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Economy Is Reversing Course, According to Business Analysts

By John M. Berry
THE WASHINGTON POST -- Since the middle of 2000, businesses throughout the economy have been reducing their stocks of unsold goods by slashing their orders for replacements below the level of their sales. As orders fell, so did production and the economy fell into a recession last spring.

Now this powerful process is reversing itself and many forecasters expect it to add significantly to U.S. economic growth beginning with the current quarter.

Over the past 18 months, the U.S. economy has grown at an average annual rate of only 0.6 percent, an average dragged down when economic activity declined in last year’s third quarter after September’s terrorist attacks.

But during the same year and a half, the big swing from accumulating inventories to liquidating them at a record pace late last year clipped an average of 1.25 percentage points off the U.S. growth rate. In the fourth quarter alone, the rise in the gross domestic product at a paltry 0.2 percent annual rate would have been increased to nearly 2.5 percent except for the added liquidation of unsold goods.

“Inventory liquidation appears to have passed the point of maximum intensity, so stocking should be a solid positive for real GDP going forward,” economists at Goldman Sachs Group Inc.told their clients last week.

“Total business inventories fell 0.4 percent during December, following declines of 1.6 percent and 1.2 percent in October and November, respectively,” the Goldman Sachs economists explained. “An end to the drawdown in motor vehicle stocks played the largest role in the slowdown, but manufacturing, wholesale and nonauto retail firms also liquidated goods less rapidly (during the fourth quarter).”

In the most recent 12 months, the level of inventories fell 6 percent, a far cry from the nearly 8 percent increase in the 12 months ended in mid-2000.

The really good news about inventories at this turning point in an economic cycle is that businesses do not have to begin to rebuild their inventories to have a major impact on growth. Instead, all they have to do is to decide that they do not want to continue reducing their inventories -- and there is growing evidence many firms have reached that point.

The arithmetic of the impact of inventories on economic growth works like this:

When firms do not change their policies on inventories from one quarter to the next, inventories do not affect the economy’s growth rate. That is true whether businesses are cutting inventories or building them up.

What does matter is when firms collectively move in either direction. For instance, in the fourth quarter of last year, businesses liquidated inventories at a record annual rate of $121 billion. That pace was almost twice as much as the third quarter’s $62 billion annual rate.