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Recreating the American Dream.

From a speech delivered in October 1992 as part of the Manhattan College John J. Horan Endowed Lecture Series

What happens in a democracy when the benefits of economic performance are more and more unevenly shared?

MANY OF YOU were born about the same time as I was and you've seen the world change as much as I have. At the end of World War II, the US economy stood head and shoulders above the rest of the world. As Exhibit 1 shows, our GNP in 1950 was over $1.3 trillion -- almost double the combined output of the United Kingdom, France, West Germany, and Japan. Our leaders at that time had an expansive and noble vision of how the postwar world might develop. We did not use our position to exploit our former foes. Instead, we helped rebuild their economies.

As working people in the postwar era, we had new jobs and rising incomes. Our surging economy expanded the size of the middle class and created opportunities for millions of lower income Americans. We built the interstate highway system linking new homes in the suburbs to national markets. We drove new cars and purchased televisions and refrigerators. Our children and our returning veterans went to college in unprecedented numbers. We sent our goods around the world and we sent men to the moon. In a famous statement, Henry Luce, the founder of Time magazine, called the 20th century the American century.

As the 20th century draws to a close, there are those who wonder if our best days are behind us -- if the year 2000 will mark the beginning of an Asian or perhaps a pan-European century. Editorials, business magazines, and dozens of books have chronicled the decline of America's industrial productivity. "Competitiveness" has become the buzzword of every public policy entrepreneur seeking to restore what America is presumed to have lost. At last count, this year alone members of Congress introduced over 600 bills dedicated to improving US competitiveness through educational reform, regulatory reform, new trade barriers, and dozens of other special interest agendas.

Tonight, I'd like to present my views on how the globalization of the world's economies should affect the way we in this room, as thought leaders and as business professionals, think about US economic policy.

At McKinsey & Company, we pride ourselves on the fact-based analysis we bring to our client work. In my discussion tonight, I'm going to bring a lot of facts to bear. Some of what you hear will not be new, but will be presented in a different context. But much is new and carries important implications for the course of action we choose as a nation. It will also offer insights about which actions will and will not be effective.

I'm going to use aggregate statistics, but more importantly I'm going to try and interpret these statistics in terms of what they mean to each of us as individuals -- individuals who are both producers and consumers in our economy.

The global economy

We are in the midst of a fundamental transformation of the global economy that is irreversible. It will have profound impact on both the absolute and relative well-being of people around the world. With its strong commitment to free markets and deregulation, the United States is pacing the change and is benefiting enormously from these enlightened policies.

At the same time, however, the dislocations these policies sometimes cause are bringing us face to face with some very serious challenges, to which we have yet to really face up. We are still the strongest and most productive economy in the world, but we need to take steps to ensure that all of our citizens participate in and enjoy the fruits of a modern global economy.

Micawber's rule

If we look at the US economy in terms of our performance as producers, we can be reasonably pleased. As a result of our postwar foreign policy, we saw the huge gap in economic performance depicted in Exhibit 1 substantially eroded in the 1950s and 1960s, as Exhibit 2 shows. For the last 20 years, the United States has maintained about a 20 percent lead over the rest of the developed world -- the OECD countries -- in gross domestic product (GDP) per capita using purchasing power parity (PPP) exchange rates.

As Exhibit 2 illustrates, the rate of convergence of GDP has slowed considerably since 1970, and only Japan continues to gain ground on the United States. This is quite an exceptional performance and not at all in keeping with the conventional wisdom that the United States is in a state of continuing decline. Economies are converging, but -- for reasons which I'll discuss later -- there is little risk that the US economy will be overtaken in the near future. Moreover, the successful growth of our trading partners' economies is in our interest. Competition among national economies has never been a zero-sum game.

If we compare consumption patterns among the same group of nations, we see in Exhibit 3 that the United States consumes almost 40 percent more than the OECD average on a per capita basis. This situation has changed little since 1970. While it represents an extraordinary boon for American consumers, the difference between our consumption and our production relative to the rest of the developed world has in it the seeds of a very unhappy outcome. Remember Charles Dickens: "My other piece of advice, Copperfield," said Mr Micawber, "you know. Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery."

A focus on productivity

Most economists believe that continually increasing productivity is the only route to increasing standards of living. Ergo, the reason that the United States has been able to maintain its overall lead versus the rest of the world is that it is more productive.

