Lewis — The Power of Productivity

Lewis, William, The Power of Productivity: Wealth, Poverty, and the Threat to Global Stability, U of Chicago Press, 2004. 339 pp.

[cross-posted on Albion’s Seedlings]

Preliminary headlines on the upcoming riot season in Paris are starting to appear, recalling the difficulties that European countries face in boosting their economic performance: reducing unemployment and increasing economic growth. Fareed Zakaria’s article in the Washington Post earlier in 2006 entitled the Decline and Fall of Europe is a quick and readable summary.

Zakaria quotes a particularly interesting OECD report called “Going for Growth” that shows Europe, rather than catching up to America in per capita GDP, has in fact been falling behind over the last 15 years. Efforts to catch up, while noteworthy and politically difficult, have essentially failed. When the GDP figures are adjusted by purchasing power parity (PPP), from country to country and around the world, we end up with shocking tables like the following:

Source: CIA World Factbook

and this:

Source: Adapted from Lewis, The Power of Productivity, 2004.

The United States doesn’t simply lead the world in GDP per capita (PPP adjusted). It is in a class (fully acknowledging its size) entirely by itself. Adding 1 million net citizens every nine months (one every 13 seconds), America is extending its lead in prosperity over not only poor and moderately wealthy nations, but over virtually all of its erstwhile companions on the “heights” of Mount Prosperity. Next-door neighbour Canada is the only eight digit population close to the US, coming in at 78% of US per capita GDP (PPP adjusted).

Most disconcertingly for those of us interested in history, the distribution of per capita wealth across the globe in the last century has barely budged. The only sizeable nation to make the jump from poor to rich in that period was Japan. Grimmer yet, after a half-century of international efforts at economic development, less than 5% of the world’s population has made it into the “middle-income” nations – ranked between 25 and 70% of US per capita GDP. That means we cannot expect any “new” wealthy nations (on a per capita basis) within most of our lifetimes.

Despite China’s massive growth in GDP, its per capita GDP remains very modest. As a recent commentator noted, China will get old long before it gets rich. And at current rates, both it and India would take centuries of per capita GDP growth to reach the levels currently held by the 300 million Americans living today.

The OECD responded to this disturbing pattern with a common European solution: redefine the problem out of existence. As described in a generally laudatory article in the Economist, the OECD decided that social values such as the desire for leisure, and the desire for greater income equality within a nation should permit the adjustment of the rankings of relative prosperity between nations. Well, money isn’t everything, we might grant, while still clinging to the idea that 82 million Germans earning 71 cents for every dollar 300 million Americans earn might just be a long term problem. Who pays for the old-age homes in 2025, for example?

Fifteen years ago, the folks at McKinsey Global Institute under the direction of William W. Lewis began studying globalization from a more anthropological perspective. This led them to focus on relative national productivity (the ratio of the value of goods and services provided consumers to the amount of time worked and capital used to produce the goods and services) at a microeconomic level. More specifically, they began examining countries, industry sector by industry sector, to identify the patterns of productivity within national economies.

To their surprise, their national productivity information tracked GDP per capita information (adjusted for purchasing power parity) very, very closely. Those nations that were most productive on average were also those that generated the most per capita wealth. To quote a summary of their work:

Fifty years of focus on the macroeconomic policies of developing nations didn’t lift their income levels substantially: 80 percent of the world’s people still get by on less than a quarter of the average income in rich countries, much as they did a half century ago. The McKinsey Global Institute’s research in 13 countries suggests that the productivity of the large industries where most people work — “old economy” sectors like retailing, wholesaling, and construction — has the most influence on a country’s gross domestic product. To improve the economic welfare of individuals, countries must increase their productivity, primarily by encouraging economic competition.

Their conclusion:

Global economic agencies underestimate the significance of a level playing field. Competition is more important than education or greater access to capital markets in lifting a country’s gross domestic product. To reduce barriers to competition, policy makers must stand up to business special interests and focus more on the welfare of consumers.

In The Power of Productivity: Wealth, Poverty, and the Threat to Global Stability, William Lewis takes the results of over a decade of research, and the country case studies, and assembles a compelling and very readable review of what productivity is, where it resides (within different countries) and how difficult it is to achieve in all but a handful of nations. He looks at both “best practice” and “bad practice.”

In the course of doing this research, he claims to have constantly tried to avoid using the United States as a benchmark but both his clients, and the productivity statistics, demanded otherwise. Apart from the steel, automotive and electronic industries in Japan, and retail banking in the Netherlands, virtually no other nation on earth has more productive agricultural, industrial, and service sectors than America. It is in the breadth of its economic productivity that the United States finds its great advantage over the rest of the world.

For Lewis, the absolute central issue is the competitiveness of product markets — responding directly to consumer need. The flexibility of labour and capital markets are important, but to him, they are secondary.

Nominal US competitors such as the EU leading industrial nations have some narrow productive manufacturing sectors but much of the rest of their economies (agriculture, housing, services) is quite unproductive. EU total GDP may well approach US levels but the EU now includes 170 million more people than the US. Per capita GDP, especially adjusted for PPP, still places the leading EU countries at little more than 70% of the US. The United Kingdom is a tiny bit more successful than its continental brethren, and Canada a touch still more productive. But the gap with the US is still astonishing, and still growing.

