If demography is destiny, global growth is headed for a slowdown. History, however, suggests that productivity could ride to the rescue.
Throughout history, economic growth has been fueled by two factors: the expanding pool of workers and their rising productivity. From the perspective of rising prosperity, however, it is productivity that makes all the difference. Disparities in GDP per capita among countries—or between the past and the present in the same country—primarily reflect differences in labor productivity. That in turn is the result of production and operational factors, technological advances, and managerial skills. As managers improve efficiency, invest, and innovate to be competitive, their collective actions expand the global economy.
The past 50 years have seen unusually rapid growth in GDP and GDP per capita (Exhibit 1). How likely is this growth to continue? Given the demographic drag that’s already coming into play, prospects for future growth—and the related implications for debt levels and future pension liabilities—will depend very heavily on sustained productivity growth. But arriving at useful forecasts of the productivity of future workers can be difficult.
It may be helpful to look back at lessons from the research of the McKinsey Global Institute (MGI), which during the last 25 years has analyzed the causes of differences in labor productivity between industries, sectors, and countries. These lessons help explain why some have thrived while others have fallen behind. To help celebrate McKinsey Quarterly’s 50th anniversary—and to examine the future prospects for economic growth around the globe—MGI looked forward and backward in time at productivity performance and economic growth.
We found that a simple extrapolation from the past does indeed suggest an impending decline in global growth—the result of a sharp decline in the number of available workers. A closer look, however, reveals substantial opportunities to maintain relatively high GDP growth rates through continued growth in labor productivity. Whether these opportunities are realized will depend on the reforms of policy makers and the ingenuity of managers and engineers, particularly in sectors with big productivity gaps. Can companies harness machine learning and artificial intelligence to raise the productivity of knowledge workers? What potential remains for shop-floor productivity gains as telematics and other advanced technologies pave the way for major process improvements? How far will we be able to expand the talent pool through the fuller economic engagement of women?
The bottom line is this: while half-century forecasts are hazardous—particularly for the forecaster!—a productivity-based perspective on the future of growth suggests that a demographic slowdown today need not lead to economic stagnation tomorrow.
The cross-country productivity approach
For nearly a quarter century, the McKinsey Global Institute has focused on the role productivity growth plays in economic performance. Along the way, MGI’s findings have challenged conventional thinking about the sources of productivity growth and clarified two primary lessons for policy makers and executives. The first lesson is to accept no sweeping generalizations regarding the state of a country’s competitiveness or the prospects for its future economic performance; macrolevel insights can be generated only by rolling granular examination of individual businesses up to the industry, sector, and country levels. The second lesson is to recognize productivity improvements as the primary source of sustained and long-term economic growth. To raise economic performance, we must focus on the causes of productivity differences among companies, industries, sectors, and countries.
Some examples help illustrate these lessons. The first requires going back to the 1970s and 1980s, when the export prowess of Japan led to a consensus, in the United States and Europe, that its economic performance had surpassed theirs. MGI tested this pervasive thinking through a set of cross-country comparisons at the sector level in each economy. These revealed that while Japan’s steel industry, for example, was 45 percent more productive than the US one, its food-processing industry was only a third as productive (Exhibit 2). By examining a range of representative sectors at the microeconomic level, MGI debunked the popular notion that the Japanese economy, overall, was outperforming the US economy.
This same set of cross-country productivity comparisons also highlighted the ways in which operational factors, from scale to production processes, had a far greater influence on productivity than education, the usual suspect at the time. Moreover, MGI found that productivity was highest in industries and countries that are exposed to, rather than protected from, competition. The research also revealed a shadow side of Japan’s strong productivity in the automotive and consumer-electronics sectors: weak service-sector performance (Exhibit 3). Low productivity in the service sectors, which accounted for a growing majority of jobs, soon became the Achilles’ heel of Japan’s overall economic growth.
The overarching insight to emerge from this early MGI research continues to hold a powerful validity: companies, industries, and nations can change their economic prospects only by identifying what it would take to improve their productivity growth. Sweden, for example, raised it by removing land and pricing barriers identified in a 1995 MGI study. These policy actions enabled the productivity of Sweden’s retail sector to rise at up to twice the rate of most of its counterparts in the rest of Europe during the decade that followed.
Breaking down the numbers
To get a handle on the prospects for global growth going forward, MGI took a comprehensive look at the sources of growth in the past. The global economy today is six times its size in 1964, having risen from $14 trillion to $84 trillion. In that time, the global economic balance has shifted between regions, particularly from Western Europe and North America to Asia. The story behind global GDP growth over the decades can be broken down into two pieces: growth from an increase in the number of employed persons and growth from labor productivity, or an increase in the average productivity of employed people. This approach usefully accounts for a comprehensive set of factors—from production inputs, like manufacturing technology, to operational factors, such as capacity utilization—in a single productivity rate.
This methodology shows that more than half of the 3.8 percent average annual historical growth in GDP has come from rising labor productivity—53 percent, to be exact. The balance has come from increases in the total number of employed persons. But the relative contributions of that growth and of labor productivity have not been consistent over time. The last four decades have seen relatively more and more growth come from productivity increases, particularly in emerging markets.
The rising share of labor productivity’s contribution to global growth is important because the coming years will see the dramatic effects of a slowdown in the growth of population as it ages in many countries. In the world as a whole, the United Nations forecasts an average of just 0.03 percent annual growth in the number of employed persons during the next 50 years, compared with 1.8 percent in the last 50. Thus, for global economic growth to match its historical rates, virtually all of it must come from increases in labor productivity.