Some of you may have seen the article in the New York Times on October 13 headlined "U.S. Output Per Worker Called Best." The article was based on research by McKinsey's Global Institute(*) and work by other prominent American and Dutch economists.

The reported results surprised many who believed that American productivity was on the skids. Instead, the research showed American workers outproduce workers in Europe and Japan in nearly every sector of the economy.

The United States' higher productivity can be attributed mainly to our government's relative reluctance to protect companies from the rigors of competition, domestic and foreign. In short, we're doing well because we have the most accessible markets in the world. Free-market competition forces successful producers constantly to innovate, seeking new and better ways to attract customers. Much of this innovation is based on finding better ways to bring products or services to market at lower costs. In Europe and Japan, protected oligopolies and barriers to foreign competition have reduced the pressure for productivity improvements in many sectors of their economies.

Manufacturing

Let me show you what I'm talking about, with Exhibit 4. In manufacturing productivity, the United States is ahead in the basic metal products, petroleum, rubber, and plastic products; textiles, wearing apparel, and leather; and food products, beverages, and tobacco -- in other words, all manufacturing sectors other than machinery, electrical engineering, and transport equipment. The Japanese lead in this sector.

On the one hand, machinery, electrical engineering, and transport equipment is a very substantial 31 percent of the entire manufacturing sector of the US economy, and it represents many of the internationally traded, highly visible goods, such as automobiles and consumer electronics. On the other hand, all of manufacturing accounts for only 19 percent of the total US economy. Thus, the manufacturing sectors in which we lag Japanese productivity account for no more than 6 percent of total US employment. In short, when we limit our attention to US productivity decline in autos and consumer electronics, we seriously understate the true health and strength of the US economy.

Much concern has also been raised about our slowing productivity growth. Commonly quoted analyses show us badly trailing the Japanese and Germans based on manufacturing productivity growth spanning 20 to 30 years -- a period when they gained quickly because they were so far behind.

If we look at the last decade, however, their rate of productivity growth slowed as their absolute productivity approached that of the United States. In fact, US manufacturing productivity growth surpassed that of Germany and approached that of Japan, as shown in Exhibit 5. And forecasts based on the last 10 years show that -- at those rates -- Japan won't catch up until about 2015.

On the other hand, we need to think hard about why Japan has done so well in certain sectors. There are no simple answers, but one major contributing factor is that they are working smarter as well as harder. As the recent book, The Machine that Changed the World, spells out, Japanese production systems in automobiles are based on a highly skilled workforce contributing to both problem solving and continuous innovation. The Japanese have started a revolution in manufacturing that will put very different demands on the manufacturing workers of the future. And our existing workforce and the new people entering it may not be up to the challenge.(**)

Services

In services, as shown in Exhibit 6, the US productivity performance is even stronger. In commercial air transportation, retail banking, telecommunications, and retailing US productivity is far in front of other industrialized nations. These new findings are the result of a year-long collaboration among McKinsey & Company and leading economists around the world including Robert Solow, Nobel Laureate from MIT. They are based on a new approach to measuring service sector productivity at the microeconomic rather than macroeconomic level. We believe these findings demonstrate that US superiority in the service sectors is a fundamental underlying strength of the economy.

In short, robust domestic competition and -- in some sectors -- foreign competition have compelled American producers to build a better mousetrap. Playing against someone who is trying to beat you will make you a far better tennis player than merely bouncing a ball off the wall. Our more competitive business environment trains companies to win.

Social consequences

But increased productivity has a dark side too. It means that it takes fewer people to do the same amount of work. If productivity in a company or an industry increases faster than product demand, people lose their jobs. Driven by the forces of international competition and deregulation, this is exactly what has happened in many American companies and industries. And we can expect it to continue to happen -- especially in slow-growth industries. Jobs that are lost to these types of productivity increases are not jobs that are recoverable, except at the price of subsidies, inefficiency, and, in the long run, competitive failure in global markets.

Many US industries have increased their productivity through technology gains that reduced the number of workers. For example, the United States now has one of the most competitive and innovative steel companies in the world -- Nucor of Charlotte, North Carolina. The company is the world leader in mini-mill production of steel. This new technology requires up to 90 percent fewer workers to produce the same amount of steel.

