Firms' Internal Networks and Austerity Spillover

Abstract

This paper studies how fiscal consolidation (austerity) shocks transmit across countries through multinationals’ internal networks of subsidiaries. Using a large multi-country subsidiary-level data set, we find that local business units cut capital investment in response to a foreign austerity shock. We document three channels that propagate these shocks through firms’ internal networks: production linkages among subsidiaries, business confidence, and financial constraints. In the aggregate, domestic investment and employment decline with higher exposure to fiscal shocks originated abroad, suggesting that such spillover matters for overall economic activity.

Keywords: Austerity, Fiscal Policy, Investment, Internal Networks, Spillover Effects

JEL Classification: D25, G11, H32, L14