Can we deliver? As a thought experiment, consider what would happen if the average productivity-growth rates of individual countries during the past half century were to remain unchanged over the coming one. This is arguably an aggressive assumption, as it assumes that South Korea, China, and other economies that had exceptionally rapid growth in the past can sustain it as their incomes rise. Even if we extrapolate forward historical productivity assumptions, when we apply lower employee-growth forecasts on a country-by-country basis and then aggregate up to an average annual global GDP growth rate, we see it falling from 3.8 percent over the last 50 years to 3.2 percent over the next 50.
This isn’t the end of the story, though. The lessons of MGI’s earlier work suggest that the smaller and more specific the scale we use to look at this problem, the more likely we are to understand the differentiators between growth that surprises or disappoints. We draw on dozens of country and industry studies to point out two broad categories of issues that will tell the tale in the years ahead. The first is the ability of individual countries to catch up to the productivity level of the world’s top performer, or what might be called the labor-productivity frontier. The second is the potential to push out that frontier further through advances in management, tools, technology, and the organization of functions and tasks.
Tremendous growth opportunities would come from catching up with the labor-productivity frontier. If every country were to perform at that level, global GDP would grow to nearly three and a half times its current size. Currently, however, many countries lag significantly behind, especially in emerging markets (Exhibit 4). Even China and India, which have experienced high levels of recent productivity growth, lag substantially behind front-runners, such as the United States, in absolute productivity levels.
Yet history shows that some countries, notably South Korea and Japan, have made striking gains. Looking forward, which countries and sectors might hold a similar potential? Is it possible to identify leading indicatiors of real growth opportunities, particularly where the gap between current performance and the global benchmark is wide? The possibilities stand out at three levels: across economies, within economies, and within industries:
Falling barriers to trade and foreign direct investment. MGI case studies show that countries and sectors can make rapid productivity gains when international barriers to trade and foreign direct investment fall. In the 1990s, removing these barriers led to rapid gains in areas as diverse as the automotive sectors of India and Mexico, Europe’s freight-transport industry, and Brazil’s agriculture.
Similar leaps forward may be possible if, say, Mexico’s nationalized energy industry or India’s protected retail industry are successfully opened up for foreign investors to pour in capital and increase competitive intensity.
Regulatory changes that increase competition and performance pressure. These types of reforms, which occur within rather than across economies, are particularly important in local services. Sectors with high potential for upcoming productivity improvements include retailing in Japan and South Korea if land-related constraints to large-scale retailing are opened up. (The sector is currently subject to restrictive zoning rules and to regulations governing the maximum size of stores.) Liberalizing the environment for Europe’s professional-service providers—from architects to notaries—also holds strong potential given the restrictive laws that currently constrain them. Nearly all industries in India stand to benefit if protections for small-scale production are removed, which would allow for economies of scale. Public services, whose efficiency and quality could rise dramatically through new incentives and managerial practices, are another very large opportunity across the globe.
Private-sector companies that catalyze industry change. In the United States, Wal-Mart contributed to a retail-productivity boom in the late 1990s through managerial innovations that increased the sector’s competitive intensity and propelled the diffusion of managerial and technological best practices. The rise of leading companies in emerging markets may drive a similar dynamic. In the near term, for example, Alibaba holds tremendous potential for productivity increases in online retailing. Our colleague John Dowdy’s firm-level research (see “Why management matters for productivity”) shows these dynamics at work in virtually every country and industry.
Pushing out the labor-productivity frontier is also important. In general, the boundaries of productivity move outward when engineers and managers innovate and implement more effective and efficient ways of producing goods and delivering services and when designers and engineers create new and better products and services.
The labor-productivity frontier has grown four times over since 1964, and there are many good reasons to expect it will advance. As machine learning takes holds, for example, deep-learning algorithms may substitute for people in some jobs that were previously their sole province. (It’s hard to know how this will play out, though history suggests we could be pleasantly surprised by the productivity benefits from redeploying people to new areas, as was the case in the shift from agriculture to manufacturing. ) Simultaneously, a range of technological changes in manufacturing, such as advanced robotics, large-scale factory digitization, and 3-D printing, are enabling shorter supply chains and greater proximity to innovative supply ecosystems.
Related opportunities exist in ostensibly mature operational techniques, such as lean production, which may be turbocharged in the years ahead as sensors and new analytical tools make it possible to understand, with greater precision than ever before, what customers truly value. That, of course, would eliminate additional forms of waste. Parallel efforts to restore rather than expend the material, energy, and labor inputs used in making a wide range of goods are giving rise to a circular economy, with far-reaching productivity implications. Finally, small and midsize businesses will almost certainly get a productivity boost as mobile applications, cloud computing, and other novel technologies make it easier to innovate.
Pushing out the frontier will require a willingness to make significant changes in business processes and organizational structures, as well as trade-offs between mature businesses with healthy cash flows, on the one hand, and disruptive (often digital) business models, on the other, with the potential for self-cannibalization even as they offer a transformative productivity potential. Another transformative opportunity, in many countries, continues to be the status of women, whose greater employment could alter the demographic equation and boost growth independently of productivity advances.
Expanding the frontier will also require continuing to build skills through public- or private-sector investment within specific industries. The US Department of Defense and the Apollo project, for example, catalyzed innovations in semiconductors—which rippled out into other technology sectors. Similarly, the Finnish army’s demand for reliable and efficient communications in the field led to the development of wireless technologies.
Caution and concern have underscored nearly every recent discussion surrounding the potential for global growth. To be sure, a simple examination of demographic trends suggests that we may see a slowdown, particularly in mature economies. A closer look at productivity possibilities by country and sector, however, suggests reason for continued optimism.