The Network Origin of Industry Size Variations (work in progress)


In this paper, I study the question of why some industries are big while others are small in the U.S. economy using a production network approach. Specifically, I identify the supply side and demand side characteristics of buyer-supplier relationships that contribute to the variations in industry size over the 1970-2017 period. Empirically, I conduct a variance decomposition of industry total sales into the supplier, buyer, and final demand components using the two-way fixed effects method. Our results suggest that the supplier component, which relates to an industry’s productivity or product quality, explains a majority of the variation in industry sizes (67%). In other words, being an important or attractive input supplier in the network is fundamental in shaping industry sizes. To account for the empirical facts, I build a multisector real business cycle model that allows for various sources of industry heterogeneity both on the demand side and the supply side and conduct a model-based decomposition of industry sales. And finally, I use the model for counterfactual analyses to assess the role of the production network by removing network linkages.