Academic journal article The McKinsey Quarterly

Capital Productivity: Why the US Leads and Why It Matters

Academic journal article The McKinsey Quarterly

Capital Productivity: Why the US Leads and Why It Matters

Article excerpt

"High telecom performance levels in the US are attributable to the fact that firms are owned by private investors, not the government, and that regulators focus on maintaining low prices."

How well a country uses its capital ought to be extremely important to its citizens and policymakers. While labor productivity is a topic of constant debate and was the subject of earlier McKinsey Global Institute studies, far less attention has been paid to questions about the productivity of a nation's capital stock.

"Capital" actually has two interrelated meanings: physical capital (machinery and buildings) and financial capital (stocks and bonds), which lays claim on physical capital and the income it generates. Capital productivity is the measure of how well physical capital is used in providing goods and services. Productive use of physical capital and labor are the two most important sources of a nation's material standard of living.

In addition, how well a nation uses its physical capital affects the return that people get on the money they save. The higher the returns, the less they need to save for the future, and the more they can consume today. This is especially critical because most developed countries have a rapidly growing proportion of retirees. Very small differences in rates of return create large differences in future retirement income.

To measure how productively major economies use capital and to understand the causes for differences in performance, the McKinsey Global Institute has studied capital productivity in Germany, Japan, and the US.(*) We analyzed economywide performance and also conducted case studies in five industries: auto, food processing, retail, telecommunications, and electric utilities.

Our principal findings are:

* Significant differences exist in capital productivity across nations: productivity in Germany and Japan is about two thirds US levels.

* Managers in Japan and Germany could close most of the gap without a single change in regulation but do not because of lack of incentives and lack of market pressure.

* Combining this work with the previous work of MGI on labor productivity, we find that the US achieves leading economic performance by having higher productivity in both labor and capital. Japan's low productivity is due to sub-par performance in both factors, while Germany's lower overall productivity stems primarily from less productive use of a very high level of capital [ILLUSTRATION FOR EXHIBIT 1 OMITTED].

* Higher capital productivity in the US has led to higher financial returns, which have more than compensated for lower savings and investment rates by generating more capital income [ILLUSTRATION FOR EXHIBIT 2 OMITTED]. As a result, the US has maintained greater financial wealth and consumed more at the same time.

The following sections summarize our findings about differences in capital productivity and how those differences affect economic and financial performance.

Standards of living - two paradoxes

The differing overall economic performance of the three countries poses two important paradoxes:

* Why is Japan's GDP per capita not higher than that of the US when Japan has saved so much more and worked so hard?

* Why has German labor productivity not exceeded US levels when Germany has invested so much more capital per worker?

The resolution of the Japanese paradox is straightforward. GDP per capita is simply a product of labor and capital, and how productively they are used [ILLUSTRATION FOR EXHIBIT 1 OMITTED]. Although Japan invests more capital and uses more labor than either the US or Germany, extremely low productivity in both capital and labor drags down their GDP. Japan has a market sector GDP per capita similar to that of Germany, and only 77 percent of US levels. Simply put, the Japanese invest a lot of money and a lot of time and energy and get comparatively little back in return. …

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