Financial Constraints and Propagation of Shocks in Production Networks

This study finds that small unexpected supply shocks propagate through production networks, amplified by firms with short-term financial constraints. Our data cover almost all Turkish supplier-customer links. The unexpected 2011 increase in the tax on imports purchased with foreign credit, which a affected importers heterogeneously, provides the identification. This shock had a non-trivial economic impact on exposed firms and propagated downstream through affected suppliers. A simple theory and empirical tests demonstrate that low-liquidity firms amplified its transmission. The shock provides a good setting for estimating the elasticity of substitution between domestic and foreign intermediates which is found to equal about 2.

Written with Banu Demir (Bilkent University and CEPR), Tomasz K. Michalski (HEC Paris and GREGHEC) and Evren Ors (HEC Paris and GREGHEC)