Distortions in Production Networks*

Abstract How does an economy’s production structure determine its macroeconomic response to sectoral distortions? We study a static, multisector framework in which production is organized in an input-output network and production decisions are distorted. Sectoral distortions manifest at the aggregate level via two channels: total factor productivity (TFP) and the labor wedge. We show that near efficiency, distortions have zero first-order effects on TFP and nonzero first-order effects on the labor wedge, and that a sufficient statistic for the latter are the Domar weights. We thereby provide a Hulten-like theorem for the aggregate effects of sectoral distortions. A quantitative application of the model to the 2008–09 financial crisis suggests that the U.S. input-output structure amplified financial distortions by roughly a factor of two during the crisis.