Economic productivity is about expanding the size of the pie. I sometimes point out that whether the goal is increased spending, lower taxes, more support for the poor, or better protection of the environment, it's easier to achieve that goal when the economic pie is expanding. After all, if the economic pie is not growing, all priorities must pit potential winners and potential losers against each other in a zero-sum game.
A decline in global productivity is therefore bad news everywhere. For background and policy advice, the McKinsey Global Institute publishes the following resources: “Investing in productivity improvement” (Written by Jan Mischke, Chris Bradley, Mark Canal, Olivia White, Sven Smit, Denitsa Georgieva, March 24, 2024). As they point out, „Since the Global Financial Crisis (GFC), productivity growth in developed countries has slowed by about 1 percentage point.“
Remember that 1% in a given year is not a lot, but it is a cumulative effect. For example, if productivity growth had been 1% higher since the end of the Great Recession in 2009, the U.S. economy would have already expanded by about 15% over that 15-year period. The US GDP in 2024 is $28 trillion, so a 15% expansion would add an additional $4.2 trillion. A McKinsey official said: “Today, more than ever, the world needs increased productivity. This is the method.”
This report provides interesting background on global productivity. In this figure, the horizontal axis shows the productivity of each country/region, with low-productivity regions such as China and India on the left, and high-productivity regions such as North America on the right. As you can see, there is a general pattern that lower income places are likely to grow at a faster rate. Part of the reason is that low-income regions can take advantage of technologies that have already been developed and sold to high-income countries. For the IN part, this is basically an arithmetic problem. If you start very small, it's easier to double the size than if you start very large. The „productivity frontier“ is actually a thought experiment, suggesting that certain regions of the world, such as sub-Saharan Africa, Latin America, and Western Europe, may have the potential for significantly faster productivity growth. It suggests that.
Regarding China and India, I am often asked whether their growth patterns will level off and plateau. Maybe! In China in particular, the current government appears to have decided that economic growth is less important than other priorities such as military power and social control. But there is no economic law that says these countries have topped out.
This figure illustrates some notable historical growth experiences. On the far left, all countries start with a GDP per capita of approximately $2,800. This is shown as 100 in the graph. As you can see, the growth of China and India is really just following the path that South Korea has already blazed. Before that, there was Japan, Malaysia, and Thailand. Considering the fundamental factors of productivity growth: the average worker is gaining education and skills, the average job has more capital equipment, technology is improving, and companies are India and China are likely to see growth as there are incentives for improvement and innovation. It could still take decades.
What about productivity in high-income countries like the United States? The McKinsey report suggests several key reasons why growth has slowed. Two of the reasons are that the factors that drove growth in the early 2000s have changed.
Although there are many factors that influence productivity growth, two stand out as explaining the performance of developed countries in recent years. First, manufacturing experienced a wave of productivity growth fueled by the effects of Moore's Law and the proliferation of offshoring and restructuring. (Moore's Law, which states that the number of transistors in a microchip doubles every two years, is a broader indication that computer performance and efficiency are increasing while costs are falling.) These waves It brought productivity gains before the GFC (Global Financial Crisis), but they disappeared over time. The second major factor is the long-term decline in investment across multiple sectors. These two trends almost completely explain the decline in developed countries. Although digitalization was much discussed as a prime candidate for raising productivity again, its impact did not extend beyond the information and communication technology (ICT) sector.
The main prescription for further economic growth from McKinsey's analysis is to increase investment levels. To be clear, this advice is intended to include both investing in actual physical capital and investing in investments. “Intangible” capital It leads to improved knowledge, management and skills. The report states:
Weak business investment slowed non-manufacturing productivity growth by 0.5 percentage points in the United States, 0.3 percentage points in the Western European sample of economies, and 0.2 percentage points in Japan…this decline was felt across nearly every sector. The only exceptions in the United States are mining and agriculture. In Europe, only the mining, construction, and finance/insurance industries remained generally stable, while the real estate industry accelerated.
More specifically, slower growth in tangible capital (machinery, equipment, buildings, etc.) explains almost 90 percent of the decline in the United States and 100 percent in Europe. From 1997 to 2019, gross fixed capital formation in property, plant and equipment decreased from 22% to 14% of gross value added in the United States and from 25% to 17% in Europe. Growth in intangible capital (such as research and development and software) was more resilient, but could not compensate for the decline in investment in the physical world. Gross fixed capital formation in intangible assets increased from 12 percent to 16 percent in the United States and from 10 percent to 12 percent in Europe. Investments in intangible assets are necessary to improve business performance and labor productivity, but can face barriers (skills needed to scale, limited collateral and payback value), and productivity benefits may take some time to materialize.
Economic growth does not occur purely through the invention of technology, but when that technology becomes widely available. There is a gap between invention and application, also known as the „valley of death,“ because it is very difficult to go from a conceptual idea to a practical application. “Investment” is how the economy fills that gap. A McKinsey writer said: “After the global financial crisis, investment fell sharply and continuously, and nothing could replace it. But today, investments in areas such as digitization, automation and artificial intelligence are driving productivity gains. It could fuel a new wave.'' They are less certain about the direction of future growth. For example, I think genetics and materials science could play a big role as well. But without more investment, we won't even know what we're missing.