contacts Sign In
author Image

What is productivity?

Productivity measures the amount of value created for each hour that is worked in a society.

You probably know that the amount of work you can get done in one day is your rate of productivity. Productivity in economics is pretty much the same as productivity at your desk. But for companies or even countries, measuring productivity is a little more complex than how fast you cleared your inbox today.

On a country scale, productivity can mean the difference between good and not-so-good standards of living. The only way people in a country can achieve a higher standard of living is through productivity growth. For a company, productivity can determine whether it can afford to increase wages for its employees or even if it can continue operating. Stagnating or contracting productivity can spell serious trouble ahead for individuals, organizations, and nations alike.

To maintain or increase productivity, we need to first understand what it is and how it works. Here, we’ll take a deep dive into the theory and practice of productivity.

Explore “What is economic growth?” from McKinsey Explainers for even more on macroeconomics and growth, and where productivity fits into the bigger picture.

How is productivity calculated?

Productivity is a measure of output relative to input. Labor productivity is the most common productivity measure—it’s defined as economic output (gross domestic product, or GDP) per hour worked. Labor productivity is typically the biggest determinant of economic and wage growth in the long term. And over time, labor productivity and real wages are closely—though not exactly—linked.

On a country scale, labor productivity is frequently calculated as a ratio of GDP per total hours worked. So if a country’s GDP were $1 trillion and its people worked 20 billion hours to create that value, the country’s labor productivity would be $50 per hour. Labor productivity growth is crucial to increased wages and standards of living, and it helps increase consumers’ purchasing power.

What is productivity in economics?

We’ve touched on labor productivity, but economists measure other types of productivity, too. Capital productivity is a measure of how well physical capital—such as real estate, equipment, and inventory—is used to generate output such as goods and services. (Capital productivity and labor productivity are frequently considered together as an indicator of a country’s overall standard of living.) Total factor productivity is the portion of growth in output not explained by growth in labor or capital. This type of productivity is sometimes called “innovation-led growth.”

Is productivity accelerating or slowing down?

The past 25 years have been a major success story for global productivity. These gains have largely been driven by China and India: from 1997 to 2022, China took its output from $6,000 per worker to $40,000. Median economy productivity has jumped sixfold. Thirty emerging economies, home to 3.6 billion people, are in the “fast lane” of improvement; if they maintain this pace, they will converge to advanced-economy productivity levels within about 25 years.

But despite this meteoric growth in some economies, productivity growth has slowed overall since the global financial crisis in 2008. Labor productivity growth has been declining in the United States and Western Europe since a boom in the 1960s.

Two factors account for a productivity slowdown in Japan, the United States, Western Europe, and other advanced economies. First, in the lead-up to the 2008 global financial crisis, manufacturing, primarily in the electronics industry, experienced waves of productivity advances, which have slowly faded in the years since. Second, there has been an overall decline since the 2008 crisis in capital investment across multiple sectors, likely due to a decrease in demand and ongoing macroeconomic uncertainty.

Why is productivity so important?

Increased productivity is needed if we are to meet the dual existential challenges of the 21st century: closing the empowerment gap and achieving net zero. According to McKinsey Global Institute research, closing these gaps will require the equivalent of 8 percent of global GDP annually, which will be very hard to achieve without rapid productivity growth.

What’s more, the unprecedented economic growth of the past 50 years—during which time the world economy expanded sixfold and average per capita income almost tripled—will slow dramatically if productivity doesn’t improve. That’s because population growth is slowing, which means the labor force is shrinking relative to the overall population. If there are fewer overall workers contributing to the economy, each worker’s productivity will have to increase for GDP growth to stay on track.

McKinsey Global Institute research on the future of productivity and growth after the COVID-19 crisis, which focused on the United States and Europe, found that companies’ responses to the pandemic could exacerbate long-run structural drags on demand. It’s notable that about 60 percent of estimated productivity potential comes from companies prioritizing efficiency over output growth—through automation, for instance. If productivity gains aren’t reinvested in growth that drives jobs and incomes, we risk a widening inequality gap. Fast reskilling is key to avoiding this, as it can help people whose jobs have been automated move on to another job or career quickly. If that new 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 productivity for themselves and the economy.

How can productivity be increased?

Two factors typically drive labor productivity. The first is the amount of capital per worker. Capital can be something tangible, like machines or infrastructure, or intangible, like software. For example, an office worker is more productive with a laptop than without one, and a construction worker is more productive with a crane. The second factor is human capital: the education, abilities, and accumulated experience of working people.

Investment, both public and private, is critical for productivity growth. Higher investment is associated with greater output, lower inflation, and lower poverty rates and inequality. Policy can help set strong and stable incentives for private investment. Growth in capital per worker accounted for about 80 percent of productivity growth in most emerging regions over the past 25 years.

Looking ahead, digitization and other technological advances could add up to one percentage point to annual productivity growth in advanced economies. And early adoption of recent advances such as gen AI could add an extra boost of more than half a percentage point across advanced—and several emerging—economies, too. There are signs that emerging AI applications could boost productivity faster than previous technologies; several proven productivity-enhancing use cases have already emerged, including software engineering for corporate IT and product development, sales, marketing, customer operations, product R&D, and many more.

What about productivity at work? How can business leaders drive productivity in their organizations?

There’s no denying that these are times of uncertainty. Geopolitical disruptions are mounting, and the global economic order is shifting beneath our feet. Meanwhile, our challenges are greater than ever: in coming years, the global community must deliver the connected goals of closing the empowerment gap and achieving net zero.

