Applied Economics

ISSN: (Print) (Online) Journal homepage: https://www.tandfonline.com/loi/raec20

Global production network, technology spillover,

and shock transmission

Weilin Liu & Qian Cheng

To cite this article: Weilin Liu & Qian Cheng (2021) Global production network,
technology spillover, and shock transmission, Applied Economics, 53:60, 7020-7036, DOI:
10.1080/00036846.2021.1958140

To link to this article: https://doi.org/10.1080/00036846.2021.1958140

Published online: 09 Aug 2021.

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APPLIED ECONOMICS
2021, VOL. 53, NO. 60, 7020–7036
https://doi.org/10.1080/00036846.2021.1958140

Global production network, technology spillover, and shock transmission

Weilin Liu and Qian Cheng
Institute of Economic and Social Development, Nankai University, Tianjin, China

ABSTRACT KEYWORDS
This study presents a new method to analyse the impact of exogenous shock and its transmission Global production network;
mechanism within the global production network, based on scenarios of the COVID-19 pandemic. technology spillover;
We decompose domestic and international technology spillovers and introduce them into an epidemic impact; shock
economic growth model to investigate the elasticities of factor inputs and knowledge spillovers transmission
through industrial linkages, and eventually estimate a model with spatial specifications. The results JEL CLASSIFICATION
from the scenario simulations suggest that the global total output is projected to fall by 3.60% and C23; C67; D24; O47; R15
8.41% under the V-shaped and L-shaped recovery scenarios, respectively, and that the propagation
through input-output linkages is an important channel that causes global economic fluctuations.
Economies at the hub of the production network, that is, the United States, China, and Germany,
are the most seriously affected. Structural decomposition analysis results indicate that the shortage
of intermediate inputs supply is the main driver of output decline, followed by the blockage of
technology diffusion, and lastly, the reduction of labour supply.

I. Introduction correlation in the economic growth is not fully

Since the 21st century, the trade costs reduction
and development of the information and commu­
nication technology has greatly transformed the
mode of production, which is characterized by the
division of global value chains (GVCs). The pro­
duction process is split into different segments,
providing opportunities for countries at different
development stages to be integrated into the global
production network through offshore outsourcing
and reorganizing segments. GVCs allow economies
to specialize in particular segments and promote
the diffusion of new technologies, which has
become an important driving force for the devel­
opment of the world economy. However, while
GVCs offer opportunities to participating coun­
tries, it also increases the possibility of systemic
risks and threatens the global supply chain security
during external shocks. The increasingly frequent
epidemic outbreaks have created great challenges
for the international supply chain security, and the
existing growth models fail to provide effective
tools to assess the epidemic impact and provide
evidence for policy formulation purposes.
In the traditional neoclassical growth model,
economic units are usually assumed as indepen­
dent from each other. The importance of
emphasized. In fact, due to the diffusion and trans­
mission of technological progress, technology spil­
lover is an important driver for economic growth.
The seminal paper by Romer (1986) presented an
endogenous growth model with externalities,
which incorporates technological spillover as a fac­
tor of production. Many studies follow the model
and support the existence of technology spillovers
(Fingleton and López-Bazo 2006; Ertur and Koch
2007). A growing body of literature estimates the
interaction effect on economic growth by introdu­
cing spatial spillover effects to the regional eco­
nomic growth model (Curran 2012; Yu and Lee
2012; Lu and Wang 2015; Ozyurt and Dees 2018).
In empirical methodologies, traditional panel
data models may omit the correlation between
economic units, resulting in biased estimators.
Therefore, spatial econometric methods have been
adopted in some studies on regional growth. For
instance, Xiao, Du, and Fei (2017) used the spatial
panel econometric techniques to discuss technol­
ogy spillovers among industries. The commonly
adopted spatial weight matrix specification is
based on geographical distance (Eaton and
Kortum 1996; Ertur and Koch 2007), assuming
that the spillover effects decline with the

CONTACT Weilin Liu liuwl@nankai.edu.cn No 94 Weijin Road, Nankai District, Tianjin 300071, China
© 2021 Informa UK Limited, trading as Taylor & Francis Group

