How to add $3.8 trillion to the American economy in less than a decade

Most often, I’ve written these posts on energy and the environment. This time, I’d like to range a little more broadly, and offer something like a state of the union address, with an emphasis on the economy. In doing so, I am going to draw in large part on a recent McKinsey Global Institute report to which I contributed, The US economy: An agenda for inclusive growth.

In 1858, Abraham Lincoln, who went on to become one of America’s greatest presidents, gave what became known to history as the “house divided” speech. Then, the country was divided over slavery. Today, to a large degree, economics in one way or another is the source of a divided polity; it is at least plausible that growing economic uncertainty and inequality has contributed to political polarization. I have little doubt that if middle-class incomes had actually grown over the last 20 years, ours would be a happier, healthier country. That there is a hunger for positive change is certain.

Obviously, I am in no position to solve these issues. What my colleagues and I can do, though, is to point to some ways to improve general economic conditions and prospects. We focus in particular on productivity, which has been growing at just 0.5 percent a year since 2010—well below the historic average of 2 to 3 percent. Broad and deep economic growth solves or at least softens a lot of problems, and the American record in this regard has not been great for some time. For middle-income households, annual discretionary income fell from 9 percent in 2004 to minus 1 percent in 2014.

In industry, we are seeing something similar. Corporate profits have grown dramatically since the recession, but these are increasingly concentrated in industries—and in companies—where value is created from algorithms, patents, brands, and trademarks, not factories.

Here are several very doable things that can help deliver broader, faster growth.  These initiatives could add $2.8 trillion to $3.8 trillion to annual GDP by 2025, ramping up real GDP growth to 3.1 to 3.5 percent annually over the next decade.  

1. Accelerate digitization. In many ways, today’s economy looks very different than the one that entered the Great Recession less than a decade ago—and much of the difference is due to the ongoing digital transformation. While consumers and some industries have eagerly embraced the digital world, others are lagging, including government, health care, education, local services, hospitality, basic goods manufacturing, and construction. These are not trivial sectors, and their lack of digital expertise drags down productivity—a lot. MGI estimates that as a result, the United States is only tapping into 18 percent of its digital potential. And this stratification has also created yet another form a polarization—between the digital “haves,” whose wages and profits are growing nicely, and the “have nots.” Extending just two areas of digital innovation—big data analytics and the Internet of Things—could boost GDP a full half-percentage point above the baseline forecast. To put it in terms of cold, hard cash, that would be $1.3 trillion a year more in GDP by 2025.

2. Make trade and investment work better for more people. Between 1980 and 2007, cross-border trade and financial flows increased 10 times; digital flows have increased 45 times since 2005. Clearly, many Americans see this as bad or at best dubious. MGI research finds the opposite, estimating that global GDP is 10 percentage points higher than it would have been without such flows (or $7.8. trillion in 2014). Again, there is a disparity at the heart of this: 80 percent of trade in goods and services takes place within the supply chains of large multinationals. In the United States, these make up less than 1 percent of all firms—and almost half of all exports. The vast majority of American firms do not export at all. In addition, the consumer benefits of globalization, such as lower prices, foreign direct investment ($2 trillion in the last decade) and greater quality and variety of goods—are diffuse by their nature. But the costs, such as job losses in areas and industries heavily exposed to trade with China, are local. No wonder, then, that there is widespread skepticism that trade and globalization are worth it.

To make globalization more broadly acceptable requires addressing these dislocations with more urgency, in the form of effective re-training for the displaced. In addition, it would help if more companies directly experienced its benefits, specifically by helping them export and find international partners and by making going international easier. Customs procedures, for example, can be off-putting for small business. There should also be efforts to ensure that  digital platforms do not become another way to inject protectionism into the global economy, for example by requiring a physical presence to do business in a country.

3. Invest in the cities. Private investment has not rebounded fully from the Great Recession, and public investment has also faltered. At 3.4 percent of GDP, that is a little more than half the level of the mid-1960s. In a sense, the country is living off the concrete achievements of that era, so to speak. But it is running out of road. Since 2008, public investment has fallen more in the United States than in any other developed country. This underinvestment is felt most in the cities, which are the engine of the American economy. The country’s 250 largest cities account for 85 percent of output.

There are two priorities—housing and mobility. More than 11 million households are spending half or more of their income on housing, a record. This is a source of household stress, and carries a substantial human cost. It is also an economic drag: families that spend that much on a roof have little left for other types of consumption. In addition, high real estate costs hamper mobility, particularly for the lower paid. Why move to areas of more promise when you will never be able to find a place to live? And if they do, anyway, they may have to live well outside the city limits, adding to commuting times and congestion. In the meantime, investment in urban transport infrastructure has not kept up with their needs, harming both productivity, the environment, and general quality of life.

Given the general acceptance that this is important, and historically low interest rates, the time is right to take dead aim at improving infrastructure. Allowing transportation, housing, water, and other public goods to deteriorate raises the costs of repair and maintenance; excellent infrastructure, on the other hand, makes businesses and workers more efficient. MGI estimates that adding 1 percentage point of GDP to infrastructure spending could generate 1.5 million jobs. Closing the infrastructure gap would add up to $450 billion in GDP by 2025—and improve both the look and functioning of our cities.

4. Improve workforce skills. Rising university tuitions and student debt get a lot of attention—and deserve to. But the United States needs to create a more cohesive and effective system of skills development in general. This, of course, starts at school, beginning with kindergarten on—something that is beyond my own skillset. But it is surely possible to figure out incentives for our students to get degrees in science and technology. For non-college workers, as well, there is a need to create more pathways to solid jobs that do not follow the traditional college track. Expanding the role of community colleges is one possibility, as is the provision of short-term, industry-specific training programs. With the economy changing so fast, the possibility of large-scale job displacement is high. To cope with that, for both economic and human reasons, the answer is preparation and adaptation.  MGI estimates that if displaced workers get the skills they need to take new jobs, overall productivity could add up to $700 billion to annual GDP by 2025. The report also goes into some detail on on other subject: improving resource productivity. I’ll turn to that in a separate post.

Last thoughts

Polarization has led to a degree of pessimism that is unusual for the United States. More than a few people believe that the nation’s best days are behind it. I don’t. The country has amazing capabilities and resilience, and while stagnation is an option, it is hardly an inevitability. As Lincoln put it near the end of the house-divided speech, “We shall not fail -- if we stand firm, we shall not fail.”

In our own era, that means pursuing a long-term economic strategy in which the United States performs closer to its potential. This means  accelerating both growth and productivity—not through cost-cutting but through investment and higher output. That is a possible dream that all Americans can rally around.