From VoxEU, April 24:
What are the potential costs of cutting Russian energy imports as a further tightening of the sanction regime? One of the many uncertainties regarding the size of these costs is related to the diffusion and amplification of the shock in production networks. This column discusses what can be learned on this topic from the analysis of firm-level data. Micro-level evidence suggests that some firms adjust, mitigating the effects of the shock. However, exposure to these shocks is heterogenous across firms. This has distributional consequences, with less exposed firms gaining market shares over more exposed ones.
Editors' note: This column is part of the Vox debate on the economic consequences of war.
Imports from Russia are largely made up of energy inputs, most notably oil, coal, and natural gas. The centrality of these inputs in production networks implies that shocks affecting the price of energy have the potential to propagate downstream, leading to sizeable amplification of the shock. However, recent estimates, recovered from calibrated multi-sector, multi-country models with input-output linkages (Bachmann et al. 2022, Baqaee et al. 2022), suggest that the effect of an import ban on Russian oil and gas would generate a relatively limited GDP contraction.1 Even in a country like Germany, cutting Russian energy imports – which represent 30% of German energy consumption – would induce a 0.5-3% decline in GDP, a sizeable but manageable economic cost.
In sector-level models such as those used in Bachmann et al. (2022) or Baqaee et al. (2022), such a relatively small effect results from a non-zero elasticity of substitution among firms’ inputs. If Russian oil and gas were perfect complements to other inputs (a zero elasticity), GDP would fall one-to-one with energy imports. Some of the firms in sectors dependent on Russian energy are assumed to be able to switch to other suppliers and the same is true of firms in downstream sectors, which need to cope with the reduced production of their suppliers. In particular, the open-economy structure of the model implies that some of the inputs that can no longer be produced domestically due to energy rationing can be substituted by foreign goods.2
The assumption that there exist some substitution opportunities in production networks may seem controversial, as they are typically thought to be rigid structures shaped by relationship-specific investments. Is it more appropriate to instead be conservative and assume a pure Leontief production structure? Addressing this question is tricky in the absence of direct evidence on how technologies adjust to energy shocks.
Is technology Leontief at the firm level?....
....MUCH MORE
HT: naked capitalism
