The story of Hyderabad – the capital of the Indian state of Andhra Pradesh – is truly inspiring for late-comers to development. Within two decades, Andhra Pradesh has catapulted itself straight from a poor and largely agricultural economy into a major service centre. Fuelled by a 45-fold increase in service exports between 1998 and 2008, the number of information technology companies in Hyderabad increased 8-fold, and employment increased 20-fold. Service-led growth has mushroomed in other parts of India too. India has acquired a global reputation for exporting modern services.
India and China have both been recognised for rapid economic growth. But India’s growth pattern is dramatically different. China has a global reputation for exporting manufactured goods. It has experienced a manufacturing-led growth. India has side-stepped the manufacturing sector, and made the big leap straight from agriculture into services. Their differences in growth patterns are striking. They raise big questions in development economics. Can developing countries jump straight from agriculture into services? Can services be as dynamic as manufacturing? Can late-comers to development take advantage of the globalisation of service? Can services be a driver of sustained growth, job creation, and poverty reduction?
Figure 1 compares the share of service value added in GDP in China, India and OECD countries. The share of service sector in India is much bigger than in China, for its stage of development. India and other South Asian countries resemble the growth patterns of Ireland and Norway, rather than those of China and Malaysia. Despite being a low income region, India and other South Asian countries have adopted the growth patterns of middle and high income countries.
Figure 1. Comparing the contribution of manufacturing and service sectors to GDP in China and India, 2005
India’s growth pattern in the 21st century is remarkable because it contradicts a seemingly iron law of development that has held true for almost two hundred years since the start of the Industrial Revolution (Chenery 1960, Kaldor 1966). This law – which is now conventional wisdom – says that industrialisation is the only route to rapid economic development for developing countries. It goes further to say that as a result of globalisation the pace of development can be explosive. But the potential for explosive growth is distinctive to manufacturing only (UNIDO 2009). This is no longer the case.
Figure 2 compares what has happened in some 136 countries between 2000 and 2005 in terms of real GDP growth, shown on the vertical axis and service value added growth, shown on the horizontal axis. Each point represents one country. The positive relationship between the two variables implies that countries with high growth in services also tend to have high overall economic growth or conversely that countries with high overall economic growth have high services growth.
Figure 2. GDP growth and service value added growth (2000-2005)
Figure 3. GDP growth and manufacturing value added growth (2000-2005)
Source: Ghani, 2010.
Note: Each point in the chart corresponds to 5 year growth during 2000-2005 for a specific country. GDP growth rates control for level of initial income per capita. All values are in constant 2000 dollars. Growth rates are compounded annual averages. The sample consists of 134 countries.
Exactly the same exercise is shown in Figure 3 for the relationship between manufacturing growth and overall economic growth. Again, there is a positive relationship which probably runs from manufacturing growth to overall growth. This is the relationship which has been reported to emphasise the importance of manufacturing for growth. Comparing the two graphs, it is clear that the slope is steeper in Figure 2. That suggests that the effect of services growth seems to be stronger than the effect of manufacturing growth on aggregate economic growth.
The trend over time to a higher service sector share shows that higher real growth in services has not been offset by price declines. There is no Dutch disease – that the price of services falls with an increase in their supply (Baumol 1967). India has a higher share of services, and more rapid service sector growth, than China, although the latter is richer and has grown faster over time. That suggests that services are not simply responding to domestic demand (which would be higher in China), but also to export opportunities (Ghani and Kharas 2010).
India’s experience shows that growth has in fact been led by services, that labour productivity levels in services are above those in industry, and that productivity growth in service sectors in India matches labour productivity growth in manufacturing sectors in China. Furthermore, services-led growth has been effective in reducing poverty. India’s growth experience suggests that a “services revolution” – rapid growth and poverty reduction led by services – is now possible.
But can service-led growth be sustained?
Service-led growth is sustainable because the globalisation of services is just the tip of the iceberg (Blinder 2006). Services are the largest sector in the world, accounting for more than 70% of global output. The service revolution has altered the characteristics of services. Services can now be produced and exported at low cost (Bhagwati 1984). The old idea of services being non-transportable, non-tradable, and non-scalable no longer holds for a range of modern impersonal services. Developing countries can sustain service-led growth as there is a huge room for catch up and convergence.
The Services Revolution could upset three long-held tenets of economic development. First, services have long been thought to be driven by domestic demand. They could not by themselves drive growth, but instead followed growth. In the classical treatment of services, any attempt to expand the volume of services production beyond the limits of domestic demand would quickly lead to deterioration in the price of services, hence a reduction in profitability, and hence the impulse towards expanded production would be choked off.
Second, services in developing countries were considered to have lower productivity and lower productivity growth than industry. As economies became more service oriented, their growth would slow. For rich countries, with high demand for various services, the slowdown in growth was an acceptable consequence of the higher welfare that could be achieved by a switch towards services. But for developing countries such a trade off was thought to be inappropriate.
Third, services jobs in developing countries were thought of as menial, and for the most part poorly paid, especially for low skilled workers. As such, service jobs could not be an effective pathway out of poverty.
India’s development experience offers hope to late-comers to development in Africa. The marginalisation of Africa during a period when China and other East Asian countries grew rapidly has led some to wonder if late-comers to development like Africa are doomed to failure. Many considered the “bottom billion” to be trapped in poverty (Collier 2007). The process of globalisation in the late 20th century led to a strong divergence of incomes between those who industrialised and broke into global markets and a bottom billion” of people in some 60 countries where incomes stagnated for twenty years. It seemed as if the bottom billion would have to wait their turn for development, until the giant industrialisers like China became rich and uncompetitive in labour-intensive manufacturing.
The promise of the service revolution is that countries do not need to wait to get started with rapid development. There is a new boat that development late-comers can take. The globalisation of service provides alternative opportunities for developing countries to find niches, beyond manufacturing, where they can specialise, scale up and achieve explosive growth, just like the industrialisers.
The core of the argument is that as the services produced and traded across the world expand with globalisation, the possibilities for all countries to develop based on their comparative advantage expand. That comparative advantage can just as easily be in services as in manufacturing or indeed agriculture.
Note: The views expressed are those of the author and not the World Bank
Baumol, William J (1967), “Macroeconomics of Unbalanced Growth: the Anatomy of Urban Crisis”, American Economic Review 57(3):415-426.
Bhagwati, Jagdish N (1984), “Splintering and Disembodiment of Services and Developing Nations”, The World Economy 7:133-144.
Blinder, Alan S (2006), “Offshoring: The Next Industrial Revolution?”, Foreign Affairs 85(2):113-28.
Chenery, H B (1960), “Patterns of Industrial Growth” American Economic Review 50:624-654.
Collier, Paul (2007), The Bottom Billion. Why the poorest countries are failing and what can be done about it?, Oxford University Press.
Ghani, Ejaz and Homi Kharas (2010), “Service Led Growth in South Asia: An Overview”, in Ejaz Ghani (eds), The Service Revolution in South Asia, Oxford University Press, India.
Kaldor, N (1966), “Causes of the Slow Rate of Economic Growth of the United Kingdom”, Cambridge University Press.
Kuznets, S (1959), Six Lectures on Economic Growth. New York: The Free Press of Glencoe.
United Nations Industrial Development Organization (2009). Breaking In and Moving Up: New Industrial Challenges for the Bottom Billion and the Middle Income Countries. Industrial Development Report, Vienna.