MGI Research

Investing in productivity growth

| Report

At a glance

  • The past quarter century has been a success story for global productivity. Median economy productivity has jumped sixfold. Thirty emerging economies, with 3.6 billion people, are in the “fast lane” of improvement; if they maintained this pace, they would converge to advanced-economy productivity levels within roughly the next quarter century.
  • Yet amid this global revolution, many economies have experienced productivity stagnation. Advanced-economy productivity growth has slowed by about one percentage point since the global financial crisis (GFC). At their current pace of improvement, “slow-lane” emerging economies, home to 1.4 billion people, would never catch up to advanced-economy levels.
  • Today the world needs productivity growth more than ever. It is the only way to raise living standards amid aging, the energy transition, supply chain reconfiguration, and inflated global balance sheets.
  • By investing to regain pre-GFC productivity growth, advanced economies stand to gain between $1,500 and $8,000 in incremental GDP per capita by 2030. These economies experienced their slowdowns as two waves of productivity growth in manufacturing (powered by Moore’s law and offshoring) came to an end. Post-GFC investment declined sharply and persistently, failing to generate anything to take their place. But today, directed investment in areas such as digitization, automation, and artificial intelligence could fuel new waves of productivity growth.
  • Investment is also the primary driver for emerging economies to reach or remain in the “fast lane.” Current fast-lane economies (China, India, parts of Central and Eastern Europe, and Emerging Asia) have sustained high investment, at 20 to 40 percent of GDP. They have channeled it into building the cities and infrastructure that underpin successful urbanization, higher productivity in service sectors, and globally connected manufacturing. Economies in the middle and slow lanes might follow suit.
  • There is reason for hope and motivation for action. Higher inflation and interest rates may signal stronger demand and encourage productive capital allocation—while discouraging the increasing debt and inflating asset prices of the past two decades. AI has potential to change work rapidly and broadly, creating fertile conditions for such investment.

The world needs to—and can—accelerate productivity growth

The world’s living standards have climbed sharply over the past 25 years, driven by strong productivity growth.1Pixels of Progress: A granular look at human development around the world, McKinsey Global Institute, December 2022; and Max Roser, The short history of global living conditions and why it matters that we know it, Our World in Data, 2016. Median economy productivity surged sixfold over this period.2Rekindling US productivity for a new era, the most common measure is nonfarm, private business labor productivity, while in this report we use total economy productivity. Additionally, that report uses data from the US Bureau of Labor Statistics, while here we use The Conference Board and other sources that allow us to make comparisons across economies. Like the United States, other economies have local sources whose statistics may differ slightly from the numbers we present.

Yet productivity growth is fading, and in many parts of the world, it has failed to start at all. Since the global financial crisis (GFC) around 2008, there has been a near-universal slowdown. In advanced economies, productivity growth had already decelerated before the GFC—from an average of 2.2 percent per year in the five years to 2002 to 1.6 percent through 2007—and then fell further, to less than 1 percent, in the 2012–22 decade.3 In emerging economies, productivity growth accelerated before the GFC, from 2.0 percent in the five years to 2002 to 5.9 percent through 2007, and then fell to 3.4 percent in the decade to 2022.4

Productivity growth means getting more from our work and from our investments (see sidebar “Measuring productivity”). It is especially needed now as the world faces the many challenges of a new geo-economic era. Productivity growth is the best antidote to the asset price inflation of the past two decades, which has created about $160 trillion in “paper wealth” and even larger amounts of new debt. Absent a surge in productivity, we could be headed for a Japan-style wealth reset or a period of sustained inflation.5The future of wealth and growth hangs in the balance, McKinsey Global Institute, May 2023. Second, we need to fund the net-zero transition and keep improving living standards if we are to achieve sustainable inclusive growth. Closing the empowerment gap and the net-zero investment gap requires the equivalent of 8 percent of global GDP annually, which will be very hard to achieve without rapid productivity growth.6From poverty to empowerment: Raising the bar for sustainable and inclusive growth, McKinsey Global Institute, September 2023. Other looming challenges include aging populations in most advanced economies, China, and elsewhere, along with global trade tensions and supply chain disruptions.

This report provides an overview for private and public decision makers on the most important features of productivity growth, why it slowed, and what reaccelerating it would take.7Outperformers: High-growth emerging economies and the companies that propel them, September 2018, and Rekindling US productivity for a new era, February 2023, and, for example, Global productivity: Trends, drivers, and policies, World Bank, 2021; World Bank and Bart van Ark, Klaas de Vries, and Dirk Pilat, Are pro-productivity policies fit for purpose? Productivity drivers and policies in G-20 economies, The Productivity Institute, September 2023. It offers a fresh look at the slowdown in advanced economies and quantifies the few drivers that matter most. It analyzes emerging economies that are traveling in different “lanes” at varying speeds and distills what lagging economies would need to do to shift into the fast lane of growth.

It argues for one common imperative across all economies: investment in tangible and intangible capital.

This report consists of four sections. Section 1 reviews worldwide productivity performance over the past 25 years and identifies which emerging economies are in the fast, middle, and slow lanes on the highway of convergence with advanced-economy standards of living.8 Section 2 offers in-depth analysis of the recent productivity growth slowdown in advanced economies. Section 3 delves into emerging economies and what it takes to be in the fast lane. Finally, section 4 discusses productivity growth in this new geo-economic era, laying out the main challenges and opportunities for businesses and policy makers.

1. The rise and fall of global productivity growth in the 21st century

Over the past 25 years, the world experienced strong productivity growth, driven in large part by China and India. This trend enabled many emerging regions and economies to narrow the gap—or “converge”—with the living standards of more advanced economies. However, the global financial crisis (GFC) worsened an existing slowdown in productivity growth in advanced economies and applied the brakes to a pre-crisis surge in emerging economies.

The world has had strong productivity growth over the past 25 years, driven by standout regions

From 1997 to 2022, median economy productivity jumped roughly sixfold, going from approximately $7,000 to $41,000 per employee, which is equivalent to an annual growth rate of 7.3 percent.9 The average global productivity growth rate was 2.3 percent annually during this period. (For an even longer-term perspective, see sidebar “The very long run: 100 years of convergence and divergence.”)

The average global productivity growth rate was 2.3 percent annually from 1997 to 2022.

Gains were most prominent in the middle and at the bottom of the global productivity distribution, as several major population centers experienced a surge of catch-up growth (Exhibit 1). The bottom 10 percent of economies made large gains, quadrupling their productivity, while progress was slower for the top 10 percent, which edged forward by 20 percent over this period.10

Median economy productivity jumped sixfold, while the top was more static.

China and India accounted for nearly half of aggregate global productivity growth (Exhibit 2). Other regions—Central Europe, Eastern Europe, and Emerging Asia—also made rapid progress, narrowing their gap with advanced economies. Yet growth rates in the Middle East and North Africa, Sub-Saharan Africa, and Latin America and the Caribbean were similar to or lower than those in advanced economies, which means that they did not converge at all or even fell behind.

