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There was a time when levels of inventories, or stocks, drove the economic cycle. Before the era of cheap computing power, matching inventories to future demand was fiendishly difficult. When demand fell unexpectedly, as in recessions, companies ended up with unwanted inventories. They slashed orders, hitting producers, and reinforcing the downturn. When companies ordered too little, demand for new products surged, fuelling demand and inflation. Inventories yoyoed and so did demand.
In this way inventories magnified, and indeed drove, the ups and downs of the economic cycle. The US economist, Alan Blinder, has estimated that in the eight US recessions between 1945 and 1982 falling inventories accounted for a remarkable 87% of the fall in GNP. No wonder economists pored over inventory data for early signs of faltering demand. Books and academic papers were written on the inventory cycle, economists built careers analysing it.
That started to change in the 1980s. The share of the most inventory-heavy sector, manufacturing, was shrinking in most western economies. Supply chains became longer, more complex and more international. Improvements in computing power provided firms with more detailed and timelier data, enabling them better to forecast demand. High interest rates added to the cost of holding inventories and provided strong incentives to reduce inventories.
All of these factors helped drive a shift to just-in-time supply chains which minimise inventories. That process was helped, from the 1990s on, by declining levels of macroeconomic volatility.
Growth ran faster and was more stable. Unemployment fell and inflation hit multi-decade lows. The big problem of economic management – how to avoid recessions and maintain strong growth – seemed to have been solved. Economists variously attributed this happy period, what became known as the Great Moderation, to globalisation, the end of the Cold War, technological change, independent central banks and greater political consensus on economic management (this was the era of Bill Clinton and Tony Blair).
In such a benign, predictable world companies could run even lower levels of inventories. Activity was easier to forecast and globalised supply chains could respond quickly to any unexpected shifts in customer demand or preferences. Macro stability made it easier to manage inventories, and, in turn, better inventory management contributed to lower levels of economic volatility. It was a virtuous circle.
Then came the pandemic, an event that was in no one’s business plans. Just-in-time inventory models came under tremendous pressure. As economies reopened the chronic mismatch between low inventories and pent-up demand created shortages and fuelled inflation. The inventory cycle mattered again.
That cycle has changed course, just as a 1950s macroeconomist would have predicted. The post-pandemic surge in demand has raised prices, brought forth new supply and dampened demand. Now shortages are starting to give way to rising, and in some cases excess, inventories, and lower prices.
The Purchasing Managers survey reports that manufacturing delivery times across the developed world have fallen sharply from their peaks. Unprecedented shortages of shipping containers have been followed by a glut. A record backlog of 109 container vessels that had built up outside the ports of Los Angeles and Long Beach this time last year is no more. Soaring output of semiconductors has overshot demand creating a glut of memory chips, with prices halving from last year’s peak. In textbook fashion excess inventories have caused manufacturers to scale back production sharply, with South Korea’s chip output falling at the fastest rate since the global financial crisis.
The same story can be seen at a company level. Despite making progress in reducing excess stocks last year, Walmart revealed in November that its US operation was holding $1bn in excess inventory. Clothing retailer GAP has offered aggressive discounts to shift excess stock over the winter holiday period. Tesla, which struggled to meet demand as the economy rebounded from the pandemic, is facing an oversupply of new cars and has cut prices by up to a fifth in the US and Europe.
There are some important exceptions. The supply of agricultural produce is constrained by the war in Ukraine and vulnerable to adverse weather. Bad weather or political developments in Europe or the Middle East could yet strain energy supplies.
Yet outside these areas the inventory cycle is back, and with a vengeance. Inventories and supply chains have been tested as never before, and once again, they matter. Economists and policymakers are poring over supply and inventory data in the way they used to back in the 1980s.
By and large the lean inventory system has coped well with swings in demand for which it was not remotely designed. But vulnerabilities have also emerged and not just in relation to unexpected shifts in demand. Rising tensions between western countries and China and Russia have created new risks to supply.
The search for ever greater efficiency was behind the rise of today’s lean inventory system. Those supply chains were a product of a period of exceptional stability. With the Great Moderation behind us resilience is likely to play a bigger role in the evolution of tomorrow’s supply systems. Once again, inventories matter.