geographic distance between regions. However,
Griliches (1992) discussed the limitation when
approximating the distance by geographical vici­
nity or contiguity. In some seminal studies, inter­
national trade is considered as an important
technology spillover channel across countries
(Grossman and Helpman 1991; Coe, Helpman,
and Hoffmaister 1997). Debarsy and Ertur (2019)
compared three different types of spatial weight
matrices and showed that bilateral trade flow out­
performs genealogical distance and linguistic
proximity in accounting for spatial interactions.
Therefore, many studies have adopted trade flow
as a proxy for technology spillover among regions
(Ertur and Koch 2011; Ho, Wang, and Yu 2018).
The interdependence in GVCs is reflected in
network collaborations at the industry-level.
Hulten (1978) suggested that an industry’s techni­
cal progress not only increases its own output, but
also benefits other industries by reducing the price
of intermediate goods. Acemoglu et al. (2012) con­
cluded that productivity shocks in one sector may
propagate through input-output linkages. The
intermediate inputs structure has become the
main channel through which technological change
is transmitted across industries. Several studies on
technology spillover also used intermediate flows
to specify the spatial weighting matrix (Badinger
and Egger 2016; Foster-McGregor, Pöschl, and
Stehrer 2017).
Although studies are increasingly focusing on
inter-industry spillover effects, a growth frame­
work that describes the interactions in global pro­
duction networks is yet to be effectively developed.
Further, how exogenous shocks are transmitted
across industries through GVCs has not been
fully identified. Thus, in this study we develop a
global growth model that explicitly considers inter-
industry spillover relationships by incorporating
data from the world input-output databases,
which not only contributes to the literature on
economic growth, but also provides a tool to inves­
tigate the effect of exogenous shocks and its trans­
mission mechanism in the global production
network.
In recent years, frequent epidemic outbreaks,
such as SARS, Ebola, H1N1, Zika, and other emer­
gent epidemics have significantly threatened eco­
nomic development and human health.
APPLIED ECONOMICS 7021
Specifically, the global COVID-19 pandemic has
unprecedentedly disrupted the world economies.
To block the spread of COVID-19, most countries
have taken measures, such as social distancing and
closure of schools and workplace, which not only
hamper their economic operations, but also affect
other economies through the intermediate lin­
kages, as well as capital and knowledge diffusion,
and thus challenge the global production network.
How to assess the economic impact of COVID-19
effectively has attracted attention worldwide.
Some scholars have studied the potential impact
of the COVID-19 outbreak by comparing it with
historical pandemics and epidemics, such as the
Spanish flu and SARS (Barro, Ursúa, and Weng
2020; Beach, Clay, and Saavedra 2021; Bloom,
Kuhn, and Prettner 2021). However, COVID-19’s
epidemiological characteristics are significantly dif­
ferent from those of historical events and the cur­
rent labour division and economic operations
differ greatly from the situation decades ago. Due
to the uncertainty surrounding the pandemic
development, a number of studies have evaluated
the economic effects of the COVID-19 pandemic,
based on scenario settings (Malliet et al. 2020;
McKibbin and Fernando 2020; Qiu, Chen, and
Shi 2020). However, most of the models in previous
studies were based on the assumption that eco­
nomic units are independent of each other.
In this study, we extend the Solow model (Solow
1956) using a spatial econometric specification to
propose a growth model with spatial spillovers. We
estimate the economic growth model and spatial
spillover effects using a panel data of 43 countries,
for the period 2000–2014, and thus investigate the
impact of the COVID-19 pandemic on the global
production network and the value chain
transmission.
This study contributes to the literature, first, by
developing a growth model, which considers spa­
tial spillovers among industries, and by calculating
the direct and indirect marginal effects of the input
factors and technical changes. Second, this study
decomposes the spillover effects into domestic and
international spillovers by applying the local
Leontief matrices from the inter-regional input-
output model. Third, it explores the transmission
mechanism of the COVID-19 shock and evaluates
the impact of pandemics through three channels,
7022 W. LIU AND Q. CHENG
under the L-shaped and V-shaped recovery
scenarios.
The rest of the paper is organized as follows.
Section II presents a growth model of the global
production network and discusses the COVID-19
pandemic shock transmission mechanism. Section
III describes the pandemic scenarios and the data.
Section IV estimates the growth model and spil­
lover effects and evaluates the impact of the
COVID-19 pandemic on the global economy.
Finally, Section V concludes the study.
II. Model
This study uses the Cobb–Douglas production
function with spatial externalities to construct
industry-level growth models. We obtain the out­
put elasticities of four factors: capital, labour, inter­
mediates, and technological progress, based on
their partial output derivatives, and further calcu­
late the effect of technology spillovers among
industries. The spillover effects are decomposed
into domestic and international effects by applying
the Ghosh inverse matrix in the input-output
model, which presents a new method to analyse
the transmission mechanism and measure the
impact of COVID-19.
Spatial model with technology spillover
A production function with spatial externalities
Consider the aggregate Cobb–Douglas production
function for industry i at time t, using Hicks-
neutral technical change, as
Yit ¼ Ai ðtÞKit α Lit β Mit γ ; i ¼ 1; . . . ; N; t
¼ 1; . . . ; T
whereYit is the gross output, Kit , Lit , andMit are the
capital, labour, and intermediate inputs, respec­
tively, and α, β, andγare the elasticities of the
three input factors. As in the Solow model (Solow
1956), Ai ðtÞ is the Solow Residual, which represents
the total factor productivity of industry i. When
each industry’s technology progress is assumed as
exogenous and interdependent with other indus­
tries, Ai ðtÞ could be expressed as:
Ai ðtÞ ¼ Ωi eRðtÞ
where Ωi is the initial technology level, RðtÞis a
time-varying component that is identical in all
industries, and the quadratic functional form is
assumed asRðtÞ ¼ δ1 t þ δ2 t2 .
However, in the global production network, the
intermediate flow in a GVC promotes technology
diffusion among participating industries.
Following Ertur and Koch (2007), we relax the
assumption of Hicks-neutral technical change and
technical independence among industries and
explicitly consider an interdependent relationship
in the technological progress path. From the indus­
trial linkages perspective, we consider two chan­
nels: First, through the upstream spillover, the
productivity improvement in supplier industries
may cause higher quality intermediates and knowl­
edge in downstream industries, thus boosting the
customer industries’ productivity (Keller 2004).
Second, through the downstream spillover, the
productivity growth in customer industries, may
increase the requirements for intermediate quality
or standard and thus promote learning and capa­
city building in upstream industries (Baldwin and
Yan 2014). In addition, the participation of inter­
national markets is often accompanied by increas­
ingly intensive competitions, which also improve
the suppliers’ productivities (Humphrey and
Schmitz 2002).
We extend the Cobb–Douglas production func­
tion to incorporate spatial externalities. The
externalities include three components. First, the
exogenous Hicks-neutral technological growth
may diffuse through learning and imitation
among participants in the GVCs. Therefore, the
technological progress in industry i depends on
the technological advances in the neighbouring
(1) industry j. The strength of interdependence is
denoted by wij . Second, according to the new
growth theory (Arrow 1962; Romer 1986; Lucas
and Robert 1988), the accumulation of physical
and human capital has spillover effects that
increase the aggregate marginal output. The spil­
lover effect of Kjt and Ljt indicates the capital-
augmenting and labour-augmenting technical pro­
gress in the production network, respectively. The
intermediate input expansion also indicates the
improvement of vertical specialization (Hummels,
Ishii, and Yi 2001), which improves productivity in
(2)
 APPLIED ECONOMICS 7023

the network. We denote the spillover effect of Mjt Y ¼ ρðIT � WN ÞY þ αK þ βL þ γM þ ω0 þ δ1 t þ δ2 t 2

as the intermediate-augmenting technical progress. þ V þ ðϕ αρÞðIT � WN ÞK þ ðφ βρÞðIT � WN ÞL
Therefore, Ai ðtÞ can be rewritten as: þ ðη γρÞðIT � WN ÞM
Y
N Y
N Y
N Y
N (7)
Ai ðtÞ ¼ Ωi eRðtÞþvit Aj ðtÞρwij Kjt ϕwij Ljt φwij Mjt ηwij (3)
j�i j�i j�i j�i whereY, K, L, M, and Vare NT � 1vectors, WN is
Then, taking the logarithm of Equation (3), we N � N matrix, ω0 ¼ lT � ln Ωi , and lT is the
obtain the following form: Tdimensional vector of ones.

X
N X
N
Direct and indirect effects of international industrial
ln Ai ðtÞ ¼ ρ wij ln Aj ðtÞ þ ϕ wij ln Kjt linkage
j�i j�i
X
N X
N The usual interpretation of α, β, and γ, as the
þφ wij ln Ljt þ η wij ln Mjt output elasticities of the input factors, is invalid
j�i j�i due to technological interdependence and spatial
þ ln Ωi þ RðtÞ þ vit (4) externalities. Therefore, LeSage and Pace (2009)
propose the following approach to calculate the
We solve (4) for ln Ai ðtÞ, when ρ�0 and 1=ρ is not direct and indirect marginal effects of input
an eigenvalue of IT � WN : factors. For instance, the matrix of partial deri­
! 1 vatives of output Y, with respect to capital K, in
X N
ln Ai ðtÞ¼ 1 ρ wij industry 1 ~ N and in period t can be:
j¼1 � �
0 1 @ ln Y @ ln Y @ ln Y
P
N P
N Ek ; ; ;���;
(5) @ ln K1 @ ln K2 @ ln KN t
B ϕ j�i wij ln Kjt þ φ j�i wij ln Ljt C 2 @ ln Y1 @ ln Y1 3
B C @ ln K1 @ ln K2 � � � @@ lnln KYN1
B C 6 @ ln Y2 @ ln Y2 7
@ P
N A 6 @ ln K1 @ ln K2 � � � @@ lnln KYN2 7
þη wij ln Mjt þ ln Ωi þ RðtÞ þ vit 6
¼6 . 7 (8a)
j�i . .. .. .. 7
4 . . . . 5
@ ln YN @ ln YN ln YN
Substituting (5) in the production function (1), @ ln K1 @ ln K2 � � � @@ ln KN t
then taking the logarithms, we obtain the produc­
2 3
tion function with technology spillover: α w12 ðϕ αρÞ � � � w1N ðϕ αρÞ
6 w21 ðϕ αρÞ α ��� w2N ðϕ αρÞ 7
! 6 7
1 ¼ ðIN ρWN Þ 1 6 .. .. .. .. 7
X
N 4 . . . . 5
ln Yit ¼ 1 ρ wij wN1 ðϕ αρÞ wN2 ðϕ αρÞ � � � α
j¼1
(8b)
0 1
P
N P
N