About 50 percent of global productivity growth came from China and India, and 75 percent from all emerging economies combined.

Emerging economies are on a three-lane highway to catch up with advanced economies

Ideally, all economies would have high productivity growth and raise their living standards. Additionally, economies with lower productivity levels would catch up—that is, converge—with higher-productivity economies as they replicate the best ideas in humanity and generate higher initial returns on fresh capital.

Exhibit 3
Emerging economies occupy the fast, middle, or slow lane to convergence with advanced economies.
Emerging economies occupy the fast, middle, or slow lane to convergence with advanced economies.
Emerging economies occupy the fast, middle, or slow lane to convergence with advanced economies.
Emerging economies occupy the fast, middle, or slow lane to convergence with advanced economies.
Emerging economies occupy the fast, middle, or slow lane to convergence with advanced economies.
Emerging economies occupy the fast, middle, or slow lane to convergence with advanced economies.
Emerging economies occupy the fast, middle, or slow lane to convergence with advanced economies.

Fast-lane regions carved out the productivity growth frontier, thanks to strong increases in capital per worker

Taking a regional view over time, China, Eastern Europe, Central Europe, Advanced Asia, and North America each defined the “frontier” of growth possibilities at different stages of development over the past 25 years (Exhibit 4).17 Thanks to internal reforms and global integration, China produced the highest growth rates and took its output from only $6,000 per worker to more than $40,000. Central and Eastern Europe also achieved rapid progress, particularly during the integration period with Western Europe. Central Europe doubled output per worker to more than $80,000. Meanwhile, Latin America and Sub-Saharan Africa stayed well below the productivity frontier throughout the period.

Fast-lane regions carve the path of the productivity frontier.

Across all regions, the standout driver has been increasing capital per hour; in most places, it accounted for 70 to 80 percent of overall productivity growth.18 China and India led the way, with growth in capital per hour contributing 6.5 and 3.9 percent to productivity growth, respectively (Exhibit 5). They started in 1997 with capital stock of just $10,000 to $11,000 per person, about 5 percent of the level in advanced economies.19 Both economies then invested heavily in urbanization, infrastructure, businesses, and manufacturing facilities. They multiplied their capital stock per worker by factors of eight and four, respectively, and contributed about 45 percent of global capital formation. Central Europe and Emerging Asia were the closest followers, roughly doubling their capital stocks.

Increasing capital per hour has been the main driver of labor productivity growth.

Switching lanes is possible

Although the successes of China and India over the past quarter century may seem miraculous, they are not unique. China and India were once slow growers, and they have recently been following the paths previously taken by economies such as Japan and South Korea (Exhibit 6).

China and India seem miraculous but are not unique.

Similarly, an economy in the middle or slow lane can take steps to enter the slipstreams of faster productivity growth, lifting standards of living in the process. From 2014 to 2019, for example, the Philippines grew its productivity at an annual rate of 4.5 percent, Thailand at 3.7 percent, and Malaysia at 3.0 percent. In Africa, Tanzania (4.7 percent), Cameroon (4.2 percent), and Kenya (4.0 percent) each achieved fast-lane rates over the same period.

Productivity growth and the pace of convergence have slowed since the GFC

In recent years, progress in emerging economies has slowed across all three lanes (Exhibit 7). This means the pace of convergence with advanced economies has been decelerating, as shown in Exhibit 4 by the almost universal inverted U-shape in each region’s trajectory. The growth rates of emerging economies have been falling toward those of advanced economies, despite their significantly lower productivity levels. The pandemic accelerated this negative trend from 2020 to 2022, though productivity numbers during crises should be interpreted with care.20

Productivity slowed across all lanes and regions after the global financial crisis—a trend that started even earlier in advanced economies.

In recent years, the growth rates of emerging economies have been falling toward those of advanced economies.

Productivity growth in advanced economies had already slowed before the GFC, falling from an average of 2.2 percent per year between 1997 and 2002 to 1.6 percent between 2002 and 2007. Since then, it has declined to less than 1 percent. Across North America, Western Europe, and Advanced Asia, the persistence of the slowdown, more than a decade after the GFC, is striking. The United States was one of the few advanced economies that managed to rebound slightly in the final years preceding the COVID-19 pandemic. Yet even there, productivity growth rates for 2018 and 2019 (0.9 percent and 1.6 percent, respectively) would not be enough to conclude that the economy was on a new acceleration path.

For emerging economies, all three lanes experienced an acceleration in the run-up to the GFC, but the surge did not last. Almost all fast-lane economies suffered sharp declines after the GFC, though the lane as a whole stayed above its 1997–2002 pace thanks to China and India’s large and growing weight.21 The slow lane (largely populated by economies in Sub-Saharan Africa, Latin America and the Caribbean, and the Middle East and North Africa, with some notable exceptions) experienced sluggish growth of 2.1 percent before the GFC, then turned negative for the entire 2012–22 period.

If capital per worker explained most of high productivity growth for 25 years, did it also drive the slowdown? In advanced and fast-lane economies, slower growth in capital per worker after the GFC does indeed explain a lot. By contrast, middle-lane economies had higher capital deepening after the GFC than they did before it (in part because the Asian financial crisis of 1997 choked off investment). In the slow lane, growth in capital per worker was low all along, explaining persistently slow productivity growth. Beyond capital, other factors that had accelerated before the GFC weakened after it. These include slower growth in international trade and the integration of global supply chains, which hindered advances in the economic complexity of exports, slower progress of institutional reforms, and less favorable demographic trends.22 

2. Advanced economies: The breaking waves of productivity

In this section, we unpack the causes of declining productivity growth in advanced economies. We look in particular at various factors and sectors for the United States, Japan, and the five largest economies of Western Europe, which together represent 78 percent of GDP in all advanced economies.23

While many drivers affect productivity growth, two stand out for explaining the performance of advanced economies in recent years. First, manufacturing experienced waves of productivity advances fueled by the effects of Moore’s law and a burst of offshoring and restructuring. (Moore’s law, which holds that the number of transistors in a microchip doubles every two years, signals more broadly that computers become more powerful and efficient while coming down in cost.) These waves yielded productivity gains before the GFC but petered out over time. The second major factor is a secular decline in investment across multiple sectors (Exhibit 8). These two trends explain the slump in advanced economies almost entirely.24 Digitization was much discussed as the main candidate to rev up productivity again, but its impact failed to spread beyond the information and communications technology (ICT) sector.

Manufacturing and capital investment explain the recent productivity growth slowdown in advanced economies.

The implications of the slowdown are significant. If the United States had not had a manufacturing slowdown, its GDP per capita in 2022 would have been around $5,000 higher. If growth in capital per worker had not declined, it would have been around $4,500 higher.25 Overall, if the United States had continued growing its productivity at pre-GFC rates, its GDP per capita would have been $8,900 higher in 2022. In Germany, France, and the United Kingdom, per capita income could have been $3,500 to $5,900 higher; in Japan, it could have been about $1,700 higher. Yet economies could reverse these trends in the years ahead. If they invest to regain pre-GFC productivity growth, advanced economies stand to gain between $1,500 (Japan) and $8,000 (United States) in incremental GDP per capita by 2030.