Other industries have boosted their productivity by redesigning their ways of doing business to allow them to sell or make more products per employee -- again reducing the number of workers. Stores such as Home Depot, Wal-Mart, Staples, Price Club, and Toys "R" Us have less than half the general, selling, and administrative expenses of a traditional department store. Ford has opened a new plant in Atlanta with a new assembly process. It takes Ford a third less employee hours to build a car in this plant than it did 10 years ago. This plant -- staffed by union members -- is on par with any automobile manufacturing facility anywhere in the world.

All this increased productivity is very good for individuals as consumers, i.e., they receive comparable products and services at lower prices -- but it can be painful to devastating for individuals as producers. Painful for those who have marketable skills but need to find new places to apply them. Devastating for those who find skills acquired over a career or a lifetime obsoleted and who need to start all over.

The jobs question

The solution to the problem of jobs lost to increased productivity is not, however, increased job protection, closed markets, and trade barriers. The solution is the creation of new jobs that produce new goods and services that will create lasting opportunities for displaced workers.

In fact, the US economy has been very good at providing new opportunities. In the 25 years from 1965 to 1989 the US economy created 46 million new jobs compared to 9.8 million in Europe and 14 million in Japan, as shown in Exhibit 7. In many cases, increases in the sophistication and the potential value added of products produced made it possible to create new jobs closer to the customer, to replace jobs lost to increased productivity on the factory floor.

For example, as US-based toolmakers have improved their manufacturing capabilities, they have shifted people from the factory floor to the customer's door. Chemical and pharmaceutical companies now have many more employees in the field working with customers to define needs and design products, than they did 10 years ago. These are not simple sales jobs. They are an integral part of product design and manufacture. If you were to take the roof off a manufacturing facility today, you would see fewer and fewer people actually making things, and more and more people involved in figuring out what to make, how to make it, and how to service it for customers.

Additionally, technological advances have created whole new industries and jobs in the last decade. Who in 1980 would have imagined an enclave of computer software creativity on the banks of the Puget Sound? Who had ever heard of materials called spandex or Gore-Tex? Entire industries are now built on these software and athleticwear innovations. Tens of thousands of jobs have been created in Portland designing and marketing Nike shoes, in Austin building computers, and in selling these products in a thousand Wal-Mart stores in small towns across the country.

This rapid job creation can take place because the United States is the most flexible job market in the developed world. We have a regulatory and industrial environment that gives employers great flexibility in labor management practices. For example, plant closings are relatively easy in the United States. There is also greater use of part-time and contract employees. This flexibility permits US companies to continually seek new ways to lower labor costs and increase relative US productivity.

Where the United States falls short is in supporting displaced workers. We have found the superior model for improving productivity, but not for aiding the individual casualties of productivity gains, as Exhibit 8 demonstrates. This is due in part to lack of government support. The United States trails far behind most developed countries in public spending on training, placement, and direct job creation subsidies.

We need to start thinking harder about what a modern, developed economy looks like. Manufacturing literally means made by hand. Very few products are made by hand these days. An automobile produced by a Japanese manufacturer or at the new Ford plant in Atlanta has only 17 hours of labor content. In the future, an increasing proportion of the value added to products of all kinds will be made by mind, not body.

This has been and will continue to be the key to success for existing products and markets and will absolutely be the key to success in emerging products and markets -- such as software. High wages for performing routine manual labor in either a blue-collar or a white-collar job -- whether classified as manufacturing or services -- are a thing of the past. And any national strategy based on protecting or pursuing these kinds of jobs is doomed to failure. The march of technology and the replacement of physical labor by intellectual activity are irreversible.

As a nation, we must find ways to promote continuous productivity growth while substantially lessening the human costs associated with the inevitable industrial change in a globalizing economy. We must now choose to invest more of the benefits of increased productivity in workforce transitions. The single biggest threat to the US competitive edge in productivity is that the rising social costs of change will lead to political solutions -- that is, protectionism -- that will hamper future productivity breakthroughs.

Why we feel so bad

US citizens are the most productive in the world, have more job opportunities, and lead in personal consumption. So why, when we talk about US economic health, do we feel so bad? I believe the reason is that the impact of the move to a global economy has been to provide higher wages to more highly skilled and educated individuals at the upper income levels while driving down the wages of less and moderately skilled workers at middle and lower income levels. At the same time, prices of luxury items have continually decreased while prices of necessities have risen.

