Inventory Investment and the Implications on GDP Growth

Inventory Clearances Necessary

These forecasts follow a dismal 3.8% decline in the fourth quarter of 2008, which could have been much worse had it not been for the 1.3% increase in private inventories. This inventory build up is not reflective of strong economic activity, but rather the result of low consumer demand. The economy will not regain its footing until businesses are able to clear these inventories off their shelves and lots. Most economists estimate that this will begin in the second half of 2009.

Eliyahu M. Goldratt, in his supply chain economics book, The Goal, defines inventory as “all the money that the system has invested in purchasing things in which it intends to sell.” The chart below plots the cumulative cost of nonfarm business inventories against the cumulative amount of personal consumption expenditures on durable goods.

There are several noticeable trends, the most prevelant being that these two series tend to grow and contract with one another, with the level of invested monies in inventory more or less mirroring the level of consumption expenditure.

First Distinct Trend

However, within this larger pattern there are two distinct trends that help frame the outlook for the inventories component of GDP. First, just-in-time inventories have helped reduce the current shock of the slowdown in consumer expenditures to the overall economy.

Prior to the 1980s, the value invested in inventories was typically greater than the value spent on the goods. Nevertheless, there is a reversal of this trend fueled by changes to public policy, including the Staggers Act of 1980, which helped deregulate the railroads (who at the time, were being used as defacto warehouses), and through advancements in technology including the global internet and other “real time” tools. Consequently, just-in-time inventories have helped lower the inventory-to-sales ratio to record low levels, allowing businesses to lower the amount invested in inventories at any given point in time relative to the final sales of their products. Therefore, in today’s environment of low consumer demand, the amount of inventories being carried are already at relatively low levels, and the burden of these excess inventories on the general economy is not as severe as it would have historically been.

Furthermore, it is likely that improvements in trade infrastructure, including technological advances and economies of scale at the ports, as well as improved inland transportation networks, will help further reduce the carried level of inventories in the future.

Economic growth results from getting more output from the same level of resources used. More efficient/reliable freight transportation allows companies to hold less inventory because there is a lower chance of a stock-out. This frees up capital from being invested in inventory and allows it to be used for other purposes. Since investment is a driver of productivity growth, it increases economic growth.

Second Distinct Trend

As for the second trend, the beginning and end of the last two recessions have been marked by the peak and trough in the cumulative level of spending on inventories. This is a logical phenomenon and is coordinated with the declines in consumption expenditures.

As the consumer begins to pull back, businesses likewise attempt to lower their spending on inventories. It is not uncommon in the early stages of a recession for the level of consumption expenditures to approach or even touch the value of inventories. This is where we find ourselves today as of the latest data for the fourth quarter 2008. Historically it has taken three or four quarters of inventory reductions before there is a return to growth in both consumer and inventory spending. However, in this current recession, which officially began in December 2007, this process appears to be at a more mature stage.

It must be noted that even though all of 2008 was officially in recession, the first half of the year showed positive GDP growth, during which time both the level of inventory investment and consumption expenditure fell. Inventories had fallen for seven consecutive quarters from March ’07 through September ’08, while consumption expenditures have fallen for the last four consecutive quarters.
This would imply that businesses had been paring back inventory investment growth in anticipation of the slowdown in consumption expenditures. While it is unlikely that the economy will see the return of the debt fueled consumption habits of those in recent history, lower inflation (for the time being — the $787 billion stimulus package could lead to higher inflation by 2010) and eventual stabilization in the labor market should help stem the declines in consumption expenditures.

There are signs that this may already be happening. Retail sales for January showed a 1% increase from December (0.9% excluding autos) but are still well below levels from a year ago. Nevertheless, this appears to be supportive of a partial recovery in GDP growth in the second half of 2009.

In This Issue

News, Trends & Analysis
New Items

Inventory Investment and the Implications on GDP Growth

Supply Chain
Responding to Changes in the Supply Chain

Compliance Corner: How to Utilize Technology to Manage Global Trade Compliance

Overseas Opportunities for Exporters

Create a Strategy before Cutting Costs

Features
Gateway at a Glance – Great Lakes, St. Lawrence Seaway

2009 Ro-Ro Trend

Supply Chain product review
Automotive Supply Chain Software

Ports & infrastructure
Five Major Ports, Five Different Ways to Handle the Recession

Funding a National Freight Policy

Commentary
Will the Stimulus Package Help the Trade Conditions?

Casualties

Who, What, Where, When

Final Say