Two waves of productivity growth in manufacturing have ended

Two cresting waves explain much of the rapid productivity growth in manufacturing until the mid-2000s as well as the subsequent slowdown. First, Moore’s law (the doubling of the number of transistors in a microchip every two years) translated into price declines and rapid consumer gains. But this effect waned over time, slowing total factor productivity (TFP) growth in electronics manufacturing (Exhibit 8, 1A).26 Second, before the GFC, the automation, restructuring, and offshoring of labor-intensive production boosted capital per worker in manufacturing, while advanced economies retained primarily capital-intensive (and knowledge-intensive) activities. But that effect petered out, too (Exhibit 8, 1C). There was also a slowdown in TFP growth in manufacturing subsectors other than electronics, with multiple causes depending on the subsector, though none standing out (Exhibit 8, 1B).27

Moore’s law translated into price declines and rapid consumer gains, but the effect waned over time.

These waves caused strong pre-GFC growth in both electronics and other manufacturing, which significantly contributed to aggregate productivity growth (Exhibit 9, US example).28 As their contribution waned after the GFC, so too did productivity growth in the overall economy (see sidebar “A detailed economy-sector view of the productivity slowdown and the mix effect” for a comprehensive economy-by-economy and sector-by-sector analysis).

In the United States, productivity growth was slowing in manufacturing before the global financial crisis.

The declining value of Moore’s law

While most manufacturing subsectors suffered a productivity slowdown, electronics was the main culprit. The main reason was slowing growth in consumer value derived from the effects of Moore’s law (Exhibit 8, 1A). While nominal value added growth was relatively stable, product performance per unit of price surged in the late 1990s and early 2000s, and subsequently fell. Hence, despite the ongoing progress of Moore’s law, the translation into real value added slowed.29 Technically, this shows up as lower growth in the value-added deflator (Exhibit 10, US example).30 This was true in the United States, Japan, the United Kingdom, Germany, and France (but particularly stark in the United States and Japan because they benefited from a larger positive pre-GFC wave).

Moore’s law is producing diminishing returns in US computer and electronics manufacturing.

In the United States, productivity growth in electronics manufacturing fell from 24.0 to 5.4 percent, explaining about 40 percent of the slowdown in all of manufacturing and 20 percent of the economy-wide decline. This was despite the fact that this sector represents about 1 to 2 percent of employment and value added; this small part of the economy had an outsize effect. The other manufacturing subsectors dropped from 3.7 to 0.6 percent. In our Western European sample, on average, growth in electronics productivity declined from 8.9 to 2.4 percent, explaining a fifth of the manufacturing slowdown (with the United Kingdom and Germany experiencing larger declines off a higher base); other subsectors declined from 3.0 to 1.3 percent. In Japan, electronics declined from 12.6 to 3.7 percent; the other subsectors went from 1.8 to 1.4 percent.

The end of an offshoring and restructuring wave

Productivity growth in manufacturing also slowed after the GFC with the breaking of the offshoring and restructuring wave (Exhibit 8, 1C).31 In the late 1990s and early 2000s, labor-intensive manufacturing jobs in many advanced economies were either moved to places where labor was cheaper (often to China but also to Mexico, Central Europe, or Eastern Europe) or automated.32

In the United States, these choices led to a decline in manufacturing hours worked of 2.4 percent per year between 1997 and 2007 (Exhibit 11). Capital investment did not suffer an equivalent decline, resulting in a boost in capital per worker and hence productivity growth, presumably because the parts of manufacturing that remained required ongoing investment to stay on the frontier. Once the offshoring and restructuring wave ended, the hours worked in manufacturing resumed growth, and growth in productivity and capital per worker slowed to more moderate levels. A similar pattern emerged in Europe and Japan. In Germany, a 0.6 percent decline in hours worked reversed to 0.5 percent growth, and in the United Kingdom, a 3.7 percent decline became 0.3 percent growth. In France the decline continued but slowed, going from a 1.5 percent reduction to 0.4 percent, and in Japan from 2.0 percent to 0.6 percent. Of these economies, only Germany saw equivalent growth in capital services.

A wave of off­shoring and restructuring in manufacturing has ended.

A secular investment decline also weakened productivity growth

A marked and persistent decline in the growth of capital per worker explains the other half of the post-GFC productivity slowdown in the United States, Germany, the United Kingdom, and Japan.33

The slump in capital investment slowed productivity growth beyond manufacturing by 0.5 percentage point in the United States, 0.3 point in our Western European sample economies, and 0.2 point in Japan, accounting for about 30 to 50 percent of their overall slowdown (Exhibit 8, 2). This decline spanned almost all sectors: in the United States, the only exceptions were mining and agriculture; in Europe, only mining, construction, and finance and insurance generally remained stable, while real estate accelerated.

More specifically, slowing growth in tangible capital (for example, machines, equipment, and buildings) explains almost 90 percent of the drop in the United States and 100 percent in Europe. From 1997 to 2019, gross fixed capital formation in tangibles fell from 22 to 14 percent of gross value added in the United States and from 25 to 17 percent in Europe. Intangible capital growth (for example, R&D and software) was more resilient but could not make up for falling investment in the material world. Gross fixed capital formation in intangibles increased from 12 to 16 percent in the United States and from 10 to 12 percent in Europe.34 Investment in intangibles is needed to boost corporate performance and labor productivity, but it may face barriers (skills needed to scale up, limited collateralization and recovery value), and the productivity benefits can take longer to materialize.35Getting tangible about intangibles: The future of growth and productivity?, McKinsey Global Institute, June 2021; Erik Brynjolfsson, Daniel Rock, and Chad Syverson, “The productivity J-curve: How intangibles complement general purpose technologies,” American Economic Journal: Macroeconomics, volume 13, number 1, January 2021.

To complete the investment picture, we looked beyond the growth of capital per worker to net fixed investment as a percentage of GDP (Exhibit 12). Two dips occurred in most economies. The first and smaller one coincided with the end of the dot-com boom: as the bubble burst in the early 2000s, investment slowed, particularly in the United States and Europe. The larger slump occurred when the GFC hit; to date, none of the advanced economies we analyzed has seen its investment rate recover to pre-crisis levels.

The rate of net investment fell after the global financial crisis, driving lower growth of capital per hour.