In other words, most of the population is continually losing ground. This problem is partly caused by the increasing number of workers whose skills are becoming obsolete because of information technology and the introduction of more sophisticated production approaches that require more highly skilled workers.

A house divided

Between 1977 and 1989, as shown in Exhibit 9, personal income growth was highest for the top 5 percent of the population.|1~ The lowest 20 percent, or quintile, of the population saw their real income decline. In 1989, while the best-off families may have enjoyed their greatest share of total income since World War II, 60 percent of the population faced their lowest ever postwar share.|2~

As Exhibit 9 shows, tax reform has not helped this situation. In the last decade and a half, only the top two quintiles have seen their after-tax income increase. The bottom three quintiles have seen their after-tax income decline. Tax cuts in the last decade benefited mostly the wealthiest 1 percent of the population.|3~ In addition, payroll taxes have increased and corporate taxes have decreased.|4~ Moreover, state and local taxes have grown.|5~ The net effect is that our tax system has become much less progressive.

The underlying cause of this decline in income over the last decade has been declining real wages. The upper quintiles of the population receive a significant portion of their income from investment and capital, while the lower quintiles receive much of their income from government transfers.|6~ The middle quintiles, however, receive most of their income from wages. Thus, the middle class appears to have been hit hardest.

A recent study by the Economics Policy Institute indicates that since 1987, nearly 70 percent of Americans have seen their real wages decline. As Exhibit 10 illustrates, McKinsey's own analysis of Labor Department earnings and employment data from 1979 to 1991 reveals declining wages in nearly every sector of the economy.

Furthermore, competition has rewarded businesses that have increased productivity through means that eliminate middle-management, middle-income jobs. Thus, even in industries experiencing rapid growth, the average wage is being dragged down by a growing lower-paid, front-line workforce and a shrinking middle-tier workforce. For example, successful retail outlet giants create a high number of jobs, but the majority are for salespeople, stockers, and check-out clerks. Similarly, insurance companies and banks are improving their competitiveness by decreasing the number of white-collar managers and sales and service representatives through front-line automation.

It is also true that US family income did rise during the last decade. This is the result, however, of families putting more people to work and working longer, as shown in Exhibit 11. On average, each American increased his or her hours worked by two work-weeks per year between 1979 and 1989. In married couples, husbands only slightly increased their work hours outside the home, but the amount of time wives spent earning wages increased by over 30 percent. Without a second contribution to family income, 80 percent of families would have experienced declines in real family income over the last decade.|7~ Families relying on a single earner fell behind two-income families by nearly $10,000 year.|8~

Education and mobility

There is a great deal of mobility of individuals between quintiles. Isabel Sawhill, at the Urban Institute, recently published data that tracked individuals over a 20-year period -- starting in 1967 and separated into two 10-year periods. She found the incomes of the top and the bottom groups she studied grew farther apart.

Importantly, 60 percent of individuals changed their position -- with about half moving up or down the income ladder -- while 40 percent stayed where they were, as shown in Exhibit 12.

The net result of the movements was that the people who ended up in the bottom quintile were no better off than those who had been there 25 years ago. Those who ended up in the top were a lot better off, as shown in Exhibit 13. When Isabel took a further look at the impact of education on this movement, she found that education was crucial.

During the first period, 1968 to 1977, the average increase in family income for all levels of education was around 20 percent. Those with some college education saw their family incomes rise by 24 percent, while high school dropouts still saw a 20 percent gain. Over the period 1978 to 1987, while the average income gain had dropped only slightly to just under 20 percent, the difference by education level became striking. High school dropouts saw their incomes decline by 4 percent while college graduates experienced a gain of 48 percent.

What this means is that there is still tremendous mobility in the economic pecking order, but the better educated are rapidly outpacing those with less education. This is an extraordinary piece of information -- and it is compelling evidence that the problems in the US economy are rooted in an increasing mismatch between the jobs available in a modern, knowledge-intensive economy and the mix and the level of skills and intellectual development currently available in the US labor force.

