Working Paper: CEPR ID: DP16588
Authors: Gene M. Grossman; Elhanan Helpman; Hugo Lhuillier
Abstract: Supply chain disruptions, which have become commonplace, are often associated with globalization and trade. Little is known about optimal policy in the face of insecure supply chains. Should governments promote resilience by subsidizing backup sources of input supply? Should they encourage firms to source from closer and presumably safer domestic suppliers? We address these questions in a very simple model of production with a single critical input and with exogenous risks of relationship-specific and country-wide supply disturbances. We follow Matsuyama and Ushchev (2020) in positing a class of preferences that are homothetic with a single aggregator and that obey Marshall's Second Law of Demand. The familiar case of CES preferences is a member of the class, but it imposes restrictions that are important for policy conclusions.We find that, in the CES case, a subsidy for diversification achieves the constrained social optimum and dominates a policy that promotes reshoring or offshoring. When the demand elasticity rises with price, two policy instruments generally are needed to achieve efficient supply chains, private investments in resilience may be socially excessive, and policy that alter incentives to invest at home versus abroad may achieve greater welfare than ones that encourage or discourage diversification.
Keywords: Global Supply Chains; Global Value Chains; Input Sourcing; Resilience
JEL Codes: F13; H21; F12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| subsidies for diversification (Q29) | constrained social optimum (D61) |
| subsidies for diversification (Q29) | resilience in supply chains (M11) |
| reshoring policies (L52) | effectiveness in supply chains (M11) |
| private investments in resilience (R42) | socially excessive investments (G11) |
| two policy instruments (E64) | correction for inefficiencies in supply chain organization (D21) |
| optimal policy (C61) | promote diversification (O25) |
| demand for differentiated products is elastic (D12) | need for diversification (G11) |