From Barron's, June 9:
About the authors: Asutosh Padhi is the managing partner in North America for McKinsey & Company. Olivia White is a senior partner in McKinsey & Company’s San Francisco office and a director of the McKinsey Global Institute.With U.S. and global inflation lingering at above-average levels, interest rates continuing to rise in major markets, and financial turbulence surfacing, all eyes are on central banks. Their decisions matter. But improving productivity growth matters more.
These challenges are symptoms of a larger one: an unbalanced “global balance sheet.” The global balance sheet takes stock of the assets and liabilities of all households, corporations, governments, and financial institutions. Before 2000, net worth in advanced economies grew at roughly the same rate as gross domestic product. Since then, net worth has ballooned, but economic growth has been tepid and inequality within countries rose. From 2000 to 2021, asset price inflation, chiefly from equities and real estate, created $160 trillion in paper wealth and every $1 in investment generated $1.90 in debt.
The pandemic tilted the global balance sheet even further out of kilter. As governments acted aggressively to support businesses and households, every $1 in investment generated $3.40 in debt. When inflation surged, household wealth plunged.
Rebalancing will be tricky. In terms of monetary and fiscal policy, failing to tighten enough would keep inflation high, potentially leading to 1970s-style “stagflation.” But tighten too much and the economy and financial system suffer. This happened in Japan in the 1990s, when its real estate and equity bubble burst, triggering drawn-out deleveraging and a sharp contraction in asset prices. If a sharp rise in real interest rates, ensuing financial system stress, and rising perceptions of risk were to happen in the U.S., equities and real estate values would drop 30% or more by 2030 in our model.
But going back to the conditions that prevailed from 2000 on is not a great option, either. In the U.S. and many other countries, this era has been characterized by chronic underinvestment in the kinds of things that support labor productivity, such as infrastructure, plants, and equipment. That contributed to soft demand, rising inequality, and sluggish GDP growth.
The simple fact is that only faster productivity growth can combine strong growth in income, wealth, and balance-sheet health. But productivity growth has been sluggish. In the U.S., business sector labor productivity has grown an average of under 1.4% a year since 2005. Western Europe is in the same range (and some individual countries have done much worse); Japan has been faltering, too. The McKinsey Global Institute has estimated that U.S. GDP would be $10 trillion greater by 2030 if productivity returned to the postwar average of 2.2%....
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