Economies around the world are linked by international supply chains – a global network of trading relationships between firms. Although only a small fraction of firms in each economy directly engages in international trade, many more are indirectly involved through the imports and exports of their buyers and suppliers.
The phenomenon of indirect links to international supply chains is particularly relevant in many low- and middle-income economies, where trade through intermediaries accounts for a larger proportion of international trade.1 However, studying the characteristics of indirect importers and exporters often poses a challenge, as it can be difficult to track the indirect links to international supply chains. Conventional customs data predominantly capture firms that are directly involved in importing or exporting and thereby often overlook firms with indirect exposure to global markets. A newly compiled administrative data set comprehensively maps Kenya’s domestic formal sector network,2 and its exposure to international supply chains, allowing us to overcome these constraints.3
A shock, such as a sudden increase in the demand for a product or a supply shortage due to a natural disaster, can be transmitted and amplified along supply chains. The administrative data allows us to study how these changes in global supply and demand also ripple through domestic networks. The period covering the lead-up to the COVID-19 pandemic, the pandemic itself and the recovery phase, was characterised by both negative and positive shocks, providing a relevant case study for our analysis. This article highlights three of our key findings.4
Almost all Kenyan firms are (weakly) linked to international supply chains
In 2018, only 11% of Kenyan firms imported and 3% exported directly.5 However, virtually all formal firms have at least one direct trading relationship with either an exporting or an importing firm. Almost 90% of Kenya’s domestic formal firms, for example, buy from an importing firm. These links tend to be weak, however, accounting for only a minor share of the firms’ inputs or outputs. We therefore zoom in on the characteristics of firms with strong links to international supply chains – firms that either directly or indirectly source more than 25% of their inputs, or sell more than 25% of their output, on international markets.
Firms with high direct or indirect exposure to international markets tend to be larger, older, and well-embedded in the domestic economy
Only 5% of Kenyan firms have strong links to export markets, based on the classification above,6 and only 9% have a strong exposure to import markets. However, these firms play an important role in the Kenyan economy. The total sales of firms with strong exposure to import markets account for 57% of formal sector output. These firms are also older, employ substantially more workers, and have more domestic buyers and suppliers than firms without strong international linkages. In the figure below, we look at the importance of firms with strong direct and indirect links to import markets, by sector. In energy and water, manufacturing, and transportation and logistics, these firms account for more than half of total formal sector sales. Construction, mining and agriculture are the sectors with the least exposure to import markets. Only between 25% and 30% of total sales in these sectors, respectively, is generated by firms with a high exposure to import markets.
Looking at exporting firms, we find that those with strong links to export markets only account for 13% of formal sector sales across Kenya, but are well-embedded in the domestic firm network. Firms with strong direct (indirect) exposure to export markets have, on average, 60 (32) domestic suppliers, while the average for the remaining firms sits at 25. On the export side, many of these firms operate in primary sectors. In commercial agricultural they accounted for three-quarters of aggregate sales in 2018 (see next figure).
Favourable conditions in import markets crowd in domestic purchases
We further study how domestic firm dynamics in Kenya respond to fluctuations in the global supply and demand of products relevant for Kenyan firms.7 Unsurprisingly, we find that favourable global conditions in markets that Kenyan firms export to translate into higher direct exports. A 10% increase in world demand results in a 3.7% increase in exports by Kenyan firms. We find, however, that this co-movement of global demand and Kenyan exports was particularly pronounced during the COVID-19 crisis, and considerably weaker prior to it. A shock of the same magnitude to the world supply of products usually purchased by Kenyan firms increases imports by 8.6 percent.8 As a next step, we look at how changes in global market conditions get passed on to domestic supply chains. We study both the domestic supply chains of direct exporters and importers, and the impact of shocks on firms that import and export indirectly.
A key question is whether imports and domestic purchases act as substitutes or complements in firms’ responses to international trade shocks. We find no evidence that, at least on average, firms purchase less domestically if they experience a positive shock in the global supply of products they usually import, either directly or indirectly. If anything, we find that direct importers buy larger volumes domestically and increase the number domestic suppliers. Firms that are indirectly exposed to positive import shocks, via their suppliers, do not see their domestic purchases decline, but their purchases become more concentrated among fewer domestic suppliers. This pattern changed, however, during the recovery from the 2020 economic downturn. As global supply chains recovered in the second half of 2020 and early 2021, Kenyan firms which indirectly source products from global markets, for which conditions improved more swiftly, also purchased from a larger number of domestic suppliers.
We find, however, that domestic sales and exports act as substitutes. As demand in some of Kenya’s export markets declined during the pandemic, firms instead sold their output to domestic consumers and business customers. More generally, if firms face favourable conditions in the world markets they sell to, directly or indirectly, they purchase more inputs both domestically and through imports as a result.
Conclusion
Our findings challenge the notion that firms in lower-income economies that are linked to global supply chains are isolated from domestic networks. The study underscores that both favourable conditions and disruptions in global demand and supply transmit to domestic trade partners. International market ties hence come with opportunities and vulnerabilities. Our analysis focuses on short-term effects, but the approach can also be used to investigate medium- and long-term dynamics in future research.
Disclaimer: The views expressed in this article are those of the authors based on their experience and on prior research and do not necessarily reflect the views of UNIDO (read more).
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