Supply Network Formation and Fragility joint with Benjamin Golub and Matthew Leduc

Abstract:

Modern production is complex: For instance, building an airplane requires combining many components. In turn, many of the components - e.g., navigation systems, engines, etc. - are complex, themselves made up of many components, and so on. Because, in each step, several inputs are essential, there are strong complementarities, both within a single firm's production and in the economy more broadly. Indeed, a disruption in sourcing can inhibit the production of many other goods. Thus complementarities have the capacity to amplify shocks and misallocations. The induced sensitivity of production to the environment created by complementarities has helped explain a range of empirical phenomena including very large cross-country differences in production technology and aggregate productivity; rapid output increases during periods of industrialization; and the structure of production networks and international trade flows. Of course, the probability of failures, and the consequences of a given failure for production, are endogenous firms invest effort in multisourcing and in making their supply relationships work. We study how individual multi-sourcing decisions translate into global reliability and find some stark phenomena that are new and that occur because of the complex nature of production (multiple essential inputs). While endogenous multi-sourcing makes an individual firm relatively robust to the failure of some of its relationships, and the economy as a whole robust to firm-specific shocks, the system also exhibits very stark global fragility with respect to certain types of more aggregate shocks. Even when these shocks are small, aggregate output can fall discontinuously.