Data source: The Economic Report of the President, 1999. U.S. Government Printing Office.
Today I shall make a new use of the blog. I will use it go on record as being aware of two possible weaknesses of an hypothesis that I have recently presented in an article just accepted for publication. I apologize to my regular readers if what follows proves to be boring stuff. It is excerpted from an e-mail sent this week to Dr. Willem Spanjers, head of the International Network for Economic Research (INFER) in the U.K.
Dear Dr. Spanjers:
I am most grateful for INFER's acceptance for publication of my article, "Operating at the Rate of Consumption: Did Inventory Reductions in U.S. Manufacturing Prevent Recessions During the 1990s?" ...
Just to make sure there is a record of my having thought about such things, I want to share with you two contrary hypotheses offering possible explanations for the behavior of manufacturing inventory turnover as described in my article, "Operating at the Rate of Consumption." Please comment, and then save this message in the INFER files, lest I ever have to demonstrate that I am a thinker as opposed to an ideologue, or manufacturing chauvinist. You may even want to consider publishing this missive in a newsletter, as these hypotheses might provide directions for research, should anyone decide to follow up on my piece.
Contrary Hypothesis No. 1: The increase in the ratio of Cost of Goods Sold to Inventory between 1982 and 1997 was the result of the shift of American manufacturers from FIFO to LIFO accounting, coupled with inflation of the US dollar during that period.
The apparently systematic and prolonged increase in the ratio of sales dollars to inventory value from 1982 through 1997, as seen in The Economic Report of the President and reported in my article, may be an accounting mirage that resulted in no way from, or only partly from increased physical turnover of goods in inventory at American manufacturers. Assuming no change in the average Gross Margin ratio of the manufacturing sector as a whole, the pattern of growth in Sales/Inventory as reported in the subject article would be matched closely by the pattern of growth in Inventory Turnover, defined as the ratio of Cost of Goods Sold (CGS) to Inventory. We know that there was during most of those years both inflation in the American dollar and a continuing tendency of American corporations to shift from First-In-First-Out (FIFO) accounting for the cost of goods sold to Last-In-First-Out (LIFO) accounting, done to reduce income taxes by increasing reported product costs to their inflated levels. The long term effect of this shift in accounting practice would be to relieve each year from inventory the current manufacturing costs of items sold, leaving in ending inventory records the less costly units made previously. This method of accounting was permitted for income tax purposes, and if employed for tax purposes, was required also on the financial statements. Hence, all companies employing LIFO accounting could be, ceteris parabus, expected to show increases in inventory turnover as their CGS inflated each year. I have little doubt that this hypothesis will explain in part the effect reported in "Operating at the Rate of Consumption." The interesting question is whether it explains it all.
Contrary Hypothesis No. 2: The increase in the ratio of Sales to Inventory between 1982 and 1997 in the United States was the result of the outsourcing of low-margin manufactures to other nations.
The apparently systematic and prolonged increase in the ratio of sales dollars to inventory value from 1982 through 1997, as seen in The Economic Report of the President and reported in my article, may be the effect of the export by American Industry of such low-margin industries as consumer electronics, shoemaking and textiles, leaving in the sector a higher-margin mix of manufactured goods, such as pharmaceuticals and software products. In other words, my use in the article of the proxy Sales/Inventory instead of Inventory Turnover (CGS/Inventory) may explain much or all of the observed change. If the export of low-margin industries has been continuing steadily since 1982, then the average gross margin (Sales - CGS) of America's manufacturing sector might have been increasing steadily, creating the observed effect.
In closing, I know that a clever researcher with sufficient time will be able to address both of these contrary hypotheses and demonstrate either their validity, or lack thereof. I have simply never found time to do so. I stand ready to discuss these and other related ideas with any who may wish to pursue them, and to encourage their efforts.
Sincerely yours,
Duncan C. McDougall
Plymouth State University,
Plymouth, New Hampshire, USA 03264
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