What steps can business leaders take to help their companies unlock productivity in these times? New McKinsey research points to a three-sided productivity opportunity: upskilling workers and changing how their organizations operate; striving to offset higher input prices and interest rates; and better targeting investments in capital and technology (exhibit).

Why is this cocktail of jobs, corporate value, technological advances, and economic growth the right aspiration for our times? These four elements delivered the last great productivity acceleration in the United States, between 1995 and 2000. When faced with intensifying international competition, companies that coupled capital and technology investments with capability and changes in management practices saw their productivity soar—which in turn lifted the entire economy.

The same economic uplift is possible in the current climate if business leaders can deliver productivity growth. Here are three ways business leaders can unlock their productivity potential:

  • Modernize operating models. Leaders who embrace resource reallocation and a technology-forward culture improve their chances of achieving operational goals.
  • Multiply the impact of frontline production and delivery. The front line is where the battle for efficiency and value creation is won or lost. Organizations that deliver sustained productivity increases pay careful attention to their balance sheets and maximize their return on talent investment.
  • Accelerate top-line growth by raising the value of existing and new market offerings. Successful innovation is essential to driving the value of existing and new offerings. Innovative growers put growth at the center of strategic and financial discussions and commit significant financial resources to innovation.

How can new AI tools catalyze productivity?

The point of technology is to help us get things done faster and with less effort. This in turn means giving more to consumers for less, which leads to increasing social welfare. You might assume, therefore, that increased technological innovation would mean increased productivity. That’s exactly what happened in the 1990s, when a revolution in information and communications technology sparked a boom in productivity.

But that hasn’t been the case more recently: technology has continued to develop but productivity growth remains sluggish. According to analysis by the McKinsey Global Institute, this disconnect is the result of three waves that collided in the aftermath of the 2008 financial crisis: waning of the 1990s productivity boom; financial crisis aftereffects, including weak demand and uncertainty; and digitization, which culminated in the explosion of gen AI tools beginning in late 2022.

McKinsey estimates that gen AI’s impact on productivity could add trillions of dollars in value to the global economy—up to $4.4 trillion annually across 63 use cases we analyzed. Around 75 percent of that value would fall across four areas: customer operations, marketing and sales, software engineering, and research and development. But to achieve the labor productivity boost gen AI makes possible—to the tune of up to 0.6 percent annually through 2040—organizations will need to rapidly adopt the technology and efficiently redeploy worker time into other activities.

What is the productivity outlook by region?

  • Europe. Europe leads the world in sustainability and inclusion: European countries are global leaders in carbon emissions and boast the lowest income inequality and highest life expectancy. Europe’s challenge in the years ahead will be to bolster the growth part of the equation. At present, European corporations lag behind their American counterparts on scale and performance. Recent years have also exposed new frailties, including Europe’s energy import dependencies and its supply chains’ sensitivity to geopolitical conflict. To boost growth, European companies could aim to increase their R&D budgets with the goal of winning a share in new areas of competition, such as autonomous driving or AI in healthcare. European policy makers could also make steps to strengthen supply chains and diversify energy sources.
  • Africa. Despite a few difficult years of growth, Africa’s rich natural resources and young and growing population provide opportunities to establish productivity as the foundation of economic growth in the 21st century and beyond. Certain African countries, cities, sectors, and companies have charted a course toward productivity that others can use as a guide. Increasing digitization, developing talent, collaborating more regionally, supporting more business champions, and building green business are some of the ways African stakeholders can increase productivity.
  • Latin America. Between 2000 and 2019, people entering the workforce accounted for approximately 75 percent of Latin America’s GDP growth, while productivity gains accounted for 25 percent. But demographics are changing. Without productivity growth, Latin America’s aging population could trigger a regional slowdown. Investment and innovation could raise productivity, boost private and public income, and build capital to enable further growth.
  • Asia. The Asian economies with the highest productivity are the rapidly aging societies of the Pacific Rim. By 2050, up to 34 percent of high-productivity parts of Asia, including China, Hong Kong, Japan, Singapore, and South Korea, will have elderly populations. To avoid a slowdown, and to lift more Asians out of poverty, Asian stakeholders will need to shift value chains and significantly boost productivity elsewhere, including through automation.India has serious growth aspirations in the coming decades, including 600 million jobs created, income rising sixfold to over $12,000 per capita, and GDP growing to $19 trillion. Impressively, between 2012 and 2022, one in every five Indian companies was able to double its revenue every five years and quadruple it in ten. This extraordinary growth rate has the potential to act as a GDP growth catalyst.
  • The United States. Since 2005, US labor productivity has grown at a lackluster 1.4 percent. More recently, the United States has seen an uptick in productivity growth, although it’s too soon to say whether this trend will have staying power over the long term. Regaining a long-term productivity growth rate of 2.2 percent annually could mean a $10 trillion increase in US GDP by 2030. Achieving productivity gains to this extent will require unlocking the power of existing technology, investing in intangibles, improving workforce reskilling and labor mobility, and implementing place-based approaches tuned to specific geographies.

For a more in-depth exploration of these topics, see McKinsey’s Productivity and Prosperity collection. Learn more about the McKinsey Global Institute—and check out job opportunities with McKinsey Global Institute if you’re interested in working at McKinsey.

Articles referenced:

This article was updated in May 2024; it was originally published in February 2023.

Click to see source of this article.

Leave a Comment