Themes > Current Issues
17.11.2000
C.P.
Chandrasekhar
In India, as in the rest of the world, the share of the services sector
in the GDP of the country has risen quite sharply. A rise in the share
of services in the GDP generated by the private sector, from 29 per
cent in the early 1980s to 35 per cent by the mid 1990s, ensured that
services came to account for as much as 43 per cent of GDP in 1996-97.
With the rise of public sector incomes since then, it is to be expected
that the share of services in GDP generated by the public sector would
have also risen significantly, taking India closer to the "50 per
cent of services from GDP" mark. This closes the "structural gap"
between India and the developed OECD economies where services account
for 60 to 70 per cent of overall economic activity.
Till some time back, this would have been considered an infirmity, since barring a few productive services, the strength of an economy was seen to be reflected by the expansion of and productivity increases in the commodity producing sectors. But increasingly we observe a tendency to treat service sector growth to be as good as growth in the commodity producing sectors. Some even privilege service sector growth, interpreting it as the sign of a new dynamism. The OECD has for example argued that services have become a major driving force in economic growth.
Like much else, this view is a conceptual import from the West - a product of the ideology of globalisation that believes that all economies, independent of their size and level of development should behave like and resemble the developed economies, especially the US. Two questions are ignored in that perspective. First, is the growing service orientation of some of the developed economies necessarily positive? Second, is the growth of services in developed and developing countries similar in nature?
An affirmative answer to the first of these questions comes from a reinterpretation of the nature and role of services in modern economies. According to a study conducted by economists at the US Department of Commerce, over the 1972 to 1996 period, the overall growth of the U.S. economy has been accompanied by a decline in the share of manufacturing gross output, an increase in the share of services gross output, and a growing U.S. trade deficit. From 1972 to 1996, U.S. nominal GDP grew at an average annual growth rate of 8 percent from $1.2 billion to $7.8 billion. However, the growth of manufacturing industries' GDP lagged behind at 6.5 percent annually. Because of its slower growth, manufacturing's share of GDP declined from 24 percent to 18 percent.
But this was not all. Within manufacturing, while the share of intermediate transactions or costs paid out by individual activities remained constant at 43 per cent of industry gross output, the share of manufacturing intermediates declined from 22 per cent to 17 per cent and that of services rose from 21 per cent to 27 per cent. This growing services-intensity of manufacturing can be interpreted in two ways. On the one hand, it can be taken to reflect the growing productive role of services activity in the US economy. On the other, it can be seen to be a reflection of a growing trend towards outsourcing of services by US corporations. This would imply that the rise is the share of services and decline in that of manufacturing is in part a statistical rather than a real phenomenon, reflecting the splicing out of services that were earlier part of the value of manufacturing output. In France, for example, the combined contribution of manufacturing and industry-related services has increased only marginally from 27 to 29 per cent between the 1980s and 1990s, indicating that restructuring rather than expansion accounts for the growing share of services.
The role of outsourcing in explaining the rise in services sector GDP is also partly corroborated by the structure of growth in the services sector. Conventional services such as transport and communications have seen a constancy or decline in their share, while "finance, insurance, real estate and business services" have registered noticeable increases in all major OECD economies. Value added as a share of GDP in this group of services has risen between 1987 and 1997 from 20.4 to 22.9 per cent in France, 11.3 to 14 per cent in Germany, 18.8 to 22.3 per cent in the UK and 25.5 to 28.6 per cent in the US.
There are clearly two process underlying these changes. To start with, the burgeoning of the financial services sector, ensured by financial liberalisation and stock market buoyancy. The rise to dominance of finance and the financial liberalisation that ensued not only opened up new market segments in the financial services area, but saw a rapid rise in the number of firms and the volume of their operations. Few can deny that the financial buoyancy of the 1990s has embedded in it a major role for speculation, rendering the productive implications of such growth suspect. However, even this development, where financial buoyancy results from creating new "products", in the form of derivatives for example, is being provided as the conversion of the financial sector into a productive sector like manufacturing. To quote and OECD study: "There was a time when a bank would lend to a business or provide a mortgage, would take the asset and put it on their books much the way a museum would place a piece of art on the wall or under glass – to be admired and valued for its security and constant return. Times have changed. Banks now take those assets, structure them into pools, and sell securities based on those pools to institutional investors and portfolio managers. In effect, they use their balance sheets not as a museums, but as parking lots – temporary holding spaces to bundle up assets and sell them to those investors who have a far greater interest in holding those assets for the long term. The bank has thus gone from being a museum where it acquired only the finest assets and held and exhibited them in perpetuity into a manufacturing plant which provides a product for the secondary market. Just as Henry Ford did 80 years ago, banks today are focusing on producing a standardised product at a predictable rate, under standard norms of quality, and are teaching their workforces to produce that product as quickly and as efficiently as possible." The fact that there is no production process here, making a difference to the productive nature of the operation, is completely glossed over, rendering the distinction between the generation of surplus and redistributing it immaterial by definition.
