The Hindu : Limits of a service economy

Online edition of India's National Newspaper
Saturday, Jun 21, 2003

Opinion

Opinion - Leader Page Articles

Limits of a service economy

By C. Rammanohar Reddy

The highly amorphous nature, the divergent driving forces and the very different levels of productivity in India's services indicate that this sector cannot drive economic growth.

FOR ALMOST two years now, a revival in manufacturing has been forecast as round the corner. Yet, industry continues to under-perform. The disappointments in the manufacturing sector have prompted the search for alternative sources of economic growth. Now the talk is that the service sector can drive the economy and that it is better if the Government switches its attention to this sector. On the surface, the recent performance of the service sector in India has shown that it can fuel GDP. Over the last decade, services have seen their share of GDP rise from 44 per cent to over 50 per cent. They now make up the largest sector of the economy, contributing almost double of what agriculture and industry do to GDP. Services recorded annual rates of growth of more than 7 to 8 per cent a year during the past decade and the Reserve Bank recently suggested that this was responsible for much of the resilience of growth in the 1990s. India's exports of services such as software have grown rapidly and these earnings (within the larger income from trade in "invisibles") have resulted in a healthy balance of payments position.

Why should India not then use the service sector as an engine of growth, and let China use the manufacturing sector to drive its GDP? There are many reasons why it would be wrong to put all our eggs in the service basket, just as it was a mistake in the late 1990s to flirt with the idea that the so-called "new economy" would provide the magic wand for the country's growth problems. History tells us that no economy has developed without going through the route of rapid agriculture growth followed by industrial growth and only then an expansion of services. This is how the present-day developed economies grew and this is the route which China now seems to be taking. A large share of services in GDP is a sign then of a mature economy. But there is no iron law which says that an economy cannot leapfrog to the last stage of a service sector dominating the economy. This is especially so since today many manufactured products contain a large "service" component. The best example (and worst in another sense) is the aerated soft drink, where the value added in the manufacturing process is insignificant compared to the value added in the branding of the drink by the advertising, packaging and entertainment sub-sectors, all of which are services.

In all economies, the service sector by its very nature comprises a very heterogeneous set of activities. It is made of financial and telecom services, of restaurants and hotels, transport, retail and wholesale trade, sports and entertainment, government administration and defence, and personal and community (NGO) services. There is an additional dimension to the service sector in India. There is heterogeneity here in the drivers of expansion of services. There is the traditional source of growth — the development of industry leading to the development of services such as transport, trade and the like.

In addition, we are witness to five other important sources of growth. One, a growing number of activities that were earlier done within the manufacturing sector are being "out-sourced" to the service sector. Manufacturing firms now routinely hand over repair and maintenance, data processing, warehousing and logistics services, which they earlier used to perform in-house, to specialised service firms. Therefore, this is in part (but not entirely) a shuffling of GDP creation from the manufacturing to the service sectors. Two, liberalisation has created new avenues for growth.

Financial services and now telecom are two such important service sub-sectors. Three, there is the external demand which is driving a small number of sub-sectors, the most important of which are software service and the information technology-enabled services (ITES) such as call centres, data transcription and the like. Four, a larger Government and an expansion of defence results in the growth of "public administration and defence". Given the methodological problems of measuring output in this sector, a larger manpower and higher salaries are reflected as higher growth — irrespective of whether or not the net output of Government services has increased. This is what happened during 1997-99: when the recommendations of the Fifth Pay Commission were implemented, this sub-sector registered a faster pace of growth. And, five, perhaps the most important, there is the "residual" nature of service activity in India.

The slow growth of agriculture and industry and the presence of widespread under-employment have been driving people to seek work in the informal services. This is particularly true in the urban areas where petty/pavement retail trade, transport, unorganised repair and service establishments, etc., have proliferated.

The growth of these services is more a reflection of inadequate growth in agriculture and industry and the need to survive, than an autonomous source of growth. In that sense, there is an element of the growth of India's service sector which is not reflective of "a post-industrial economy", as would be suggested by the 50 per cent share of services in India's GDP, but instead reflects a relative failure of the other two sectors.

It is clear that any sustained and high-productivity dynamism in the service sector can come only from the first three kinds of activities. But there are limits on how much each of them can contribute to India's GDP growth. Growth of services triggered by manufacturing firms depends eventually on the growth of Indian industry. Telecom services will continue to grow, but the 1990s' pace of expansion of financial services cannot be sustained unless other sectors too expand. And while the opportunities for ITES/business process outsourcing (BPO) services (along with export-related software services) continue to be huge, these high-profile activities still make a relatively small contribution to India's GDP. The Central Statistical Organisation has not estimated the size of the entire IT sector; but informed estimates place the IT sector (including hardware and domestic software) at less than 2 per cent of the GDP. And the workforce in software and ITES/BPO at around 6,00,000. What this means is that even if ITES/BPO grow phenomenally over the next few years (assuming there are no road blocks placed by domestic groups in the export markets), this sub-sector of services will still make only a minor contribution to GDP growth. Growth in ITES/BPO will provide considerable high-wage opportunities for the educated young. The foreign exchange it will bring in will give considerable manoeuvrability in the balance of payments. But even if the industry can grow seven-fold by 2008 (from $ 3.6 billion in 2003-04 to a 5 per cent share of a $ 225-billion global market in 2008), it will remain a small sector in India's economy. On the other hand, trade, hotel and restaurant activities alone account for 30 per cent of India's service sector or about 15 per cent of the GDP. The size of the "residual" service activities is not known; but casual observations and guess-estimates place them at 30 to 40 per cent of the total service sector.

The highly amorphous nature, the divergent driving forces and the very different levels of productivity in India's services indicate then that this sector cannot drive economic growth. That function has to be performed by agriculture and industry, which are yet in danger of languishing for want of attention as policy-makers pursue the chimera of the services solution to more rapid economic growth.

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