Productivity leads to prosperity

Roberta Fusaro: US productivity is a big deal because …

Charles Atkins: … over the long view of human history, productivity is the way that we collectively get wealthier.

Roberta Fusaro: That’s McKinsey partner Charles Atkins. He says if we want to grow wealthier and more prosperous as a nation …

Charles Atkins: Then we really have to get more productive by generating more output with each hour that we work, which is really quite a simple insight, but also a really important one, because we very often get lost in the day-to-day of the business cycle of employment and unemployment fluctuating over time.

Roberta Fusaro: So what exactly is productivity? Charles says that, in economics, the definition is pretty simple.

Charles Atkins: Productivity is a measure of output relative to some set of inputs. So it can be easiest understood in the context of labor productivity, where we look at what the output per worker is for each hour that they work.

Olivia White: So in a sort of economic context, think about a café. How many lattes does a barista make in an hour? Think about a car assembly plant. How many cars roll down the line complete in a day?

Roberta Fusaro: That’s McKinsey senior partner Olivia White.

Olivia White: Think about productivity as doing more with less.

Roberta Fusaro: Doing more with less is exactly what the McKinsey Global Institute’s recent report, “Rekindling US productivity for a new era,” examines. The report says that in the face of workforce shortages, debt, inflation, and the energy transition, regaining historical rates of productivity growth would add a whopping $10 trillion to US GDP—something the US sorely needs.

Productivity across US states

Roberta Fusaro: Olivia, I was thinking a little bit about the community that I live in. I am based in Massachusetts, and we’ve got biotech communities and huge healthcare systems. Thinking about how companies settle into particular cities and particular states, how is that reflected in our research?

Olivia White: So we looked at the productivity of all US states. There are 25 states that have below-average productivity and below-average productivity growth. And there are effectively seven states that have above-average productivity and above-average productivity growth for the past 10 years or so. And those are New York, Massachusetts, Texas, Colorado, Washington, California, and North Dakota.

The broad dynamic here is that we have increasing divergence in the productivity level of a lot of different states across the US. That’s a really important dynamic, and it’s not one that we’ve observed historically.

Charles Atkins: We were somewhat puzzled by this because the US is a unified market. You would expect that there would be mobility of labor, the spreading of ideas, and that you would start to see productive practices spreading more easily. And that’s not what we’ve seen.

Tech is not the differentiator

Roberta Fusaro: What are some of the factors that are playing into this divergence? We haven’t seen it before, so what’s different now?

Olivia White: What’s happening? Well, let me first bust a myth on technology. You might expect, “Well, the states that have higher productivity and higher productivity growth, maybe they’re just the ones in tech.” Not so. They don’t have per se higher amounts of technology or other particularly productive sectors.

Some of it may be that there is an increasing divergence between the companies that are most productive and the companies that are least productive. So where you have states that have managed to attract and continue to foster more productivity among their companies, that can be one of these reasons. But I will just say, honestly, that some of this is an honest-to-goodness real open question.

Charles Atkins: There seems to be something about the leading states in that they have been able to attract the right kinds of firms, attract the labor and the capital that those firms need. And those [firms] have created some healthy dynamics in terms of productivity growth within those states.

Productivity across US cities

Roberta Fusaro: What are the implications for individual cities in a state like mine, where productivity is high?

Olivia White: I’ll give you my answer, and you should absolutely get Charles’s view on this one. So there are a set of cities, in fact eight cities specifically in the US, where actual productivity is meaningfully higher today than it is elsewhere. And I will tell you that Boston is the eighth on that list. San José is actually the first and San Francisco the second.

Roberta Fusaro: We’ve got to catch up!

Olivia White: Yes! And then just for people listening, there’s Seattle, Houston, San Diego, Los Angeles, New York, and then Boston. It’s really clear that agglomeration effects can matter.

When you agglomerate or get a bunch of stuff together in a city – aka CLUSTERS – you get a synergistic effect of one plus one being either a lot or at least a little more than two. And what we see here in the US is that there are some cities where that’s really true in spades, and others which don’t really fully or at all benefit from their “citiness,” if you will.

But when it works, this is where you’re able to get a set of companies that actually interact and learn from one another. Workers who actually work at different companies, but nevertheless are able to be better at what they do by virtue of their own interaction.

A lot of it has to do with the sort of ferment of intangibles, how people interact and aid in innovation in different sorts of fields.

Charles Atkins: I think one of the interesting findings from what we’ve seen that is also noted in the academic literature is that the benefits seem to accrue not just to the firms in the technology sector, like what we see in a place like San Francisco or San José, but actually spreads more broadly through the different sectors within those cities.

So it’s not true to say that the success of California is a tech story, because there’s actually multiple sectors that are doing quite well. But it is true to say that if you look at a city like San José or San Francisco, the story of technology and the story of agglomeration effects is very significant in driving the productivity growth that they’ve seen.

Productivity across industries

Roberta Fusaro: I’m curious to hear a little bit more about which industries are growing and which industries are lagging.

Olivia White: It’s not sector-level productivity that makes some states more productive, but there are some sectors that are simply more productive and faster growing than others. I’ll call out a few categories. The first is information, which includes tech and most of what we would consider tech companies; finance and insurance; mining; and wholesale trade.

There’s a set of sectors that are more productive than average, but where productivity is not growing so fast. They’re sluggish, and they include manufacturing, real estate, rental, and leasing.