Sluggish demand and macroeconomic uncertainty are likely the main culprits behind the decline in investment

Given the timing of the slumps, investment most likely fell as a result of each crisis. In their wake, the macroeconomic outlook was uncertain and demand was weak, resulting in lower productivity growth. Then, even when economic activity resumed and conditions improved, the temporary shock appeared to cause longer-term scars (or so-called hysteresis effects).36

Over the longer term, other macro trends such as a structural savings glut from aging, inequality, and capital inflows from emerging economies may have added to the problem, driving advanced economies into “secular stagnation” (a phenomenon marked by sluggish demand, persistent output gaps, low interest rates, and low investment).37

These longer-term effects and the timing of the slowdown suggest that sluggish demand played a strong role in slowing productivity growth, which contrasts with the typical supply-side-centered explanation. The virtuous cycle of growth can begin with (or be constrained by) any of its parts, including the demand side. Labor productivity growth drives higher incomes, which increase demand for products and services, which in turn encourages business investment and innovation, driving productivity growth and restarting the cycle.

On the plus side, US shale oil and gas attracted a major investment boom, with yearly capital expenditure increasing by a factor of seven between 2007 and 2014. Investment into the sector later fluctuated, but in 2023 it was still about five times higher than in 2007. Consequently, the United States added more output to oil and gas than any other economy in the world. However, this was not enough to offset the overall investment decline.

Regulation may have contributed to lower investment

Changing dynamics in regulation and competition policy may also play a role in holding back investment. A surge of reform swept advanced economies from the early 1980s to about the time of the GFC, with nothing comparable in the past decade.38 Business surveys have singled out regulation as one of the central impediments to investment.39 Other regulatory aspects, such as credit tightening in the post-crisis years (at least partially due to more stringent banking regulation), may also have contributed to lower investment and productivity growth.40

However, regulation is a complex topic encompassing many aspects that can enhance or hinder investment. Even the issues cited above have had mixed or unclear effects. Some evidence suggests that the relationship between credit access and productivity growth may be U-shaped—that is, productivity growth is lower with both high and low levels of credit access, and higher at a sweet spot in the middle.41 And some studies find no relationship between increasing regulatory stringency and the lower business dynamism observed in the United States.42

The decline in investment was steep and sudden, occurred in both the early 2000s and 2008 (coinciding with recessions), and affected most sectors—all of which suggests that regulatory changes were probably not the main reason behind it. But some regulatory choices, including the absence of a strong new surge of pro-competition reform in the past decade, may have contributed to the investment slowdown, or at least limited its recovery in some economies.

Digitization didn’t make a broad splash beyond the ICT sector

The periodic introduction of new technologies has fueled productivity growth over the past century. If Moore’s law effects and offshoring added momentum at the turn of the century, it may have been unrealistic to expect their energies to continue. A burst of digital innovation might have compensated, but so far it has had a muted impact on productivity beyond the ICT sector.

The tech sector at the heart of the digital transition has indeed delivered productivity growth—in fact, the fastest growth among all sectors in the United States both before and after the GFC (6.7 percent per year before the crisis and 5.0 percent afterward; see Exhibit 9). ICT similarly had the fastest productivity growth in Western Europe. Although it slowed from 5.1 percent in 1997–2007 to 2.7 percent afterward, this was still about four times higher than overall productivity growth. In Japan, ICT productivity growth went from 1.9 to 0.5 percent. (See sidebar “A detailed economy-sector view of the productivity slowdown and the mix effect.”)

However, digitization has not made the same impact on productivity in other sectors—at least not yet. Three reasons might account for this: the time required for technology adoption and creative destruction, the less transformational nature of current innovation, and mismeasurement.

The first and most convincing argument is that digital and technological adoption is a long-run phenomenon. There are multiple historical precedents for a lag between the invention of a technology and its impact on productivity, from electricity in the early 20th century to computers and IT systems toward the end of it.43 In fact, the early years of a new technology may generate a drag on productivity growth before it can be usefully adapted, with productivity following a J-shaped trajectory.44 Digitization has also led to duplication of online and offline channels, giving customers more choice but delivering productivity benefits only when the offline channels are rationalized or discontinued. Finally, diffusing digital technologies across small businesses can be slow and difficult.45

A second proposed reason is that digital and other innovations of the past decade may be simply less transformational than past innovations.46 But looking ahead, there is reason for optimism about the effects manifesting. Previous MGI research has estimated that digitization and other technological advances could add 0.5 to 1.0 percent to annual productivity growth, which is substantial.47Will productivity and growth return after the COVID-19 crisis?, McKinsey Global Institute, March 2021. In healthcare, for example, telemedicine could account for up to 1.5 percentage points per year through better care quality, less time lost in waiting rooms, and better back-end processes. Other research, including from MGI, has argued that more recent advances such as AI could have an even larger impact on productivity growth.48The economic potential of generative AI: The next productivity frontier, McKinsey, June 2023.

Last, it may be that current measures of productivity do not capture the increases in value added that these technologies promote. Many new benefits are incorporated into products or services free of charge, for example, which means productivity statistics do not capture them. The best available evidence suggests that mismeasurement might explain up to 10 percent of the overall slowdown in productivity growth, a relevant but comparatively small effect.49

3. Emerging economies: The fast lane to prosperity

Over the past 25 years, emerging economies in the fast lane of productivity growth have caught up with advanced economies, with China and India at the forefront.

In this section, we map our three lanes against five factors commonly called out in development economics literature and find a strong match—as well as interesting nuance:

1. Radically high capital investment, at 20 to 40 percent of GDP, is the standout driver of rapid productivity growth, in most cases underpinning at least 70 to 80 percent of it.

This investment is deployed into:

2. Building cities in the right way and mechanizing agriculture, moving workers off the farm and into urban construction and service sectors;

3. Achieving distinctive productivity growth within these expanding service sectors, where capital deepening is instrumental to creating formal productive jobs; and

4. Making manufacturing more sophisticated and global, driving its output and value added beyond commodities (although often not adding employment).

All of this is enabled by:

5. Solid institutions, innovation, and education, all of which support investment but also require it.

Fast-lane economies are generally high performers across these five factors (Exhibit 13). Middle-lane economies have either not put some of the building blocks in place or have done so less successfully, while slow-lane economies have faced structural challenges such as weak institutions and high commodity dependence. Interestingly, workforce shifts from agriculture into services turn out to be of lesser importance in distinguishing the lanes. What matters is building cities and their service sectors in the right way, with significant capital investment and formal jobs.

Five elements characterize fast-lane productivity growth.

To understand how fast-lane economies have outpaced other emerging economies, we have used sector data for 54 economies that represent 87 percent of emerging economies’ GDP.50 To illustrate our findings, we have selected 18 example economies (six each from the fast, middle, and slow lanes); they represent all regions and 72 percent of emerging economies’ GDP.51 For analyses of additional factors such as urbanization, commodity dependence, and education, we cover all the economies represented in previous chapters.52

Fast-lane economies invest more than the rest

Growth in capital per worker accounted for about four-fifths of productivity growth in most emerging regions over the past 25 years and for much of the difference in productivity growth between lanes, as seen in section 1. Most fast-lane economies managed to sustain investment at 20 to 40 percent of their GDP over the whole period.

