The Effect of Supply Base Diversification on the Propagation of Shocks

We study how supply base diversification affects the propagation shocks. We identify exogenous shocks with the occurrence of natural disasters in the US from 1978-2017. Affected suppliers reduce their customers’ sales growth by 30% on average. Notably, firms with input purchases spanning many suppliers, geographies, or producers within industries attenuate the transmission of shocks by 60-70%. We then show, causally, that diverse firms mitigate shocks by temporarily substituting towards unaffected suppliers producing similar inputs. A general equilibrium production networks model reveals that aggregate volatility would have been 33%greater from 1978-2017 in a counterfactual without input substitution by diverse firms.