Inventories in Developing Countries: Levels and Determinants, a Red Flag on Competitiveness and Growth

We find that raw materials inventories in the manufacturing sector in the 1970s and 1980s and 1990s were two to five times higher in developing countries than in the United States, despite the fact than in most developing countries real interest rates are at least twice as high. Given the high costs of capital in most developing countries, the impact of those high inventory levels on the cost of doing business, and productivity/competitiveness is enormous. Poor infrastructure and ineffective regulation as well as deficiencies in market development rather than the traditional factors used in inventory models such as interest rates and uncertainty are the main determinants and explain these differences. Cross-country estimations show that a one standard deviation worsening of infrastructure increases raw materials inventories by 27% to 47%. Poor functioning markets, as measured by the ratio of transfers and subsidies to GDP, are also an important factor with a one standard deviation change leading to a 19% to 30% increase in raw materials inventories. We show that these increases in raw materials inventories are not offset by a decrease in finished goods inventories upstream. The policy implications are clear and strong, improvements in infrastructure, better regulation and development and deregulation of markets.