Residential and commercial property are essential for the urbanization that raises growth and productivity in a modern economy. Infrastructure investments make transportation and utilities more productive and produce spillovers across the economy. Machinery and equipment, from traditional types to new sophisticated robots, complement all sorts of workers’ tasks. Investment in R&D and other intangibles enables manufacturing to diversify and become more complex and productive, and it raises productivity in all types of services, from hospitals to digital and IT systems.

This is not to say that higher investment is always good, or that what economies invest in does not matter. As economies develop and returns on investment decline, rebalancing to lower investment and higher consumption is natural. Investment can stay too high for too long, ignoring low returns, which can be particularly destabilizing if it is funded by debt instead of savings. But on the whole, higher investment has been associated empirically with higher output and productivity growth, lower inflation, better fiscal and external balances, and lower poverty rates and inequality.53

Higher investment is associated with higher output and productivity growth, lower inflation, better fiscal and external balances, and lower poverty rates and inequality.

China, Ethiopia, India, Poland, Türkiye, and Vietnam make up our sample set of fast-lane economies, and their high rates of investment multiplied their ratio of capital stock per worker (Exhibit 14).

Rising capital investment per worker has been the main driver of labor productivity growth.

In these fast-lane economies, policies set strong and stable incentives for private investment. They included opening markets to some level of competition and foreign investment, setting up efficient financial sectors, and establishing legal systems to protect ownership rights. Central and Eastern European economies that were integrated into the EU drew in foreign investment and consolidated their financial sectors. From 2004 to 2008, one-fifth of the $220 billion (€168 billion) of net foreign direct investment inflows to Central and Eastern Europe went into the financial sector.54A new dawn: Reigniting growth in Central and Eastern Europe, McKinsey Global Institute, December 2013. Much of the rest went to modernize outdated factories and production methods. For example, vehicle production more than doubled between 2000 and 2011, while employment in the sector rose only 60 percent, resulting in a significant productivity increase.

Large companies drive investment and growth, making it important to help firms scale up.55Outperformers: High-growth emerging economies and the companies that propel them, McKinsey Global Institute, September 2018. Larger entities have more capacity to invest and export, to adopt technology, to develop talent, to pay their workers better wages, and to adapt to shocks. Many emerging economies have large shares of small, informal businesses that find it hard to boost productivity, affecting development.56A tale of two Mexicos: Growth and prosperity in a two-speed economy, McKinsey Global Institute, March 2014; and Franziska Ohnsorge and Shu Yu, eds., The long shadow of informality: Challenges and policies, World Bank, 2022.

Fast-lane economies also had the willingness and capacity to plow public money into critical infrastructure such as road and railway networks, power and telecommunication systems, health and education facilities, and other urban infrastructure. Ethiopia’s impressive pace relied in large part on public investment, while China’s capital stocks were 86 percent public by 1997 after nearly two decades of high state investment.57 When this type of investment is very high, however, it eventually starts yielding lower returns. In China, for instance, public capital stock is already at OECD levels, but private capital per worker is still well below that point, despite remarkable increases.58 This suggests there is scope for faster growth of private capital.

Slow- and middle-lane economies did not enjoy this pace of public or private investment growth. Even lower-income economies such as Cameroon and Pakistan that had very low capital stock per worker in 1997, comparable to China and India, achieved very little growth. Without enough savings and the policy settings to attract private and foreign investment, and without the capacity for public investment, they did not build the infrastructure, plant, machinery, and human capital needed to improve productivity growth. For example, 18 percent of Africa’s urban population still lacks access to electricity, and 66 percent has no access to piped water and sewerage systems.59Reimagining economic growth in Africa: Turning diversity into opportunity, McKinsey Global Institute, June 2023.

Urbanization shifts workers away from farms and into services and construction

Enabled by investment in infrastructure, urbanization has meant a major shift in the composition of economies, away from agriculture and into the construction and service-sector jobs that concentrate in cities (Exhibit 15). The urban share of the population in emerging economies has increased on average by nearly ten percentage points over the past quarter century, with remarkable cases across regions (China’s share grew by 31 percentage points, Costa Rica’s by 26 points, Albania’s by 24 points, and Botswana’s by 22 points). Urbanization itself is a weaker differentiator of fast-lane economies than the other factors discussed in this section; many middle- and slow-lane economies also urbanized rapidly. How urbanization is harnessed is what makes the difference.60 Fast-lane economies were better able to develop their cities’ infrastructure and buildings as their workforce was moving there, creating an environment more conducive to investment, growth, and prosperity. Growth in construction jobs was generally higher in fast-lane economies. In China, India, and Vietnam, the share of workers in construction increased by five to 12 percentage points.

As emerging economies urbanized, their workforces moved away from agriculture.

Well-managed cities have all the ingredients to activate the virtuous cycle of rising productivity, income, and demand. As workers move to cities and secure better, more productive jobs, they earn the higher wages that boost both savings and consumption. Higher consumption gives business the incentive to invest, and savings fund the investment—which, in turn, makes workers more productive, restarting the cycle.

Across our sample of 54 economies, an average of roughly one-sixth of the workforce left agriculture from 1997 to 2018. In China, agriculture fell from 50 to 27 percent of the workforce, with 150 million people leaving the sector.61 Vietnam’s share dropped from 70 to 38 percent, and Romania halved its share, from 40 to 19 percent.

Urbanization’s productivity boost in emerging economies is due both to workers leaving the low-productivity agriculture sector (the mix effect) and to better performance in the agriculture sector itself (the within effect) as it mechanized or lost redundant labor (Exhibit 16). In fastlane economies, agriculture contributed to roughly one-third of all productivity growth from 1997 to 2018. In these economies, across regions, the employment share and often even total employment in agriculture decreased, yet total output nearly doubled.

Improvements within agriculture and shifting employment away from it have had a significant impact on economy-wide productivity growth.

In emerging economies where urbanization started earlier, the productivity impact of agriculture was understandably lower. In 1997, Central and Eastern European economies had a relatively small 17 percent share of workers in agriculture, on average, and Latin American economies 23 percent. The sector contributed about or less than half a percentage point to total productivity growth.

Growing service-sector jobs have distinctively high productivity growth in fast-lane economies

Across lanes, most of the workers leaving agriculture entered services. But fast-lane economies invested to enhance the productivity of these service sectors even as they industrialized.

One central tenet of development economics is that industrialization is the main way to boost productivity growth; by contrast, increasing service-sector productivity is hard.62 While manufacturing is still extremely relevant, we find that many fast-lane economies achieved notably high productivity growth in services, too.

Reallocating workers toward services in itself does not always translate into a large productivity boost. In fact, in most cases, more than 60 percent of the workers who entered services went into relatively low-productivity subsectors such as wholesale and retail trade or transportation.63 For example, while 15 percent of China’s workforce entered services between 1997 and 2018, that added only 0.2 percentage point to productivity growth, as about 80 percent of the workers joined low-productivity services.

What matters to the success of fast-lane economies is the push to raise productivity within services.