B ϕ j�i wij ln Kjt þ φ j�i wij ln Ljt C Further, the mean direct effect of capital for all
B C
B
@ P
N
C
A
industries, which we denote as eDir K , and is
þη wij ln Mjt þ ln Ωi þ RðtÞ þ vit measured by the average of the diagonal ele­
j�i
ments in the matrix shown in Equation (8b),
X
N
(6)
þ α ln Kit þ β ln Lit þ γ ln Mit ¼ ρ wij ln Yjt represents the percentage change in industry i’s
j¼1 output, due to a percentage increase in its
þ α ln Kit þ β ln Lit þ γ ln Mit þ ln Ωi þ δ1 t þ δ2 t2 capital input. The indirect effect of capital,
X
N X
N
which is denoted by eInd
K , is the average row-
þ vit þ ðϕ αρÞ wij ln Kjt þ ðφ βρÞ wij ln Ljt
j¼1 j¼1 sum of the off-diagonal elements in the matrix
X
N shown in Equation (8b), and it measures the
þ ðη γρÞ wij ln Mjt impact on industry i’s output after a unit
j¼1
increase in the sum of the capital across all
The matrix form of (6) is given by other N-1 industries. The mean total effects of
7024 W. LIU AND Q. CHENG

capital is calculated by eTot Dir Ind

K ¼ eK þ eK (LeSage
intermediate goods trade across borders. Assuming
and Pace 2009), which refers to the impact on that there are k countries in the production network
the output of industry i when all N industries and country m has Qm industries, the global spatial
change the capital input simultaneously. weight matrix WN is expressed as:
Similarly, we can obtain the direct, indirect, 2 3
and total effects of labour and intermediate W11 W12 ��� W1k
inputs. 6 W21 W22 ��� W2k 7
6 7
WN ;6 .. .. .. .. 7 (10)
Further, the spillover effects of Hicks-neutral 4 . . . . 5
technical progress, when estimated using the Wk1 Wk2 ��� Wkk
matrix of partial derivatives of the output in (7),
with respect to the time trend in period t, is where Wmm is a Qm � Qm matrix, denoting the
� � local linkages among industries within the borders
@ ln Y
gt ; ¼ ðIN ρWN Þ 1 RðtÞ0
@t t 2 3
of countrym, and Wmn is a Qm � Qn matrix, which
w~ 11 RðtÞ0 w
~ 12 RðtÞ0 ��� ~ 1N RðtÞ0
w denotes the linkages among the industries in coun­
0
6w
6 ~ 21 RðtÞ w ~ 22 RðtÞ0 ��� ~ 2N RðtÞ0
w 7
7
¼6 . .. .. .. 7 (9) try m and those in country n. We define the left
4 .. . . . 5
0
~ N1 RðtÞ w
w ~ N2 RðtÞ0 ��� ~ NN RðtÞ
w 0 multiplier in Equation (8b) as the global multi­
t

0
plierG;ðIN ρWN Þ 1 , and the local multiplier of
whereRðtÞ ¼ @RðtÞ=@t ¼ δ1 þ 2δ2 t, w ~ ij is the ijth
the countrym asHmm ;ðIQ ρWmm Þ 1 . Using the
element of the spatial multiplier
1
Ghosh inverse matrix in the input-output model,
matrixðIN ρWN Þ . Each diagonal element of the global multiplier G can be decomposed into
the matrix on the right-hand side of Equation (9), two terms:
which is denoted by gitDir , represents the direct effect where the first matrix on the right-hand side,
and measures the Hicks-neutral productivity decomposed by Hmm in the diagonal, represents
change for industry i at time t. By adding the non- the domestic multiplier, which is denoted by MD,
diagonal elements in row i of the matrix, on the and the second matrix represents the international
right-hand side of Equation (9), the indirect effect, multiplier, which is denoted by MI. The off-
denoted by gitInd is obtained. This indirect effect is diagonal blocks in MI reflect the spillovers between
used to calculate the aggregate spillover effects of the two countries and the diagonal blocks reflect
an industry, which are received from all of its the countries’ spillovers, which are first transmitted
neighbours via the inter-industry linkage, and abroad and then retransmitted back to the original
they reflect the interaction effects of Hicks-neutral country. For example, the sub-matrix of
technological progress among industries. The Pk
mean total effects of technological progress are ρG1n Wn1 H11 corresponds to the diffusion pro­
n�1
calculated by adding the direct and indirect effects cess in which the technological advances are first
received from all industries, denoted by gitTot . transmitted directly from country 1 to country 2, 3,
. . . k then retransmitted back to country 1 and
Decomposition of spillovers by domestic and diffused among the industries within country1.
international effect Using Equation (8b), the global spillover effects of
The shock of the COVID-19 pandemic on the capital can be decomposed into the domestic
GVCs production network mainly affects the cross- effectðEDK Þand the international effectðEIK Þ:
border flow of intermediate goods, while its impact
on the domestic supply chain is relatively small. It is EDK ¼ MD
2 3
necessary to distinguish the spillover effects through α w12 ðϕ αρÞ � � � w1N ðϕ αρÞ
6 w21 ðϕ αρÞ α ��� w2N ðϕ αρÞ 7
the domestic network from those through the inter­ 6 7
�66 .. .. .. ..
7
7
national network. Domestic spillovers occur among 4 . . . . 5
domestic industries through the internal flow of wN1 ðϕ αρÞ wN2 ðϕ αρÞ � � � α
intermediate goods and international spillovers are (12)
transmitted among international industries through
 APPLIED ECONOMICS 7025

EIK ¼ MI of the virus, many countries chose to lockdown the

2 3
α w12 ðϕ αρÞ ��� w1N ðϕ αρÞ ports of entry, suspend flights or shipments, and
6 w21 ðϕ αρÞ α ��� w2N ðϕ αρÞ 7 restrict the volumes of import and export trade.
6 7
�6
6 .. .. .. ..
7
7 These policies are equivalent to raising trade bar­
4 . . . . 5
riers, which cause a decline in the intermediate
wN1 ðϕ αρÞ wN2 ðϕ αρÞ ��� α
input supply and, consequently, break up some
(13)
international supply chains. Due to the different
Using the matrices of EDK and EIK , we can mea­ COVID-19 outbreak periods in each country and
sure the mean direct, indirect, and total domestic some countries not experiencing or controlling the
effects of capital, as well as the corresponding inter­ pandemic, the disruption of the production of
national effects. Likewise, we can obtain the intermediate inputs in the upstream countries
decomposition results for other input factors and affects the downstream firms, causing shut downs
the time trend of productivity. or output losses due to shortages of materials or
components. Furthermore, this negatively affects
The mechanisms of COVID-19 shock on the global
all the downstream sectors in the entire supply
production network
chain.