Japan leads the world in the productivity of several sectors of its economy. Its techniques (such as the Toyota Production System) are adopted with great success by American plants, so we know that great productivity is not culture-specific in some ethereal way. But much of the rest of the Japanese economy reaches productivity levels barely 40% of the US in areas such as food processing, housing construction, retailing and wholesaling. When averaged across the economy, Japan fairs little better than Europe in average productivity and GDP stats. And its growth in productivity, like the Europeans, seems stalled in comparison to America since the early 90s. The tremendous post-WW2 global injection of capital and labour, which offers medium-term increases in productivity as an economy industrializes, has come to an end. The Japanese public is still willing to put up with dismal returns on its savings in order to subsidize the inefficiencies of the Japanese economy. For how long is anyone’s guess. Vast portions of the populace in the Japanese economy are working at very low levels of productivity. Housing, for example, operates less productively than the United States did in the 1930s.

Korea, a dweller on the “foothills” of the GDP wealth curve, is trying to follow Japan’s approach to productivity growth but it shares the same narrowness of high-productivity sectors across its economy. And it shares its same vulnerability to stagnation and economic crisis when the ability to improve productivity by working longer or adding cash reaches a limit. A protectionist economic system ensures that only a select few sectors of the economy actually face international competition and exposure to methods of improved productivity.

When Lewis turns to Brazil or Russia or India, virtually no portions of their economies reach 50% of the level of productivity of the United States, unless they are small industrial enterprises run according to Japanese or Western management principles as fully-controlled branch operations. For much of the agricultural sector, per capita productivity in these nations can run as low as the single digits, in some cases, merely one or two percent as productive as the United States. In light of the fact that 65 million Indians are in the dairy farming industry alone (the largest group of people in the world in one business), it’s little wonder that Indian per capita GDP will remain very low for a very long time. The much vaunted Indian IT industry, operating at 50% of the productivity of the United States, yet represents 0.1% of the Indian workforce. Islands of productivity as small as this can’t make a dent in the average stats of a nation where 60% of the workforce is still in agriculture.

Lewis admits that his research surprised him a number of times over the decade or so that information was assembled. In the early part of the 20th century, when the United States had a per capita GDP somewhat similar to the middle-income nations of the modern world, the portion of GDP represented by the American government was about 8%. Today, for countries such as Brazil and Russia, struggling their way toward increased productivity, their government GDP percentage is closer to 40%. Thus the relative amounts of per capita capital available for private commercial economic expansion in these countries are a fraction of what was available to the American economy before the First World War!

So what about that American economy? Apart from a few industries where Japan and the Netherlands have something substantial to teach it, why does America keeping growing wealthier than everyone else? Was it the computer boom of the 90s?

According to Lewis, no. The industries (large enough to make a real dent in the productivity stats, remember) that made the greatest gains in the 80s, 90s and 00s weren’t high-tech. They were the massive retail and wholesale businesses who employ millions and sell to tens of millions more. Those businesses, typified by Wal-Mart, were able to rationalize, consolidate and optimize in ways unmatched by the companies of any other nation in the world. The disruption to local businesses, mid-sized wholesalers and retailers is well-known. Sears and K-Mart and a huge number of small paper-pushing wholesalers entered very troubled water and many did not survive. In their place, new giants appeared — much as standardization and automation had struck the agriculture, manufacturing, and housing businesses in America decades before. More importantly, Wal-Mart’s methods were matched by a new generation of retail stores — the Targets, Office Depots, etc. that applied the new information technology to improve their businesses. Silicon Valley itself may only have had a modest impact on the productivity stats of America but the spinoff benefits of its products, especially once AMD began to compete with Intel, were applied to vast sectors of the economy with tremendous success.

In a brief review for a focused blog, it’s impossible to do justice to the broader microeconomic argument which Lewis provides across hundreds of pages. One could do worse however than read the interview with Lewis in TCS Daily which was so striking that I purchased his book for further study. There is also additional information at the McKinsey website on the title.

I can summarize his arguments briefly and then turn to some implications for the Anglosphere:

1. Poor national economic performance can be better understood by analysis at the level of individual industries rather than macroeconomics alone.

2. Differences in capital and labour markets are overstated as determinants of national economic performance. Differences in competition in product markets are much more important.

3. While attention to exchange rates, inflation and government solvency were emphasized to developing nations, the importance of a level playing field for competition in a country was vastly underestimated.

4. The importance of the education of a workforce has been taken way too far. Education is not the way out of the poverty trap. Workers around the world are successfully trained on the job for high productivity. In a favourite Lewis anecdote, illiterate Spanish-speaking unskilled labourers in Houston have some of the highest construction productivity levels in the world because of the system they work in and how they are trained.

5. The solution for developing countries does not start with more capital — it starts with the way that it organizes and deploys the capital and labour it has. Balanced budgets and better productivity would allow most countries to access all the capital they need from both domestic and foreign sources.

