The Economy Is Getting Hotter. Is a Productivity Boom Next?

Two of the most important facts about the global economy over the last decade are these: A giant financial crisis led to mass unemployment in many countries and years of disappointing growth. And despite a seeming barrage of technological innovation, productivity growth has been the weakest in decades.

Maybe it’s not a coincidence.

That is the provocative conclusion of new research from the McKinsey Global Institute, the in-house think tank of the consulting giant, that suggests we should change how we think about the advancements that make society richer over time. It implies that as the economy returns to full employment, an outburst of faster growth in productivity — and hence economic growth — is a real possibility.

This idea should excite both conservatives and liberals.

It suggests that the Trump administration’s ambitions for faster growth driven by rising productivity aren’t as outlandish as warier forecasters have argued. And it tends to back arguments by liberal-leaning commentators that the Federal Reserve ought to move cautiously in raising interest rates, in hope that the economy will more fully repair itself from damage caused by the 2008 recession and its aftermath.

For years, McKinsey researchers have tried to understand what drives productivity growth from the ground up. They’ve studied how innovations that enable a company to make more goods and services per hour of labor spread across the economy.

The latest wrinkle is that the researchers now believe that productivity growth depends not just on the supply side of the economy — what companies produce and what technologies they use to do it — but also significantly on the demand side. That is to say, productivity advancements don’t happen in a vacuum just because technology is available. They also happen because companies need to increase production to match demand for their goods, and a shortage, either of workers or of materials, forces them to think creatively about how to do so.

“We have always looked at this from the supply side to a large extent,” said James Manyika, a partner at the firm and a co-author of the study. “You look at companies and the introduction of technology and business processes, the adoption of best practices. We’ve always kind of assumed away the demand side of the equation.”

From the mid-1980s through 2008, that seemed like a reasonable approach. Recessions in that period, sometimes called the Great Moderation, tended to be short and mild. But the deeper and more prolonged downturn that affected the United States and Europe since has made at least some economists rethink their assumptions.

Productivity growth in the United States was 3.8 percentage points lower in the period from 2010 to 2014 compared with the 2000-2004 period. Part of that, McKinsey found, was a result of the information technology boom of the 1990s — which paid continuing productivity dividends into the first years of the 21st century — having run its course. But 1.1 percentage points of the drop was due, in its analysis, to aftereffects of the financial crisis. Those effects sapped even more productivity growth, 1.3 percentage points, from the British economy.

Take the auto industry. Automobile production in the United States fell 50 percent from 2007 to 2009, meaning the sector had tremendous excess production capacity in the ensuing years even as the sector recovered. “Companies could fulfill a lot higher demand without having to make any new investments,” said Jaana Remes, a McKinsey partner and a co-author. “Typically the newest technology is implemented in the latest factories. People don’t upgrade a factory that can fulfill demand perfectly well.”

Or consider how this dynamic might apply in the restaurant industry (or retail, or tourism).

The basic technology for self-serve kiosks has been around for years. But when the unemployment rate was at its post-crisis highs, employers could have their pick of good workers at relatively low prices. Now, with the jobless rate at 4.1 percent, good workers are harder to find. And, perhaps unsurprisingly, companies have been more open to installing technology that may have a significant upfront cost and require reworking how a restaurant is organized, but allow more sales without hiring more workers.

“A consequence of a really tight labor market is a higher turnover rate,” said Liah Luther, marketing manager at Nextep Systems, a Michigan company that sells self-ordering kiosks to restaurants, casinos and corporate facilities. “Once you eliminate the need for extensive training on a point of sale system, you can focus on soft skills like customer service, and reduce the cost of turnover.”

The optimistic case for both productivity and overall economic growth goes like this: For the last several years, a lack of demand and plenty of spare capacity of both workers and equipment made businesses complacent and unwilling to invest in new equipment, software or new ways of doing things that might allow more output per hour of labor.

Now, with companies having a harder time finding qualified workers and with demand for their products rising, they’ll have no choice but to re-engineer how they work to try to increase productivity. Higher productivity will in turn make it easier to justify higher wages, creating a self-reinforcing cycle of higher economic growth.

There are some risks to that rosy forecast, which Ms. Remes and Mr. Manyika warn about.

They see a great deal of potential from digitization of businesses that have been slow to embrace the lessons of the cutting-edge companies in their industry. But this might be slow to generate the kinds of big productivity gains that are possible.

Even as more retailers adapt to an age of digital commerce and learn from Amazon, for example, they may in the near term end up simply doubling up traditional retail and e-commerce-focused workers, making such companies less productive rather than more.

And if automation leads to more income going to owners of capital, who already tend be wealthy, that could hollow out middle-class jobs and fuel higher inequality.

“Unless displaced labor can find new highly productive and high-wage occupations, workers may end up in low-wage jobs that create a drag on productivity growth,” the McKinsey researchers wrote.

So it’s not worth pulling out Champagne bottles for productivity yet. First we have to see if the theory holds up — that a tighter economy will feed into higher capital investment and experimentation by businesses about finding new efficiencies. Then we have to see whether that feeds into a virtuous cycle in which more productivity creates more growth and vice versa. And then we have to hope that it turns into wage gains for workers who haven’t seen many of them in the last decade — or else it just may not last.

Neil Irwin is a senior economics correspondent for The Upshot. He previously wrote for The Washington Post and is the author of “The Alchemists: Three Central Bankers and a World on Fire.” @Neil_IrwinFacebook

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