DIVERSIFICATION INCREASES FIRMS' RESILIENCE TO SUPPLY CHAIN DISRUPTION: Evidence from the SARS epidemic in China

27 Mar 2018

The experience of Chinese importers during the SARS epidemic indicates the value of having suppliers from a wide range of places. New research by Hanwei Huang, to be presented at the Royal Economic Society''s annual conference at the University of Sussex in Brighton in March 2018, shows how firms'' resilience to supply chain disruption is improved by diversification in global sourcing.

His study examines the response of Chinese importers to the SARS epidemic in 2002-03, the first of the new millennium. Globally, about 8,000 people were infected by SARS, of which about 10% lost their lives. The epidemic first hit mainland China, then spread to its key trade partners, including Hong Kong, Taiwan, Singapore and Canada.

Many flights to regions with local outbreaks were cancelled due to travel bans. The World Health Organization provided guidelines asking port authorities to impose stringent health checks on ships. Within China, local governments set up health checkpoints on roads to examine traffic from other local areas, especially regions with SARS. These measures inevitably made it more difficult for Chinese importers to access ports for imports and their foreign suppliers.

The new study uses Chinese firm and customs data to test predictions from a theoretical model of how geographical diversification increases firms'' resilience to shocks. The basic idea is that more diversified firms are less reliant on inputs from any particular supplier. Whenever that supplier is hit by a shock, it will translate into a smaller loss for the firm.

The research finds that:

• The SARS shock reduced firm imports by about 8% on average.

• The impact depends on firms'' diversification. For a firm without any diversification, the impact of the shock was as large as 52%.

• The SARS shock increased firms'' marginal cost by about 0.7% on average, less for firms with more trade routes for imports.

• Aggregated across affected firms, the epidemic reduced Chinese manufacturing output by about 0.7% at the peak of the epidemic.

These results have implications for policy-makers. One finding is that by reducing trade costs, infrastructure such as road and rail networks enables firms to diversify their sourcing strategy further, and helps to dampen the negative impact of shocks. Infrastructure policies not only increase efficiency, but also increase the robustness of the economy to shocks by facilitating diversification.

The human race has been haunted by epidemics throughout history: the black death, smallpox, HIV\AIDS, Ebola, Zikka and of course, influenza. The drastic policies that were taken against the SARS epidemic, especially stopping the flow of goods and people, had large side-effects. But at least from the Chinese experience during SARS, we know that diversification can reduce the economic harm.

''Germs, Roads and Trade: Theory and Evidence on the Value of Diversification in Global Sourcing'' by Hanwei Huang, Working Paper, London School of Economics. Hanwei Huang is a PhD Candidate from the London School of Economics and the Centre for Economic Performance.

Hanwei Huang

+44 7450 290090 | h.huang7@lse.ac.uk