Germs, Roads and Trade: Theory and Evidence on the Value of Diversification in Global Sourcing

Abstract

This paper studies the value of diversification in global sourcing in improving firms' resilience to supply chain disruptions. I build a model in which firms select into importing from countries and via customs with different efficiencies, taking into account domestic and international trade costs. The model predicts that firms which are more geographically diversified in sourcing are more resilient to supply chain disruptions. Reductions in trade costs induce firms to further diversify their sourcing strategies. I then exploit the 2003 SARS epidemic as a natural experiment to examine the resilience of Chinese manufacturing importers. Firm imports fell by 7.9% on average when the trade route was hit by SARS, but as much as 52% for firms without any diversification. The disruptions led to smaller increases in marginal cost for firms with more trade routes for imports. The epidemic reduced total Chinese manufacturing outputs by about 0.7% at its peak. Connectivity to roads increased firms' resilience to the epidemic by facilitating input diversification.

Keywords: Global sourcing, Diversification, Resilience, Firm heterogeneity, SARS

JEL Classification: F12, F15, O18