The Effect of Supply Base Diversification on the Propagation of Shocks

Author name: 
Bahal G
Jenkins C
Lenzo D

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.

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