Left behind

Even where family incomes have increased, it is likely that family discretionary income increased little, if at all. The cost of nondiscretionary items rose substantially in the last decade, as shown in Exhibit 15, magnifying the negative impact of income reduction on the lower quintiles' standard of living. Because nondiscretionary spending comprises a larger part of the household budgets of lower-income quintiles, these households benefit less as consumers from increased productivity in discretionary goods.

The benefits of significant productivity-driven cost reductions in long-distance calls, cellular technology, and airfares mean precious little to families who are struggling to pay rent, food, health care, and insurance costs. America was the greatest place in the world to be a consumer in the 1980s, if you had a lot of discretionary income.

Unfortunately, many families apparently attempted to maintain their standard of living in the 1980s by borrowing. Exhibit 16 shows that family debt as a percent of income rose substantially. Throughout the 1970s, it hovered at around 60 to 70 percent of annual family income. In the 1980s it rose to well over 80 percent. Families in the lower quintiles increased their debt load as a percentage of family income significantly more than those near the top.|9~ Paying down this debt will inevitably further reduce discretionary spending for most families in the 1990s.

In sum, perhaps 60 to 80 percent of US consumers felt the productivity parade pass them by in the 1980s. Their anger over the failure of the American dream of growth and opportunity for all classes of citizens in the 1980s may be the single most important cause of the Democrats' return to the White House in 1993.

A dream deferred

Now, there are those who argue that the wage and employment trends I've described are temporary effects attributable primarily to the recession. Our client experience suggests otherwise. Companies have altered fundamentally the way they do business, and the old ways aren't coming back. While sales may pick up and employment opportunities return, they will not return at the pace -- or in the places -- they disappeared.

In an economy characterized by intense competition, flexible employment, and rapid improvements in productivity, the critical issue for individuals (as producers) has become education and the speed at which they can learn new skills and adapt old ones. Clearly, the pace of change and the skills demanded in the workforce have changed dramatically in the last two decades.

Contrary to conventional wisdom, the education of today's high school graduates as measured by the Educational Testing Service is comparable to previous generations, as indicated in Exhibit 17. However, the previous generation of blue-collar workers did not need to understand statistics to operate a machine in an assembly line; nor did the entry-level white-collar worker need to know how to use word-processing programs, spreadsheets, and statistical packages just to get a job. Nor was the mix of available high-paying jobs so heavily skewed toward knowledge workers. Finally, the previous generation did not face a workplace where it was likely that they would change jobs (and perhaps careers) an average of eight times in their adult lives.

The US economy now faces a situation that is paradoxical, unique, and potentially very dangerous. As workers become more and more productive, increasing numbers of workers are experiencing a real decline in their ability to enjoy the fruits of their labor. Income polarization is increasing, and middle-income opportunities may decline as a result of productivity-driven job elimination.

Most families won't have the luxury of adding a third family wage-earner to replicate the 1980s second earner "income bubble" in the 1990s. The income growth opportunities and the standard of living historically associated with middle-class lifestyles are, I believe, very much at risk. If we cannot continue to create millions of paths to upward mobility, I fear that social instability and economic decline are inevitable.

Rebuilding the dream

What do we need to do to "fix" the US economy? I think we need to develop a long-term strategy that leverages our current strengths and strong position and systematically attacks our most critical problems. To do so we need to have a clear vision of what we would like the US economy to achieve. My vision is really a set of four aspirations -- some economic and some philosophical; they are outlined in Exhibit 18.

* First and foremost, we must aspire to raise the standard of living for all segments of the population -- the fifth quintile as well as the first. Thus, we need at least to stabilize, if not reverse, the growing gap between our nation's haves and have nots. We should aspire to accomplish this not through increased transfer payments, but rather expanded opportunities for all population groups to increase real income growth and discretionary income.

* Second, we need to pursue productivity gains in all sectors of the economy. We have done very well in improving productivity in those sectors where we have deregulated and opened markets. In other sectors, such as health care, education, and government, measurable gains in productivity have been low, while qualitative improvements favor the wealthy. Improving the efficiency of these nondiscretionary services and passing cost savings on to consumers would dramatically and quickly improve the standard of living in the United States.

* Third, we must seek to have full productive employment for all those capable of working and discourage safety nets that lead to lifetimes of dependency on transfer payments. Achieving this ambitious goal will require comprehensive programs for realigning our educational, training, and retraining systems with the needs of a modern information- and knowledge-intensive economy. It will also require creating meaningful jobs for those who cannot make the transition.

