Inventories in Developing Countries: Levels and Determinants - a Red Flag for Competitiveness and Growth

Abstract

High inventory levels in developing countries increase the cost of doing business and limit productivity and competitiveness. Improvements in infrastructure (roads, ports, and telecommunications) and in market development can help to significantly reduce inventory levels (and thus the cost of doing business), especially when accompanied by effective regulation and the development and deregulation of associated markets.

Raw materials inventories in the manufacturing sector in the 1970s, 1980s, and 1990s were two to five times as high in developing countries as in the United States, despite the fact that in developing countries real interest rates are at least twice as high. Given the high cost of capital in most developing countries, these high inventory levels have an enormous impact on the cost of doing business and on productivity and competitiveness. 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 of these differences.

Cross-country estimates show that a one-standard-deviation improvement in infrastructure reduces raw materials inventories by 27-47 percent. Poorly functioning markets, as measured by the ratio of transfers and subsidies to GDP, are also an important factor, with a one-standard-deviation improvement leading to a 19-30 percent reduction in raw materials inventories.

Guasch and Kogan show that these reductions in raw materials inventories are not offset by a reduction in finished goods inventories upstream. The policy implications are clear and strong. Improvements in infrastructure (roads, ports, and telecommunications) can help to significantly reduce inventory levels (and thus the cost of doing business), especially when accompanied by effective regulation and the development and deregulation of associated markets.

This paper - a joint product of the Office of the Senior Vice President and Chief Economist, Development Economics, and the Finance, Private Sector, and Infrastructure Sector Management Unit, Latin America and the Caribbean Region - is part of a larger effort in the Bank to assess and improve the competitiveness and productivity of developing countries. The authors may be contacted at