How are shocks transmitted through global supply chains?
Figure 1. GDP growth rates of select OECD countries: 2002-2012
There has been increased attention to the sources of such business cycle synchronisation, particularly among policymakers attempting to limit the negative effects of international spillovers. A great deal of empirical work has documented the financial (see Peek and Rosengren 1997, 2000 and Kalemli-Ozcan et al. 2013) as well as policy channels (Gilchrist et al. 2014, for the case of monetary policy) of such spillovers. Comparatively less is known about the effects from ‘real’ (non-financial) channels such as international trade and investment. As discussed by di Giovanni and Levchenko (2010), there is an ongoing debate among economists as to whether these real linkages contribute to business cycle synchronisation, or whether the observed correlation is simply a by-product of some other causal mechanism. Disentangling the competing explanations is difficult, as economists generally do not have access to controlled experimental environments for the study of particular macroeconomic mechanisms.
New evidence on the transmission of shocks via input linkages
In a recent paper (Boehm et al. 2014), we provide new evidence for the role of trade and multinational firms in the cross-country transmission of shocks. Two novel contributions enable us to identify the specific mechanism at work.
- First, we link information on international ownership to firm-level data from the US Census Bureau and develop a new methodology for identifying intermediate input trade at the firm level.
- Second, the paper makes use of a ‘natural experiment’ of a large and exogenous shock – the 2011 Japanese Tōhoku earthquake/tsunami – to isolate causal spillovers from other potentially confounding factors.
In addition to the human tragedy caused by the cumulative effect of these disasters, there were severe consequences for Japanese industrial production. Manufacturing output fell by roughly 15 percentage points in the month of March (see Figure 2, left scale), only recovering to pre-shock levels five months later in August. As expected, US imports from Japan fell dramatically as well, though the large drop was recorded in April 2011, reflecting the several weeks of travel time for goods to reach the US. More surprising is the effect of this shock on the US economy, as measured by the deviations from trend in US manufacturing output during this time. US manufacturing output fell by about 1% in the month of April (see Figure 2, right scale), and remained significantly below prior levels for roughly six months following the Tōhoku event.
Figure 2. Manufacturing production in Japan and the US: Months surrounding the 2011 Tōhoku earthquake
Source: Boehm et al. (2014).
What were the mechanisms behind the transmission of this shock to the US economy? To answer this question, we turn to the detailed firm-level data at our disposal.
- In particular, we shed light on the way in which vertical production linkages served as a conduit for the transmission of this shock to the US.
With this in mind, we focus on US manufacturing firms’ exposure to Japanese inputs. The US manufacturing affiliates of Japanese multinationals are – almost universally – highly dependent on inputs from Japan. These inputs comprise almost one-quarter of the cost share in these firms’ US production, and the large majority (86%) is purchased intra-firm. Moreover, these firms are large; taken as a whole, they represent over 60% of the total US imports of intermediate inputs from Japan.
The US manufacturing affiliates of Japanese multinationals suffered large drops in US output in the months following the shock, roughly one-for-one with the fall in imported inputs (see Figure 3).1
- This behaviour indicates that there is virtually no scope for substitution to other inputs for these firms – such that the shock passed directly to their US operations following the shock in Japan.
Figure 3. Relative imported inputs and output (proxy) of Japanese affiliates in the US
Source: Boehm et al. (2014).
- Our results also suggest that these firms reduced their expenditures on non-Japanese inputs in line with the fall in Japanese inputs. This implies that other firms in the US economy – upstream or downstream from the Japanese affiliates – would have suffered from the shock even without direct input exposure to Japan.
Our findings suggest that global supply chains are sufficiently rigid to play an important role in the cross-country transmission of shocks. We believe there are three key lessons for policymakers resulting from this research. First, the responsiveness of trade patterns to exchange rate changes may be muted in the short-run. Second, trade linkages and increased international input sourcing – which in part follow from foreign direct investment by multinational firms – will not always lead to greater diversification of country-specific supply chain risk. Finally, in light of low input substitutability, policies affecting the production decisions of firms – particularly those of multinational firms – should include sufficient notice in order to prevent short-run disruptions.
This article is published in collaboration with Vox EU. Publication does not imply endorsement of views by the World Economic Forum.