* Finally, we need at least to maintain parity as a world economic power. I believe that we can outperform the other leading industrial nations if we apply ourselves to the problems I have outlined above. Any strategy that attempts to solve our job problems by isolating us from the world economy will diminish our economic competitiveness and seriously risk national economic security. Thus, we need to continue to pursue free trade and to invest in those world-class technologies and industries where future US jobs reside.

Getting started

Much of this vision requires a long-term program for renewal, but there are things we can do in the short term to help alleviate the present pain. We should, for example, reduce health care costs, which were 9 percent of GNP in 1980, are presently 12 percent, and are projected to be 16 percent by the year 2000. Evidence from around the world would indicate that we should be able to provide high-quality health care for all of our citizens for less than 10 percent of GNP.

In other words we have a serious cost problem with our delivery system. Solving this problem would help alleviate the pressure on nondiscretionary expenditure that many Americans now feel. This type of systematic assault on individuals' nondiscretionary expenses could buy us the time to make the necessary labor transitions over the next decade.

A vision for economic renewal must be translated into a specific plan for action, and this has been a year of political plans to fix the economy. The most important proposals of these plans can be divided into three broad categories -- job creation, education and retraining, and investment in infrastructure. Given our shared understanding of global productivity trends and why we feel so bad about some of their effects, it's worth discussing which types of proposals are most likely to address the root cause of our problems and which will only exacerbate them.

Regarding job creation, we know that the world is in transition. Protecting manufacturing jobs within noncompetitive producers will only stave off the inevitable and probably prevent resources from being reallocated to more productive sources. Instead, we should fight for open markets around the world. To encourage world-class productivity among Americans, producers need to expand demand -- and therefore employment -- for the most competitive US industrial sectors. I have already described the productivity advantage American workers enjoy in many industries -- airlines, banking, and telecommunications. We need to fight hard to open world markets in these and other industries where we are world leaders.

At the same time, we should discourage foreign governments from subsidizing and protecting their own industries, as it clearly results in the misallocation of resources within their country and disadvantages their own consumers. And as we know from -- for example -- the Airbus story, lasting damage to US companies can result from these kinds of government actions. What we probably need is a higher level of government/industry cooperation in selected instances such as this.

Within the United States, people must be prepared for jobs that place a high premium on critical thinking. Political candidates refer to this as "training and education." A better understanding of the labor market would suggest a phrase such as "creating a highly-skilled and flexible workforce."

In education this may require experimentation -- with new methods of teaching, new curricula, and new ways of organizing schools. It is becoming clearer every day that methods of teaching by rote will not equip our children for tomorrow's job market. At the same time all schools must have learning goals. This entails not only the introduction of national standards for the three Rs of "readin," "ritin," and "rithmetic," but also as importantly, the three Cs of computing, critical thinking, and capacity for change.

These standards need to be set at levels which rise over time, so that both high and low achievers have ambitious and attainable goals -- rather than merely needing to attain "average." To the extent we do not provide these challenges and opportunities widely or restrict access to education because of cost, we will be rewarded with a noncompetitive workforce.

Retraining should be aimed at building core skills, not preparing groups for specific jobs. We could, for example, create information extension centers across the country where people could receive training in the use of computers and software. We should not assume that the public sector will administer these programs. The government is good at administering transfer payments, lousy at predicting private-sector skill requirements. It is inconceivable that these types of programs would be successful unless led by major private-sector institutions.

In order to be flexible, employees must be able and feel able to move to a new job. Today, many employees suffer from benefits "job lock." Having invested years in securing health benefits and pension programs, they stand to lose substantially if the value of these programs is reduced or lost if they move to a new job. To facilitate employee flexibility in the workplace -- a key to maintaining productivity -- health plans and pensions must be portable.

I realize not all people will have the educational capability or will be of an age at which training will allow them to compete successfully in the open job market. For these people, I suggest that we create jobs dedicated to improving the common good -- for example, repairing highways, cleaning the environment, patrolling the streets, or caring for the sick or elderly. Such opportunities will contribute to our nation's sense of well-being and restore dignity to the chronically unemployed.

