The Effect of Supply Base Diversification on the Propagation of Shocks

Abstract

We study how supply base diversification affects the propagation shocks. We identify exoge-nous shocks with the occurrence of natural disasters in the US from 1978-2017. Affected suppliers reduce their customers' sales growth by 30% on average. Notably, firms with input purchases spanning many suppliers, geographies, or producers within industries attenuate the transmission of shocks by 60-70%. We then show, causally, that diverse firms mitigate shocks by temporarily substituting towards unaffected suppliers producing similar inputs. A general equilibrium production networks model reveals that aggregate volatility would have been 33%greater from 1978-2017 in a counterfactual without input substitution by diverse firms.