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BW Businessworld

Impact Of Inventories

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The funny thing is that this phrase does not fit the facts. If you look at the latest forecasts for GDP growth in 2009 made by the International Monetary Fund (IMF) in mid-April, one point stands out immediately: the US economy is actually faring rather better than most other rich countries.

The IMF forecasts a contraction in the US’s GDP this year of 2.8 per cent. By most standards, that would be bad. But the forecast for the Euro-zone countries is worse, at 4.2 per cent, a figure dragged down by Germany’s 5.6 per cent contraction. The UK clocks in at a drop of 4.1 per cent, while Japan is predicted to suffer a fall of fully 6.2 per cent — a shrinkage which is virtually the same as the predicted expansion in the economy of its great regional rival, China.

How come? The reason lies with manufacturing, and behind it stands an argument for a slightly more optimistic expectation for countries such as Japan and Germany next year. Whereas in the UK and US, both with large current-account deficits in recent years, manufacturing accounts for only about 10-12 per cent of economic output, in Japan and Germany the figure is more like 20 per cent.

In all sorts of ways, this crisis is unusual. But for these rich manufacturers, it is taking a rather classical or orthodox shape. In the past, when manufacturing loomed larger in developed economies and when neither IT nor efficient transport existed, recessions were generally characterised by substantial adjustments in manufacturers stocks, or inventories.

As demand slowed, and especially as and when manufacturers became pessimistic about demand, they found themselves carrying much larger inventories than they wanted to. As a result, they had to cut production by much more than the fall in demand in order to run down the inventories. Then, when that process gets over and expectations about future demand starts to firm up, there would be a period when inventories become too small and production would be increased by more than the immediate rise in demand in order to rebuild them.

In other words, inventory adjustments amplified the business cycle. That is exactly what is happening to Germany, Japan and other big exporters now. Many car makers closed down factories in the first few months of 2009 in order to clear a big surplus of unsold cars. Demand had indeed dropped sharply — hence, world trade is expected to shrink overall by 9 per cent this year — but the inventory adjustment amplified the effect for some economies.

Now, however, that adjustment seems to be coming to an end. Japanese car factories increased their production during March for the first time in several months. Similar rebound is likely in other manufacturing sectors. Demand remains depressed, but the situation is not as disastrous as some of the data from the past six months suggested.

As a result, even though Japan is set to win the contest to be the worst-performing rich economy this year, companies there are beginning to sound rather more positive. Some recovery in GDP is expected there in 2010.
It is at that point that this downturn might start to match the finance ministers’ phrases. The US, UK and other economies, where consumer debt had become very high and savings very low, look likely to continue to suffer during 2010. Their budget deficits will be in the region of 10-15 per cent of GDP, which in turn will make voters and finance ministers alike expect that taxes are going to go up.

Not that consumption anywhere looks poised to boom. Even in China, the place that everyone is hoping will be able to stoke up some demand, the economy is currently depending on government spending rather than on consumers. That could well persist, since in China’s flexible labour market the loss of tens of millions of jobs by migrant workers is likely to mean that wages begin to fall — maintaining the country’s export competitiveness but depressing its consumer demand.

In the end, though, we must keep in mind a common feature of slumps: the causes and shape of recovery are just as hard to forecast as that of the slump itself. We cannot know how and when recovery is going to happen. That is the trouble with economies: they behave in mysterious ways.
The author is a former Editor of The Economist.

policyworld dot bw at

(Businessworld Issue Dated 05-11 May 2009)

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