Tuesday, February 3, 2015

Higher productivity growth holds the key to sustained economic and per capita income growth

A new study (PDF here) by the McKinsey Global Institute looks at the scenario where population growth slows down (as is happening right now in developed countries and some emerging economies) and working age population declines. The report finds that global growth will depend on how fast productivity rises in the scenario when number of employees peak and starts to decline. Higher growth in productivity will push an economy’s GDP potential in the long run as employment growth slows down.

Productivity has to grow by at least 3.3% annually (80% faster than its average rate over 1964-2014) to compensate for the slower employment growth. The study found that about three-quarters of the potential productivity growth will come from broader adoption of existing best practices (or catch-up improvements). The remaining one-quarter will come from technological, operational or business innovations that go beyond current best practices.

According the MGI, the ten key enablers of growth are as follows:

  1. Remove barriers to competition in service sectors
  2. Focus on public and regulated sector efficiency
  3. Invest in physical and digital infrastructure
  4. Foster R&D demand and investment
  5. Exploit date to identify transformational improvement opportunities
  6. Improve education and skill matching, and labor-market flexibility
  7. Open up economies to cross-border economic flows
  8. Boost labor-force participation among women, young people, and older people
  9. Harness the power of new actors through digital platforms and open data
  10. Craft regulatory environment, incentivizing productivity and innovation

Broadly, countries need to enable catch-up by creating transparency and competition; help to push the frontier by incentivizing innovation; mobilize labor to counter the waning of demographic tailwinds; and open up economies to cross-border economic flows, from trade in goods and services to flows of people.

In follow-up commentaries, Ricardo Hausmann argues that there has to an adequate supply of productivity-enhancing public goods (when markets don’t supply such goods), and its effectiveness may be rated by an independent ration agency. Justin Lin argues that China should be able to benefit from “latecomer advantage” by achieving technological advances through innovation, importation, integration and licensing (a lower-cost and lower-risk path to productivity improvement).