Inputs in distress: geoeconomic fragmentation and firms' sourcing

We study how disruptions to the supply of foreign critical inputs (FCIs) – inputs primarily sourced from extra-EU countries with highly concentrated supply, advanced technology products, or inputs which are key to the green transition – may affect value added at different levels of aggregation. Using firm-level customs and balance sheet data for Belgium, France, Italy, Slovenia and Spain, our framework allows us to assess how geoeconomic fragmentation may affect EU economies differently. Our baseline calibration suggests that a 50 per cent reduction in imports of FCIs from China and other countries with a similar geopolitical orientation would result in sizeable value added losses with significant heterogeneity across firms, sectors, regions, and countries, driven by the heterogeneous exposure of firms. Our findings show that the short-term costs of supply disruptions of FCIs can be substantial, especially if firms cannot easily switch away from these inputs.