MAKING IT IN AMERICA

JUNE 2017

RESEARCH PREVIEW
A SPECIAL INITIATIVE FOR THE
2017 ASPEN IDEAS FESTIVAL

EXECUTIVE SUMMARY
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 MAKING IT IN AMERICA
JUNE 2017

RESEARCH PREVIEW
A SPECIAL INITIATIVE FOR THE
2017 ASPEN IDEAS FESTIVAL

James Manyika | San Francisco

Gary Pinkus | San Francisco
Sree Ramaswamy | Washington, DC
Katy George | New Jersey
John Warner | Cleveland
Andrea Serafino | New Jersey
 Revitalizing manufacturing in America
Infographic: Manufacturing
Manufacturing plays an outsized role in national competitiveness Manufacturing as % of US total, 2016 or latest

Employment GDP Net capital Patents Exports R&D

stock spending

9 12 20 55 60 70
The future of production is digital
As global demand rises and fragments, manufacturers need agilityand technologies such
as analytics, the Internet of Things, advanced robotics, and 3-D printing can provide it.
Optimized, autonomous factories will connect with supplier networks in a fully digitized and tightly
integrated value chain. Real-time data will run from product design through customer usage,
enabling new services and business models.

Real value added is at 10- to 20-year lows for a range of Compound annual
US manufacturing industries1 growth rate
Index: 100 = 1980 Vehicles and heavy machinery %
160
156 1.3 1.0 0.3

140 Locally
processed goods
145 1.0 0.6 0.8

120
Resource-intensive 118 0.5 0.1 0.9
commodities

100
Basic
consumer goods 78 0.7 1.0 2.6
80
1980 1990 2000
1980 1990 2000 2010 2016 2016 2016
1 Chart does not include technology-driven products (e.g., pharma and computers), where value added has increased by 7.7x since 1980.

Key priorities to help US manufacturing regain its competitive edge

Stimulate long- Revitalize domestic Increase Encourage more

term investment supply base workforce training firms to export

6 McKinsey Global Institute Executive summary

 Many workers are not making it in America
Infographic: Income

The middle class has slipped back 2% of workers, Some industries have felt more pain
or 3 million
to labor income levels of the 1990s people, earn more than others in terms of wage growth
than $200,000
Evolution of real labor income Average real hourly wages by industry
(Index 1990=100) $200K (Index 1990=100)
150 150
Highest quintile Finance
140 140
Avg. wage
RECESSION RECESSION
$169,195
130 130

120 120
Avg. wage
Manufacturing Retail
$35,629
110 110

Middle quintiles
100 100
Construction Transportation

90 90
1990 2000 2010 1990 2000 2010

2015 distribution of US working population by total annual wages

Millions of working people by annual wages1 14% Select occupations in each wage bracket

$100K
98% of workers, or Lawyers
158 million people, Software developers, managers
earn less than $200,000 $90K Engineers

$80K

$70K
85% of workers, or Registered nurses; accountants and auditors
136 million people, 18% Elementary school teachers;
earn less than $75,000 $60K first-line supervisors
Electricians

$50K

Truck drivers
67% of workers, or $40K Office clerks
107 million people, 30% Retail salespersons
earn less than $45,000 $30K Home health aides;
childcare workers

$20K
37% of workers, or Cashiers;
59 million people, 37% food prep workers;
earn less than $20,000 $10K wait staff
$5K2

0 million 2 4 6 8 10 million workers 12 14 16 18 20 million

The US doesnt just need growth. It needs more inclusive growth.

Reinvest in hard- Reimagine Retrain Remove barriers to
hit communities work workers mobility and participation

1 Wage statistics based on 2015 compensation data reported by the employer on W-2 forms. Occupational information from
US Bureau of Labor Statistics Occupational Employment Survey.
2 All brackets, but especially those at the bottom, may include part-time workers and people who did not work the full year.

