Productivity growth matters more than ever in a changing geoeconomic era

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Productivity – the amount of output each worker produces – is the core of our shared global prosperity and as the world wrestles with shifting geoeconomics, it matters more than ever. Asia has experienced a productivity surge in recent years, but cannot afford to be complacent if the region’s economies are to continue closing the gap with their advanced counterparts.

Recent McKinsey Global Institute research, Investing in productivity growth, shows that the world has been doing well on productivity. Over the past 25 years, median economy productivity has jumped sixfold from around US$7,000 per employee to US$41,000. On average, productivity has grown at an annual rate of 2.3%.

But this average disguises the important contribution of Asia – and variation within the region. China and India alone contributed almost half of the global total with rapid productivity growth of 7.7% and 5.6% per year, respectively. Other Asian countries in the fast lane of convergence with advanced economies, including Bangladesh, Cambodia and Vietnam, with growth rates of around 4.0 to 4.5%. Indonesia, Thailand and Malaysia were in the middle lane, with productivity growth closer to 2%.

In other regions, the productivity story has been less impressive. Central and Eastern European countries also did well, but 1.4 billion people who live in slow-lane economies, largely in Latin America and sub-Saharan Africa, failed to narrow their productivity gap with advanced economies. Advanced economies, in turn, slowed to below 1% annual growth after the global financial crisis.

Investment is the key differentiator of fast growers. Across Asian countries, growth in capital per worker explains between 70 and 100% of productivity growth. Capital stock per worker – the amount of infrastructure, machines, software and other forms of capital available to workers – jumped twofold in Indonesia, fourfold in India, fivefold in Vietnam and eightfold in China. Fast-lane economies have sustained very high investment of 20 to 40% of GDP over the past quarter century.

This investment has been channeled into building the infrastructure that underpins successful urbanization, higher productivity in service sectors, and globally connected and increasingly sophisticated manufacturing. Thanks to high productivity growth in agriculture, emerging Asian economies have been able to reduce employment in the sector, very often between 20 and 30%, and move people to higher value-added jobs in construction, manufacturing and services, increasingly in cities. Some countries, like Bangladesh, China and India have achieved high productivity growth in the service sector, too, often downplayed as a path to development. In India’s case, its early upgrading of digital infrastructure and workforce skills in the 1990s enabled it to become a global IT leader, especially in software.

But this is not a time for complacency. Productivity growth slowed down almost universally after the global financial crisis, and suffered a new blow with the COVID-19 pandemic. Fast-lane economies have seen productivity growth per hour decelerate since the global financial crisis, from 8.6% in the half-decade preceding 2007 to around 5% since 2012. This trend has been even more striking in middle-lane economies. Their productivity growth per hour has slipped from 3.9% to about 1.5% over the same period.

Emerging Asian economies have traveled fast, but their journey is far from over. Despite fast growth, the productivity level of most emerging Asian countries is still between 5 and 25% that of the United States. Capital stock per worker stands at around $40,000 per worker on average. That is far lower than an average of $85,000 in Latin America, $150,000 in Central Europe, and close to $300,000 in North America. There is plenty of room for investment and growth.

Closing such gaps may well become more challenging in a new era for Asia and the world. Several forces are at work that could bear down on productivity growth, including aging populations, rising energy costs, supply-chain reconfiguration amid geopolitical tensions, and macroeconomic turbulence.

The reconfiguration of global trade is of particular concern. The global trade system is being shaken by trade tensions, protectionist policies and geopolitical fracturing. Uncertainty remains about how, and to what degree, global trade patterns may shift, but if – overall – globalization were to recede, this could hamper productivity growth in both advanced and emerging economies.

If trade were to fragment along geopolitical lines, the impact on global growth may be substantial; some economies could lose up to 6% of GDP due to trade effects alone. The long-term impact on productivity growth could be more substantial if barriers to cross-border investment were to be raised, and the diffusion of ideas and technology were to decline.

Times of change, however, offer opportunities amid challenges. Some emerging economies are beginning to assume a larger role in global trade networks. India’s annual greenfield investment has surged by 54%. Indeed, trade reconfiguration could enable a new wave of economies to capture a greater share of higher value-added exports.

Aging societies are a fact, but with the exception of China, emerging Asian economies have a younger demographic profile than many regions in the world. Technologies such as digitization and AI can boost productivity significantly if adopted so long as the investment, infrastructure, institutional settings and worker skills are there.

The world may be becoming more complex, but that complexity only makes productivity gains more important – and offers opportunities for Asian economies to keep improving their citizens’ living standards.

This article originally appeared in Bloomberg.

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