McKinsey Explainers

What is productivity?
Simply put, productivity measures the amount of value
created for each hour that is worked in a society.

February 2023
 Focus up: you probably know that the amount of Why is productivity growth
work you can get done in one day is your rate of slowing in advanced countries?
productivity. Productivity in economics is pretty In the United States and Western Europe, labor
much the same as productivity at your desk. productivity growth has been declining ever since
But for companies or even countries, measuring a boom in the 1960s. The story is a little different
productivity is a little more complex than how in each country. In the United States and Sweden,
well you were able to hold a video call over the for example, there was strong productivity growth
construction noise from the street or your cat’s from the mid-1990s to the early 2000s, followed
incessant meowing. by the largest decline in productivity growth among
countries surveyed (due to financial crisis aftereffects
On a country scale, productivity can mean the and uncertainty). In Italy and Spain, however,
difference between good and not-so-good productivity growth was close to zero for years before
standards of living. For a company, productivity the financial crisis in 2008, which meant that the
can determine whether it can afford to increase severe contraction in the labor market after the crisis
wages for its employees or even if it can continue actually accelerated productivity growth.
operating. Stagnating or contracting productivity
can spell serious trouble ahead for individuals, Across the sample of countries in Western
organizations, and nations alike. Europe and North America, there have been
three micro patterns of productivity slowdown.
Understanding what economic productivity is and First, for a variety of reasons, the recovery from
how it works is critical to working toward maintaining the 2008 financial crisis has created a job-rich
and increasing it. Here, we’ll take a deep dive into the but productivity-weak environment. Next, the
theory and practice of productivity. few sectors that are experiencing accelerated
productivity growth are too small or moving
too slowly to shift the overall numbers. Finally,
What are the different kinds technological development hasn’t had the boosting
of productivity? effect on labor productivity that it has in the past.
We’ve already touched on labor productivity. On To some analysts, this state of affairs seems like a
a country scale, labor productivity is frequently reappearance of the Solow Paradox of the 1980s,
calculated as a ratio of GDP per total hours worked. named for economist Robert Solow who observed in
So if a country’s GDP were $1 trillion and its people 1987 that the gathering momentum of the computer
worked 20 billion hours to create that value, the age wasn’t reflected in productivity statistics.
country’s labor productivity would be $50 per hour. The original Solow Paradox was resolved in the
Labor productivity growth is crucial to increased 1990s when a few sectors—technology, retail, and
wages and standards of living, and it helps increase wholesale—led an acceleration of US productivity
consumers’ purchasing power. growth. It remains to be seen when—or whether—
the current productivity paradox will be resolved.
Economists measure other types of productivity,
too. Capital productivity is a measure of how well So why is this happening? Some economists think it
physical capital—such as real estate, equipment, is a supply-driven issue. In practice, this could mean
and inventory—is used to generate output such one of a few things: either that digitization hasn’t
as goods and services. (Capital productivity and yet reached its full potential or that the age of great
labor productivity are frequently considered innovation has passed and the low-hanging fruit has
together as an indicator of a country’s overall already all been picked. Another line of thought is
standard of living.) And total factor productivity is that developed economies are increasingly service-
the portion of growth in output not explained by oriented, which by nature have less productivity
growth in labor or capital. You could call this type growth potential (it takes professors, for example,
of productivity “innovation-led growth.” the same amount of time to grade a paper today as

2 What is productivity?
it did in 1966, or nurses the same amount of time third wave is digitization, which has necessitated a
to change a bandage). What’s more, decades of transformation of operating and business models.
industrial overcapacity killed the manufacturing
growth engine, and no alternative has been found— The first two waves each dragged down productivity
least of all in the low-productivity activities that growth by about one percentage point. The third
make up the service sector. wave promises to boost productivity but comes
with adoption barriers, transition costs, and lags
Other economists believe the productivity associated with the need to reach technological and
paradox is a demand-driven issue, meaning that business readiness. Moving forward, the McKinsey
households have lower propensity to consume Global Institute predicts growth, most of which
due to the financial crises of 2008 and 2010 will come from emerging digital opportunities. But
and ensuing austerity policies. Combined with this growth will require a dual focus on promoting
increasing inequalities, this leads to lower income demand growth and digital diffusion, in addition to
for households with a higher propensity to consume. traditional supply-side approaches. Growth also
This leads to lower aggregate demand, which in turn depends on human capital—meaning people with
causes a more stagnant supply because there is less the right skills and training to put digitalization, AI,
incentive for firms to innovate, invest, and take risks. and new technologies to work.

