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 / Winter 2006 / Issue 45(originally published by Booz & Company)


The Productivity Riddle

Research finally links management skill to macroeconomic growth.

Illustration by Lars Leetaru
Robert Lucas, a Nobel laureate in economics, famously wrote that once one starts to think about economic growth, it is hard to think about anything else. In other words, even slight increases in growth rates, when accumulated over time, have an overwhelming impact on quality of life. Not just corporate profits, but the livability and prosperity of nations and regions depend on economic growth. Moreover, economic growth and the firm-level performance that underlies it are not givens, but can be shaped. The most critical and overlooked factor is the quality of management.

A peasant toiling on a farm in East Anglia in 1600 was not much better off than his Druid ancestors. But his descendants were. Economic and social conditions began to change dramatically when the Industrial Revolution took hold in England in 1750. But why did the Industrial Revolution begin there and then, and not in 1650 or even the year 50, when Hero of Alexandria developed a steam engine? And why in England and not in China or the Roman Empire, states brimming with technical genius? Why did Hero’s contemporaries use steam engines to wow Roman tourists with magical toys, instead of powering instruments of production with them?

History proffers an intriguing answer. As a consequence of the Glorious Revolution of 1688 (when a group of nobles overthrew James II and crowned William of Orange as king), the British government committed itself to upholding private property rights, protecting wealth, and eliminating arbitrary increases in taxes. These institutional changes gave entrepreneurs the incentives they needed to make the most out of the technological inventions of that time. Though China may have had a more sophisticated economy then, it lacked the business institutions that would allow entrepreneurship to flourish.

In his article “The Good Life: How Managers Made the Modern World” (Hermes, Winter 2004), Columbia Business School Professor Bruce Greenwald puts the point more crisply. The Industrial Revolution, he writes, “appears to have arisen largely from the application of sustained management attention to everyday enterprise.” But economists and business analysts need to go further still and inquire why management matters. The reasons have powerful implications for business — and business education.

Productivity’s Hidden Effects
Let’s start with a “macro” perspective on one of the most interesting economies in the world today — that of the United States, where productivity is growing about a full percentage point faster than it did a decade ago. This increase is the reason that, despite all contrary or negative economic indicators, corporate performance and living standards continue to improve in the U.S. It is important to recognize that this improvement is not the result of more labor or capital. It reflects the ability of American enterprise to produce more output per unit of input each year than it did the year before. Moreover, the rate of productivity growth rose noticeably during the 1990s in the United States and stayed high through the difficult early 2000s, even when productivity growth in many other major economies headed in the opposite direction.

American productivity growth is often attributed to the effect of information technology. But those who chalk it all up to IT have spent too little time in Tokyo, Seoul, and Berlin. Technology is more sophisticated in many other countries than it is in the United States. Cell phones and PDAs in Europe and Asia do things that American mobile devices cannot; they pay for goods and display far more information. Broadband Internet access, both wireless and fixed, is also faster and more ubiquitous elsewhere.

But if America’s greatest companies did not become more effective simply by buying faster computers or networking their operations, what then is the answer to the productivity riddle? At first glance, there is an obvious answer: There were enough American companies in which leaders and managers knew how to integrate these investments with new business models to raise their effectiveness. They also benefited from a distinctive economic context: The flexible financial markets of the United States foster the celebrated resilience of its economy, in which entrepreneurs can swiftly respond to external shocks — from financial market downturns to disasters such as Hurricane Katrina — and to opportunities for innovation and expansion.

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