70 Finance & economics The Economist April 30th 2022
Cascadeeffects
R
ussia’s decisionto halt the supply of gas to Bulgaria and Po
land has added fuel to an already heated debate in Germany,
which is heavily reliant on the commodity. For weeks the coun
try’s economists and officials have argued over just how much a
ban on Russian hydrocarbons would harm the economy. Now it
seems imaginable that Russia itself could turn off the taps. What
toll would an embargo take? A wide body of research, which exam
ines a range of past disruptions, sheds light on the question.
The relationships between modern firms are not simple links
connecting one producer with another, but a tangle of complex in
teractions. The breakdown of a seemingly insignificant link in the
chain can disrupt firms that are either upstream or downstream of
it, causing wider damage. In a paper published in 2019 David Ba
qaee of the University of California, Los Angeles, and Emmanuel
Farhi of Harvard University used a model of complex supply net
works to study the oil shocks of the 1970s. Linkages between firms
and sectors meant that the overall economic effect was quite a bit
larger than the direct impact on sectors that used oil. Recent re
search on the effect of social distancing on America by JeanNoël
Barrot, then ofhecParis, and his coauthors finds that ripple ef
fects through production networks accounted for more than half
of the total economic impact.
Another muchstudied instance of disruption is the earth
quake that struck northeastern Japan in 2011. As the worsthit ar
eas only accounted for less than a twentieth of gdp, local disrup
tion should not have had a noticeable nationwide effect. But it did.
In a review Vasco Carvalho of the University of Cambridge and col
leagues disentangle the impact on the affected areas from the rip
ple effects along supply chains, and find that the latter accounted
for more than half the hit to Japanese growth.
Researchers have also uncovered the types of links and mecha
nisms that enable shocks to propagate widely. The shutdown of a
company altogether is one way in which a jolt can create a much
bigger economic hit, according to a paper by Daron Acemoglu of
the Massachusetts Institute of Technology and Alireza TahbazSa
lehi of Northwestern University (as well as another study by Mr
Baqaee). That explains why Alan Mulally, then the chief executive
of Ford, a carmaker, urged American lawmakers to bail out hiscompetitorsduringtheglobal financial crisis. Ford feared the col
lapse of the auto sector’s suppliers, which would cause severe dis
ruptions at its own plants, too.
Intimate commercial relationships, such as those within
firms, tend to be especially affected, because they are harder to re
place. Another study of Japan’s 2011 earthquake by Christoph
Boehm of the University of Texas, Austin, and others finds that the
American subsidiaries of Japanese firms also suffered, as did their
suppliers. Other research also concludes that the more custo
mised the relationship between firms and their suppliers, the big
ger the ripple effects. Mr Barrot and Julien Sauvagnat of Bocconi
University examine 30 years of American natural disasters and
find that disruption to just one supplier leads to a loss in sales for a
downstream firm of two to three percentage points, which, consi
dering that most suppliers provide a small portion of a firm’s pro
duction inputs, is a sizeable fall.
Such findings provide fodder for opponents of an energy em
bargo in Germany. And some estimates of the impact of an embar
go also suggest that the shortterm disruptions could be large. Six
leading German research institutes conclude that an embargo
could lead to a gdploss for the country of around 1% this year and
5% in 2023. The Bundesbank estimates a hit of 5% in 2022.
Yet there are two reasons why things need not be so bad. For a
start, just as past experience shows that supply disruptions can
have sizeable nearterm effects, it also shows that the economy in
aggregate has a great ability to adjust. In 2010 China banned the ex
port of rareearth metals to Japan, one of the world’s biggest users
of the minerals. Japanese firms were able to quickly substitute
away from previously cheap rare earths and find alternative sup
plies, according to research by Eugene Gholz of the University of
Notre Dame and Llewelyn Hughes of the Australian National Uni
versity. In a study of the potential effects of a Russian energy em
bargo on Europe, Rüdiger Bachmann of the University of Notre
Dame and his coauthors find that while the hit could be large, it
would be partly offset by the economy’s ability to adapt. The over
all impact, they reckon, could be in the region of 0.53% of gdp.Production, interrupted
Moreover, it is within the gift of governments to mitigate the
shortterm pain of supply disruptions. euofficials, for instance,
are mulling stricter sanctions on energy imports from Russia. The
more notice firms receive about the measures, which could in
clude a tax on Russian energy, the easier adjusting to them is likely
to become. Past episodes suggest that if policymakers do want to
change regulations or trade relationships, they should do so con
sistently and carefully. A liberalisation of Indian trade in the 1990s
led to little wider disruption because it was gradual, helping firms
adjust. A recent study by Alessandra Peter of New York University
and Cian Ruane of theimfpoints out that Indian firms were able
to find substitutes for inputs.
Governments could also take into account the fact that busi
nesses may not do enough to ensure that networks are solid in the
near term. Matthew Elliott of the University of Cambridge and
others find that firms might invest in the robustness of their sup
ply chains if they have a business case to do so. But they might not
seek to ensure the resilience of the wider network, because they
do not stand to reap the rewards from such investment. Encourag
ing firms and households to shift away from using fossil fuels,asa
tariff would do, could enhance that resilience. Managed well,Ger
many’s supply disruptions need not be quite so disruptive.nFree exchange
How do supply disruptions affect the wider economy? Some lessons from past episodes