The Service Sector as India’s Road to Economic Growth? By Barry Eichengreen, University of California at Berkeley; Poonam Gupta, ICRIER, New Delhi

The Indian economy is very different from the export-oriented manufacturing powerhouses of East Asia, simply because it is dominated by the services sector. Some economists have said that this is a drawback, because it comprises a small high-tech sector and a floating mass of people who eke out a precarious living from paan-bidi shops and the like.

The implied criticism is that unlike the huge factories of China, India’s service sector is incapable of providing decent jobs to the masses. Eichengreen and Gupta’s paper explores whether this criticism is justified or whether India can indeed take a different route to growth by expanding the services sector.

The authors find one reason for the rapid growth of services in India is because it started from a very low base, partly the result of Nehru’s emphasis on heavy industry. But if it is only a process of catching up to the international norms, then it’s doubtful whether the rate of growth in services will persist. On the other hand, if there’s indeed a structural transformation in the sector, it’s possible that it may continue to be the driver of growth.

To answer that question, the researchers divide the sector into three parts. Group 1 comprises traditional services such as trade, transport, public administration, defence; Group 2 includes hotels, education, health and community and social services; and Group 3 is the modern services sector, including financial services, computer services, business services, communications, and legal and technical services. The authors find that the share of Group 1 activities has stagnated, which is in accordance with the trend in the OECD (Organisation for Economic Co-operation and Development) countries. The rise in the share of Group 2 services too is in line with the trend. But what is unusual is the rapid rise in Group 3 services since 1990. The authors point out, “The results show that the contribution of communications, business services, and financial services has in fact risen to the point where it contributes more to growth of GDP (gross domestic product) than manufacturing. In particular, communications, business services, financial services, education, health and hotels accounted for roughly half of total growth of the service sector in 2000-08".

What about the argument that services growth bypasses the poor and that it cannot provide decent jobs to them? The authors say that the skill content of the labour content employed in both manufacturing and services is showing signs of convergence. Data from the OECD show increasing employment among Group 3 services, but it is true that demand for higher-skilled workers rises at a faster pace. The paper contends that “it is no longer obviously the case that manufacturing is the main destination for the vast majority of Indian labour moving into the modern sector and that modern services are a viable destination only for the highly-skilled few".

So what’s the conclusion? A very significant finding is that growth in the services that were both liberalized and tradeable was 7-8 percentage points higher than growth in non-tradeable/ non-liberalised services. The authors argue that this “implies that there are likely to be substantial future gains in economic growth from encouraging exports of IT, communication, financial and business services while also liberalizing activities like education, health care and retail trade, where regulation has inhibited the ability of producers to meet domestic demand".