28 McKinsey Global Institute Part1: Can America still manufacture?

 Stacey Markel Photography/Moment/Getty Images
EXECUTIVE SUMMARY

The United States always assumed that its forward momentum would carry the next
generation toward greater prosperity, just as it took for granted that its technical prowess
in manufacturing would guarantee its global market share. But now those assumptions
have been upended. Although unemployment is down and wages are finally ticking up
again, these indicators can distract from the bigger picture. Tens of millions of workers
are struggling to make it in America, and even a full-time job does not guarantee a decent
standard of living.

Manufacturing is not the only sector with poor wage growth, nor is it the largest. But it was
once the backbone of the middle class, and its erosion is symptomatic of broader shifts
in the economy. Part1 of this research preview looks at how this unfoldedand outlines
how the sector could exploit changes in technology and value chains to compete for new
market opportunities. Part2 traces what has happened to wages across the economy more
broadly and considers what caused these pressures. Finally, Part3 opens what we hope will
be an ongoing conversation about solutions that can lead to more inclusive growth.

US MANUFACTURING NEEDS TO REGAIN ITS COMPETITIVE

EDGE AND RETOOL FOR THE 21ST CENTURY
Manufacturing remains a pillar of the US economy and the primary industry in some 500
counties from coast to coast. The sector drives 30percent of US productivity growth,
60percent of exports, and 70percent of private-sector R&D spendingall factors that
keep the nations innovation machine humming. But it now accounts for just 9percent
of US employment, a much smaller share than two decades ago. Excluding computers
and pharmaceuticals, value added in most other manufacturing industries is no higher
today than it was in 1997. The United States has lost market share not only to low-
cost countries in labor-intensive industries but also to other advanced economies in
knowledge-intensive industries. Today there are 30percent fewer US manufacturing
firms than in 1997, and the sector has lost roughly one-third of its jobs. Not only have
plants closed, but fewer are opening. The United States remains the worlds second-
largest manufacturing nation, and the diversity of its industrial base presents multiple
opportunities for growth. But the nation cannot afford to let its manufacturing muscle
continue to atrophy.

Today demand, global value chains, and technology are evolving in ways that play to US
strengths. The United States can capitalize on these shifts to boost output and narrow
its trade deficit, particularly in advanced manufacturing industries. The first promising
factor is rising consumption in emerging economies, combined with the fact that the
United States itself remains one of the worlds largest and most lucrative markets. Factor
costs are changing, too, to the benefit of many US-based producers. Wages are rising
in emerging economies, automation weakens the case for labor arbitrage, and the shale
boom has made energy cheap and abundant in the United States. More of the worlds
production is up for grabs; global value chains are shifting as firms emphasize service-
based business models and proximity to markets, suppliers, and innovation partners.
The new world of digital manufacturing represents a profound shift toward higher
productivity and the agility needed to meet fragmenting demand. Technologies such as
the Internet of Things, analytics, advanced robotics, and 3D printing are transforming
 factory floors into flexible, self-maintaining operations. Companies will soon be able to
connect their entire value chain with a seamless flow of data, unlocking efficiencies and
new service offerings.

The growth opportunities for US manufacturing are real, but it would be nave to minimize
the challenges of turning around two decades of negative trends. This effort has to start
with stimulating a wave of investment from both domestic and foreign sourcesnot just
with tax incentives but through targeted strategies to bring the industries of the future
to communities that have been left behind. The second critical priority is revitalizing
the domestic supplier base, which has been hollowed out in the past two decades.
Most US manufacturing firms are small companies that need financial, technology, and
advisory support; large firms can take a step toward building their own collaborative
supplier networks by helping smaller firms modernize and become more innovative.
Third, the jobs at stake in 21st-century manufacturing may be service roles or positions
requiring digital skills, which means that workforce training will be an important piece of
the puzzle. Larger companies will have to do more to develop the capabilities they need
by offering their own training, partnering with education providers and industry groups,
or establishing workforce platforms. Finally, the United States needs a comprehensive
strategy to boost net exports and regain global market shareone that encourages
more small firms to participate, bringing the benefits of globalization to more workers.

