Manufacturing firms in developing countries often hold surprisingly large stocks of inputs
compared to similar firms in the developed world. In new research published in the latest
Economic Journal, Marcel Fafchamps, Jan Willem Gunning and Remco Oostendorp show
that this fact stems from the higher risks these firms face compared to their developed-world
counterparts. Unreliable sources of supply force manufacturers to hold large inventories of inputs,
tying up funds that could have been used for investment. This implies that the risky environment
in which firms have to operate in is costly in terms of economic growth.
The research uses survey data for 200 manufacturing firms in Zimbabwe. These data include
detailed information on the pervasive risks that firms face: inputs not arriving on time, delays in
payments, large changes in demand from one year to another, etc.
Analysing these data, Gunning and his colleagues find strong evidence that the risk of delayed
deliveries and payments explains much of the inventory and financial behaviour of manufacturers.
Holding large inventories of inputs offer firms insurance against the risk that late deliveries will
disrupt their production process. Inventories reflect unreliable input supply whereas large unused
overdraft limits reflect the risk of payment delays.
The researchers argue that economic liberalisation (which Zimbabwe undertook in the early 1990s
but later reversed) reduces the risks firms face by strengthening competition and improving
infrastructure. Liberalisation thereby removes the need for holding large stocks. In Zimbabwe, this
was important: manufacturing firms reported drastic reductions in inventories when supplies
became more reliable.
The study also shows that firms deal with changes in demand by maintaining excess capacity so
that they have the flexibility to adjust to these changes. Hence, the day-to-day risks of delays in
payments and deliveries induce large stocks while the year-to-year market risk is reflected in low
capacity utilisation.
This is important because although firms' response to their risky environment is efficient, it is
costly in terms of forgone growth. Rather than investing in inventories or in stand-by capacity,
firms could have invested in expansion. In Zimbabwe, managers reported that they drastically
reduced stocks of inputs when the economic reforms of the early 1990s made the delivery of
inputs much more reliable.
The results imply that stocks are a measure of the risk of a firm's environment. Economic reform
is not just about 'getting prices right' but also about releasing firms from the need for holding large
inventories.
Note for Editors: 'Inventories and Risk in African Manufacturing' by Marcel Fafchamps, Jan
Willem Gunning and Remco Oostendorp is published in the October 2000 issue of the Economic
Journal. Fafchamps is at Oxford University; Gunning and Oostendorp are at the Free University
Amsterdam.
For Further Information: contact Jan Willem Gunning on 00-31-20-4446141 (email:
Jgunning@econ.vu.nl); RES Media Consultant Romesh Vaitilingam on 0117-983-9770 or 07768-
661095 (email: romesh@compuserve.com); or RES Media Assistant Niall Flynn on 020-7878-
2919 (email: nflynn@cepr.org).