The coming productivity revolution

“Red warnings lights are once again flashing on the dashboard of the global economy,” British Prime Minister David Cameron declared after the G-20’s summit in November. He is right. But the real worry is not the risk associated with near-term challenges, like Japan’s return to recession in 2014 or the eurozone’s enduring sluggishness; it is the gale-force headwinds that the entire world will face over the next half-century.
Despite nerve-wracking ups and downs, the last 50 years delivered an unprecedented global growth dividend. Measured according to GDP (admittedly a flawed metric), the world economy expanded sixfold. Income per capita almost tripled.

In the developing world, sustained wealth creation and public-health advances have increased average life expectancy by 20 years since the mid-1970s, and adult illiteracy has been nearly halved in the last 30 years. Inequality among countries has decreased, with more than one billion people lifted out of extreme poverty in the last two decades alone.

But if we pursue business as usual, the odds of making similarly impressive progress over the next 50 years are not very promising. Since 1964, two key forces have fueled exceptionally fast GDP growth: the expansion of the labor supply, driven by rapid increases in population, and steady productivity gains. According to a report by the McKinsey Global Institute (MGI), the average annual GDP growth rate of 3.5% in the 19 member countries of the G-20 (not including the European Union) and Nigeria owes about 1.8 percentage points to labor and 1.7 points to productivity.

But, as fertility declines and populations age, the labor engine’s contribution to growth will fall sharply, to little more than 0.3 percentage points of annual growth. Even if productivity continues to rise at the same rate, global GDP growth could slow to just over 2% annually, on average – a 40% drop from the last 50 years.

The good news is that this trajectory can be raised. But to do so requires a shift in focus from reducing inequality to delivering growth that benefits the poor and middle class as well.

The historian Ben Friedman has observed that the “central question” in US history is not “the poverty of the most disadvantaged” or “the success of the most privileged”; it is “the economic well-being of the broad majority” of the population. The same is true on a global level, as billions of aspiring consumers rise up to join the middle class.

On the labor-market side, the most powerful lever to bolster the majority’s wellbeing would be to increase the employment of women, whose workforce-participation rate still lags behind that of men by as much as 40% globally. Including more women presupposes better childcare and other social support in many countries, as well as further progress on pay equality, including the more equal taxation of second earners.

Moreover, MGI estimates that addressing barriers like mandatory retirement ages and perverse tax incentives could add about 200 million workers over the age of 65 to the world’s labor pool. Efforts to reduce youth unemployment would also help.

These changes, while important, would have a limited impact, lifting labor’s contribution to future growth from one-fifth to only one-third of post-war levels. What the world really needs to do is accelerate productivity – not at a modest pace, but at the economic equivalent of warp speed.

Fortunately, today’s private-sector labs are bursting with innovations that could spark major productivity-enhancing technological and operational improvements. Advanced materials like nanolaminates (edible lipids) can, when sprayed on food, provide protection from air or moisture and reduce spoilage. Carbon-fiber composites are making cars and airplanes both more resistant and lighter, reducing their fuel consumption. And the “Internet of things” will rationalize production processes by detecting potential failures early, boost crop yields by measuring the moisture of fields, and dramatically reduce the cost of remotely monitoring patients’ health.

Just a little further out on the productivity frontier are commercially viable self-driving cars and trucks. Likewise, synthetic biology will be possible before too long, with scientists using the huge amount of increasingly available and inexpensive genetic data to design DNA from scratch – a practice that has applications in medicine, agriculture, and even biofuel production.

But the private sector cannot realize this potential alone. Most countries need increased public-sector investment to support essential long-term research and development, and smarter, more innovation-friendly regulation to facilitate future gains. Because the biggest opportunities lie in spurring faster productivity catch-up by adopting and diffusing today’s best practices, politicians must keep pushing to reduce trade and regulatory barriers to market integration and competition.

Perhaps most important, labor markets must be made as flexible as possible, with well-trained workers secured by strong social-safety nets. This would enable workers to weather the transition to the jobs of the future and allow the economy to benefit from new waves of wealth and value-generating creative destruction. It is worth recalling that more than one-third of employment growth in the US since 1990 has come from jobs that did not exist, or barely existed, 25 years ago.

Some countries may even want to consider appointing a “growth czar” to connect all of these policy dots. In the end, however, the actual growth figures are not the point. What matters is ensuring that the wellbeing of as many citizens as possible is improving – and that requires concerted action by business leaders, governments, and civil society.

This article is published in collaboration with Project Syndicate. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Dominic Barton is the global managing director of McKinsey & Company.

Image: A man stands in the middle of Grand Central Terminal as he speaks on a cell phone in New York, September 25, 2013. REUTERS/Zoran Milich.