Endogenous Production Networks under Uncertainty

Abstract

Supply chain disturbances can lead to important increases in production costs. When looking for new suppliers, firms therefore worry about the risks associated with potential trading partners. We investigate the impact of beliefs and uncertainty on the structure of the production network and, through that channel, on the level and volatility of macroeconomic aggregates. Todo so, we construct a model of endogenous network formation in which uncertainty about future outcomes affects the structure of the production network. In the model, when uncertainty rises producers prefer to purchase from more stable suppliers, even though they might sell at higherprices. The resulting reorganization of the network leads to less macroeconomic volatility, but at the cost of a decline in aggregate output. We calibrate the modelon U.S. data and find that the mechanism can account for a sizable decline in expected GDP during periods of high uncertainty like the Great Recession.