To accelerate productivity, business leaders,

policy makers, and individuals must commit to the What’s the relationship between
digital transition. They must manage the social and economic growth, labor productivity,
economic changes brought by digitization, including and a changing labor market?
its impact on job displacement. Over the past 50 years, the world economy
expanded sixfold and average per capita income
almost tripled. These incredible advances were
How can we reconcile slowing powered by rapid population growth—which
productivity growth and rapid expanded the number of workers—and a healthy
technological change? increase in labor productivity.
The point of technology is to help us get things
done faster and with less effort. This, in turn, But looking ahead, this unprecedented economic
means giving more to consumers for less, which growth will slow dramatically if productivity doesn’t
leads to increasing social welfare. So you might improve. That’s because population growth is
assume that increased technological innovation slowing, which means the labor force is shrinking
would mean increased productivity. That’s exactly relative to the overall population. If there are fewer
what happened in the 1990s, when a revolution overall workers contributing to the economy, each
in information and communications technology worker’s productivity will have to increase for GDP
sparked a boom in productivity. growth to stay on track. McKinsey Global Institute
research on the future of productivity and growth
But it hasn’t been the case more recently: after the COVID-19 crisis, focused on the United
technology has continued to develop but States and Europe, found that some firms responded
productivity growth remains sluggish. According boldly to the pandemic, acting in ways that have the
to analysis by the McKinsey Global Institute, this potential to increase productivity in the years ahead.
disconnect is due to three waves that crashed in But the economic shock of the pandemic and how
the aftermath of the 2008 financial crisis. First companies have responded could exacerbate long-
was the waning of that 1990s productivity boom, run structural drags on demand. It’s notable that
combined with the aftereffects of the financial about 60 percent of estimated productivity potential
crisis, including weak demand and uncertainty. The comes from companies prioritizing efficiency over
output growth—through automation, for instance.

What is productivity? 3
 If productivity gains aren’t reinvested in growth 45 percent of respondents to an executive survey
that drives jobs and incomes, we risk a widening reduced their operating expenditure as a share of
inequality gap. Fast reskilling is key to avoiding this, revenue between December 2019 and December
by helping people whose jobs have been automated 2020. These indicators point to the potential of a
quickly move on to another job or career. If that new postpandemic productivity increase.
job is more productive than the last one—which is
often the case—that worker is turning a “threat”
(the lost job) into an opportunity and a boost in What can companies and
productivity for themselves and the economy. policy makers do to boost
postpandemic productivity?
When the pandemic hit, businesses and policy
How has the COVID-19 pandemic makers were creative and bold in responding to
affected productivity growth? unprecedented challenges. Moving forward, they
Productivity was stagnating prior to the onset need to be equally audacious in contributing to
of the COVID-19 pandemic. The pandemic, the recovery. CEOs and individual firms need to be
which ushered in the most significant economic proactive rather than reactive. For example, cutting
disruption since World War II, only exacerbated the costs may respond to immediate challenges, but
productivity slump. longer-term investments such as new products
and services (and, perhaps, increased wages)
But that means there’s more room to grow. Research can better serve the goal of driving sustainable,
from the McKinsey Global Institute finds that there inclusive growth.
is the potential to accelerate annual productivity
growth by around one percentage point in the McKinsey research suggests three interlocking
period to 2024. That would be more than double the priorities for business leaders and governments:
prepandemic rate of productivity growth. While this
potential hasn’t been realized, it does exist. 1. Sustain and grow innovation and other
advances that increase productivity.
This projected rate of growth could spell exciting Corporations can focus on catalyzing
changes. Achieving one percentage point of change across their entire supply chains and
additional productivity growth per year in every ecosystems. Policy can support these efforts
country by 2024 could mean an increase in per through public procurement focused on
capita GDP ranging from about $1,500 in Spain to innovation, direct research and development
about $3,500 in the United States. investment, and by revising platform and
competition rules.
Widespread action—combined with robust
demand—could realize this potential. But 2. Ensure actions that boost productivity also
without appropriate action, rising inequality and support employment, median wages, and
unemployment could undermine demand and demand. Businesses can help boost demand
imperil the possible productivity boost. by emphasizing growing revenue rather than
just seeking efficiency. They can also reskill and
The pressures of the pandemic have already upskill their employees so they can be deployed
inspired some organizations to attack the problem into more valuable tasks. Policy makers can
creatively. Faced with the necessity of digitization, support demand with fiscal stimulus and wage-
one McKinsey survey found that companies setting norms.
digitized many activities 20 to 25 times faster
than they had previously thought possible. What’s 3. Increase investment to the right places.
more, the pandemic has inspired companies Long-running investment gaps related to
to become more efficient. Between 42 and sustainability, infrastructure, and affordable