An interconnected production system can amplify

Blockage of technology diffusion
the shock of COVID-19. For instance, in an indus­
Trade and travel restriction measures also block
try, a shock occurring due to a lack of intermediate
technological links among industries in each coun­
inputs will cause chain effects in related industries
try. Input-output intermediate linkages among
that are connected to it through input-output lin­
countries are important technology transfer chan­
kages. Based on the evaluation of the COVID-19
nels across countries (Coe and Helpman 1995;
impact by WTO (2020), this study focuses on three
Foster-McGregor, Pöschl, and Stehrer 2017; Lee
channels to assess the impact of the COVID-19
2020). Due to the international trade decline, tech­
shock in the production system.
nology spillovers may reduce, impeding technolo­
gical innovation activities, which include the
Reduction of labour supply
application of new technologies, development of
The COVID-19 pandemic outbreak directly leads
new products, upgradation of equipment, and
to the reduction of labour supply in affected coun­
improvement of management. Technology spil­
tries. Following the global trade model by WTO
lovers most likely have significant long-term effects
(2020) the potential impact is based on three
on potential growth. Conversely, the reduction of
aspects: first, asymptomatic cases have to stay at
labour supply and shortages of intermediates
home and a number of those infected will die. This
mainly have short-term impacts.
is represented in mortality and morbidity rates,
To assess and quantify the impacts of the pan­
which include the deceased and infected patients,
demic on global production networks through the
with social distancing measures forcing their
triple channels mentioned above, we rewrite
families to stay at home or in centralized accom­
Equation (7) as follows:
modations. Second, labour productivity has
reduced owing to factory closures or working Y ¼ UW ðUK þ UL þ UM þ UT Þ (14)
from home. Third, due to school closures, at least
one parent or guardian has to stay home to take where
care of the children, which also leads to a reduction UW ¼ ðI ρIT � WN Þ 1 ,­
in labour supply. UK ¼ ½αI þ ðϕ αρÞðIT � WN Þ�K,­
UL ¼ ½βI þ ðφ βρÞðIT � WN Þ�L,
Shortage of intermediate supply UM ¼ ½γI þ ðη γρÞðIT � WN Þ�M,­
With the rapid expansion of GVCs, the trade in UT ¼ ω0 þ δ1 t þ δ2 t2 þ V. Suppose the pandemic
intermediate industries constitutes about two- impact on the capital inputs and technological pro­
thirds of the global trade. Due to the global spread gress in an industry are negligible, based on the
7026 W. LIU AND Q. CHENG

Table 1. Economic shocks under the two scenarios. in international trade, CðΔUL Þ represents the
V-shaped (optimistic) L-shaped (pessimistic) impact due to the reduction of labour supply, and
Labour supply
Morbidity 1% 4% CðΔUM Þrepresents the impact due to the shortage
Mortality 2% 2% of intermediate input supply. We adopt the two-
Working from home 3 months 1 year
School closures 3 months 3 months polar-averaging decomposition method by
Volume of merchandise trade Dietzenbacher and Los (1998) to measure the aver­
Exports
North America −17.1% −40.9%
age contributions from each channel.
South America −12.9% −31.3%
Europe −12.2% −32.8%
Asia −13.5% −36.2%
Imports III. Scenarios and Data
North America −14.5% −33.8%
South America −22.2% −43.8% The COVID-19 pandemic has spread rapidly
Europe −10.3% −28.9%
Asia −11.8% −31.5%
worldwide and infected hundreds of millions of
Source: ‘Trade set to plunge as COVID-19 pandemic upends the global people. Due to the uncertainties in its transmission
economy’ (WTO 2020), https://www.wto.org/english/news_e/pres20_e/ capacity and transmission pathways, we refer to the
pr855_e.htm
research by WTO (2020) and consider two scenar­
ios to project the possible economic effects of the
COVID-19 pandemic.
structural decomposition analysis method, the
change of gross output can be decomposed into Description of scenarios
1
� �
ΔY ¼ UL1 þ UM
UW 1
þ UK1 þ UT1 UW0
UL0 þ UM0
þ UK0 þ UT0
� The scenarios are based on the Trade Statistics and
¼ ΔUW UL1 þ UM
1
þ UK þ UT þ 0
UW ΔUL þ UW0
ΔUM
Outlook specifications (WTO 2020), which make
¼ CðΔUW Þ þ CðΔUL Þ þ CðΔUM Þ
quantitative simulations of the COVID-19 pan­
(15)
demic impact on labour supply and trade in differ­
where the subscripts 0 and 1 denote the states ent countries or regions.1 We choose optimistic
before and after the shock, respectively. The and pessimistic scenarios that correspond to the
shock from the COVID-19 pandemic can be V-shaped and L-shaped recovery situations,
decomposed into three components through equa­ respectively, as presented in Table 1. The
tion (15): CðΔUW Þ represents the impact due to the V-shaped recovery scenario assumes that the out­
block of technology diffusion, following the decline break will be controlled relative quickly; therefore,

Table 2. Percent reduction in labour supply and the contribution of the different factors.
V-shaped (optimistic) L-shaped (pessimistic)
Regions Morbidity Mortality School closure Work home Total Morbidity Mortality School closure Work home Total
ASEAN 0.12 0.0068 3.3 1.25 4.68 0.48 0.0068 3.3 5 8.79
Australia 0.12 0.0068 2.61 1.25 3.99 0.48 0.0068 2.61 5 8.10
Brazil 0.12 0.0068 2.66 1.25 4.04 0.48 0.0068 2.66 5 8.15
Canada 0.12 0.0068 2.15 1.25 3.53 0.48 0.0068 2.15 5 7.64
China 0.12 0.0068 2.11 1.25 3.49 0.48 0.0068 2.11 5 7.60
European Union 0.12 0.0068 2.11 1.25 3.49 0.48 0.0068 2.11 5 7.60
India 0.12 0.0068 1.79 1.25 3.17 0.48 0.0068 1.79 5 7.28
Japan 0.12 0.0068 1.87 1.25 3.25 0.48 0.0068 1.87 5 7.36
Mexico 0.12 0.0068 3.4 1.25 4.78 0.48 0.0068 3.4 5 8.89
Newly 0.12 0.0068 1.6 1.25 2.98 0.48 0.0068 1.6 5 7.09
industrialized
countries
Other Asian countries 0.12 0.0068 4.24 1.25 5.62 0.48 0.0068 4.24 5 9.73
United States 0.12 0.0068 2.51 1.25 3.89 0.48 0.0068 2.51 5 8.00
Rest of World 0.12 0.0068 2.72 1.25 4.10 0.48 0.0068 2.72 5 8.21
Source: ‘Trade set to plunge as COVID-19 pandemic upends global economy’ (WTO 2020), https://www.wto.org/english/news_e/pres20_e/pr855_e.htm

1
We note that the above scenarios are not a prediction and may not describe the actual situation accurately because of the uncertainty in the spread of the
virus and the different control measures in each country.
 APPLIED ECONOMICS 7027

Table 3. Summary statistics. Table 4. Statistical tests of spatial autocorrelation by Moran’s I

