Cascading Failures in Production Networks

Abstract

The interaction of input-output networks with industrial structure affects the propagation and amplification of shocks, and is an important consideration for business cycle fluctuations. This paper shows how the extensive margin of entry and exit can greatly amplify idiosyncratic shocks in the presence of a production network and external economies of scale. In this model, sales provide a poor measure of the systemic importance of industries. I derive a new notion of systemic influence called exit centrality that captures how exits in one industry will affect equilibrium output. Exit centrality need not be related to an industry’s sales, size, or prices. Unlike the relevant notions of centrality in standard input-output models, exit centrality depends on the industry’s role as both a supplier and as a consumer of inputs, as well as market structure. Unlike competitive models, vanishingly small industries can have arbitrarily large effects on equilibrium outcomes. Furthermore, the same shock can have both demand-side and supply-side manifestations, depending on the structure of the network.