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Production Networks and War

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. Using unique transaction-level data on Ukrainian railway shipments around the start of the 2014 Russia-Ukraine crisis, we uncover several novel indirect effects of conflict on firms. First, we document substantial propagation effects on interfirm trade--trade declines even between partners outside the conflict areas if one of them had traded with those areas before the conflict events. The magnitude of such second-degree effect of conflict is one-fifth of the first-degree effect. Ignoring this propagation would lead to an underestimate of the total impact of conflict on trade by about 67\%. Second, war induces sudden changes in the production-network structure that influence firm performance. Specifically, we find that firms that exogenously became more central--after the conflict practically cut off certain regions from the rest of Ukraine--received a relative boost to their revenues. Finally, in a production-network model, we separately estimate the effects of the exogenous firm removal and the subsequent endogenous network adjustment on firm revenue distribution. For a median firm, network adjustment compensates for 80\% of the network destruction a year after the conflict onset.

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