6. “Social objectives” which distort markets severely and limit productivity growth also slow economic growth and cause unemployment. Creating a level playing field and then managing distribution of a bigger pie through taxes on individuals is the better sequence.

7. Big governments demand big taxation. The more informal the economy, the more legitimate and productive businesses are held back by such taxation. Western countries did not have this problem in the late 19th and early 20th centuries.

8. Salvation does not come from elites. Elites are responsible for big government and reward themselves richly. They are in the business of the un-level playing field.

9. Protectionism of national industries keeps highly productive companies out of a country. Poor countries have the ability to grow much faster than people think but subsidizing low productivity is self-defeating.

10. Production unlinked to consumer desire misunderstands the real nature of “value.” Production is only worth what people will pay. Only one force can stand up to producer special interests — consumer interests. Most poor countries are a long way from a consumption mindset and consumer rights. As a result, they are poor.

Again, I encourage anyone interested in the global economy, and in evaluating how nations differ in their economic attitudes and success, to read this book. It’s very well written, lucidly argued, and offers up some very useful information (and fascinating anecdotes) on the national economies discussed above. The chapter on India, particularly, is a sobering balance for those considering India’s role in the “Third Anglosphere.”

Anglosphere Implications

The Power of Productivity offers us yet another way of examining economies, both modern and historical. On the one hand, the Anglosphere economies enjoy a position of affluence on the global ranking of per capita GDP, yet that troubling 20-25% gap in productivity between the United States and virtually everyone else needs explaining and examination.

For myself, I think Lewis’ book is yet another strong argument for suggesting that America is a unique data point, even within the Anglosphere. To have reached such a size, and such an economic and demographic growth rate over the last hundred years is unprecedented. More importantly, since 1990, there is every indication that other industrialized nations have stalled in keeping up. Other Anglosphere nations suffer perhaps a little less than Japan or continental Europe but still — there is something about Lewis? point on consumer focus, and the broad competitiveness of the product markets (goods and services) — that places the United States out by itself on the charts. It’s an outlier nation yet again, as it is on so many surveys and assessments. Neither fish nor fowl.

What is clear is that the remaining Big Five in the Anglosphere (UK, Canada, Australia, NZ, Eire) will struggle with their cultural predisposition to “fix” the product markets and penalize their overall economic productivity growth. The US market is huge and fiercely competitive — and manages to constantly find new areas where technology, technique and economies of scale can be applied. One look at eBay and Amazon.com confirms it. In many ways, the next largest economy (the UK) is very aware of these trends and routes to increased productivity but the political culture of Great Britain does not allow the nation’s government to extract itself from the product marketplace to the same degree.

As for India’s role in the Anglosphere, as mentioned above, I found Lewis’s book very sobering. India, short of some new kind of mathematics, simply cannot reach even middle-income per capita GDP within a century or two. Whether the intervening years bring a great exodus of Indian talent to the other Anglosphere countries — or some epidemiological catastrophe shrinks the population such that new economic rules can be instituted — it’s hard to read Lewis and come to the conclusion that India as we know it will fulfill any national role as broadly wealthy country in the near- or medium-term. Indian individuals and cohorts may be tremendously influential. The nation however, as it is currently organized, falls behind the rest of the Anglosphere (let alone the US) minute-by-minute.

It should be emphasized that Lewis himself is very cognizant of the importance of raising productivity levels around the world, if only from the perspective of global stability, while admitting that he was overwhelmed by the great practical divide that separates the Anglosphere, Europeans and Japan from the rest of the world. His research really suggests (as the ten points above indicate) that institutions such as the World Bank and IMF are still not grasping the cultural nettle in the developing world that inhibits productivity growth and therefore the accumulation of national per capita wealth.

As he notes, decades of international development efforts (let alone Christian missionary efforts) have created Third World cadres with explicit rationales for behaviour that intrinsically inhibits economic productivity. And we can see the same behaviour replicated across the Anglosphere itself to greater or lesser degrees. Have we reached a situation where nations are their own worst enemies? Big government and educated elites are hitting developing economies at the very point in time when they need the unusually high levels of productivity growth that can only come from unimpeded foreign direct participation in national economies. By and large, it ain’t going to happen. Which in turn suggests that some 22nd century William W. Lewis may well write a book on how little has changed on the per capita GDP curve during the 21st century. One hopes not, but the data in this book on 20th century progress is hard to deny.

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Table of Contents

1 Findings: The Global Economic Landscape [1]

Part 1 Rich and Middle-Income Countries

2 Japan: A Dual Economy [23]
3 Europe: Falling Behind [50]
4 The United States: Consumer is King [80]
5 Korea: Following Japan’s Path [105]

Part 2 Poor Countries

6 Brazil: Big Government is a Big Problem [135]
7 Russia: Distorted Market Economy [166]
8 India: Bad Economic Management from a Democratic Government [197]

Part 3 Causes and Implications

9 Patterns: Clear and Strong [229]
10 Why Bad Economics Policy around the World? [257]
11 New Approaches [285]
12 So What? [312]