Here is a brief excerpt from an interview of Robert Solow by Martin Neil Baily and Frank Comes for the McKinsey Quarterly, published by McKinsey & Company. The economist who won a Nobel Prize for advancing our understanding of technology looks at the past and future of productivity-led growth. To read the complete interview, check out other resources, learn more about the firm, obtain subscription information, and register to receive email alerts, please click here.

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More than 50 years have passed since Robert Solow published the path-breaking model of economic growth for which he won the Nobel Prize in 1987. This model proposed that growth occurred not solely from the accumulation of capital and increase in labor, as previously theorized, but also from what Solow called “technological progress”—a term now better known as total-factor-productivity growth, which encompasses advances in technology as well as in management and organizational techniques. In the early 1990s, Solow accepted the role of academic adviser to the then-fledgling McKinsey Global Institute (MGI), which was proposing to research and explain differences in the productivity of industries and countries. Economist Martin Neil Baily and McKinsey Publishing’s Frank Comes recently sat down with Solow to discuss the implications of those early studies for business and economics, as well as the prospects for future productivity-led growth.

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What, if anything, surprised you about the findings of the early MGI studies?

What came as something completely new to me was that if you looked at the same industry across countries, there were almost always dramatic differences in either labor productivity or total factor productivity. To my surprise, it turned out that most of the time, certainly more often than not, the difference in productivity—in the auto industry or the steel industry or the residential-construction industry in the US and in countries in Europe—was not only substantial but couldn’t seriously be explained by differences in access to technology.

We also found that the productivity differences could not be traced to differences in access to investment capital. The French automobile industry, much to my surprise, turned out to be more capital intensive than the American automobile industry. So it was not that either. The MGI studies instead traced these differences in productivity to organizational differences, to the way tasks were allocated within a firm or a division—essentially, to failures in managerial decisions.

I was, of course, instantly suspicious of this. I figured to myself, “What do you expect a bunch of management consultants to find but differences in management capacities? That’s in their genes. That’s not in my genes.” But MGI made a very convincing case for this. And I came to believe that it was right.

So management was the primary factor in productivity differences?

Yes, and there was another surprise, for which there was partly anecdotal, partly statistical evidence. If you asked why there were differences that could be erased or diminished by better management, the answer was that it took the spur of sharp competition to induce managers to do what they were in principle capable of doing. So the idea that everybody is everywhere and always maximizing profits turned out to be not quite right.

MGI made a very good case that what was lacking in these trailing industries in other countries—or in the US, in cases where the US trailed—was enough exposure to competition from whoever in the world had the best practice. And this, of course, can apply within a country. We know that in any industry, there is a whole distribution of productivity levels across firms and even, sometimes, across establishments within a firm. And much of that must be due to the absence of any spur to do more.

So an interesting conclusion to me was that international trade serves a purpose beyond exploiting comparative advantage. It exposes high-level managers in various countries to a little fright. And fright turns out to be an important motivation.

So competing against the global best-practice leaders is a way to encourage your own industry to use best practice?

Yes, and it goes beyond that, even. Competing as part of the world economy is an important way of gaining access to scale. If you’re a Belgian company or even a French company, it may be that best practice requires a scale of production larger than the French domestic market will provide for French producers.

So it’s important for such companies to have access to the international market. That was not something I had thought of. And I don’t think anyone had—at least I had no reason to think, within economics, that there had been much thought about management activities as a big difference between best practice and less good practice. We had always thought, “Well, people seek profits. And if they seek profits, they’ll have to adopt best practice.” Not so.

Do you think the lessons from the microsector-level view have changed the way economists work? Or has this remained outside the economics profession?

I think it’s been partially absorbed by the economics profession. There is much more interest in industrial organization, in competitive advantages and how they work themselves out in productivity.

Looking toward the future, are there other issues in economics that MGI’s sector-level approach might be helpful for?

I would like to see more work on the determinants of productivity and productivity increases within the service sector. To begin with, I don’t think we even have a very clear idea about the relative capital intensity within the service sector or between the service sector and goods-producing sector.

I remember I was once writing something in which I was describing the service sector as being of relatively low capital intensity. And then I stopped and remembered that the following day I had an appointment with my dentist and that my dentist’s office was as capital intensive a 500 square feet as I had ever seen in my life.

So I think the place where the MGI approach is most needed right now is in the service sector. There has been service-sector work within MGI, and outside of it as well, but not as much as is warranted in view of the 70 percent or more of all employment in advanced economies that’s in service industries.

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Here is a direct link to the complete interview.

This interview was conducted by Martin Neil Baily, who holds the Bernard L. Schwartz Chair in Economic Policy Development at the Brookings Institution, and McKinsey Publishing’s Frank Comes.