What matters to the success of fast-lane economies is the push to raise productivity within services (Exhibit 17). This includes gains in the lower-productivity service sectors mentioned above (such as the spread of modern-format stores in retail) as well as in higher-productivity sectors such as business and financial services.

Fast-lane economies achieved distinctively high productivity growth in services as those sectors expanded.

A substantial share of fast-lane productivity gains was likely due to investment in physical and human capital. India’s early upgrading of digital infrastructure and workforce skills in the 1990s enabled it to become a global IT leader, especially in software, for example.64 Other types of infrastructure, such as transport services, matter as well. Central and Eastern European economies raised productivity in services markedly due in no small part to their ability to attract significant foreign direct investment.65A new dawn: Reigniting growth in Central and Eastern Europe, McKinsey Global Institute, December 2013.

In fast-lane economies, manufacturing sectors have become more sophisticated and global

Fast-lane economies of different income levels were able to outpace other emerging economies in the race to industrialize. They raised growth in manufacturing productivity—and output—largely through building more complex supply chains, producing more sophisticated products, and plugging into global value chains.

Whether economies can still industrialize their way to prosperity, as some East Asian economies did in the past, is an ongoing and lively debate in development economics.66 Our findings suggest that manufacturing, including via exports, has continued to be a common way for emerging economies to raise productivity, despite only rare instances in the past quarter century in which the sector significantly expanded employment. In contrast to services, the share of manufacturing jobs in fast-lane economies, except for a few that started from a very low base, either stayed flat or fell (Exhibit 18).67

As their manufacturing sectors became more sophisticated and global, fast-lane economies achieved fast productivity growth with similar employment.

In China, manufacturing was the single most important driver of productivity, adding 2.6 percentage points in annual growth. Manufacturing also contributed strongly to productivity growth in fast-lane Central and Eastern European economies such as Romania (1.4 percentage points), Slovakia (1.4 points), and Poland (1.0 point).

These gains were achieved, in many cases, once economies already had a relatively large manufacturing sector (about 20 percent of total employment), without increasing the sector’s share of employment. In fact, in three of the six fast-lane economies in our sample, the sector’s share of workers actually fell or held steady: China went from 22 to 20 percent, Türkiye dropped from 20 to 18 percent, and Poland stayed at 22 percent.68 India experienced very limited growth in manufacturing’s share of employment, starting from a low base. Only Ethiopia and Vietnam, starting even lower, managed to grow their manufacturing employment substantially.

Manufacturing provides a channel for the kind of investment in R&D and innovation that helps drive overall productivity growth; trade in manufactured goods within a global value chain accelerates that growth. A strong manufacturing sector also enables economies to produce the basic materials and capital goods they need for urbanization, infrastructure, and mechanization in other sectors. Fast-lane economies pursued each of these factors more than those in the slower lanes; many of the latter relied more on commodity exports.

R&D-rich, globally integrated manufacturing supports the evolution to a more diversified and sophisticated economic fabric. Indeed, fast-lane countries have above-average economic complexity, a measure of the diversity and sophistication of the products that an economy is capable of producing. This capability is an indication of a country’s economic development and competitiveness.69 China has increased its economic complexity toward advanced-economy levels (Exhibit 19).

Fast-lane economies export more complex products and are less dependent on the export of commodities.

Trade in manufactured goods amplifies the productivity dividend, especially when it is part of a global value chain. Trading firms learn faster and are more competitive at home and abroad.70 When they are part of a global value chain, companies are also able to specialize in core tasks and access inputs and knowledge from their foreign partners. Greater exports are also an important source of demand, providing economies with the incentives and revenues to invest in capital goods and technology.

Where fast-lane economies benefit from economic complexity and trade, slow-lane economies may suffer from excessive reliance on resources. On average, 78 percent of the goods exported by slow-lane economies are commodities, about double the share in fast-lane economies and advanced economies.71 This dependence makes economies more vulnerable to global shocks and impedes their industry-driven productivity growth.72 High-value commodity exports also put upward pressure on the exchange rate, making exports less competitive. This, in turn, discourages investment in tradable sectors and accelerates the growth of nontradable services.73

Solid and improving enablers pave the way to the fast lane

Strong investment and productivity growth can only be built on a firm foundation. Knowing the necessary conditions for economic development and growth is the holy grail of economics. The drivers are many, and the circumstances and extent to which they drive productivity growth are hotly debated. Some research institutions have built lists of productivity drivers, including the World Economic Forum’s Global Competitiveness Index of 12 drivers and the World Bank’s 2019 Global Productivity framework of ten.74 There is also a question about whether it takes a certain level of each enabler to achieve a large acceleration in productivity or whether improvements in each driver are enough. The answer is probably a combination. In this section, we focus on three enablers: institutions, innovation (through R&D), and human capital.

Effective institutions are fundamental to long-run growth, through both effective public intervention and creating the rules of the game in which businesses invest and thrive. From the vast literature on institutions and productivity growth,75 we have selected pillar 1 from the World Economic Forum’s Global Competitiveness Index to analyze our lanes. This pillar, measuring the relative strength of institutions, includes metrics for government performance, property rights, transparency, security, and a lack of corruption, among other things.76 On a scale from 0 (worst) to 100 (best), the average score of advanced economies is 71. Fast-lane economies have an average of 56, middle-lane economies 52, and slow-lane economies 48.

Investment in R&D is a simple proxy for an economy’s capacity to innovate. Fast-lane economies invest on average nearly 1 percent of their GDP in R&D, compared with 0.6 percent and 0.4 percent by middle- and slow-lane economies.77 China has dramatically increased investment in R&D, from 0.6 percent of GDP in 1997 to 2.2 percent in 2019, matching the advanced-economy average for that year. Economies in Central Europe lifted their R&D investment from 0.6 percent to 1.0 percent over that quarter century. Economies in Latin America, many of which are in the slow lane, invest only 0.2 percent of GDP in R&D. The region accounts for less than 2 percent of the world’s patent applications, and of these, less than one-fifth are filed by Latin Americans.78What could a new era mean for Latin America?,” McKinsey Global Institute, July 2023. Note that the investment in R&D over GDP quoted on this article is close but slightly different, at 0.6 percent. The discrepancy stems from some small differences in the economy set used.

The third enabler we examined is education, or productive investment in human capital.79 Ample literature supports the relevance of human capital as a driver of economic development.80 A simple measure of education is learning-adjusted years of schooling in the working population. Advanced economies average about 11.0 years, fast-lane economies 9.0 years, middle-lane economies 7.5 years, and slow-lane economies 6.0 years.

Regions with an overrepresentation of slow-lane economies are significantly weaker when it comes to these enablers. For example, Latin America’s growth has long been held back by underdeveloped financial sectors and certain regulations that block investment. Weak public institutions and governance also limit government capacity to reduce the region’s considerable gaps in human capital, technology, and infrastructure.81

Similar factors affect economies in Sub-Saharan Africa, despite significant differences in income levels. Political instability can add to this story. Previous MGI work found that coups and other political events affected 30 percent of Africa’s population in the 2010s, compared with 4 percent in the 2000s.82Reimagining economic growth in Africa: Turning diversity into opportunity, McKinsey Global Institute, June 2023. After peaking in 2008, foreign direct investment flows into Africa declined in 31 of Africa’s 54 economies, falling fastest in the continent’s two largest economies, Nigeria and South Africa.

