Backward linkages: Meaning, Criticisms & Real-World Uses

What Are Backward Linkages?

Backward linkages, within the field of economic development, refer to the interconnectedness of an industry with other economic sectors from which it purchases its necessary inputs for its production process. This concept highlights the demand-side connections a firm has with its suppliers, emphasizing how the growth or establishment of one industry stimulates growth in upstream industries that provide it with raw materials, components, or services. Essentially, when a new industry emerges or an existing one expands, it creates a demand for intermediate goods and services, thereby "linking backward" to its suppliers and encouraging investment in those supplying sectors. A strong backward linkage indicates that an industry's output requires substantial intermediate inputs from many other industries, fostering broader economic growth and industrialization.

History and Origin

The concept of backward linkages is a core element of input-output analysis, a framework developed by Russian-born American economist Wassily Leontief. Leontief, often considered the "father of input-output analysis," was awarded the Nobel Memorial Prize in Economic Sciences in 1973 for his pioneering work in this area.⁷ He developed a system that systematically analyzed the intricate interindustry transactions within an economy, showing how different industries buy from and sell to one another.⁶ Leontief's input-output tables provided a detailed, quantitative picture of the goods and services circulating in a national economy.⁵ The idea of linkages, including backward linkages, gained prominence as economists sought to understand how investments in specific sectors could create ripple effects throughout the broader economy, driving overall industrialization and development.

Key Takeaways

Backward linkages describe the demand an industry creates for inputs from other sectors of the economy.
They are a fundamental concept within input-output analysis, illustrating inter-industry dependencies.
Strong backward linkages can stimulate growth and investment in supplying industries.
Understanding backward linkages is crucial for strategic economic development and industrial policy.

Formula and Calculation

Backward linkages are typically quantified using input-output tables, often through the Leontief Inverse Matrix (also known as the total requirements matrix). This matrix captures both direct and indirect intermediate consumption.

The Total Backward Linkage for an industry j can be expressed as the column sum of the Leontief Inverse Matrix, L:

c_j = \sum_{i=1}^{n} l_{ij}

Where:

(c_j) = Total Backward Linkage for industry j
(l_{ij}) = Element from the Leontief Inverse Matrix, representing the total (direct and indirect) output required from industry i to produce one unit of final market demand in industry j.
(n) = Number of industries in the economy.

An industry exhibits significant backward linkages when its production necessitates substantial intermediate goods from numerous other sectors.⁴ The Bureau of Economic Analysis (BEA) in the U.S. compiles comprehensive input-output accounts which provide detailed data on these inter-industry relationships.³

Interpreting Backward Linkages

Interpreting backward linkages involves understanding how the expansion of a specific industry impacts its upstream suppliers. A high backward linkage suggests that an increase in production in a given industry will create a significant demand for inputs from other industries, thereby generating economic activity across its supply chain. For policymakers and planners, identifying industries with strong backward linkages can be a strategic tool for fostering economic growth. Investing in or promoting such "key" industries can lead to a multiplier effect, stimulating development in the entire network of supplying economic sectors. Conversely, weak backward linkages might indicate that an industry relies heavily on imported inputs or has a limited domestic supply base.

Hypothetical Example

Consider the hypothetical expansion of a new electric vehicle (EV) manufacturing plant in a region. This plant represents a significant new industry. The backward linkages generated by this EV plant would include:

Demand for batteries: The plant would require a substantial volume of EV batteries, stimulating growth in battery manufacturing facilities.
Raw material suppliers: Battery production, in turn, creates demand for commodities such as lithium, cobalt, and nickel, potentially encouraging investment in mining and refining operations.
Component manufacturers: The EV plant would also need various other components like electric motors, semiconductors, wiring harnesses, and interior materials, driving demand for specialized component suppliers.
Software and electronics: Modern EVs are highly dependent on complex software and electronic control units, creating backward linkages to software development firms and electronics manufacturers.

This chain of demand, extending backward from the final product to its constituent parts and raw materials, illustrates how the new EV industry could foster a broader ecosystem of industries through its backward linkages.

Practical Applications

Backward linkages are a vital concept in regional and national economic development planning, industrialization strategies, and supply chain management. Governments and economic planners often use input-output models to identify industries with high backward linkages that can serve as "growth poles" or "leading sectors." By promoting these industries through policies like targeted investment incentives, infrastructure development, or fiscal policy, they aim to stimulate a broader base of economic activity.

For businesses, understanding backward linkages is crucial for managing their supply chain and assessing vulnerability to disruptions. Diversifying sources of inputs and building resilient supply chains are key strategies.² The International Monetary Fund (IMF) has highlighted that diversifying sources of imports can mitigate the impact of adverse trade shocks, emphasizing the importance of resilient value chain relationships.¹

Limitations and Criticisms

While backward linkages offer valuable insights into economic interdependencies, they are not without limitations. A primary criticism stems from the static nature of traditional input-output models, which assume fixed technical coefficients—meaning the amount of input required to produce a unit of output does not change over time. This assumption may not hold true in dynamic economies where technological advancements, efficiency improvements, or changes in production process can alter input requirements.

Additionally, while strong backward linkages can indicate potential for domestic growth, they do not guarantee it. If the supplying industries are not locally available or competitive, the demand generated by an expanding industry may simply be met by imports, leading to limited domestic impact. Furthermore, focusing solely on backward linkages might overlook other important aspects of economic growth, such as the creation of new products or services for end-users (forward linkages) or the broader impact of consumer spending (consumption linkages).

Backward Linkages vs. Forward Linkages

Backward linkages and forward linkages are two complementary concepts used in economic analysis to describe the interdependencies between industries. While backward linkages describe the demand an industry places on its suppliers for inputs, forward linkages refer to the supply side—when the output of one industry serves as an input for another industry further down the production process.

For example, a steel mill creates backward linkages by demanding iron ore, coal, and machinery from mining and manufacturing sectors. Simultaneously, the steel mill creates forward linkages by supplying steel to industries like automotive, construction, and appliance manufacturing. Both types of linkages are crucial for understanding the overall structure and interconnectedness of an economy, with backward linkages focusing on the "pull" from input demand and forward linkages focusing on the "push" from output supply.

FAQs

What is the main purpose of analyzing backward linkages?

The main purpose of analyzing backward linkages is to understand how the growth of one industry stimulates activity in its upstream supplier industries. This helps identify key sectors that can drive broader economic development and create a multiplier effect throughout the economy.

How do backward linkages contribute to economic growth?

Backward linkages contribute to economic growth by creating market demand for the products and services of supplying industries. When a sector with strong backward linkages expands, it necessitates increased production from its suppliers, leading to new investment, job creation, and overall economic expansion in those upstream sectors.

Are backward linkages always beneficial?

While often beneficial for fostering inter-industry growth, backward linkages are not always solely positive. If domestic suppliers cannot meet the demand or are uncompetitive, the increased demand may be satisfied by imports, leading to less local impact. Also, a heavy reliance on a single source of inputs, regardless of strong backward linkages, can expose an industry to supply chain vulnerabilities.