The propagation of worldwide sector-specific shocks

This paper analyses the aggregate impact of industry-specific shocks and their propagation through global production networks. We focus on the case in which a common shock affects simultaneously the same industry across different countries. Thus, our analysis can be a useful tool for several policy-relevant scenarios, such as changes in environmental regulations or the implementation of new technologies. For that purpose, we highlight the importance of departing from standard linear models that assume unitary elasticities of substitution. We combine a theoretical framework of production networks with arbitrary elasticities of substitution (Baqaee & Farhi, 2019) and we make use of World Input-Output Database to account for international linkages. This setting illustrates how, in the presence of production input complementarities, the interaction between simultaneous shocks has significant non-linear effects on sectoral composition and aggregate output. The aggregate impact of negative (positive) shocks gets significantly amplified (mitigated) when they affect simultaneously industries with strong production linkages. Our results show that ignoring production complementarities leads to vastly underestimating the aggregate consequences of regulatory or technological shocks in industries like chemicals or vehicle manufacturing. In contrast, simultaneous shocks to services industries are well accounted for by standard measures.