Propagation of Negative Shocks Through Firm Networks: Evidence from Simulation on Comprehensive Supply-Chain Data

Abstract

This paper examines how negative shocks due to, for example, natural disasters, propagate through supply chains, applying a simulation technique to actual data on supply chains of Japanese firms. We obtained the following five results. (1) Network structures severely affect the speed of propagation in the medium run and total loss in the long run. The scale-free nature of the actual supply chain network, i.e., the power law degree distribution, leads to faster propagation, while dense links between firms within the community in the actual network slow propagation. (2) More intensive damages, i.e., larger damages to fewer firms, result in faster propagation than extensive damages of the same total size. (3) When substitution of undamaged suppliers for damaged suppliers is more difficult to achieve, propagation of negative shocks becomes substantially fast. (4) Direct damages in industrial regions promote faster propagation than those in rural regions. (5) Different sectoral damages cause large differences in the speed of propagation and the long-run loss. All of these results imply that the same size of direct damages by disasters can generate considerably different damages, depending on the structure of the supply chain network in the economy.

Using Randomized Controlled Trials and Network Analysis in International Economics: An Introduction

“…An interpretation of this evidence is that because internationalized firms have sufficient information about potential suppliers and customers in the world, they can find substitute firms for their damaged supplychain partners relatively easily. This confirms the importance of input specificity and substitutability found in Barrot and Sauvagnat (2016) and Inoue and Todo (2017). Also, the importance of diversity of network partners found here is in line with the conclusion of Todo, Matous, and Inoue (2016).…”

Inflation targeting as a shock absorber

“…The interpretation as an adverse supply shock is in line with microeconomic evidence hinting toward economic disruptions that also cause indirect losses. Inoue and Todo (2017) show that the Great East Japan earthquake of 2011 was propagated via supply chain disruptions to other regions. The substitution of production inputs poses a drag on firm productivity.…”

Firm-Level Simulation of Supply Chain Disruption Triggered by Actual and Predicted Earthquakes

“…Actual production is a function of product inventories, production capacity, and demand. The actual production is equal to the realized demand (from [Inoue and Todo, 2017]). The vertical axis shows the total value added in yen.…”

“…Although the damage areas are separated into the inland and the coast side, the firms in these areas obviously did not experience uniform damage. In addition, the heterogeneity of the damage caused totally different outcomes [Inoue and Todo, 2017]. Therefore, each firm's damage is stochastically decided by a distribution based on the statistics [The Small and Medium Enterprise Agency, 2011].…”

“…However, we can create any artificial scenario by adding damages into the supply chain. Regarding such artificial disasters, we have simulated many scenarios before [Inoue and Todo, 2017]. These simulations are about heterogeneous shocks, network structures, substitutes, regions and industries.…”