Strong and improving foundations in institutions, education, and innovation are three of the most relevant enablers of productivity growth. They require—and also unleash—the necessary investments that are critical to moving economies into the fast lane.

4. An agenda for productivity growth in a changing geo-economic era

Our diagnosis suggests priorities for advanced economies: a focus on revamping investment and harvesting the productivity dividend from digital and other technologies such as AI. Conversely, commonly raised solutions such as reshoring manufacturing and trying to influence the sector mix are less likely to reaccelerate productivity growth. Improving how we measure GDP and productivity is a worthwhile pursuit, but the drivers of the slowdown outlined in this research have been real and keenly felt regardless of measurement.

We also outline the priorities for emerging economies to get to the fast lane: boost capital investment, build on that investment to urbanize effectively, grow the productivity and size of the service and construction sectors, and increase the sophistication and global interconnectedness of manufacturing.

In this last section, we explore the future of productivity growth by posing seven questions. Because we cover the full range of global economies with different characteristics, we necessarily focus on general points. The first two questions—linked to investment and technology—focus on what is needed to reverse the slowdown and position economies for high productivity growth in a changing era. The final five explore how future productivity growth will be shaped by the big puzzles on the horizon: shrinking and aging populations in many economies, including most advanced economies and China; new ways of working; the growing importance of services; trade tensions and supply-chain disruptions; and energy costs.

1. Can we revamp investment and demand in a changing macro environment?

If there is a common thread in this report, it is the importance of investment. Fully half of the drop-off in productivity growth in advanced economies is a slowdown in capital deepening (that is, the growth of capital per worker). High capital deepening is also the key characteristic of emerging economies in the fast lane.

Investment flows best in “high-pressure” economies that enjoy strong demand, strong growth, and low unemployment. Inflationary pressure and rising interest rates could be signs that we are leaving behind secular stagnation and entering an era of higher demand and investment. Higher real wages may motivate more capital investment, too.83The future of wealth and growth hangs in the balance, McKinsey Global Institute, May 2023. Although it is too soon to tell, some signs appear positive, particularly in the United States. Real GDP beat expectations by growing at annualized rates of 4.9 and 3.3 percent in the third and fourth quarters of 2023, respectively; this was largely driven by equally high productivity growth.84 Aggregate metrics show that investment is up from pandemic lows, though it still has a long way to go. Anecdotally, the big five US tech firms spent $350 billion among them on R&D and capital expenditures in 2022, as part of a race for supremacy in AI and the cloud.85 Construction activity in the US manufacturing sector is two to three times its normal level, driven in part by a rush to build battery supply chains.86

Advanced economies might also tilt regulatory conditions in favor of investment and innovation. Priorities would include reducing unwarranted burden and complexity (for example, for permits to build renewable power), more effective market regulation, fixing land markets to facilitate building, and better intellectual property and competition policies. Creating the right balance of competition and entrepreneurship would motivate new waves of investment. In the United States, business dynamism shot up in 2020 and kept pace through 2023.87

Emerging economies would benefit from public and private investment in urban infrastructure and in the public services and worker skills that make cities function. While people moving from farms to cities is a major lever for productivity growth, it can result in “sterile agglomeration” without the right hard and soft investments.88 The focus can also extend to secondary cities with large potential.89Reimagining economic growth in Africa: Turning diversity into opportunity, McKinsey Global Institute, June 2023. This requires creating savings or borrowing power to unleash that investment. However, emerging economies may find funding hard to come by. In the aftermath of the COVID-19 crisis, growing debt distress could be a limitation, and investors may be more attracted to the higher interest rates available again in advanced economies.90

An attractive business environment therefore becomes even more important. This includes low corruption, nimble regulation, high-quality financial markets, and macroeconomic stability, all of which have proved to be persistent challenges in many parts of the world. Solving these issues would not only help attract foreign capital but also activate the virtuous cycle of rising productivity, incomes, demand, and domestic savings. Greater investment in a more favorable business environment would help businesses grow, allowing them in turn to invest in productive capital, hire and develop talent, pay higher wages, and compete in international markets. Developing large leading firms while keeping up competitive pressure would be a major spur of productivity growth in emerging economies.

2. Can we harness the promise of technology for a more productive future?

Productivity tends to accelerate in waves. As mentioned, digitization and other technological advances could add 0.5 to 1.0 percentage point to annual productivity growth in advanced economies.91Will productivity and growth return after the COVID-19 crisis?, McKinsey Global Institute, March 2021. Early adoption of recent advances such as generative AI could add an extra boost of more than 0.5 percentage point across advanced (and several emerging) economies by transforming how jobs are done.92The economic potential of generative AI: The next productivity frontier, McKinsey, June 2023.

Digitization has been the main promise for a productivity boost over the past decade, but its benefits will materialize beyond the ICT sector only with faster creative destruction, market share shifts, and the adoption of technologies, ideas, and best practices. Several AI applications hold significant productivity potential, and there are signs that they could expand faster than previous technologies.93 While the direction and impact of AI are uncertain (and big claims about any new technological solution are often overblown), several proven productivity-enhancing use cases have already emerged.94The economic potential of generative AI: The next productivity frontier, McKinsey, June 2023.

In emerging economies, wider adoption of existing technologies—for example, smartphones—rather than frontier innovation can go even further in boosting productivity, but sometimes this process takes time and must overcome barriers. For instance, Latin America has generally been a latecomer to technologies. But the pandemic boosted the adoption of technology such as digital payments and e-commerce, which could trigger catch-up growth. Yet as frontier technologies such as AI take off, the region risks lagging once again: estimates suggest that AI’s impact on Latin America’s economy will be three to five times lower than in North America and China.95What could a new era mean for Latin America?,” McKinsey Global Institute, July 2023. Opportunities in digital technology adoption abound in Africa, too. Simpler, nondigital technologies can also significantly boost productivity. Further irrigation and fertilizer investment, for example, promise much for Africa’s agricultural sectors.96

3. Can we reshape the effects of aging on productivity?

Demographics will continue to affect both the supply side (worker availability and individual productivity) and demand side (consumer spend) of the economy, and hence aggregate productivity. While there is no consensus in the literature, studies suggest that young workers get more productive as they grow older and then decline in productivity as they near retirement, with the turning point varying between sectors. Simply, it is not good to be too young, because workers lack the learning effects that come with experience, but it is also not good to be too old, because many occupations show productivity peaking at midlife. Estimates based on econometric studies are associated with some difficulties, and the ranges found are large (from a positive impact of aging on productivity growth to a 0.5-percentage-point productivity drag per year, depending on the economy and the time period).97

Globally, the number of working-age people per person over 65 will shrink from 6.6 in 2022 to 3.8 in 2050.98 Advanced economies and China, in particular, are now in a synchronized march into aging.99 This is a risk to productivity growth unless businesses and policy makers work toward mitigating or turning around the effects of aging through reskilling, rethinking retirement policies, and other means. They might also target the growing “silver economy” of older consumers, creating new markets with more and better products and services.