Variable Observations Mean Std. Dev Min Max and Geary’s C.
gross output 32,505 9.41 1.98 3.38 15.24 year I Z-stat P-values C Z-stat P-values
capital 32,505 9.08 2.17 1.82 16.83 2001 0.536 71.055 0.000 0.565 −27.105 0.000
labour 32,505 4.28 2.11 0.00 12.49 2002 0.536 71.075 0.000 0.570 −26.735 0.000
intermediates 32,505 8.74 2.00 1.90 14.98 2003 0.536 71.050 0.000 0.571 −26.474 0.000
2004 0.538 71.302 0.000 0.568 −26.619 0.000
2005 0.537 71.152 0.000 0.569 −26.546 0.000
2006 0.536 71.014 0.000 0.570 −26.283 0.000
2007 0.536 71.079 0.000 0.569 −26.277 0.000
2008 0.535 70.938 0.000 0.569 −26.348 0.000
social distancing measures can be relaxed in three 2009 0.533 70.572 0.000 0.569 −26.211 0.000
2010 0.538 71.298 0.000 0.564 −26.711 0.000
months. In this scenario, the morbidity and mor­ 2011 0.539 71.457 0.000 0.560 −26.918 0.000
tality rates are 1% and 2%, respectively, people 2012 0.538 71.283 0.000 0.560 −26.762 0.000
2013 0.537 71.124 0.000 0.558 −26.630 0.000
work from home, and school closures are assumed 2014 0.539 71.419 0.000 0.559 −26.545 0.000
to hold for 3 months, which may cause each coun­
try to experience a 3%–5% reduction in labour
supply. Under the L-shaped recovery scenario,
social distancing measures are assumed to last for
one year. In this scenario, we assume morbidity period 2000–2014. The countries in our sample
and mortality rates of 4% and 2%, respectively, account for approximately 85% of the world gross
and that the economies will experience a 7%–9% domestic product (GDP) for the period 2000–2014.
drop in labour supply. Table 2 shows the contribu­ We use the intermediate flows from the WIOD to
tion of each factors. Upon substituting the change construct the spatial weights matrices. To avoid
of L in Equation (15), we measure the contribu­ possible endogeneity between the input factor
tions of the reduced labour supply to the short- levels and spatial weights matrixðWÞ, we average
term change of gross output. the intermediates flows for the period 2000–2014
Similarly, ports of entry restrictions may cause a and normalize the matrix by using the maximum
fall in merchandise trade. The trade effects in dif­ eigenvalue.
ferent regions are expected to reduce by 10–20% However, estimating and comparing production
and 30–40% under the V-shaped and L-shaped functions at the industrial level is challenging due
scenarios, respectively. The international trade to the limited availability of the industry-level input
decline may influence the output from two per­ and output data. In this study, we combine the
spectives (i) through an intermediate supply short­ Socio Economic Accounts (SEA) from the World
age, due to the disruptions in international supply Input-Output and PWT databases. SEA tables pro­
chain, and (ii) through reduced technology diffu­ vide industry-level gross output and intermediate
sion, due to the decline in international intermedi­ input data at current prices, the corresponding
ate flow. By substituting the change of M into price indices in the national currency, and the
Equation (15), we can estimate the short-term
number of workers. It also provides the capital
impact on output due to the shortage of intermedi­
stock in the nominal national currency. The PWT
ates, and by substituting the change of W, we can
database provides country-level data on income,
measure the long-term impact on output due to the
block of technology diffusion. output, input, and price (Feenstra, Inklaar, and
Timmer 2015). The price index of capital service
and exchange rates of the current PPP for each
Data country are collected from the latest published
PWT version 9.1, matched with the WIOD data,
We draw our data from the World Input-Output
Database (WIOD) and the Penn World Table and then the output and input data are converted
(PWT version 9.1). The WIOD 2016 Release covers into data series in constant US dollars; we lag the
43 economies and a rest of the world (ROW) factor inputs by one period. The summary statistics
region, each consisting of 56 industries, for the of the variables are listed in Table 3.
7028 W. LIU AND Q. CHENG

Table 5. Estimation results: growth models with spatial spillover.

SAR SDM
(1) (2) (3) (4) (5) (6)
Variables W1 W2 W3 W1 W2 W3
ln K 0.0544*** 0.0542*** 0.0541*** 0.0571*** 0.0560*** 0.0560***
(0.0031) (0.0031) (0.0030) (0.0031) (0.0032) (0.0031)
ln L 0.1027*** 0.1029*** 0.1024*** 0.1036*** 0.1035*** 0.1035***
(0.0044) (0.0044) (0.0042) (0.0043) (0.0044) (0.0043)
ln M 0.5937*** 0.5936*** 0.5928*** 0.5943*** 0.5952*** 0.5938***
(0.0034) (0.0034) (0.0033) (0.0033) (0.0034) (0.0033)
W � ln K −0.1380*** −0.0766** −0.1088**
(0.0351) (0.0388) (0.0483)
W � ln L −0.1464** −0.0625 −0.1483*
(0.0599) (0.0687) (0.0876)
W � ln M −0.2642*** −0.4477*** −0.2857***
(0.0452) (0.0560) (0.0657)
t 0.00878*** 0.00871*** 0.00865*** 0.00868*** 0.00870*** 0.00863***
(0.00089) (0.00089) (0.00081) (0.00081) (0.00089) (0.00081)
t2 −0.00073*** −0.00073*** −0.00072*** −0.00071*** −0.00072*** −0.00071***
(0.00006) (0.00006) (0.00005) (0.00005) (0.00006) (0.00005)
W � ln Y 0.2380*** 0.2429*** 0.3470*** 0.6850*** 0.7730*** 0.7640***
(0.0234) (0.0239) (0.0234) (0.0316) (0.0402) (0.03012)
Implied ϕ −0.0989 −0.0333 −0.0661
Implied φ −0.0754 0.0175 −0.0692
Implied η 0.1429 0.0124 0.1679
σ2 0.0169 0.0169 0.0157 0.0156 0.0156 0.0156
R2 0.9960 0.9960 0.9960 0.9960 0.9960 0.9960
loglikelihood 19,930 19,931 19,987 20,019 20,030 20,026
LR-test 178.6495 199.1095 79.2102
Observations 30,338 30,338 30,338 30,338 30,338 30,338
Fixed Effects Yes Yes Yes Yes Yes Yes
Note. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. The standard error is in parentheses.

IV. Empirical results Based on the specification in Equation (7), we

Empirical test for growth model with spatial
externalities
Before we estimate the production function, we
first statistically test for spatial interdependence
among industries. We calculate the Moran’s I and
Geary’s C index for the total output of industries
from 2001 to 2014. As shown in Table 4, all statistic
of Moran’s I and Geary’s C are significant at the 1%
level, indicating a strong positive spatial autocorre­
lation across industries. Consequently, the indus­
trial production models should consider the
interactions among industries.
estimate the production function using the spatial
Durbin model, by maximum likelihood. We intro­
duce industry-specific fixed effects to control for the
time-invariant individual difference factor.
Meanwhile, the Hausman test results support the
fixed effects model.
The spatial weight matrix W1 is constructed
using the transposed input-output table, where
the element wij represents the intermediate inputs
from industry j to industry i, implying that the
direction of technology spillovers is from upstream
to downstream industries. We also consider the
interaction matrices W2 and W3 to test for the

Table 6. Direct, Indirect, and Total Effects of input factors.

