Busting economic myths: service revolution in India

Busting economic myths: service revolution in India

The story of Hyderabad—the capital of Andhra Pradesh—is truly inspiring for latecomers 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 eight fold, and employment increased 20-fold. Service-led growth has mushroomed in other parts of India too. The country has acquired a global reputation for exporting modern services.

India and China have both been recognized for rapid economic growth. But India’s growth pattern is dramatically different. China has experienced a manufacturing-led growth, while India has side-stepped the manufacturing sector and made the big leap straight from agriculture into services. Their differences in growth patterns raise big questions in development economics.

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 200 years since the start of the Industrial Revolution. This law—which is now conventional wisdom—says that industrialization is the only route to rapid economic development for developing countries. It goes further to say that as a result of globalization, the pace of development can be explosive. But the potential for explosive growth is distinctive to manufacturing only. This is no longer the case. Countries with high growth in services also tend to have high overall economic growth; conversely, countries with high overall economic growth have high services 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. 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.

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.

Such growth is sustainable because the globalization of services is just the tip of the iceberg. Services are the largest sector in the world, accounting for at least 70% of global output. Services can now be produced and exported at low cost. 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.

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 developing countries, this 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.

The process of globalization in the late 20th century led to a strong divergence of incomes between those who industrialized and broke into global markets, and a bottom billion of people in some 60 countries where incomes stagnated for 20 years. It seemed as if the bottom billion would have to wait their turn for development, until giant industrializers such as China became rich and uncompetitive in labour-intensive manufacturing.

The globalization of service provides alternative opportunities for developing countries to find niches, beyond manufacturing, where they can specialize, scale up and achieve explosive growth, just like the industrializers.

The core of the argument is that as the services produced and traded across the world expand with globalization, 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.

Edited excerpts. Printed with permission from VoxEU.org. The views expressed are those of the author and not the World Bank. Comments are welcome at views@livemint.com

Ejaz Ghani is economic adviser at the World Bank.