Endogenous Production Networks and Supply Chain Disruptions

This paper studies the role of production networks and provides a causal estimate of how supply chains affect prices and productivity. Leveraging unique firm-level production network data from Turkey, a country with high inflation and expansionary monetary policy, I isolate the supply shock by exploiting the disruption from Chinese suppliers due to the lockdown. I document that firms relying on imports from China raise their prices by 11 % and experience a 24 % decrease in productivity following the supply chain disruption. To explore the mechanism, I further extend the analysis at the firm-product level and uncover that the effect on labor productivity is primarily driven by the intermediate and capital goods. Guided by the empirical findings, I propose a theoretical framework where firms are heterogeneous regarding their core and network productivities. The firm's supplier matches shape these network productivities as firms select into productive or low-cost suppliers to maximize their profits. I show that the endogeneity of the production network also originates from interdependent choices. In this way, this paper offers a new layer of firm heterogeneity as supply chain choices. Finally, I calibrate the model to analyze the implications of expanding the firm's supply chain. Counterfactual supply chains, with lower fixed costs associated with Chinese suppliers, translate into a decrease of 1.2 % in aggregate prices