Variables Direct Effects t values Indirect Effects t values Total Effects t values
overall ln K 0.0568*** 18.99 −0.0142*** −2.81 0.0426*** 7.67
ln L 0.1034*** 24.58 −0.0106 −1.21 0.0928*** 9.90
ln M 0.5947*** 182.35 0.0203*** 3.78 0.6150*** 96.46
domestic ln K 0.0568*** 18.99 −0.0122*** −2.81 0.0446*** 9.00
ln L 0.1034*** 24.58 −0.0091 −1.21 0.0943*** 11.39
ln M 0.5947*** 182.35 0.0175*** 3.78 0.6121*** 106.79
international ln K 0.0000*** −2.79 −0.0020*** −2.81 −0.0020*** −2.81
ln L 0.0000 −1.21 −0.0015 −1.21 −0.0015 −1.21
ln M 0.0000*** 3.73 0.0029*** 3.78 0.0029*** 3.78
Note. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.

robustness of the results. W2 is directly obtained
from the input-output table, where element wij
indicates the intermediate inputs from downstream
industry i to upstream industry j. W3 is derived
from the sum of input and output flows. To exam­
ine whether the spatial interaction of the factor
inputs exists, we estimate the spatial autoregressive
model and employ the LR-test to choose the appro­
priate model between the two specifications. Table
5 shows the empirical results of the spatial autore­
gressive term (SAR) in columns 1–3 and the spatial
Durbin model (SDM) specified production func­
tion in columns 4–6.
The estimation results for the three spatial
weight matrices are consistent; therefore, our dis­
cussion mainly focuses on the results for the matrix
W1 . We use the likelihood ratio test to compare the
goodness-of-fit for the SAR and SDM models, since
SAR is a special SDM model with a restrictive no-
spillover-effect condition for input factors. The LR
statistics is 178.65 and LR>χ2(3), which suggests
that the SDM specification is more statistically sig­
nificant than the SAR specification, and implies
that the spillover effect of factor inputs exists. In
column 4 of Table 5, the spatial autocorrelation
coefficient ρ is 0.6850 and is statistically significant
at the 1% level. The coefficients of capital, labour,
and intermediate inputs are 0.0571, 0.1036, and
0.5943, respectively, and statistically significant at
the 1% significance level. The coefficients of t and
t2, which reflect the average Hicks-neutral technical
change, are positive and negative, respectively, and
both are statistically significant. This implies that
technological progress in the global industries
aggregate is represented as an inverted-U curve,
which is consistent with the results in most studies
that the total factor productivity (TFP) growth
slows down (Gordon 2012; Feenstra, Inklaar, and
Timmer 2015; Inklaar and Diewert 2016).
Tables 6 and 7 provide the estimates of the
direct, indirect, and total effects of the factor inputs,
technological progress, and significance, following
the algorithms by LeSage and Pace (2009), who
drew parameter estimates 1000 times, based on
the variance-covariance matrix of the parameters,
2
There is some difference in the results due to different function forms, specifications, samples of countries, and periods. In general, the coefficients of
intermediate inputs are usually large, and the coefficients of labour and capital are relatively small.
3
The international direct effect is negligible since the impact of international feedback effects of factor inputs, which is first transmitted abroad and then
retransmitted back to the original country, is quite small.
APPLIED ECONOMICS 7029
to get the corresponding distribution of these
effects. Table 6 shows that the global direct effects
of capital, labour, and intermediates are 0.057,
0.103, and 0.595, respectively, and are statistically
significant at the 1% significance level. The relative
magnitude of the coefficients, with intermediates
having the largest output elasticity, followed by
labour, then capital, is consistent with Saliola and
Seker (2011) and Baptist and Hepburn (2013), who
used samples from developing countries and from
the United States, respectively, to estimate a model
with three factor inputs.2 The global indirect effect
of capital is significantly negative whereas that of
intermediates is significantly positive. This suggests
that the increased usage of intermediates in the
supplier or customer industries will benefit their
productivity, which is consistent with the vertical
specialization theory (Hummels, Ishii, and Yi
2001). However, the increased usage of capital in
the supplier or customer industries may have a
negative effect on these industries because of the
scarcity in capital, and the competitive relationship
may outweigh the complementary relationship
among industries. The indirect effect of labour is
not statistically significant, thus, the existence of
externalities in labour usage is not supported.
To distinguish the spillover effects through the
domestic and international production networks,
we decompose the spillover effects based on
Equation (12) and Equation (13),3 respectively. As
is shown at the bottom of Table 6, the international
spillovers of capital, labour, and intermediates
account for approximately 14% of the indirect
effects for each factor inputs.
The average technical change of industries over
the sample period, based on Equation (13), is shown
in Table 7. We consider that the hicks-neutral tech­
nological growth is composed of both direct and
indirect effects. The former includes the technolo­
gical innovation, efficiency improvement, and
industrial upgrading occurring in the industry itself,
and the latter considers the technology spillovers
from its neighbouring industries, through the
input-output linkages. As shown in Columns 2 of
Table 7, the indirect effects of technical change are
7030 W. LIU AND Q. CHENG

Table 7. Technical change and spillover effects.

overall domestic international
Direct Effects Indirect Effects Total EffectsDirect Effects Indirect Effects Total Effects Indirect Effects Total Effects
t2001 0.00729 0.00072 0.00801 0.00729 0.00062 0.00791 0.00010 0.00010
(10.39) (7.18) (10.39) (10.39) (7.20) (10.39) (7.10) (7.10)
t2002 0.00585 0.00058 0.00643 0.00585 0.00050 0.00635 0.00008 0.00008
(9.75) (6.96) (9.75) (9.75) (6.97) (9.75) (6.87) (6.87)
t2003 0.00442 0.00044 0.00486 0.00442 0.00038 0.00480 0.00006 0.00006
(8.82) (6.58) (8.82) (8.82) (6.59) (8.82) (6.51) (6.51)
t2004 0.00299 0.00030 0.00328 0.00299 0.00025 0.00324 0.00004 0.00004
(7.37) (5.89) (7.36) (7.37) (5.90) (7.37) (5.84) (5.84)
t2005 0.00155 0.00015 0.00171 0.00155 0.00013 0.00169 0.00002 0.00002
(4.91) (4.36) (4.91) (4.91) (4.37) (4.91) (4.34) (4.34)
t2006 0.00012 0.00001 0.00013 0.00012 0.00001 0.00013 0.00000 0.00000
(0.50) (0.49) (0.50) (0.50) (0.49) (0.50) (0.49) (0.49)
t2007 −0.00131 −0.00013 −0.00144 −0.00131 −0.00011 −0.00143 −0.00002 −0.00002
(−6.65) (−5.57) (−6.66) (−6.65) (−5.57) (−6.66) (−5.53) (−5.53)
t2008 −0.00275 −0.00027 −0.00302 −0.00275 −0.00023 −0.00298 −0.00004 −0.00004
(−13.38) (−8.09) (−13.41) (−13.38) (−8.11) (−13.42) (−7.97) (−7.97)
t2009 −0.00418 −0.00041 −0.00460 −0.00418 −0.00036 −0.00454 −0.00006 −0.00006
(−16.06) (−8.57) (−16.10) (−16.06) (−8.59) (−16.12) (−8.42) (−8.42)
t2010 −0.00562 −0.00056 −0.00617 −0.00561 −0.00048 −0.00609 −0.00008 −0.00008
(−16.49) (−8.62) (−16.53) (−16.49) (−8.64) (−16.55) (−8.47) (−8.47)
t2011 −0.00705 −0.00070 −0.00775 −0.00705 −0.00060 −0.00765 −0.00010 −0.00010
(−16.32) (−8.59) (−16.36) (−16.32) (−8.61) (−16.37) (−8.44) (−8.44)
t2012 −0.00848 −0.00084 −0.00932 −0.00848 −0.00072 −0.00920 −0.00012 −0.00012
(−16.04) (−8.54) (−16.07) (−16.04) (−8.56) (−16.09) (−8.39) (−8.39)
t2013 −0.00992 −0.00098 −0.01090 −0.00992 −0.00084 −0.01076 −0.00014 −0.00014
(−15.77) (−8.49) (−15.80) (−15.77) (−8.52) (−15.82) (−8.35) (−8.35)
t2014 −0.01135 −0.00112 −0.01247 −0.01135 −0.00096 −0.01231 −0.00016 −0.00016
(−15.54) (−8.45) (−15.57) (−15.54) (−8.48) (−15.58) (−8.31) (−8.31)
Note. T-values in parenthesis: All estimates are statistically significant at the 1% significance level; therefore, we omit the asterisk. The international direct effect
is not shown here because the international feedback part of direct effect is negligible.

