For the third day it is very sunny here in Washington DC, after we had our fair share of rain over the weekend. Spring is coming and the popular saying that “after the rain comes the sun” is once again firmly confirmed.
The economic equivalent of this saying might well be “after destocking comes restocking”. Destocking was a crucial factor in the collapse of production during the crisis, as it is during every recession. And restocking is a key element during the recovery, albeit in a complicated way. So, it is not a surprise that the world economy is waiting for that restocking.
As demand fell, and uncertainty increased, inventories were sharply reduced during the crisis. That meant that producers met part of the remaining demand by depleting stocks. As a result, production fell much faster than demand. Partly because of the destocking the rain turned into a torrent.
From there on the inventory dynamics became (as usual) a bit more obscure, but actually quite fascinating. Even as the rundown of inventories continued, the negative impact on production growth quickly dissipated. That is always surprising, but the explanation is based on a simple mathematical rule: growth of production depends on the change in stockbuilding, or the change in the change of inventories. If the inventories continue to fall, but at a more moderate rate, then the impact on production growth actually turns positive. That is what indeed happened during the latter part of 2009 in many countries.
Korea provides a nice illustration. The numbers are shown in two graphs below. The first one shows the level of inventories and the stockbuilding (i.e. change in stockbuilding). The level of inventories is actually not observed, but it is easy to derive at a plausible estimate. The graph shows the sharp decline in inventories at the start of the crisis from around 50% of GDP to 35% of GDP. Stockbuilding was strongly negative, but the rate of decline in the inventories was slowing during the last two quarters of 2009.
The (perhaps surprising) impact on the growth of Korea’s GDP is shown in the second graph. First a sharp negative impact, but then GDP growth was temporarily boosted as the destocking slowed. The wait is now for an additional boost in GDP growth. That one comes when destocking completely stops and restocking starts. That is when the real sun breaks through the data. I will follow this story in this blog as more data becomes available. In the mean time, let me enjoy the sunshine in Washington DC.