How demand shocks propagate through an input-output network: The cases of the global financial crisis and the COVID-19 pandemic

Previous studies report the propagation of shocks via supply chains from downstream, but little is known about the propagation from customers to suppliers driven by demand shocks. This column uses Japanese firm-level input-output data to fill this gap. The authors find that negative demand shocks only propagated from large exporters to larger suppliers during the global financial crisis, but were transmitted from small customers even to their small suppliers during the COVID-19 pandemic. Identifying the propagation route helps in the design of targeted policies.

The propagation of shocks via input-output linkages among firms (i.e., supply chains) has gained attention among economists. The ongoing COVID-19 pandemic and recent geopolitical incidents further necessitate studies on the theme. In this context, recent theoretical analysis (e.g., Acemoglu et al. 2012) shows that microeconomic shocks to hub firms in an input-output network have a large impact on aggregate output. Furthermore, because of the increasing availability of firm-level data, recent empirical studies directly analyse such firm-level input-output networks and find propagation phenomena. For example, Barrot and Sauvagnat (2016) use natural disasters in the US as the source of negative shocks to firms and examine the propagation of these shocks via input-output linkages. Boehm et al. (2019) and Carvalho et al. (2021) use the Tohoku earthquake in Japan in 2011 and show that this negative shock propagates to other customers in unaffected regions.

These previous studies focus on propagation driven by supply shocks; that is, shocks propagate ‘downstream’ from supplies to customers. In contrast, ‘upstream’ propagation from customers to suppliers driven by demand shocks is rarely examined in the empirical literature. Two exceptions are Acemoglu et al. (2016) and Kisat and Phan (2020), but their analysis relies on a sector-level input-output network. To the best of our knowledge, there is no empirical study that directly observes the demand-shock propagation through a firm-level input-output network.

In a recent paper (Arata and Miyakawa 2022), we aim to fill this gap in the literature using Japanese firm-level input-output data. We focus on demand-shock propagation originating from the sharp drop in exports during the Global Crisis and the change in consumer behaviour during the COVID-19 pandemic. Viewing these events as exogenous to Japanese firms, we examine how sales growth rates are affected by the presence or absence of their transacted customers which were damaged by the negative shocks. We use the heterogeneous treatment effect model developed by Athey et al. (2019) and Wager and Athey (2018), which enables us to analyse how the propagation effect depends on firm characteristics, such as firm size. By focusing on the heterogeneity of the propagation effect, we examine the route of the demand-shock propagation through the input-output network.

To read the full text:
https://www.rieti.go.jp/en/columns/v01_0186.html

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