significantly different from zero and account for 9%
of the total effects. The decomposition of domestic
and international spillovers indicates that the inter­
national component accounts for approximately
14% of the indirect effects, suggesting that the inter­
national diffusion of technology is an important
source of technology progress in economic growth.
The shock of COVID-19 pandemic on global
production network
Based on the above estimated growth model and the
simulated COVID-19 shock scenarios, we estimate
the impact of the pandemic based on the two scenar­
ios. Based on the output decline results presented in
Figure 1, the global total output is expected to drop
by 3.60% under the optimistic specification scenario
and by 8.41% under the pessimistic scenario.4
With the coronavirus spreading globally, each
economy in our sample exhibits different degrees of
impact. Overall, economies deeply embedded in the
GVCs experience a sharp drop in output. Specifically,
4
From the current estimation of the decline of global GDP in 2020 by international organizations, such as OECD (2020) (6%–7.6%), World Bank (2020) (5.2%–
7.7%), IMF (2020) (4.9%), among others, and considering the natural growth rate and the difference between added value and output value, our estimates are
in line with the results of these studies.
countries that are at the hub of the production net­
work are the most affected (World Bank 2020),
which suggests that the propagation of shocks
through input-output linkages is an important driver
of macroeconomic fluctuations (Acemoglu, Akcigit,
and Kerr 2015). Under the V-shaped recovery sce­
nario, as shown in Panel (a), the United States, China,
and Germany are the top three most severely affected
countries whose output declines by 15.22%, 10.36%,
and 6.6%, respectively. These countries are the most
important regional hubs in the GVC networks.
Between 2000 and 2014, the United States, China,
and Germany had the top three highest export and
import volumes of intermediate goods globally. As
the major suppliers and customers of global inter­
mediate goods, the effect of the COVID-19 shock will
be amplified in these countries because of their trans­
mission through GVCs linkages. The countries
expected to experience severely negative effects are
Luxembourg, France, United Kingdom, Netherlands,
Canada, Belgium, Ireland, Malta, Japan, and Mexico,
with an output decline of 3.76%–5.60%. The
 APPLIED ECONOMICS 7031

World World
United States United States
Turkey Turkey
Sweden Sweden
Slovenia Slovenia
Slovakia Slovakia
Russia Russia
Romania Romania
Portugal Portugal
Poland Poland
Norway Norway
Netherlands Netherlands
Malta Malta
Mexico Mexico
Latvia Latvia
Luxembourg Luxembourg
Lithuania Lithuania
Republic of Korea Republic of Korea
Japan Japan
Italy Italy
Ireland Ireland
India India
Indonesia Indonesia
Hungary Hungary
Croatia Croatia
Greece Greece
United Kingdom United Kingdom
France France
Finland Finland
Estonia Estonia
Spain Spain
Denmark Denmark
Germany Germany
Czech Republic Czech Republic
Cyprus Cyprus
China China
Switzerland Switzerland
Canada Canada
Brazil Brazil
Bulgaria Bulgaria
Belgium Belgium
Austria Austria
Australia Australia
-0.32 -0.24 -0.16 -0.08 0 -0.32 -0.24 -0.16 -0.08 0
technology spillover labor intermediate technology spillover labor intermediate

(a) V-shaped scenario (b) U-shaped scenario

Figure 1. The percentage of decline in output under the two scenarios. (a) V-shaped scenario. (b) U-shaped scenario.

estimated output reduction for the rest of the coun­
tries is less than the average global output losses, and
ranges from 1.77% to 3.57%. Under the L-shaped
recovery scenario, as shown in Panel (b), all countries
may experience an aggravated output reduction. The
annual output in the United States, China, and
Germany will reduce by approximately 30.94%,
22.01%, and 14.87%, respectively. The annual output
reduction for Luxembourg, France, United Kingdom,
Netherlands, Belgium, Malta, Canada, Ireland, Japan,
Hungary, and Mexico will range from 8.55% to
13.89%; and that in the rest of the countries is
expected to decline by 4.06%–8.05%.
Decomposition of contribution in three channels
We decompose the pandemic impact based on the
contribution through three channels: intermediate
shortage, labour supply reduction, and the reduced
technology spillovers, using Equation (15). As shown
in Panel (a) of Figure 1, under the V-shaped scenario,
the intermediate shortage is the most important fac­
tor causing output losses, accounting for 56% of the
average output change. Intermediate trade, as the
core factor for maintaining the steady operation of
GVCs, is severely affected by the pandemic.
Nonetheless, due to the larger output elasticity of
the intermediate input, compared with the capital
and labour inputs, output is particularly sensitive to
intermediate change. The blockage of technology
diffusion and labour supply reduction contribute
27% and 17% of the output losses, respectively.
However, the contribution of the three channels var­
ies across countries. In some countries, including the
United States, China, Japan, Germany, France,
United Kingdom, and Italy, the block of technology
diffusion contributes over 50% to output losses.
These countries are deeply embedded in GVCs and
are particularly active in interchanging knowledge
and information. Strong technology linkages exist
7032 W. LIU AND Q. CHENG

Agriculture, forestry and fishing Food, beverages and tobacco

Mining and Quarrying Textiles and clothing

Manufacture Wood products

Electricity, gas Paper

Water, waste Printing and recording

Construction Coke and refined petroleum

Wholesale and retail trade; repair Chemicals

Transportation and storage Pharmaceuticals

Accommodation and food service Rubber and plastic

Information and communication Other non-metallic minerals

Financial and insurance Basic metals

Real estate activities Fabricated metal

Professional, scientific and technical Computer, electronic and optical

Administrative and support service Electrical equipment

Public administration and defence Machinery and equipment n.e.c.

