Why Productivity Growth May Be Poised to Recover – Real Time Economics

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Weak productivity growth has been a head-scratcher for economists in recent years, but a new study argues the tide is poised to turn, and the next wave will be driven by digitization.

The diffusion of new technologies into everyday use holds promise for bringing back the kinds of annual 2% productivity growth seen in the past but digitization is still at an early stage in many industries, according to the latest study from the McKinsey Global Institute.

Looking at the past half-century, it estimates the time from commercial availability of new technologies to 90% adoption ranges from about eight to 28 years.

It’s a matter of some urgency. U.S. worker productivity grew below its long-run average for the seventh straight year in 2017, advancing a meager 1.2% last year from 2016.

Labor productivity—real economic output divided by the numbers of hours worked—is key for economies to grow, improve living standards and keep inflation in check. Yet with labor-supply growth projected to stall in coming decades given the aging population, U.S. productivity growth would need to increase 44% over the next half-century to sustain past rates of economic growth, McKinsey projects.

The study puts productivity’s poor performance in recent years on a combination of three factors. First, a productivity boom that began in the 1990s petered out after about a decade. Then major economies faced weak demand in the wake of the 2007-09 recession, and now they’re grappling with digitization.

The waning of the 1990s productivity boom and the aftereffects of the financial crisis dragged down productivity growth by 1.9 percentage point on average across countries since the mid-2000s, according to the study, which focused on France, Germany, Italy, Spain, Sweden, the U.K. and the U.S.

Digitization “contains the promise of significant productivity-boosting opportunities but the benefits have not yet materialized at scale,” the McKinsey report said. Not least because of barriers, lags and transition costs to digitization.

The study adds a further voice to economists’ call to be patient when it comes to productivity.

Just ask retailers. The industry is in the throes of technological disruption, with bricks-and-mortar retailers facing steep competition from e-commerce sales. Yet only nine cents out of every dollar spent on retail is spent online, according to the Commerce Department, suggesting there is still enormous room for digitization.

McKinsey identifies the retail sector as one of the laggards on digitization, along with agriculture, construction, hospitality, health care, government and education. Industries at the forefront of digitization include technology, media, and professional and financial services.

Digitization isn’t the only factor economies could embrace to unlock productivity growth. The report calls for policies to encourage education, businesses investment and the purchasing power of low-income consumers.

Rising income inequality since the mid-2000s has been a constant, if moderate, drag on demand, according to the report. If income distribution today were at the same level as in 1985, it says, U.S. consumption would be about 2.5% or $460 billion higher.

Harriet Torry

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