While the United States may be outperforming other advanced economies, it is underperforming relative to its own potential. Slower growth has been feeding on itself in a vicious cycle of weak demand, low investment, and slowing productivity growth. In real terms, the median US household income is back at its level of two decades ago. Meanwhile, the vast majority of income gains have gone to households in the top quintile, which do not have the same propensity to spend. This in turn hobbles aggregate demand in the short term—and when businesses do not see the need to invest, it reinforces the cycle. US productivity growth recently turned negative for the first time in 30 years.
These trends have produced real pain for most households. The steady march of progress that once fed consumer confidence has been replaced by worries about how to afford housing, health care, a college education, and a decent retirement. Resigning ourselves to slower growth will mean an endless series of tough trade-offs, with competing interests fighting to protect their piece of a smaller pie.
It doesn’t have to be that way. A new briefing paper from the McKinsey Global Institute, The US economy: An agenda for inclusive growth, suggests that the United States can regain its dynamism and restore the sense that everyone is advancing together. This effort can take many forms: reengaging more workers in the labor force, enabling them to move to more productive jobs and locations, creating an environment that fosters new business formation and healthy competition, and helping declining cities reinvent themselves. When the economy is firing on all cylinders, income gains tend to be more broad-based and less easily concentrated.
From vicious cycle to virtuous cycle
Launching a virtuous cycle of growth can start with increasing demand by investing for the future and giving US consumers more spending power (exhibit). Since corporate investment has not responded to the signals sent by low interest rates, the public sector may need to play a role in kick-starting this process. Net of depreciation, US public investment fell from 3 percent in the 1960s to 1.3 percent in 2007 and further to 0.4 percent in 2014. There is room to make targeted investments for the future.
As demand returns, companies also begin to invest and boost output, creating more and better goods and services. This paves the way for job creation and higher productivity growth, and the resulting economic value can be passed on to employees as wage increases or to consumers in the form of savings, which similarly increases their purchasing power. Each part of the circle then becomes mutually reinforcing.
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Historically, productivity growth has complemented demand growth to deliver broad-based prosperity—and while the link between productivity and wage growth may have weakened in recent decades, it still exists. Robust productivity performance remains one of the fundamental components of a healthy economy. We estimate that more than three-quarters of the productivity growth required to reignite the economy can be achieved by closing the gap between lagging companies and those on the productivity frontier.
Five pillars for progress
We see five areas where targeted investment and policy action could create substantial economic impact. We estimate that these five initiatives can collectively raise GDP growth to 3 or even 3.5 percent—levels not seen since the 1990s. This is not an exhaustive list, but these are areas in which the McKinsey Global Institute has already conducted extensive research and where we see room for substantial economic impact within a decade.
- Digitization. The US economy is rapidly digitizing, but its progress is highly uneven. Focusing on the gap between lagging sectors and those on the digital frontier is a key part of the productivity puzzle. Government can play a role by promoting digital investment, digitizing public services and procurement, clarifying regulatory standards to encourage digital innovation, and taking a nimble and experimental regulatory approach to keep pace with technological change.
- Globalization and trade. The current debate around trade misses the point that globalization is becoming more digital—a shift that plays to US strengths. Today, less than 1 percent of US firms sell abroad. There are ways to expand participation by helping small businesses export on global e-commerce platforms and playing a matchmaking role to connect individual cities and smaller companies with foreign investors. But it is also time to confront the needs of communities that have experienced trade shocks. The workers who are caught up in industry transitions need more than retraining; their communities need reinvestment.
- America’s cities. Eighty percent of the US population lives in cities or the surrounding metro areas. But investment in urban transport infrastructure has not kept up with their needs, creating congestion that harms both productivity and the quality of life. A shortage of affordable housing and commercial space has worsened the squeeze on households and small businesses. Addressing urban issues would improve mobility, create new investment opportunities, and benefit companies. The overall economy would stand to gain, since cities are the engines of productivity.
- Skills. The United States needs to build a more dynamic and efficient labor market. Colleges and universities have to adapt and address the growing cost burdens. Additionally, we could make occupational licenses more portable, create more short-term training and credential pathways, expand “earn while you learn” apprenticeships, and make better use of online talent platforms to improve matching and design quicker, more effective education pathways.
- A resource revolution. Competition among fuel sources and efficiency improvements are combining to produce an unheralded energy revolution. Technology innovations are driving increased efficiency both in demand and supply, and renewables are becoming more price competitive. America’s widely diversified energy portfolio has hugely benefited the economy. The most important thing the ongoing resource revolution needs is room to play out. Technology is moving quickly, and a responsive regulatory approach would speed the allocation of capital to the most promising opportunities. The primary policy agenda here involves reducing friction and market distortions.
Bringing these initiatives to fruition requires investing in the future. But that is not to say that the only answer is trillions of new taxpayer dollars. Some of these policy actions are simply about creating opportunities, modernizing rules, convening, and matchmaking. In addition, there is a great deal of private capital on the sidelines, and investors are hungry for opportunities. Some businesses are already working with federal and local administrators in areas ranging from workforce training to urban redevelopment. With so many technology breakthroughs and new markets on the horizon, the United States does not have to settle for stagnation.