The Expert: Business Inventories Function as Economic Indicators

The Department of Commerce announced last week that total business inventories, stocks of finished goods, work in progress and raw materials, decreased 1.3 percent in February, in line with expectations. The largest decline took place across the categories of furniture, electronics and appliances, consumption of which can be deferred until consumer confidence returns.Prior to every recession since World War II, unsold merchandise would accumulate in company warehouses. And past recessions have, in part, been attributed to excessive inventory levels. Historically, adjustment was slow and inventories did not meaningfully contract until the recession was over. Companies now employ minimal safety stock and tight inventory management strategies to become more efficient, thereby reducing the necessary overall size of inventories, even while the global supply chain has lengthened and become more complex. This progression is apparent when examining the current recession. For the first time in U.S. history, inventory levels hit a record low six months into the recession.In the first quarter of 2008, companies began slashing output and stockpiles well before demand started to plunge. Businesses continued to trim inventories, keeping pace with weakening demand through the remainder of last year. While there is more contraction to come, the adjustment has been quick, which will mean a more rapid rebound in demand during recovery.Also, there is far less “shadow,” or underutilized, space in the market, as better inventory management allows for better space planning. Additionally, new supply coming onto the market is minimal, and the spigot for new development starts has been shut off. While vacancy rates are rising and demand continues to contract, supply is expected to be at a record low in 2009. Therefore, with the lack of new supply, combined with a reduction in shadow space, even a nominal uptick in economic growth will trigger businesses to increase orders for new goods, incrementally contributing to economic growth.Owing to lean inventory levels throughout the supply chain, a sharp rebound is likely when the economy starts to recover, orders increase and companies have to act fast to meet demand.David Twist is vice president of research for AMB Property Corp.