Production Networks and Business Cycles in China

Abstract Business cycles are often regarded as aggregate phenomena. However, against the backdrop of rapid structural transformation in Chinese economy, they are also influenced by cyclical changes in various sectors and the evolution of the economic network structure. From the perspective of production networks, this paper analyzes the causes of business cycles in China. Firstly, a theoretical model is constructed to discuss the impact of structural characteristics and transformation processes of production networks on the relationship between sectoral shocks and economic fluctuations. Subsequently, using Bayesian structural vector autoregressive (SVAR) model with heterogeneous constraints, based on the China Industry Productivity Database (CIP/China KLEMS), the paper empirically identifies the source sectors of China’s business cycles from 1978 to 2018. The research findings are as follows: (1) Business cycles can be attributed to a combination of a few sectoral shocks, which are propagated and amplified through input-output linkages; (2) As China’s production network evolves, sectors that drive business cycles vary across times, transiting from labor-intensive sectors to capital-intensive sectors; (3) Construction and real estate sector is the key node in the production network. On the one hand, shocks to the key node sector are widely propagated to other sectors. On the other hand, shocks to their upstream and downstream sectors, in turn, affect the macroeconomy through the key node. These structural dynamics have shaped China’s business cycles. This paper reveals the structural characteristics of China’s business cycles, providing significant academic and policy value for understanding the relationship between macroeconomic performance and sectoral structure, as well as for maintaining stable economic growth.