Production network diversification and economic development

Abstract

We provide empirical evidence and a theoretical analysis of the influence of production network diversification on countries' economic performance, reflected in their GDP per-capita levels. Using a panel sample of 55 countries, we find a strong positive association between the number of active links in the input-output network of a country and its GDP per-capita over time, even after controlling for several country characteristics. To complement and scrutinize our empirical finding, we advance economic theory on the link between network diversity and economic development by proposing a multisector model with input-output linkages, non-unitary elasticity of substitution in production, and a love of diversification in the bundle of intermediate inputs that rationalize our empirical results. In the long run, when labor and intermediates are substitute inputs, denser production structures enjoy higher productivity in the intermediate input bundle and also amplify positive shocks more strongly than less connected networks. Hence, our model predicts that economies with denser production structures display higher income.