Retooling the U.S. Economy for Growth

Preview the full findings of the McKinsey Global Institute’s study here.

As the United States crawls out of recession, many commentators have wondered out loud whether the economy can ever get back on a path toward healthy growth. In the immediate term, there are concerns about when and from where the next wave of jobs will come. In the long term, some are questioning whether America’s best economic days are now behind it. The Barack Obama administration caught the thread of that conversation early and tried to counter naysayers in the January State of the Union address. “The future is ours to win,” Obama told the country, “But to get there, we can’t just stand still.” Specifically, what’s required, the president explained earlier that month, is to “unlock the productivity” of the American people.

He may be on to something. In a report released today by McKinsey Global Institute (MGI), McKinsey & Company’s business and economics research arm, we find real, tangible ways that the United States can retool its economy for the coming age of global growth — and productivity is at the heart of this endeavor. In fact, the United States must increase its productivity growth rate by 30 percent or more to sustain historical economic growth rates in coming years. As the labor force ages and economic rivals crop up the world over, boosting the efficiency of every American worker will be vital to staying ahead in the global economic race.

Why is productivity key now? In short, because two other factors are working against the weak economy: Government and individuals are cutting back on spending in order to pay off debts, even as an aging population no longer gives the economy the natural demographic lift it once did. MGI finds that the United States needs to accelerate productivity growth to an average rate not seen since the 1960s if the economy is to return to the rates of GDP growth witnessed over the past 20 years and sustain the gains in living standards to which Americans have become accustomed.  

Still skeptics abound on all sides. Some doubt whether productivity can really help return the United States back to economic health. Naysayers argue that the U.S. productivity engine is running out of steam anyway. Others yet worry that productivity is little more than business-speak for job cuts. They point to the period since 2000, during which sectors that saw the largest productivity gains — computers, electronics, and manufacturing — also lost jobs. Still others see China’s pursuit of higher technology manufacturing as a sign of pending U.S. decline.

The numbers tell a different story, however. Since 1929, the United States has recorded simultaneous increases in both productivity and employment every ten-year rolling period except one, research from the MGI report finds. Even on a rolling annual basis, productivity and jobs have grown in tandem the majority of the time. In anything but the short term, it is a fallacy to suggest that there is a trade-off between productivity and jobs.

One reason is that productivity has two components: efficiency and innovation. Getting new, faster computers or organizing production to minimize waste are examples of the first; building better, higher quality products or creating new services are examples of the second. Both types of productivity gains can lead to higher employment when the savings are put to work elsewhere in the economy. In the 1990s, for example, the United States saw productivity growth from both efficiency and innovation, and unemployment hovered below 6 percent. This is a broad balance to which it now needs to return.

And productivity growth needs to accelerate. For half a century, increases in both labor supply and productivity contributed almost equally to robust GDP growth of 3.3 percent. Baby boomers and women streamed into the workforce. Now however, the boomers are retiring and female participation appears to have plateaued. Already, in the first decade of the 21st century, productivity gains have contributed 80 percent of total GDP growth compared with 35 percent in the 1970s. If the United States is to continue to enjoy the same levels of GDP growth experienced by previous generations, productivity will have to bear even more of the burden going forward. To compensate for the coming demographic changes, productivity growth will need to accelerate by 34 percent — to a rate not that hasn’t been seen since the 1960s.

This sounds like a daunting challenge, but meeting it is quite possible. Indeed, even with no change in the current business and regulatory environment, U.S. companies can deliver three-quarters of the productivity growth acceleration that the United States needs just by continuing on the path they are on. It is, in fact, partly because of the efficiencies achieved over the past decade — which strengthened corporate balance sheets through the better use of technology, for example — that U.S. businesses are well positioned to take advantage of future opportunities to boost productivity now.

One of those opportunities is for companies to simply adopt the existing best practices of their more productive peers. Many, but not all, U.S. businesses have incorporated information technology and lean management strategies into their operations. Broadening their use would yield one-quarter of the productivity growth acceleration that the United States needs. Even in sectors such as retail, where U.S. businesses have had a strong record on productivity, there is scope to do more, for instance by taking lean practices from the stockroom to the storefront. Health care, most of which faces limited price competition and hence is scarcely encouraged toward efficient practice, has only begun to go lean. Today, nurses still spend less than 40 percent of their time with patients and much of the rest on paperwork.

Companies could deliver another half of the needed productivity acceleration by tapping into the next wave of innovation. For instance, retailers who have made great strides in boosting the efficiency of their supply chains can now manage them even more precisely using a cheaper tracking technology called radiofrequency identification, or RFID. Increasing responsiveness to customers is another way of boosting productivity. The financial industry, for example, is looking at ways to provide a new set of customers — those who don’t currently have a bank — with financial services such as pre-paid payment cards specifically tailored to their needs. Businesses can also boost productivity by innovating in what and how they provide goods and services to their customers. For example, an office supply company can offer comprehensive procurement services in addition to stocking the paper and pens.

The private sector can get the United States three-quarters of the way on productivity, but to obtain the last one-quarter — and potentially boost productivity growth by even more — government and business have some work to do together in removing economic barriers to growth. Efficient infrastructure is an important enabler for business, yet the quality of U.S. infrastructure is ranked only 23rd in the world, below Germany, South Korea, and even Oman. Skills are another necessary ingredient; The United States faces a shortfall of almost 2 million technical and analytical workers and a shortage of several hundred thousand nurses and as many as 100,000 physicians over the next 10 years. Making it easier for seniors to stay working for longer would help; so too would easing the path in the United States of skilled immigrants. The workforce training system in the United States could also be radically improved by aligning more closely to employers’ human resources’ systems and financing specific educational programs based on job placement results.

Tackling misaligned incentives in public and regulated sectors, including health care, is also a prerequisite for lifting the productivity of the U.S. economy as a whole. These sectors represent more than 20 percent of the U.S. economy but post persistently low productivity growth. If the public sector could halve the estimated efficiency gap with similar private-sector organizational, its productivity would be 5 to 15 percent higher, generating annual savings of between $100 billion and $300 billion.

Finally, the United States needs to ensure that it has the information technology infrastructure in place to fully take advantage of the possible gains from “Big Data” – including everything from data-crunching, to information storage in cloud computing, to IT applications in biology and the life sciences. Although the United States remains the global leader in research and development, other countries are catching up, particularly in new, cutting-edge industries. In 2009, China surpassed the United States for the first time in the size of clean energy investments, for example. Reducing the red tape to deploy new research or manufacturing facilities would help the United States to keep its lead. Obama signaled in January that he would tackle exactly that in a government-wide review.

GDP and productivity growth are vital not just at home, but for American competitiveness worldwide, ensuring that the United States remains an attractive place for businesses to operate, invest, and expand. The core of the United States’ competitive strength has been the economy’s rapid rate of innovation and productivity growth, as well as the large, expanding, and dynamic U.S. domestic market. The United States has led the world’s developed nations in terms of productivity performance for years. However, today emerging economies such as China and India are experiencing rapid GDP and productivity growth, intensifying the competitive pressure on the United States in an increasingly broad range of goods and services.

So companies can do the heavy lifting — but the government needs to weigh in, too, enabling the private sector to unleash a new era of dynamism that ensures the nation’s long-term growth and competitiveness. The United States is certainly capable of this step-change in productivity growth. Not meeting the productivity imperative would risk leaving the next generation of Americans with slower increases in the standard of living than their parents or grandparents experienced. The time to act is now.

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