Finally, there must be a base upon which to build jobs. This will require investment in infrastructure. In 1955, President Eisenhower said, "Our unity as a nation is sustained by free communication of thought and by easy transportation of people and goods. Together, the uniting forces of our communication and transportation systems are dynamic elements in the very name we bear -- United States. Without them, we would be a mere alliance of many separate parts."

Eisenhower was referring to the national highway program, but he just as easily could have been describing our present need to build a high-speed information highway for the next century. Such a national investment to facilitate the flow of goods and ideas follows the precedent set by the building of the railroads, highways, and telephone system. This large-scale effort would not only facilitate US productivity, it would also provide a wide variety of jobs.

Moving forward -- together

The magnitude of these objectives sounds daunting, but I think it is important for us to remember where we are starting from.

First, we are still the leading economy in the world, and though we are intimately aware of our social and economic problems, the Germanys and Japans of the world have their own emerging problems. Relatively speaking, we're in pretty good shape, and we ought to act while we can.

Second, we have the resources to accomplish all the things we have to do. What we need most is the political courage to stop papering over the problems of the past and start dealing with the problems of the future. We must stop wasteful investments, focus on the requirements of a successful US economy in the next 20 years, and balance our national accounts.

Third, our economy is moving rapidly from the manufacture of material-intensive products to the production of intellectually-intensive products and services. Our national bias for focusing on manufacturing success while ignoring service-sector opportunities must end. Additionally, we need a new way of monitoring US industrial output that reflects a 20th century understanding of goods and services, not the structure of the 19th century industrial organizations. We absolutely dominate these new service and "soft manufacturing" sectors, and we must take great care to understand the sources of our success.

The cornerstone of the strategy I have described for dealing with our situation -- stated simply -- is, it is not possible to recreate the old world. Unlike Michael J. Fox, we cannot go Back to the Future. I believe we are witnessing the same kind of fundamental shift the United States experienced at the turn of the century when this nation moved from an agrarian to a manufacturing economy. We faced a similar challenge at that time, namely, creating a new middle class with widespread opportunity for all Americans in the face of massive change in technology and global trade.

Tonight, I have laid out the United States' present economic position and suggested a few approaches for guiding us into a productive and equitable future. The scenario relies on the creation of a highly educated, highly skilled populace willing to invest in the public good. There are some who will argue that this is not possible. There are not enough good jobs out there for all the educated people. Or, that nobody will be willing to support the amount of funding required to teach the skills or build the infrastructure.

I ask you to consider the alternative. While we are very productive, many of our fellow Americans are struggling to keep pace with the change. Many of our common areas -- roads, parks, schools -- are in need of repair. Without action by you, me, and others across the country I do not see evidence that these fundamental trends can be reversed. There is a pattern that requires a common understanding of the problem and a collective will to change. I invite all of you to use all of the personal and professional resources at your disposal to play a role in making this change happen.

Purchasing power parity versus exchange rate national income comparisons

A FREQUENTLY CITED indicator of the productivity of a nation's economy is GNP or GDP per capita. When comparing different countries, national currencies are converted to a common currency using market exchange rates. These figures provide a good indicator of the relative position of countries in goods that are internationally traded.

Many goods, however, are not internationally traded. Market exchange rates are most strongly affected by flows of goods and capital, not by the internal activities of consumers buying goods and services produced and sold strictly in their domestic markets. Thus, income per capita converted using market exchange rates does not provide an accurate comparison of the conditions, or standard of living, faced by consumers. For this, purchasing power parity (PPP) provides a better picture. When constructing a PPP conversion, costs of buying specified quantities of similar goods and services -- including nontradeables -- in different markets are compared.

When this adjustment is made, we generally find the relative position of individuals in the United States to be much better than it appears using straight exchange-rate conversions, reflecting US superiority in quality of housing, distribution systems, and nontradeable sectors.

Manufacturing versus service: An increasingly irrelevant distinction

THE GROWTH of the service sector and the shrinking of the manufacturing sector are commonly and incorrectly taken as symptom of serious sickness in our country. This misdiagnosis rests on some questionable notions about the US economy.

The shift from manufacturing to service does not always destroy jobs; often it creates jobs. A new technology or process may decrease the number of workers needed actually to produce or assemble a product, but the resulting increased output or increased product complexity may also increase the demand for workers to service or support that product. For example, a technology gain in the computer industry may decrease the number of people needed to manufacture computer hardware, but increase the demand for software, systems design and implementation, and customer service.

