Input-Output Network as Insurance against Financial Crises

62 Pages Posted: 24 Aug 2018 Last revised: 13 Oct 2022

Date Written: September 23, 2022

Abstract

This paper argues that an economy becomes more resilient to nationwide shocks such as financial crises when the input-output network has high entropy. In networks, entropy increases as each node has widely and evenly distributed relationships with other nodes. I construct a measure of economic diversity based on entropy and empirically investigate how this measure relates to the aftermath of financial crises. It turns out that countries with high domestic upstream or downstream diversity were less affected by financial crises. The role of the network changes in a global economy: Upstream diversification in the global market does not serve as insurance, but downstream diversification still plays a crucial role in reducing the negative impact. This implies that geographic export diversification is essential to reduce the adverse effects of financial crises. I construct a multisector model with financial constraints and show that the volatility of GDP in response to productivity shocks or financial shocks shrinks if each industry has widely and evenly distributed relationships with its input suppliers. When demand shocks hit the economy, the volatility of GDP declines if each industry has widely and equally distributed relationships with its customers.

Keywords: Entropy, Diversity, Input-Output Network, Aftermath of Financial Crisis

JEL Classification: C67, D85, E32, G01

Suggested Citation

Kim, Seongeun, Input-Output Network as Insurance against Financial Crises (September 23, 2022). Available at SSRN: https://ssrn.com/abstract=3226776 or http://dx.doi.org/10.2139/ssrn.3226776

Seongeun Kim (Contact Author)

Sejong University ( email )

209 Neungdong-ro, Gwangjin-gu
Seoul, 05006
Korea, Republic of (South Korea)

HOME PAGE: http://https://sites.google.com/site/sekimphd

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