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The Effect of Supply Base Diversification on the Propagation of Shocks

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  • Girish Bahal
  • Connor Jenkins
  • Damian Lenzo

Abstract

This paper studies the role of supply base diversification on the propagation of shocks through production networks. We identify exogenous shocks with the occurrence of natural disasters in the US between 1978 and 2017. We find that affected suppliers reduce customers’ sales growth by ≈25%, on average. Notably, firms that source intermediate inputs across many suppliers, geographies, or industries attenuate shocks to their suppliers by ≈60-70%. We interpret our empirical findings using a general equilibrium model of production networks. First, we establish that diverse firms exhibit gross substitutability among inputs relative to non-diverse firms, suggesting diverse firms insulate themselves by substituting away from disrupted suppliers. By estimating the structural elasticity parameters, we find real GDP would have been ≈$740 billion lower in 2017 in the absence of diversified firms.

Suggested Citation

  • Girish Bahal & Connor Jenkins & Damian Lenzo, 2022. "The Effect of Supply Base Diversification on the Propagation of Shocks," CAMA Working Papers 2022-60, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    • Handle: RePEc:een:camaaa:2022-60
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    File URL: https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2022-10/60_2022_bahal_jenkins_lenzo.pdf
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    More about this item

    Keywords

    production network; propagation of firm-level shocks; supply-chain diversity;
    All these keywords.

    JEL classification:

    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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