And the final category I’ll call out are the sectors that are lagging—the ones where productivity growth is basically at a standstill. This includes construction. It includes accommodation and food services. It includes transport and warehousing. It also includes healthcare.

Roberta Fusaro: Looking specifically at companies as engines of this productivity in the economy, what did we see in the report?

Olivia White: We found something really unusual in the data that the US collects. Individual companies within a given industry have widely varying levels of productivity and productivity growth.

Take the manufacturing sector. The most productive companies are five times more productive than the bottom decile of companies in terms of productivity. So there’s a huge amount that many companies can learn from the most productive. In general, we find that that’s true across industries.

Charles Atkins: And that gap has actually been growing wider over time. Our productivity is actually not slowing down at the level of those in the top 10 percent of companies. They are actually growing more productive at a rate that is at least in line with historical growth, and depending on the sector, sometimes exceeding the historical growth rate.

The question is more: Why is the other 90 percent falling further behind? And this is a key pattern to understanding what it will take to unlock productivity growth.

Because understanding the dynamics at a firm level, how some firms can take technology, and skilled labor to drive business benefit from it, is actually the key to understanding what is happening in productivity growth in the US economy.

Roberta Fusaro: Are there any examples of companies getting this right?

Charles Atkins: There’s a company by the name of Dot Foods.

What’s interesting about this company is that it’s in a sector that is viewed as a laggard sector in terms of productivity. It’s in food services redistribution. It is a small company in contrast to a lot of the superstar firms that are talked about as being productivity leaders.

It’s based mostly in rural areas compared with many of the other firms in cities. Many of the same things I just spoke about are inherent in its success story. It digitized early. It reconfigured its organization around its digital infrastructure and digital engagement of its customers. It was able to find and attract scarce talent even in [rural] areas. And now it’s one of the largest food services redistributors in the United States.

How to increase productivity

Roberta Fusaro: What can companies do to improve productivity?

Olivia White: Let me make a couple of suggestions for the CEO seat. Number one is to prepare for the future war on talent. Labor markets are going to be tight in some form for the foreseeable future, and human capital plays an incredibly important role.

As you’re looking at hiring people for their talent and if they have the relevant experience, don’t focus just on credentials or where someone has a degree from. Make sure that once you bring people in, you really invest in on-the-job training and rotation programs that build skills over time. It also matters a lot to make sure that you have policies on childcare and elder care and parental leave, so that you’re not de facto excluding people with talent from the workforce, so you are able to get the most out of everybody.

The second broad thing is that digital transformations are important. Commit to that transformation with real goals and shared accountability.

Make sure that your investments aren’t just in technology, but that you’re investing in the research and development and the intangibles that actually allow you to create business operations that are designed around your goals, and make the technology serve your goals, rather than the other way around.

Charles Atkins: What we find is that most firms have actually made investments in technology, but very few have actually gotten the benefits. The companies that are getting the benefits tend to do a couple of things right. They tend to be able to bring together skilled labor that’s more suited to utilizing that technology.

They reconfigure their organizations and the workflows and operations within their companies to take the benefit of both the technology and the skilled labor. And then, finally, they will also start to invest in reskilling programs and other forms of intangible assets like brand and advertising, et cetera, that will help them really get the benefits of those investments in technology and people.

So when we see that [inefficient use of technology] is what’s holding many of those companies back, it’s not for lack of trying to invest in technology. But in many cases, it’s often the inability to fully capitalize on the benefits [of the technology], by not necessarily reconfiguring their organizations or being able to attract the types of talent that you need to capitalize on the benefits. (This reminds me of the early days of mainframe computers, when companies used them mostly for printing payslips and invoices, not their computing power)

Olivia White: Technology and the efficient use of technology really matters. I hear a lot of CEOs and executives say, “We’ve invested a tremendous amount in technology, but we haven’t seen it in our productivity or in our margins.”

In order to get the most out of technology, it’s not just the widget [that matters]. It’s making sure that your processes and the way you train your people are tuned into the technology you’re putting in place.

How other countries are faring

Roberta Fusaro: Did the research look at productivity across other countries? And what’s the comparison there?

Olivia White: Yes. This is an incredibly important question, and this research focused on the US, but we did look elsewhere for a baseline comparison. If you look at the US, productivity growth in the US over the real long haul, since World War II, has been at about 2.2% per year.

Productivity growth over the past 15 years or so has been at about 1.4% per year. A little earlier we talked about how one thing productivity is important for is compensation. From 1995 to 2005, growth in real compensation in the US was 1.9% per year. From roughly 2005 to 2019, growth in real compensation was down by more than half

Roberta Fusaro: Oh wow!

Olivia White: —to 0.7%.

Roberta Fusaro: Wow!

Olivia White: So this is why we care about the US. Now, how about other countries? We looked at a bunch of countries, particularly in Europe, to provide a bit of a counterpoint. And the fact is, they’re having exactly the same sorts of struggles and the same sorts of issues. In some instances, actually, those struggles are even more acute. So this is one of those places where we may look better than some of our European peers. As I say, not by a lot, but by a little bit. But none of us look very good, and none of us look very good even by standards of what we were seeing between 1995 and 2005.

Charles Atkins: We have a double problem. Not only has our productivity growth declined, but the number of workers that we have in the economy is slowing, because our labor force participation rate is declining. And our view is that those problems are somewhat linked.