A second source of growth of the "finance, insurance, real estate and business services" group was the separation of a range of service activities from manufacturing activities, leading to the growing importance of what are termed "strategic business services" by protagonists of the new economy. Strategic business services are defined to include computer software and information processing services, research and development and technical services, marketing services, business organisation services and human resource development services. These sectors reportedly have shown rapid growth and strong employment generation in recent years in OECD countries. Total turnover in these services is estimated to have exceeded USD 1.1 trillion for 19 OECD countries in 1995. These sectors are also estimated to have employed 11 million persons in 1995 or 2.4 per cent of total employment in 21 OECD economies. However, given the fact of substantial outsourcing of services by manufacturing firms mentioned earlier, much of this growth in services may not be a net expansion but a mere restructuring of aggregate employment and production in the manufacturing and services sectors put together.
There, remain therefore only four arguments of relevance on the likely impact of service on the pace and nature of economic growth. The first is that the specialisation that results from the outsourcing of services has resulted in far greater value addition to manufactured goods through the incorporation of a range of "intangibles" provided by intellectual capital such as design features and technical inputs that enhance product quality. If such "intangibles" play a role, it should be reflected in a higher value for the product and, in particular a rise in value added per worker. The evidence on this count is by no means clear.
The second argument is that the specialisation in services has been accompanied by technological changes, especially those resulting from the role of information and communication technologies in the services sector, that have substantially enhanced labour productivity in the services sector. This either increases value added per worker in the services area or it reduces the cost of service inputs into manufacturing and therefore increase value added per worker in the latter area.
Third, some service activities, especially research and development activities that are outsourced, are seen as spurring innovation in the commodity producing sectors leading to productivity increases and growth.
Finally, there is the argument that specialisation into services generates new products the demand for which results in an induced demand for manufactures. Thus, just as the growth of the transportation sector results in increased demand for trucks, buses, ships and airplanes, an increase In demand for new forms of information and entertainment is expected to spur demand for printing presses, televisions, audio equipment and computers.
Of these, the first two are grey areas, given the fact that measurement of the output of and value added in services is extremely difficult to measure. But the little evidence that exists points to a slowdown in productivity growth in services after 1973. To quote a recent study by economists at the Brookings Institution: "From 1949 to 1973, the Bureau of Labor Statistics (BLS) estimates that U.S. non-farm multifactor productivity grew at 1.9% per year. After 1973, multifactor productivity grew only 0.2% per year. Despite a 20-year intensive research effort to find the cause, no convincing explanation of the post-1973 productivity slowdown exists.
Whatever the ultimate cause, circumstantial evidence suggests that services industries play some important role in the slowdown. In the first place, the aggregate numbers indicate that the productivity slowdown is greater in the non-goods producing portions of the economy. While no official estimate of productivity in services is published by the Bureau of Labour Statistics, nonfarm multifactor productivity slowed by 1.7 percentage points (from 1.9% per year to 0.2%), and manufacturing productivity fell by 0.6 percentage points (from 1.5% per year to 0.9%). Because manufacturing accounts for about 22% of non-farm business, this implies a 2 percentage point slowdown in the non-manufacturing sector.
If the data are right, one might infer, as did Baumol many years ago, that productivity improvements in services are harder to achieve than in goods producing industries. If so, the shift of the economy toward a larger share of services implies a reduction in the national rate of productivity improvement."
With regard to research and development there is little evidence that the volume of R&D has increased just because of the specialisation that outsourcing results in. And finally the last of the above begs the question of the source of the income increases needed to stimulate the demand for services, which in turn simulate the demand for various manufactures.
Thus, all told, the argument that the service sector has become a major driving force for economic growth is suspect even in the context of the developed industrial countries, where the expansion is in the area of finance, insurance, real estate and business services. In developing countries like India, where the growth of government "services", particularly public administration and defence, dominates the growth of services many of these benefits are not even potentially available. Any attempt to justify the slow pace of output and productivity growth in the commodity producing sectors based on tenuous arguments regarding the benefits of the service economy in the West merely provides an apology for an economic growth process that liberalisation has failed to invigorate.
Till some time back, this would have been considered an infirmity, since barring a few productive services, the strength of an economy was seen to be reflected by the expansion of and productivity increases in the commodity producing sectors. But increasingly we observe a tendency to treat service sector growth to be as good as growth in the commodity producing sectors. Some even privilege service sector growth, interpreting it as the sign of a new dynamism. The OECD has for example argued that services have become a major driving force in economic growth.
Like much else, this view is a conceptual import from the West - a product of the ideology of globalisation that believes that all economies, independent of their size and level of development should behave like and resemble the developed economies, especially the US. Two questions are ignored in that perspective. First, is the growing service orientation of some of the developed economies necessarily positive? Second, is the growth of services in developed and developing countries similar in nature?
An affirmative answer to the first of these questions comes from a reinterpretation of the nature and role of services in modern economies. According to a study conducted by economists at the US Department of Commerce, over the 1972 to 1996 period, the overall growth of the U.S. economy has been accompanied by a decline in the share of manufacturing gross output, an increase in the share of services gross output, and a growing U.S. trade deficit. From 1972 to 1996, U.S. nominal GDP grew at an average annual growth rate of 8 percent from $1.2 billion to $7.8 billion. However, the growth of manufacturing industries' GDP lagged behind at 6.5 percent annually. Because of its slower growth, manufacturing's share of GDP declined from 24 percent to 18 percent.