Education Motor vehicles

Human health and social work Other transport equipment

Arts, entertainment Other manufacturing

Households activities Repair and installation

-0.32 -0.27 -0.22 -0.17 -0.12 -0.07 -0.02 0.03 -0.32 -0.27 -0.22 -0.17 -0.12 -0.07 -0.02 0.03
technology spillovers labor technology spillover labor
intermediate input demand shock intermediate input

(a) broad industry group (b) two-digit industry divisions in Manufacturing

Figure 2. The percentage of decline in output by industry under the two scenarios. (a) broad industry group (b) two-digit industry
divisions in Manufacturing. Note. Panel (a) and Panel (b) display the change in output following the two scenario specifications. Each
industry has two bars of estimates. The top bar represents change in the V-shaped scenario, and the bottom bar represents the change
in the L-shaped scenario.

between these industries. Therefore, these countries that the demand of some industries, such as accom­
are more sensitive to the change in technology diffu­ modation, tourism, recreational activities, passen­
sion while other countries are more sensitive to the ger transport, and restaurants, have plummeted
decline of intermediate inputs. From the results in due to the social distancing measures, we consider
Panel (b), in the L-shaped scenario, the intermediate, this overlapping effect from the demand-side shock
labour supply, and technology spillovers contribute while evaluating the impact of the pandemic by
58%, 27%, and 15%, respectively, to the fall in the industry. Based on the scenarios developed by
average output. Maliszewska, Mattoo, and Mensbrugghe (2020),
World Bank (2020), and WTO (2020), we further
assume that the demand for the three industries,
The COVID-19 shock in sectors that is, accommodation and food services, educa­
Using Equation (6), we further calculate the aver­ tion, and arts and entertainment, will drop by 15%
age output reduction in industrial sectors, under and 30% in the optimistic and pessimistic scenar­
the two COVID-19 shock scenarios. In the pre­ ios, respectively.5 The results in the broad industry
vious analysis, our model only focused on the group and the two-digit industry divisions in the
impact from the production side. Considering manufacturing sector are shown in Figure 2. First,

5
The output changes in these three industries are calculated based on the minimum value between the output after the shock from the supply-side and the
output after the shock from the demand-side.

the accommodation and food services, education,
and arts and entertainment industries will experi­
ence the largest declines in output, due to the sharp
decrease in demand. Second, the construction
industry is expected to experience a 7.67% and
16.52% output reduction under the V-shaped and
L-shaped scenarios, respectively. The reason for
these expectations is twofold: on the one hand,
most countries take stringent control measures,
such as workplace closures and project shutdown
during the most severe period to stem the spread of
COVID-19. Further, local government may set
mobility restrictions to migrant workers even dur­
ing the work resumption period. Consequently,
most workers are unable to return to their work
places, resulting in delayed constructions. On the
other hand, the construction industry is closely
linked to the upstream and downstream industries
that supply raw materials, mechanical equipment,
and logistics services from other industries, and
thus is seriously affected by the shortage of inter­
mediate inputs. Third, the manufacturing industry
is greatly affected by the pandemic. Our simulation
suggests that the output losses in the manufactur­
ing industry range from 5.13% in the V-shaped
scenario to 11.99% in the L-shaped scenario.
The motor vehicles, trailers, and semi-trailers
industry is projected to experience the biggest
drop in output, which will reduce by 8.57% and
19.13% in the two corresponding scenarios. The
automobile industry is significantly characterized
by long supply chains with high proportion of
intermediates from worldwide upstream indus­
tries. The international spread of the pandemic
has disrupted the supply chain, such that, many
automobile production lines have been suspended
due to a lack of parts and components. The short­
age of intermediate accounts for approximately
50% of the output losses in the automobile indus­
try. In addition, the automobile manufacturing
sector offshore outsources many upstream and
downstream segments, which involves frequent
technology and information exchanges across bor­
ders. Further, social distancing measures may block
knowledge spillovers, causing a decline in total
factor productivity. Panel (b) shows that 44% of
the output decline is attributable to the block of
technology spillovers. Owing to the high degree of
automation in this industry, the reduced labour
APPLIED ECONOMICS 7033
supply contributes only 6% of the reduced output.
Similarly, the coke and refined petroleum products
industry will also experience relatively severe out­
put losses due to its high degree of internationali­
zation. The manufacturing sector for computer,
electronic, and optical products is the third most
highly affected. The intermediate shortage leads to
a 4.34% output reduction in the V-shaped scenario,
which is the highest drop among all industries. This
is attributed to the high complexity in the supply
chain of the components in this sector. Due to
reduced technology spillover, the output declines
by 2.74%, which is also more than that in most
industries. However, some manufacturing sectors
with relatively short industrial chains and that have
low technology-intensive industries, such as wood
products and paper industries, are relatively less
affected. This indicates that industries that are
more integrated in GVCs tend to experience a
more severe negative impact, which is consistent
with other studies (World Bank 2020; Sforza and
Steininger 2020). The intermediate inputs of such
industries usually cross the national borders several
times, and thus, may magnify the shock as the
‘bullwhip’ effect, and consequently increase the
vulnerability of the supply chain.
V. Conclusions
In this study, we develop an economic growth model
using technology spillovers among industries and
examine the spillover effects using a spatial econo­
metric specification. Moreover, we decompose
domestic and international spillovers by extending
the approach used for calculating the indirect effects.
The empirical analysis uses the global input-output
data for the period 2000–2014 to examine the char­
acteristics of technological progress and spillover
effects of global industries. Meanwhile, combined
with the recovery scenarios, we focus on evaluating
the COVID-19 pandemic shock on the global pro­
duction system and its transmission mechanism.
Based on the empirical findings of this study, first,
the spillover effect of industrial linkages is an impor­
tant factor for the economic growth of each country.
Second, scenario simulations of the epidemic impact
show that the global economy may experience a
V-shaped rebound and its output is expected to fall
by 3.6%, if the spread of COVID-19 is controlled in a
7034 W. LIU AND Q. CHENG
short time. If it takes longer, global production net­
works will be severely affected, and the total global
output is projected to fall by 8.41%. Countries deeply
embedded in GVCs will experience large output
reductions, implying that the GVCs linkages could
amplify the impact of the COVID-19 shock. The
intermediate shortage input is one of the main dri­
vers of reduced global output, followed by the
reduced international technology spillover; the
reduced labour supply has very limited impacts on
output losses.
Notably, due to the high uncertainty regard­
ing the evolution of the COVID-19 pandemic,
the policy measures to achieve a balance
between pandemic control and economic growth
vary widely across countries, and the scenarios
used in this paper are not exactly the same as
the actual situations in each country.
Meanwhile, with the limitation of model speci­
fication, data, and identification, this study
explores a preliminary approach to assessing
the COVID-19 shock in the GVC setting. With
more pandemic-control, release of detailed data
on various countries, and relevant global data­
base improvements, the evaluation model and
transmission of shocks should be discussed
further and in more detail in the future.
Based on our empirical findings, we draw some
important implications as follows. First, technology
spillover effects among industries are significant
and play an important role in all economies.
Therefore, policymakers should actively break the
market barriers between regions and eliminate the
institutional barriers of factor flows. Second, the
transmission of shocks through global production
networks and inter-industry linkages is an impor­
tant driver of macroeconomic fluctuations.
Countries should strengthen the cooperation
between value chains and supply chains to avoid
excessive trade restrictions while responding to the
pandemic.
Disclosure statement
No potential conflict of interest was reported by the author(s).
Funding
This research was supported by the National Social Science
Foundation of China under Grant (17FJL006).
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