Excess Inventories Can Lead to Layoffs

As the recession deepens, a sharp falloff in sales has left many American companies with growing stockpiles of products and materials, from cars to computer equipment to steel.

That can translate into lower prices for consumers — but it's bad news for the economy as a whole.

Inventories had been declining before they unexpectedly jumped amid faltering sales during the last three months of 2008. That bolstered the gross domestic product — the broadest measure of the economy's health — because high inventories means lots of stuff is being produced. But the figures left experts worried.

Economists say excess inventories may not be cleared until the middle of this year. That could mean more layoffs at companies as they scale back production and try to reduce stockpiles of goods to bring them in line with weaker sales.

Although retail sales jumped 1 percent in January, reversing a six-month downward trend, analysts caution the relief is unlikely to last.

Here are some questions and answers about inventories and how they may affect the economy, companies and consumers.

Q: What types of inventories are there?

A: Wholesale inventories, which are held by distributors who generally buy from manufacturers, make up about 25 percent of all business stockpiles. Factories hold a third and the rest are held by retailers.

The recent accumulation of inventories has been seen primarily in the manufacturing sector.

Q: Why do high inventories pose a problem?

A: Rising inventories could mean job cuts. Companies typically must cut production to match falling sales, and that can mean laying off workers or stopping deliveries.

The U.S. economy has lost 3.6 million jobs since the recession began in December 2007, with about half those cuts occurring in the past three months. The manufacturing sector has been hardest hit nationally, with about 1.1 million job losses, because of shrinking demand for products.

Inventories become a problem only when they grow because of lower-than-expected sales. They would not be a problem for the economy if sales were growing in tandem.

Companies could be hurt by the decreasing value of inventories as demand for their products wanes. Some businesses may have stocked up on raw materials when commodity prices were soaring last year, only to see prices plunge toward the end of 2008.

"If commodity prices are falling, generally every piece of copper, every piece of steel that you have, you're taking a capital loss on because you can buy it cheaper now than you could before," said Daniel J. Meckstroth, chief economist for the Manufacturers Alliance/MAPI, a public policy and economics research organization. "You want to run that out as fast as possible, which means you don't order new copper or new steel (or) plastics until you get rid of the old stuff."

Q: How much have inventories and sales of manufactured goods changed in recent months?

A: Manufacturers' inventories of computer and electronic products, for example, rose 6.8 percent in December compared with the same period a year earlier. At the same time, sales of those products dropped 7.1 percent.

"That's a really striking imbalance that points toward further reductions in new orders for high tech equipment and more cutbacks in production," said John Lonski, chief economist at Moody's Investor Service.

Although auto dealership inventories slid 4.9 percent annually in November, sales fell much more steeply, tumbling 23 percent. That suggested auto dealerships would cut back further on new orders of cars and light trucks. In December, wholesale inventories of automotive products climbed 11 percent. That compares with a 28 percent year-over-year drop in sales.

Q: How have businesses responded?

A: In December, U.S. businesses slashed inventories by 1.3 percent — the biggest amount in seven years — as they coped with plunging sales in a dismal holiday season. That was far worse than the 0.9 percent decline analysts expected, and it marked the fourth straight month that companies cut their stockpiles, matching a similar stretch of reductions that ended in August 2003.

Businesses cut inventories by selling or using stockpiled products or materials, and by halting new orders.

Wholesalers cut back on inventories in December by the largest amount in nearly 17 years. It was the fourth straight monthly decline. That means wholesalers may order fewer new goods, leading to reduced production and perhaps more layoffs.

Sales at the wholesale level, meanwhile, dropped 3.6 percent in December, slightly more than analysts' expectations, but less than November's record 7.3 percent drop.

Q: What do high inventories mean for consumers?

A: In the near term, high inventories mean there may be excess supply of manufactured goods, which puts downward pressure on prices. But excessive inventories result from lower-than-expected spending, which threatens the jobs of many workers — who are, after all, consumers too.

Q: How have companies changed their management of inventories?

A: Decades ago, when manufacturing and inventories comprised a bigger share of the U.S. economy, big inventory swings could cause recessions. But the inventory kept by manufacturing companies generally has declined sharply over time, so production more closely matches orders — an approach known as "lean manufacturing."

Q: When will current high inventories be worked off?

A: Economists say inventory liquidation probably will continue through the second quarter of the year and perhaps into the third quarter. Consumer spending may flatten or increase slightly with the introduction of tax cuts in President Obama's economic stimulus package. That would boost sales and help bring down inventories.