Diana Beltekian (University of Nottingham)
Bilateral trade linkages in domestic and international production networks play an important role in firm-level and aggregate economic outcomes. However, much of the earlier literature has abstracted from this channel treating production networks as exogenous, for reasons of computational tractability and the theoretical complexity of modelling endogenous link formation. The more standard approach in the economics literature has assumed an exogenous production network when modelling input-output linkages. I relax this assumption by developing a production network model where each firm’s input supplier choices and quantities purchased determine the prevailing equilibrium network structure. I apply my framework to the 2018 US-China trade war, leveraging the increase in import tariffs to quantify the impact of rising production costs on trade connections. I perform a counterfactual analysis to find that, when treating the production network as endogenous, the trade war leads to smaller GDP losses at 1%, compared to the standard case where losses are 1.6%. I find the standard approach overestimates GDP losses by 0.6 percentage points, a non-negligible difference in aggregate economic outcomes.
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