Spatial Inequality and Informality in Kenya’s Firm Network

The spatial configuration of domestic supply chains plays a crucial role in the transmission of shocks. This paper investigates the representativeness of formal firm-to-firm trade data in capturing overall domestic trade patterns in Kenya — a context with a high prevalence of informal economic activity. It first documents a series of stylized facts and shows that informal economic activity is not randomly distributed across space and sectors, with a higher incidence of informality in downstream sectors and smaller regional markets. The paper then links granular transaction-level data on formal firms with data on informal economic activity to estimate a structural model and predict a counterfactual network that accounts for informal firms. The findings show that formal sector data overstates the spatial concentration of aggregate trade flows and under accounts for trade within regions and across regions with stronger social ties. Additionally, the higher the informality in a sector and region is, the more formal sector data underestimates its vulnerability to domestic output shocks and overestimate its vulnerability to import shocks.