I started economic forecasting in 1975, which coincided with one of the largest ever falls in inventories as the economy adjusted to the first oil crisis of 1973/4. Perhaps because of this I have developed what some might think an unhealthy interest in inventory fluctuations.  But with former Fed Deputy Chairman Alan Blinder estimating that inventory fluctuations can account for between a third and a quarter of the changes in GDP in a downturn [1], arguably it makes sense for short term forecasters to stay interested.

 

The idea that inventories might show a sharp swing because of Brexit was suggested to me by former Cebr economist Angus McCrone, now a Bloomberg editor. His theory is that companies will accumulate inventories pre Brexit and will gradually run them down afterwards. This makes sense given that the cost of holding stock is close to its historic low and there is uncertainty both about the form of Brexit and its effects. This note tries to quantify the scale of the effect and see how it might create a difference between the observed path of GDP and its underlying trend.

 

It is hard to find an equivalent episode to Brexit that can be used to check on past experience. Past major inventory adjustments in the UK have more often reflected either unexpected sharp downturns in demand or difficulties with obtaining finance during credit crunches. So our estimates have to be based on anecdotal evidence, surveys and intuition.

 

The government papers on the impact of a ‘No deal Brexit’ have highlighted the potential disruption – difficulties in obtaining medicines, sandwich ingredients and various other products. But the single largest cause of disruption will undoubtedly be raw materials and semi-manufactures. Of the £260 billion of goods imported from the EU last year about £100 billion fall into these two categories.

 

Making the assumption that companies will want to stock an additional three months’ worth of raw materials and semi-manufactures imported from the EU and an additional months’ worth of supplies of finished manufactures would imply additional imports of £38 billion, a bit less than 2% of annual GDP. Obviously, since these are imports, they do not directly add to GDP but there is associated production and processing associated with such imports and they should add about a quarter of this amount (about £10 billion) to GDP. And it is probable that there will be some import substitution although there will likely also be some substitution away from UK production for imports into other EU Member States.

 

There is some evidence that a rise in inventories is already happening (eg the rise in inventories in Q2 2018 was greater than the rise in GDP), though it is not necessarily Brexit related. Our rough calculation is that GDP will be boosted by 0.5% on average above the underlying trend in the three quarters from July 2018 to March 2019. And that it will be reduced by an equivalent amount for the rest of 2019. This makes a post Brexit mini recession almost inevitable.

 

 

[1] Quoted in Andreas Hornstein, Federal Reserve  Bank of Richmond Inventory Adjustments and the Business Cycle (1998) ​

 

Contact: Douglas McWilliams, dmcwilliams@cebr.com