One might expect some sectors of the economy to experience faster productivity growth than others: for example, productivity seems likely to grow faster for semiconductor manufacturers than for a station. service. But a striking change in both the U.S. economy and the world over the past two decades is that looking at companies in the same industry – that is, in the same general industry – the companies that are productivity leaders have expanded their productivity lags behind companies in the same industry.
This change leads to other economic changes. For example, it turns out that one of the main factors behind the increase in income inequality is the widening gap between high and low productivity firms in the same sector. In other words, whether you do relatively better or worse as a result of growing inequality may not have much to do with you personally, or where you live, or with your work; it’s more about whether you work for a high or low productivity company. The McKinsey Global Institute offers some thoughts on this and other productivity-related topics in “Reviving American Productivity for a New Era (February 16, 2023). The report states:
The most productive companies in all sectors have widened their lead over the others. In fact, the gap between the most and the least productive is wider within sectors than in any other dimension studied. The manufacturing industry provides a particularly striking example; leading companies operate at 5.4 times the productivity of laggards.9 In some manufacturing subsectors, the differences are extraordinary. The major semiconductor manufacturers are 38 times more productive than the least productive companies. This mirrors other research showing similar divergence patterns in other sectors such as wholesale and news.ten
“Trailblazers” at the forefront of productivity are increasingly distancing themselves from their peers. These companies tend to be larger, more connected to global value chains, and focus on the technology-intensive aspects of their industry. Research suggests that these leading companies invest 2.6 times more in technology and other intangible assets such as research and intellectual property, and attract and invest in more skilled talent.11
As a result, the gap between pioneers and laggards has widened over the past 30 years. In manufacturing, the gap was 25% wider in 2019 than it was in 1989, with most of these changes occurring before 2000. At the same time, the dynamism of industry declined, as shown by metrics such as the new business entry rate (which declined 29% from 1989 to 2019 in the US) and labor reallocation rates (which are down 31% in all sectors).
Standard economic principles would suggest that less productive firms would be replaced or improve their performance. The researchers offered several hypotheses as to why this did not happen. For example, there is evidence that companies in the same industry can coexist without fully competing with each other, serving different customers, attracting different workers, or operating in different geographic markets. Finally, some researchers have pointed to the decline in competition measures as the source of the discrepancy, which remains a subject of active debate.
Whatever the explanation for the growing divergence, productivity gains must ultimately come from firms. If the laggards don’t catch up or are replaced by more productive firms, US productivity will continue to fall. For business leaders, the message is clear: improving your business performance matters far more than the productivity of the industries in which you operate.
As the McKinsey report points out, gains in labor productivity are essential to national prosperity. The key issue here is that productivity gains reinforce each other. So if productivity could be increased by 1% per year, each year builds on the previous one, and after a decade the US economy would be (about) 10% larger. (Actually, just over 10%, because the growth rate accumulates over time.) The US economy is currently about $23 trillion, so a 10% increase implies gains of over 2 trillion dollars. As I sometimes say, it doesn’t matter whether your goal is higher wages, increased government spending, or tax cuts, it’s easier to achieve that goal in a growing economy – where we actually argue about how a growing pie will be divided – that is to achieve your goals in a low-growth economy or even a zero-sum economy, where gains for one particular goal require losses for other goals.
The MGI report examines a number of ways the United States (or any country) can improve productivity: better education and workforce skills, support for research and development, a competitive and evolving market, etc.
Here, I want to highlight a different lesson: the growing divergence between high- and low-productivity firms suggests that the challenge is not just one of cutting-edge innovation. Again, leading companies in different sectors of the economy are doing quite well when it comes to increasing productivity. The challenge is to sustain an economic environment where the productivity laggards catch up or die, but don’t just continue to lag behind.