Productivity growth is the secret sauce that fuels economic success. It determines how much output we get from our inputs, and when it's high, living standards soar.
But here's the catch. Productivity growth has been low globally in recent years, particularly in advanced economies, and today the world needs productivity growth more than ever. It is the main way to raise living standards amid aging, the energy transition, supply chain reconfiguration, and inflated global balance sheets. Research by my McKinsey Global Institute colleagues examined why productivity growth stalled and what can be done to rev it up again.
The slowdown story: Over the past 25 years, productivity growth has been all over the map. Advanced economies have seen steady but slow growth, while some – but not all – emerging economies have made impressive strides in increasing productivity growth. However, the overall global productivity growth rate has been on a downward trend. What's causing this slowdown, and how can we reverse it?
Two main factors are to blame for the recent productivity slump in advanced economies. First, the manufacturing sector, which used to be a productivity growth powerhouse, has lost its mojo. The heyday of rapid productivity growth driven by technological advancements and offshoring of labor-intensive production faded.
Second, investment in tangible capital (think machines, equipment, and buildings) has been persistently low across various sectors. This lack of investment has put a damper on productivity growth, as capital per worker plays a vital role in driving efficiency and innovation.
Fast-lane emerging economies: While advanced economies have grappled with slowing productivity growth, some emerging economies have managed to make remarkable progress over the past 25 years. China and India have led the way, enabling more than one billion people to escape poverty.
The development paths of China, India and other high-productivity emerging economies (including Poland, Romania, Estonia, Lithuania, Vietnam, Bangladesh, Ethiopia and Rwanda) have some common threads. They include boosting capital investment, building on that investment to urbanize effectively, making service and construction sectors more productive, increasing the sophistication and global interconnectedness of manufacturing, and establishing an attractive business environment.
The way forward: To accelerate productivity growth, economies must tackle several key challenges. They need to navigate changing macroeconomic conditions, such as inflationary pressures and rising interest rates, by promoting investment and innovation. Governments can help support productivity growth by creating favorable regulatory environments and striking the right balance between competition and entrepreneurship.
In advanced economies, our research suggests leaders should focus on increasing investment in physical and intellectual capital, both of which are crucial for driving innovation, improving efficiency, and ultimately enhancing productivity.
Another priority is harnessing the power of digital technologies, which have the potential to revolutionize productivity growth. Generative AI, in particular, could accelerate labor productivity growth by 0.1 to 0.6 percent annually through 2040, depending on the rate of adoption and how effectively worker time is redeployed into other activities. Combining generative AI with all other technologies, work automation could add a significant 0.5 to 3.4 percentage points annually to productivity growth. However, adoption takes time, and the benefits may not be immediately apparent. To fully unlock this opportunity, governments and businesses can invest in digital infrastructure, promote digital literacy, and facilitate the integration of digital technologies across sectors.
Aging populations and falling birth rates in many developed countries pose another challenge to productivity growth. With fewer working-age adults and swelling populations of seniors, places like Japan, South Korea, China, and most of Europe may see their living standards come under strain unless productivity growth compensates. Governments and businesses can focus on skills training, rethinking retirement policies, and tapping into the growing market of older consumers. Emerging economies such as India and much of Africa, with their young and fast-growing workforces, will have an advantage.
Furthermore, countries can focus on delivering services more productively. While financial services and the information and communications technology sector have shown higher productivity growth, other service sectors have not. Investing in the modernization of traditional services and expanding higher-productivity sectors can drive overall productivity growth.
In the US, there are signs that the stars may be aligning. Productivity growth has been fast over the past three quarters even during a period of strong employment growth. And the excitement around generative AI has boosted technology investment.
Productivity growth is crucial for economic success—and it’s more urgently needed than ever. With the right strategies and investments, countries and companies can unleash a new wave.