US manufacturing can achieve a turnaround if the public and private sectors treat it
as a national priority. But it is important to recognize that a successful revitalization
will not produce a return to 1960s-style manufacturing employment. For decades
the sector provided economic mobility to workers with less education, and nothing
else has emerged to take its place. Part2 of this report looks at the broader trend of
narrowing opportunities.

THE UNITED STATES IS INCREASINGLY A TWO-TIERED ECONOMY,

WITH MILLIONS OF WORKERS STRUGGLING TO GET BY
Previously published MGI research found that 81percent of US households were
in segments that experienced flat or declining market incomes from 2005 to 2014.
During the previous decade, real incomes rose for all segments, with most of the gains
coming during the growth surge of the late 1990s. This stunning reversal reflects what
a powerful shock the Great Recession delivered. But the picture brightens when we
look at disposable income, taking taxes and government transfers into account. By
this measure, less than 2percent of US households were in segments with flat or falling
incomes over the 20052014 period. In other words, the government managed to
cushion the blow of the recession, although this support came at a significant fiscal cost.

A longer view shows that household incomes have been under pressure for more
than three decades. This is ultimately a wage storyand only workers at the top of the
distribution have been bringing home bigger paychecks. The top quintile almost doubled
its wages and benefits in real terms since 1983, but everyone else remains stuck at
roughly the levels of the 1990s. There is now a yawning pay gap between workers with
post-secondary education and those without it. While a small number of high-growth
metros have bounced back strongly in the recovery, real median household incomes
remain below their pre-2000 peaks in almost two-thirds of US counties. Meanwhile, the
costs of maintaining a middle-class life have continued to climb.

Multiple economic, technological, and societal forces have simultaneously contributed

to pressures on incomes and wages. Some are structural shifts, such as the changing
sector mix of the economy and the declining share of national income going to labor.
Productivity and wages have historically risen hand in hand, but now that relationship
has been weakened. In the past two decades, the ongoing digitization of the economy

2 McKinsey Global Institute Executive summary

 has also made it possible to get more output from knowledge-intensive capital using
less labor. There is a new premium on highly skilled workers who can make the most
of technology. These long-term forces were exacerbated when the Great Recession
struck. It caused a massive loss of economic output and was followed by a weak and
highly uneven recovery.

All of the forces described above have played a role in depressing wages. In addition
to exploring these aspects, this research focuses on another potential contributing
factor that is often overlooked in discussions of US income inequality: the changing
environment facing companies and industries. There has been an extraordinary
escalation of competitive pressures, including foreign competition in tradable sectors
as well as price competition and declining returns in many asset-heavy sectors.
Furthermore, profits are shifting to asset-light sectors and a small number of superstar
firms that employ relatively few people. Some struggling firms have responded with
cost-cutting measures such as squeezing suppliers or opting for automation, offshoring,
or contract work. In real terms, wages remain below their 1983 levels in some large,
asset-heavy sectors such as retail, transportation, and construction. The trends in these
sectors alone mean that at least one-fifth of the US workforce has not advanced in more
than three decades.

Workers now have fewer options when their pay stagnates. Rapidly falling costs of
automation and the availability of lower-cost global labor have created more options for
companies. As the nature of work has changed, the relationship between companies
and workers has weakened. Temporary work arrangements and outsourcing are
becoming more commonplace, and firms are better able to predict demand and
schedule labor in smaller and more erratic increments. Workers now have decreased
mobility, and the decline of union membership has weakened their bargaining power.
Large segments of the labor force lack the skills that the marketplace values.

Many of the trends we see todayincluding weak recoveries from recessions, a

reweighting of the economy toward service sectors, and foreign competitionwill persist
into the future. Some appear to be accelerating, such as digital technologies reducing
the need for low- and medium-skill workers. In the United States, some of the large
and labor-intensive sectors that have already come under wage pressure (food service,
manufacturing, and retail) appear to be most susceptible to automation in the future. The
convergence of deepening income inequality and accelerating technological change
increases the urgency to act.

