by Martin Neil Baily, Diana Farrell, and Jaana Remes

A study of US labor productivity in the years following the dot-com collapse finds that the lion's share of productivity growth continues to come from only a few sectors. But research by the McKinsey Global Institute (MGI) concludes that productivity is growing in more sectors now than in the late 1990s. (The full report, US Productivity Growth, 1995-2000, is available free of charge at www.mckinsey.com). In addition, the largest contributors to productivity growth after 2000 have been service industries. Such trends bode well for the US economy.

In our earlier research, we found that just 6 of the economy's 59 sectors accounted for virtually all net productivity growth from 1995 through the end of 1999. Since 2000, however, productivity growth has been somewhat less concentrated among the big hitters: from 1998 to 2000, the top 4 sectors (broadcasting and telecommunications; professional, scientific, and technical services; utilities; and wholesale trade) represented 100% of total growth; from 2000 to 2003 (the latest year when sector-level data are available), the top 7 sectors (retail trade, financial services, computer and electronic products, wholesale trade, administrative and support services, real estate, and professional, scientific, and technical services) contributed only 75% of the total.

After 2000, some of the sectors with the fastest-growing productivity — notably computer equipment — saw their growth slow substantially. Yet productivity growth rates in both retail and wholesale trade have continued their strong growth trajectory. Interestingly, productivity in a much broader set of service industries, including administrative support, scientific and technical services, construction, and restaurants, has also increased. As a result, five of the largest contributors to productivity growth after 2000 were service industries. Over the past decade, the service sector, which today represents 70% of US employment, has been a major source of growth in productivity and employment alike.

One reason productivity growth held up so well from 2000 to 2003 is that during this period, productivity declined in fewer sectors than it had during the previous five years. The improvement may have resulted from successful efforts by companies to cut costs. Recent figures for overall US productivity growth have been encouraging, with no sign of a return to the listless growth rates that prevailed before 1995. Despite the recession, output per hour in the nonfarm private sector grew by 2.5 percent in 2001 and has increased by well over 3% annually since then.

MGI's earlier study found that the most important driver of productivity was business process innovation spurred by good old-fashioned competitive pressure. The same factors, we believe, explain recent productivity growth. Even after the high-tech bust, companies continued to look for new ways to outperform competitors by cutting costs, using IT more effectively, and, in general, producing more for less.

The data from 2000 to 2003 suggest that most sectors have plenty of room to do more in these areas. As long as competition remains intense, we believe that the United States can look forward to strong productivity growth in the years to come.