Production Networks and War

Abstract: How do severe shocks, such as war, alter the economy? We study how a country's production network is affected by a devastating but localized conflict. We use novel transaction-level data on Ukrainian railway shipments, complemented by administrative data on firms, to document the effect of war on firms and interfirm trade. First, we document substantial propagation effects-trade declines even between firms outside the conflict areas if one of them had traded with the conflict areas before the war. Our estimates suggest that the magnitude of the second-degree effect of conflict is one-third of the first-degree effect. Second, we study firm-level consequences of a change in production network structure. Firms that, for exogenous reasons, become more central in the production network after the start of the conflict receive a lasting boost to their revenues and a temporary one to their profits. A temporary increase in markups suggests a rise in market power as one of the mechanisms. Finally, in a production networks model, we separate the effects of exogenous firm removal and subsequent endogenous network adjustment on firm revenue distribution. At the median of the distribution, network adjustment compensates for 72% of network destruction.