4 What is productivity?
 housing need to be closed. Business can transformation could enable Saudi Arabia to double
support this by making environmental, social, its GDP and create six million new jobs by 2030.
and governance (ESG) issues central to their
decision-making processes. And governments A $4 trillion investment in eight sectors—metals and
can support such investments by setting rules mining, petrochemicals, manufacturing, retail and
for carbon emissions and housing markets, and wholesale trade, tourism and hospitality, healthcare,
by increasing direct investment to high-priority, finance, and construction—was estimated to have
high-impact areas such as infrastructure and the potential to generate more than 60 percent of
skill building. this growth opportunity.

For a more in-depth exploration of these topics,

How can investments in intangibles see McKinsey’s Employment and Growth
affect productivity growth? collection. Learn more about the McKinsey Global
First, what are intangibles? Intangibles are assets Institute—and check out job opportunities with
that underpin the knowledge economy. These McKinsey Global Institute if you’re interested in
are things like intellectual property (IP), research, working at McKinsey.
technology and software, and human capital. As
investments in intangibles rise, accelerated by the Articles referenced:
pandemic, the economy becomes increasingly
dematerialized. This has ushered in a new stage — “Getting tangible about intangibles: The future
in the history of capitalism—based on learning, of growth and productivity?,” June 16, 2021, Eric
knowledge, and intellectual capital. Hazan, Sven Smit, Jonathan Woetzel, Biljana
Cvetanovski, Mekala Krishnan, Brian Gregg,
Intangibles are at the very root of productivity Jesko Perrey, and Klemens Hjartar
growth, and as they gain prominence in the
knowledge and digital economies, they matter for — “Will productivity and growth return after
productivity more and more. This suggests that the COVID-19 crisis?,” March 30, 2021, Jan
economies may trigger growth in productivity—and, Mischke, Jonathan Woetzel, Sven Smit, James
indeed, long-term economic growth—by increasing Manyika, Michael Birshan, Eckart Windhagen,
investment in intangibles. Jörg Schubert, Solveigh Hieronimus, Guillaume
Dagorret, and Marc Canal Noguer

How can a focus on productivity — “Will productivity and growth return? An author
growth help countries of our new McKinsey Global Institute research
diversify their economies? discusses,” March 30, 2021, Marc Canal Noguer
Countries dependent on one sector or resource
— “Solving the productivity puzzle,” February 20,
are more susceptible to economic instability. In the
2018, Jaana Remes, James Manyika, Jacques
case of Saudi Arabia, an oil boom from 2003 to
Bughin, Jonathan Woetzel, Jan Mischke, and
2013 propelled the national economy to become
Mekala Krishnan
the world’s 19th-largest. But a changing global
energy market and national demographics means
— “Moving Saudi Arabia’s economy beyond oil,”
that Saudi Arabia must diversify its economy if
December 1, 2015, Ghassan Al-Kibsi, Jonathan
it hopes to become more sustainable. McKinsey
Woetzel, Tom Isherwood, Jawad Khan, Jan
research shows that a productivity-led economic
Mischke, and Hassan Noura

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What is productivity? 5