Academic journal article The McKinsey Quarterly

What's Right with the US Economy: The Secret Behind the New Economy Isn't Information Technology but Old-Fashioned Competition and Managerial Innovation

Academic journal article The McKinsey Quarterly

What's Right with the US Economy: The Secret Behind the New Economy Isn't Information Technology but Old-Fashioned Competition and Managerial Innovation

Article excerpt

As companies attempt to cope with an economic downturn and the United States fights a war on terrorism, many wonder whether the long-term health of the US economy will be undermined. The answer depends on what happens to the productivity growth rate--the main determinant of how fast the economy can grow. At issue is whether the near doubling of US productivity growth rates during the late 1990s, from 1.4 percent (1972-95) to 2.5 percent (1995-2000), can continue.

Our yearlong research (1) indicates that many of the product, service, and process innovations underlying the productivity acceleration of the late 1990s will continue to generate productivity growth rates above the 1972-95 trend for the next several years, although probably not as high as those of 1995 to 1999. Higher productivity, in turn, will boost economic growth.

Surprisingly, the primary source of the productivity gains of 1995 to 1999 was not increased demand resulting from the stock market bubble, as some economists have claimed. Nor was information technology the source, though companies accelerated the pace of their IT investments during those years. (2) Rather, managerial and technological innovations in only six highly competitive industries-wholesale trade, retail trade, securities, semiconductors, computer manufacturing, and telecommunications-were the most important causes (Exhibit 1). (3) The other 70 percent of the economy contributed a mix of small productivity gains and losses that offset each other. In addition, cyclical demand factors were important in some parts of the economy.

It is not unusual, we found, for only a small number of sectors to experience a productivity jump during any four-year period. But in the late 1990s, these six sectors, departing from the norm, either enjoyed extremely large leaps in productivity (for instance, semiconductors and computer manufacturing) or accounted for a large share of employment (retail and wholesale).

At the national level, the relationship between IT spending and productivity is unclear. Many sectors other than the six jumping ones increased their pace of IT investment but experienced stagnant or even slower productivity growth (Exhibit 2). We found an inconclusive correlation between the acceleration of IT investments and changes in productivity growth. In fact, taken as a group, the other 53 economic sectors had almost no productivity growth.

The challenge, then, was to understand what caused the productivity acceleration in the six key sectors. We did a detailed study of these sectors, as well as three others that invested heavily in IT but failed to boost productivity--hotels, long-distance data telephony, and retail banking.

Explaining the 1995 productivity acceleration

Within the six jumping sectors, the most important cause of the productivity acceleration after 1995 was fundamental changes in the way companies deliver products and services. Sometimes these innovations were aided by technology (whether new or old), sometimes not. In all six sectors, high or increasing competitive intensity was essential to the spread of innovation, and in two sectors, regulatory changes played an important role in raising that intensity. Cyclical demand factors and a shift in consumer purchasing patterns toward higher-value goods were important in explaining the acceleration of productivity in retail, wholesale, and securities.

Structural factors: Competition and innovation

The bulk of the acceleration in productivity after 1995 can be traced to managerial and technological innovations that improved the basic operations of companies. These innovations were structural and are likely to persist. Sometimes, the catalyst was a dominant player with a superior business model; other times, it was managers using new technology to redesign core operations.

In general-merchandise retailing, productivity growth more than tripled after 1995 because competitors started more rapidly adopting Wal-Mart's innovations--including the large-scale ("big-box") format, "everyday low prices," economies of scale in warehouse logistics and purchasing, and electronic data interchange (EDI) with suppliers (see "Retail: The Wal-Mart effect," on page 40). …

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