Peter Warburton – 9 September 2020
The recorded value of inventories in US and UK plunged in the June quarter as consumers cleared the shelves and fractured supply chains could not cope. However, there is no estimate of the inventory that was rendered worthless by the shuttering of factories and shops. The commercial losses sustained and the threat of further Covid-19 lockdowns has created an environment of extreme caution regarding re-stocking. Tight inventory conditions will allow profit margins to be restored and inflation rates to jump.
The essence of physical economic activity is the transformation of material inputs into saleable items. This transformation should not be taken for granted: it is inherently risky. At any moment, working capital is tied up in unused materials – which might not be resaleable – work in progress, which is unsaleable and finished goods, which may be saleable, but only provided they can be “brought to market”. The economic heart attack prompted by the global pandemic destroyed a significant proportion of work in progress and perishable finished goods.
In round figures, the value of UK inventories is typically 10 per cent of GDP, but inventory is carried disproportionately by the manufacturing sector (33 per cent of value added) and the distribution sectors (29 per cent of retail sales value). According to the preliminary national accounts data for Q2, released on 12 August, the value of inventories fell by more than £7.5bn. A sectoral breakdown of this figure is not yet available, but we can hazard a guess that the distribution sectors were strongly represented, as they were in the first quarter. Retail and wholesale inventories fell by £4.3bn in Q1 when the aggregate decline was only £2.2bn. I estimate that distribution inventories fell by a further £7bn in Q2 and figure 1 shows the impact on the inventory-to-sales ratio this would have.
A similar picture is observed in the US, pictured in figure 2. As the data is monthly, it provides a more detailed account of the gyrations the inventory-sales ratio, as the denominator collapsed due to lockdowns. The June data reveals a plunge in the ratio, with the most dramatic declines for motor vehicle and parts dealers (down 32 per cent on June 2019) and building materials, garden equipment and suppliers (down 19 per cent). Conversely, the inventory ratio for clothing and accessories was still 23 per cent higher than a year ago, reflecting the difficulty of shifting seasonally inappropriate stock.
Some of the decline in inventories may be permanent as ordering shifts online with relentless force. Amazon’s regional distribution centres are more efficient in inventory management than a thousand retail outlets. The widespread adoption of a pre-ordering model, where the customer pays upfront for an item, which only may be produced after the order has been taken, will also reduce the need for inventory.
Nevertheless, the depletion of inventories is particularly important at a time when consumer demand and economic activity are ramping back up. Goods producers are being asked to match a faster run rate of retail sales and replenish inventory at the same time. For domestic production, this may not be too demanding – although US trucking capacity is still well below pre-Covid levels – but for imported goods there could be material delays before the shelves are restocked. Notably, delivery times are still unusually high and freight rates have rebounded strongly. In the past, inventory pressure has been a good indicator of coming inflation: there is every reason to expect it will again.
Figure 1
Data source: Office for National Statistics
Figure 2
Data source: US Census Bureau