WHERE DO WE GO FROM HERE?

No single solution will be a silver bullet. These complex issues raise bigger questions
than the usual economic debate, starting with how to address the deteriorating quality
of jobs and where the 45million workers without post-secondary education fit into the
economy. Areas that could be explored include how to apply technology to improve the
labor market for workers and whether incentives could boost private-sector investment
in human capital. Its also important to consider what kind of safety net will be needed
in the future, and if automation causes large-scale dislocation, we may have to debate
measures such as a universal basic income or other types of redistribution. Disrupting
current patterns in the labor market will require bolder interventions than what has
worked in the pastand inaction itself would be a choice to accept the status quo of a
two-tiered economy.

Shifting the economy into higher gear is a critical first step. The United States has to
jumpstart growth and move forward on long-recognized priorities such as restoring
business dynamism, investing in infrastructure, improving productivity, and revamping
education and training. And the nation will have to do a better job of executing on these

McKinsey Global Institute Making it in America 3

 goals. More businesses need to start up, and more of them need to become fast-
growing firms that create jobs. To accelerate productivity growth, more companies need
to be encouraged to adopt the technologies and best practices of frontier firms. Small
enterprises need assistance to seek out global market opportunities and foreign capital.
US companies and investors need to recognize the long-term value of creating training
pathways and better-quality jobsnot just out of social responsibility but to protect their
own long-term interests.

But economic growth alone may not be enough; growth also has to be more inclusive.
We see four priority areas: reinvesting, retraining, removing barriers, and reimagining
work. First, communities in distress need targeted investment from public, private, and
foreign sources to bounce back. Second, continuous technological change means
that mid-career workers need systems of lifelong learning to adaptand currently
the United States spends far less than other countries on helping displaced workers
transition into new roles. Third, we can remove barriers that keep workers from seeking
out better opportunities, such as non-compete agreements, excessive occupational
licensing requirements, inadequate child and family support, and affordable housing
shortages in booming job markets. Finally, we need to reimagine work with more flexible
models, a more sustainable version of the gig economy, and more creative options for
older workers.

The United States can do better, and there are many levers it has yet to pull. Workers are not
just a pool of labor; they are citizens and potential consumers. Raising incomes would juice
a latent source of demandand doing so could set off a virtuous cycle of growth. Lifting up
the millions who have been left behind can elevate the broader economy in the process.

4 McKinsey Global Institute Executive summary

RELATED MGI
AND MCKINSEY RESEARCH
The great re-make: Manufacturing for modern times (June2017)
This compendium of essays offers a new way to think about manufacturing
excellence and best practices in the 21st century.

The US economy: An agenda for inclusive growth (November2016)

This discussion paper explains how slower economic growth in the United
States has created a vicious cycle that has hobbled many American
households. Targeted investment and policy action could turn it around.

Manufacturing the future: The next era of global growth and innovation
(November2012)
Manufacturing remains a critical force in both advanced and developing
economies. But the sector has changed, bringing new opportunities and
challenges to business leaders and policy makers.

Poorer than their parents? Flat or falling incomes in advanced

economies (July2016)
The real incomes of about two-thirds of households in 25 advanced
economies were flat or fell between 2005 and 2014. Without action, this
phenomenon could have corrosive economic and social consequences.

Playing to win: The new global competition for corporate profits

(September2015)
A 30-year period of unprecedented corporate-profit growth could be drawing
to a close. Competition is intensifying as emerging-market companies go
global and technology and technology-enabled firms make rapid moves into
new sectors.

A future that works: Automation, employment, and productivity

(January2017)
This report explores the potential uses of automation in multiple industries and
its effects on employment and productivity.

Independent work: Choice, necessity, and the gig economy

(October2016)
Drawing on an extensive survey, MGI looks at at the size and diversity of
the independent workforceand at the opportunities and challenges
it represents.
McKinsey Global Institute
June 2017
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