Yesterday's new economic data confirm the same old story: the economy shrunk by 1.5% in the last three months of 2008.
But as David Smith points out, there may actually be a sliver of a silver lining in the storm clouds:
"Within the figures, consumer spending fell by 0.7% in the fourth quarter and net trade made a small contribution to growth, with exports falling at a marginally slower rate than imports. The eyecatching figure, however, was the big drop in inventories, £2.6 billion at 2003 prices, without which the Q4 GDP decline would have been very much smaller. That bodes well for the prospect of smaller GDP declines in the coming quarters."
In your typical recession, businesses tended to over invest in capacity, so when demand fallsoff in the recession, they are left with warehouses of unused stocks. Production halts as these stocks are run down, and only picks up once the inventory overhang is sufficiently depleted.
That's why David Smith and other journalists are so interested in the drop in inventories. With most companies seeing demand fall of a cliff at the end of last year, they were inevitably stuck with extra stock. The supposedly sharp drop in inventory suggests that the worst maybe over as companies may start producing again.
I've done a bit of digging into whether an inventory overhang would lead to a nasty economic hangover. And my conclusion is that this may not be your typical recession.
With the advances in technology over the past decade, most businesses are much better at managing their supply chains. In manufacturing, for example, just-in-time and lean manufacturing have made operations more efficient and business less reliant on inventories. And this is true across the economy, where the relative importance of stocks is declining.
One way to measure this effect is the stock-to-turnover ratio. If companies really are more efficient, we should see them (and their turnover) growing, without a similar increase in stocks. But if the traditional story line hold true...that inventories become bloated in the run up to the recession...we should see inventories increase relative to turnover just before the recession.
The Office of National Statistics Annual Business Inquiry shows that from 1995-2007, the stock to turnover ratio fell by an average of 13.2% across the whole economy and by almost 25% in manufacturing.
One sector, however, did see a big build up in inventory relative to turnover: the real estate & business services sectors saw their stock-to-turnover ratio increase by over 130% in the run up to the recession. (Why am I not surprised.)
So even though the drop in inventories was eye-catching for its sheer absolute size, relative to GDP, it's a much smaller drop than in previous recessions. That's not because there is worse to come, but because inventories are simply less important to the business cycle than they used to be.