Financial Constraints and Propagation of Shocks in Production Networks

Abstract

We examine propagation of a small unexpected supply shock through a production network and the role financial constraints play in its transmission. Using data on almost all Turkish supplier-customer links, we exploit the heterogeneous impact of an unexpected import-tax increase for identification. We find that this relatively minor shock had a non-trivial economic impact on exposed firms and propagated downstream through affected suppliers. Importantly, we show that low-liquidity firms amplified its transmission.

Trade policy changes, tax evasion and Benford's law

“…Second, as the time went by, importers were able to legally avoid the RUSF tax by using other sources of financing to replace import trade credit. Third, as documented by Demir et al (2018), who consider the same shock, Turkish importers affected by the increase in the RUSF tax responded by increasing the number of new domestic suppliers and the value of domestic purchases.…”

“…An immediate adjustment may not be possible because it takes time to find alternative sources of financing, but in the medium-run many importers may replace trade credit with other sources of financing. They also have an option of switching to domestic sourcing, as shown by Demir et al (2018). If that is the case, they will no longer have the need to engage in evasion of the RUSF tax.…”

Cross-Sector Interactions in Western Europe: Lessons from Trade Credit Data

“…Building on this early research on network, Bigio and La'o (2020) highlight the critical role of financial constraints in this propagation mechanism. Demir et al (2020) use a change in the tax on imports purchased with foreign-sourced trade credit in Turkey in 2011 to highlight how low-liquidity firms amplify the transmission of the shock. Altinoglu (2021) and Luo (2020) go further and modelize the interdependencies of firms' financial constraints through the existence of trade credit across firms.…”

“…Building on this network structure, Bigio and La'o (2020) showed that a financial shock would also propagate across sectors through those production links. Demir et al (2020) highlighted the critical role of firms' financial constraints in such propagation processes. However, while production interdependencies can be clearly mapped through input-output data, no large-scale picture exists regarding financial interactions across sectors.…”

Surviving Pandemics: The Role of Spillovers

“…8 More recently, studies have used firm-level data to show how buyer-seller linkages lead to propagation of shocks that are set off by the financial sector (Huber, 2018;Giannetti and Saidi, 2019;Alfaro et al, 2021;Bigio and Lao, 2020;Costello, 2020;Demir et al, 2020).…”