Propagation of Economic Shocks in Input-Output Networks: A Cross-Country Analysis

TL;DR

This study analyzes how economic shocks spread through input-output networks in European countries, revealing that shock impact varies with shock type, country size, and sector centrality, affecting economic stability.

Contribution

It introduces models of shock diffusion calibrated with real input-output data, highlighting the role of sector centrality and country size in shock propagation.

Findings

Shocks affecting final demand have homogeneous impacts across economies.

Changes in inter-sector dependencies lead to larger, more heterogeneous avalanches.

Larger and more central sectors cause bigger economic impacts.

Abstract

This paper investigates how economic shocks propagate and amplify through the input-output network connecting industrial sectors in developed economies. We study alternative models of diffusion on networks and we calibrate them using input-output data on real-world inter-sectoral dependencies for several European countries before the Great Depression. We show that the impact of economic shocks strongly depends on the nature of the shock and country size. Shocks that impact on final demand without changing production and the technological relationships between sectors have on average a large but very homogeneous impact on the economy. Conversely, when shocks change also the magnitudes of input-output across-sector interdependencies (and possibly sector production), the economy is subject to predominantly large but more heterogeneous avalanche sizes. In this case, we also find that: (i) the more a sector is globally central in the country network, the largest its impact; (ii) the largest European countries, such as those constituting the core of the European Union's economy, typically experience the largest avalanches, signaling their intrinsic higher vulnerability to economic shocks.