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Supply Network Formation and Fragility
Matthew Elliott, Benjamin Golub, and Matthew V. Leduc
American Economic Review. Aug 2022, Vol. 112, No. 8: Pages 2701-2747

Supply Network Formation and Fragility

Matthew Elliott1, Benjamin Golub2 and Matthew V. Leduc3

1University of Cambridge (email: )

2Northwestern University (email: )

3Paris School of Economics and Université Paris 1 (Panthéon-Sorbonne) (email: )

Abstract

We model the production of complex goods in a large supply network. Each firm sources several essential inputs through relationships with other firms. Individual supply relationships are at risk of idiosyncratic failure, which threatens to disrupt production. To protect against this, firms multisource inputs and strategically invest to make relationships stronger, trading off the cost of investment against the benefits of increased robustness. A supply network is called fragile if aggregate output is very sensitive to small aggregate shocks. We show that supply networks of intermediate productivity are fragile in equilibrium, even though this is always inefficient. The endogenous configuration of supply networks provides a new channel for the powerful amplification of shocks. (JEL D21, G31, L14)