Emerging economies with young and fast-growing workforces hold a great asset. Their talent has the potential not only to increase domestic productivity but also to support aging populations elsewhere. Africa, home of the world’s youngest and fastest-growing population, will add almost 800 million people to its working population by 2050, overtaking China and India.100Reimagining economic growth in Africa: Turning diversity into opportunity, McKinsey Global Institute, June 2023.

4. Can we make hybrid work work?

During the pandemic, people worked from home in significant numbers perhaps for the first time, and part of this shift has stuck. The long-run productivity impact of hybrid work is yet to be seen, although it could be positive if properly structured and managed.

Research shows that the effects of remote work are very sensitive to industry, role, and activity. For fully remote work, most studies show a loss in productivity per hour, which can be offset by more hours worked as commuting time is saved. Hybrid arrangements do tend to increase productivity if staged and managed properly, most studies show. On the one hand, early-stage innovation and brainstorming benefit from on-site exchange, as do training and mentoring, particularly for new employees. On the other hand, working remotely some days has a number of advantages: it promotes cross-office and cross-country connectivity; it can make happier workers put in greater effort; it allows for a quieter home environment for certain tasks; and it saves time through less commuting, shorter breaks, and less sick leave.101

In addition, remote work opens the option of completely outsourcing jobs to emerging economies, especially in services, which may drive a new wave of offshoring for economies with the right talent and infrastructure in place.

5. Can we drive productivity in services?

For someone who has time traveled from the 1960s, our phone calls and computers, and how we build them, have changed beyond recognition. Yet a haircut or going to a hotel or a restaurant would be very familiar. While some specific service subsectors (financial services, professional services, and ICT) have shown higher productivity and productivity growth than manufacturing, services tend to be harder to transform and can be a drag on an economy’s productivity growth.

Increasing productivity in services is a major puzzle. Economies are becoming more and more service intensive, not least because manufacturing involves fewer jobs as it becomes more productive. As we have established, the mix effect in some advanced economies has exerted a constant small drag on productivity growth. (See sidebar “A detailed economy-sector view of the productivity slowdown and the mix effect” in section 2.) Advanced economies have been reweighting toward services for decades, and this trend is now apparent in most emerging economies, too.

In any case, it is challenging for economies to influence their sector mix. Sector specialization depends on deep economic forces that are not simple to modify, and, more important, sector growth rates reflect changes in consumption patterns. This is why making services more productive is a more reliable and sustainable way to raise the aggregate productivity of the economy than other approaches.

For slow-growing emerging economies, solving this puzzle may be even more crucial. Even if opportunities exist, not every economy will be able to secure a manufacturing role in global supply chains to employ 15 or 20 percent of the population, especially as manufacturing becomes more automated. While manufacturing will remain an important source of productivity growth, services (both domestic and for export) will be crucial—probably increasingly so. Following the model of India, the mass export of digital and other services may be an option for several economies, both to increase overall productivity and to reduce dependence on volatile commodity exports.

6. Can we maintain high global cooperation?

The integration of global value chains unlocked huge productivity gains, both in the OECD and where new manufacturing capabilities were built. And while markers of global integration for physical goods plateaued in the years following the GFC, flows of services, data, and people have been steadily increasing. However, the pandemic interrupted global cooperation, which continues to be shaken by trade tensions, protectionist policies, wars, and other geopolitical events.102Geopolitics and the geometry of global trade, McKinsey Global Institute, January 2024; The Global Cooperation Barometer 2024, World Economic Forum and McKinsey, January 2024. If globalization recedes, it could hamper productivity growth in both advanced and emerging economies.

How global supply chains will reconfigure in the future is uncertain, and the shape of this reconfiguration will matter for productivity growth. If trade fragments along geopolitical lines, the impact on global growth may be substantial; some economies could lose up to 6 percent of GDP due to trade effects alone.103Geopolitics and the geometry of global trade, McKinsey Global Institute, January 2024. The long-term impact on productivity growth could be more substantial if we also consider barriers to cross-border investment and reduced diffusion of ideas and technology across the globe.104 Meanwhile, there are indications that some emerging economies are beginning to assume larger roles in global trade networks. Annual greenfield investment in Africa (mainly North Africa) and India has surged by 109 percent and 54 percent, respectively, relative to prepandemic averages. Future reconfiguration may enable a new wave of economies to move into the fast lane, shifting them from commodity dependence to more complex exports.

Finally, industrial policies that promote the reshoring of manufacturing in some advanced economies are on the rise but may not cause higher productivity growth.105 It was an offshoring wave—with employment growth falling while output kept growing—that led to fast productivity growth in the late 1990s and early 2000s. Trying to recover manufacturing jobs is unlikely to help productivity, since it is precisely the less productive tasks (and hence jobs) within global value chains that are generally offshored.

7. Can we reenergize productively?

Global economies have embarked on one of the largest energy transitions in history, and it is uncertain if this will be a tailwind or a headwind for productivity. High energy intensity is key as economies industrialize. However, most advanced and several emerging economies have now decoupled their economic growth from greater energy usage.106 Energy costs account for only about 6 percent of GDP, meaning even large swings in energy costs may have a muted impact on productivity growth.107

In any case, in the short run, the increasing cost of energy, materials, and other resources weighs negatively on productivity. Managing the intermittency of some renewable sources can be costly, too. Investments to speed up the transition that are not yet “in the money”—and may take years or decades to yield positive returns—do not help productivity, either.

However, investment in clean energy and innovation can spur significant productivity and efficiency increases, particularly in the longer run.108 Productivity-enhancing benefits from energy-efficiency investments include increased output yields, shorter process cycle times, improved product quality, and improved machinery performance.109 While intermittence is a current limitation of many clean energy sources, generation costs have already fallen substantially, and the electrification of transportation, industry, and heating could lead to higher conversion efficiency. Additional productivity spillovers may emerge. For example, building electric vehicles requires less labor than building internal-combustion-engine vehicles.110

The need for critical new resources can also produce regional shifts and benefit some emerging economies, if well managed. Latin America, for instance, has a unique opportunity to support global decarbonization since it holds about half of the world’s lithium, 36 percent of its copper, and 16 percent of its nickel, all of which are critical for the net-zero transition.111What could a new era mean for Latin America?,” McKinsey Global Institute, July 2023.

Productivity growth is much more than an economic concept: it is at the core of shared prosperity. Businesses and policy makers in advanced and emerging economies alike need to take action and create the conditions to boost investment, which underlies the technological, economic, and social transformations that drive productivity. This will be critical as the world wrestles with the challenges and opportunities brought by the next era.

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