector general equilibrium model incorporating firm-level frictions in labor hiring and intermediate input purchases. These distortions weaken intersectoral linkages and distort production efficiency. Reducing them to US levels generates significant gains – aggregate output increases by 27% on average and by 50% in developing economies – while accelerating structural transformation toward services, particularly modern services, and enhancing their network centrality.