Even more important, our present system for classifying jobs as manufacturing or service does not reflect what workers are actually doing. On one hand, so-called "manufacturing" companies have an ever-increasing number of employees who actually have nonproduction jobs. In 1947, 83 percent of the workers classified under "manufacturing" were actual production workers. In 1977, only 70 percent of manufacturing workers were in production. By 1989, this number had dropped to 65 percent.(*) The labor statistics neglect this important trend. If you write software for robots on an assembly line, call on customers, or do book-keeping at a manufacturing plant then your job counts as a manufacturing job.

On the other hand, many so-called "service" companies actually produce real tangible products. All of Microsoft's employees are counted as service jobs despite the fact that the software they make is as tradeable and exportable as any machine tool. The same holds true of other "service" firms like mutual fund giant Fidelity, American Express, or CBS Records, whose products are every bit as tangible as any manufactured product.

Instead of simply casting industries and companies as either service or manufacturing, we should begin to make a more subtle four-way distinction:

Hard manufacturing -- industries that make hard goods with manual processes, like autos, machine tools, heavy machinery, and electronics. This is the traditional manufacturing sector.

Soft manufacturing -- industries that do not produce a hard good or employ manual labor, yet create a product that is marketable and tradeable, should be reclassified as "soft" manufacturing. We must recognize the importance of the contribution of these industries to economic health, infrastructure, and security. Examples include software; records, tapes and publishing; and databases and information technology.

Knowledge-intensive service -- industries that require a high level of education, information technology, and/or knowledge skill base. Examples included system design, investment banking, and law.

Manual service -- industries or jobs that require modest education or skill. Examples include fast food, retail sales, and home health care and assistance.

Using these categories, we can get a clearer picture of our present and future economy. Rather than an assortment of services built on a foundation of hard manufacturing, our economy is perhaps best thought of as a web of hard manufacturing, soft manufacturing, and service. From this perspective, it can be best assessed what mix of goods and services contributes most of the health and long-term stability of our economy.

* Census of Manufacturers, US Department of Commerce.

Recreating the American Dream

* Rising standard of living for all Americans

* Continued productivity growth

* Full productive employment that will minimize transfer payments

* Economic parity internationally

* "Service Sector Productivity," McKinsey Global Institute, Washington, D.C., October 1992. See the article by William W. Lewis, Andreas Siemen, Michael Balay, and Koji Sakate, "Service sector productivity and international competitiveness," pp. 69-91.

** Editor's note: See Tino Puri, "the demographic time bomb," pp. 98-115, for Paul Kennedy's comments on the same topic.

REFERENCES

1 Lawrence Mishel and Jared Bernstein, The State of Working America, 1992-93, Washington, D.C., Economic Policy Institute, 1992, p. 46. References immediately below are to the same source.

2 p. 42.

3 p. 103.

4 p. 113.

5 p. 121.

6 p. 54.

7 Lawrence Mishel and David Frankel, The State of Working America, 1990-91, Armonk, New York, M. E. Sharpe, Inc., 1991, p. 40. References immediately below are to the same source.

8 p. 44.

9 p. 161.

Recommended reading

Books

Paul Krugman, The Age of Diminished Expectations, Cambridge, Massachusetts, MIT Press, 1990.

Lawrence Mishel and Jared Bernstein, The State of Working America, 1992-93, Washington, D.C., Economic Policy Institute, 1992.

Robert Reich, The Work of Nations, New York, Alfred A. Knopf, 1991.

Isabel V. Sawhill, Challenge to Leadership, Washington, D.C., The Urban Institute Press, 1988.

James P. Womack, Daniel T. Jones, and Daniel Roos, The Machine that Changed the World, New York, Rawson Associates, 1990.

Report

Building a Competitive America, First Annual Report to the President and Congress, Competitiveness Policy Council, Washington, D.C., March 1, 1992.

Fred GLuck is Managing Director of McKinsey & Company. Copyright |C~ 1992 by McKinsey & Company, Inc. All rights reserved.
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No portion of this article can be reproduced without the express written permission from the copyright holder.
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Title Annotation:includes related articles; sharing the benefits of economic performance
Author:Gluck, Frederick W.
Publication:The McKinsey Quarterly
Article Type:Transcript
Date:Sep 22, 1992
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