Reducing the drag on the American economy

By Lenny Mendonca and Laura D’Andrea Tyson

As Congress debates the best way of closing our budget gap and narrowing our deficit, we are only now beginning a real discussion of what should be the overarching goal of economic policy—the growth and renewal of the US economy.

As Congress debates the best way of closing our budget gap and narrowing our deficit, we are only now beginning a real discussion of what should be the overarching goal of economic policy—the growth and renewal of the US economy.

The fact is, any reasonable budget, let alone one that actually begins to bring down our massive deficit, is going to require GDP growth. Our research suggests that the United States must increase its rate of productivity growth from 1.7 percent today, to 2.3 percent as soon as possible. That is, the rate at which our productivity grows must jump by 34 percent. That is not going to happen under any current recommendations, Democratic or Republican. Indeed, it is not going to happen until we free ourselves from four anchors that have acted as a drag on growth in this country for many years now: lagging productivity in healthcare, education, energy and infrastructure, and government services.

A closer look shows that each of these areas offers tremendous opportunities not just to cut costs but to bolster productivity growth by adopting new approaches and applying proven best practices.

Healthcare

In 2008, the United States spent $2.3 trillion on healthcare—that’s more than we spent on food, and more than China spent on everything. Adjusted for population, we spend $650 billion more on healthcare than any other developed country, yet our outcomes are no better. Much of this $650 billion in excess costs is driven by characteristics of our system that have proven difficult to change, including unusually high costs for outpatient programs, local market oligopolies, a failure to apply known best practices, price-insensitive patients who don’t see the cost of their healthcare and contribute little toward paying for it, and inefficient healthcare administration.

Recently passed healthcare reform dramatically expands coverage, but we must now shift our attention to bending the cost curve. With an aging population, the demand for healthcare services will inevitably rise—indeed, even throughout the great recession, unfilled positions in healthcare in the United States have never dropped below 500,000. We need to find ways of meeting current and future demand at lower costs. Unless we do so, we will never be able to make progress on the deficit or overcome such a large “productivity tax” on our economic growth. So how do we achieve a more productive and value-based healthcare system? The way to start is by demanding more transparency, by designing better incentives, and by scaling approaches we already know work across the country.

Education

A persistent gap in academic achievement between children here and those in high achieving countries deprives the US economy of $1–$2 trillion of output per year]. Had we closed the achievement gap between low-income students and those who were better off by 2008, GDP in that year would have been $400–$670 billion higher. It wasn’t always like this. As recently as the 1960s, the United States led the world in a variety of educational outcomes. This deteriorating performance is not primarily the result of spending too little. Spending on education in the United States is among the least cost-effective in the world. By one measure, we get 60 percent less for our education dollars in terms of average test score results than do other wealthy nations.

Whether you compare the average US results to the highest performing school systems in the world (think Singapore, Finland, and Korea), or the highest performing school districts in the US, or look at differences between students of different economic means, the gaps in educational achievement by US students represents an enormous loss of human capital. In an economy increasingly dependent on knowledge to compete, the achievement gap is both a moral tragedy and an economic crisis. Recent attempts to recruit teachers from the top third of college graduates indicate that significant improvements can be generated by the expenditure of modest sums. Indeed, with most states under severe budget strains, now is the time to have a real debate about the kinds of reforms we need, to ensure that new funding actually improves educational outcomes.

Energy efficiency and infrastructure

Setting aside the endless debates on climate and carbon, research from the McKinsey Global Institute (MGI) shows that upgrading basic energy infrastructure across the nation and improving home efficiency standards over time would generate almost $200 billion in annual savings from lower energy costs. In other words, these are investments that pay off handsomely, both in financial terms and in terms of the environment. A wide range of energy market failures currently discourages consumers and businesses from embracing higher energy productivity, and deters investors from making the capital outlays that would help end users overcome initial financing barriers.

The United States could reap substantial savings by improving the way we go about identifying energy infrastructure investments as well as the way we finance and grant public access to them. Publicly financed projects should be initiated based on an overall energy policy rather than parochial concerns. Carefully structured user fees could better align energy supply and demand. With proper regulation and market price signals, we should be able to rebuild and more effectively manage the demand on these important investments in our energy infrastructure. With the right structure and revenue streams, public-private partnerships could help finance these investments with private capital. The resulting projects could create jobs for the more than 20 percent of construction workers who are now unemployed.

Government efficiency improvements

Inefficiencies in the provision of government services are the final anchor holding us back. The opportunity here is worth $100–$300 billion per year. This is the size of the annual savings that could result if the US public sector could simply cut in half its estimated “efficiency gap” with similar private sector organizations. This would require improvements in efficiency of between 5 and 15 percent, and could be accomplished without tackling super-charged issues such as defense spending and public-sector employee benefits. This is simply about making basic operations better. Managing in the public sector is undoubtedly complicated given multiple stakeholder demands, but many management practices common in the private sector like lean processes, which allow organizations to get more done with the resources at hand by organizing more effectively and working smarter, are much less common in government. Application of known best practices can help eliminate waste, enhance quality, and improve public- sector jobs.

None of this is easy, but the most striking insight of our recent MGI work on growth and renewal is that we could get three-quarters of the necessary 34 percent increase in our labor growth productivity rate without making any changes in the business and regulatory environment. Indeed, today we are operating in a dual speed economy. Private-sector companies (especially those subject to global competition) are performing remarkably well—as proven by healthy corporate profits and equity markets. However, it will be impossible for the United States to grow and innovate at the scale necessary for future generations without cutting ourselves loose from the four anchors holding us back.

Some of these savings will take years to realize, but there is no question they can be achieved. These anchor sectors each suffer from a lack of innovation and low investment in research and development, inadequate adoption of information technology and management best practices, poor transparency into performance, and often a lack of meaningful competition. Indeed, the growing imbalance between the size of the workforce and America’s retiree cohort will make it necessary that we overcome these barriers as soon as possible, as a younger generation struggles to support the swelling ranks of the retired. It is ultimately a question of whether we get to work now, or are forced into dreadful choices later on. In the meantime, our shortcomings in these four areas impose on us the economic equivalent of a permanent national recession more profound than the one from which we are now slowly emerging.

This article was originally published in McKinsey's What Matters.

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