Are Supply Networks Efficiently Resilient?

We show that supply networks are inefficiently, and insufficiently, resilient. Upstream firms can expand their production capacity to hedge against supply and demand shocks. But the social benefits of such investments are not internalized due to market power and market incompleteness. Upstream firms under-invest in capacity and resilience, passing-on the costs to down-stream firms, and drive trade excessively towards the spot markets. There is a wedge between the market solution and a constrained optimal benchmark, which persists even without rare and large shocks. Policies designed to incentivize capacity investment, reduce reliance on spot markets, and enhance competition ameliorate the externality