But this was not all. Within manufacturing, while the share of intermediate transactions or costs paid out by individual activities remained constant at 43 per cent of industry gross output, the share of manufacturing intermediates declined from 22 per cent to 17 per cent and that of services rose from 21 per cent to 27 per cent. This growing services-intensity of manufacturing can be interpreted in two ways. On the one hand, it can be taken to reflect the growing productive role of services activity in the US economy. On the other, it can be seen to be a reflection of a growing trend towards outsourcing of services by US corporations. This would imply that the rise is the share of services and decline in that of manufacturing is in part a statistical rather than a real phenomenon, reflecting the splicing out of services that were earlier part of the value of manufacturing output. In France, for example, the combined contribution of manufacturing and industry-related services has increased only marginally from 27 to 29 per cent between the 1980s and 1990s, indicating that restructuring rather than expansion accounts for the growing share of services.
The role of outsourcing in explaining the rise in services sector GDP is also partly corroborated by the structure of growth in the services sector. Conventional services such as transport and communications have seen a constancy or decline in their share, while "finance, insurance, real estate and business services" have registered noticeable increases in all major OECD economies. Value added as a share of GDP in this group of services has risen between 1987 and 1997 from 20.4 to 22.9 per cent in France, 11.3 to 14 per cent in Germany, 18.8 to 22.3 per cent in the UK and 25.5 to 28.6 per cent in the US.
There are clearly two process underlying these changes. To start with, the burgeoning of the financial services sector, ensured by financial liberalisation and stock market buoyancy. The rise to dominance of finance and the financial liberalisation that ensued not only opened up new market segments in the financial services area, but saw a rapid rise in the number of firms and the volume of their operations. Few can deny that the financial buoyancy of the 1990s has embedded in it a major role for speculation, rendering the productive implications of such growth suspect. However, even this development, where financial buoyancy results from creating new "products", in the form of derivatives for example, is being provided as the conversion of the financial sector into a productive sector like manufacturing. To quote and OECD study: "There was a time when a bank would lend to a business or provide a mortgage, would take the asset and put it on their books much the way a museum would place a piece of art on the wall or under glass – to be admired and valued for its security and constant return. Times have changed. Banks now take those assets, structure them into pools, and sell securities based on those pools to institutional investors and portfolio managers. In effect, they use their balance sheets not as a museums, but as parking lots – temporary holding spaces to bundle up assets and sell them to those investors who have a far greater interest in holding those assets for the long term. The bank has thus gone from being a museum where it acquired only the finest assets and held and exhibited them in perpetuity into a manufacturing plant which provides a product for the secondary market. Just as Henry Ford did 80 years ago, banks today are focusing on producing a standardised product at a predictable rate, under standard norms of quality, and are teaching their workforces to produce that product as quickly and as efficiently as possible." The fact that there is no production process here, making a difference to the productive nature of the operation, is completely glossed over, rendering the distinction between the generation of surplus and redistributing it immaterial by definition.
A second source of growth of the "finance, insurance, real estate and business services" group was the separation of a range of service activities from manufacturing activities, leading to the growing importance of what are termed "strategic business services" by protagonists of the new economy. Strategic business services are defined to include computer software and information processing services, research and development and technical services, marketing services, business organisation services and human resource development services. These sectors reportedly have shown rapid growth and strong employment generation in recent years in OECD countries. Total turnover in these services is estimated to have exceeded USD 1.1 trillion for 19 OECD countries in 1995. These sectors are also estimated to have employed 11 million persons in 1995 or 2.4 per cent of total employment in 21 OECD economies. However, given the fact of substantial outsourcing of services by manufacturing firms mentioned earlier, much of this growth in services may not be a net expansion but a mere restructuring of aggregate employment and production in the manufacturing and services sectors put together.
There, remain therefore only four arguments of relevance on the likely impact of service on the pace and nature of economic growth. The first is that the specialisation that results from the outsourcing of services has resulted in far greater value addition to manufactured goods through the incorporation of a range of "intangibles" provided by intellectual capital such as design features and technical inputs that enhance product quality. If such "intangibles" play a role, it should be reflected in a higher value for the product and, in particular a rise in value added per worker. The evidence on this count is by no means clear.
The second argument is that the specialisation in services has been accompanied by technological changes, especially those resulting from the role of information and communication technologies in the services sector, that have substantially enhanced labour productivity in the services sector. This either increases value added per worker in the services area or it reduces the cost of service inputs into manufacturing and therefore increase value added per worker in the latter area.
Third, some service activities, especially research and development activities that are outsourced, are seen as spurring innovation in the commodity producing sectors leading to productivity increases and growth.
Finally, there is the argument that specialisation into services generates new products the demand for which results in an induced demand for manufactures. Thus, just as the growth of the transportation sector results in increased demand for trucks, buses, ships and airplanes, an increase In demand for new forms of information and entertainment is expected to spur demand for printing presses, televisions, audio equipment and computers.
Of these, the first two are grey areas, given the fact that measurement of the output of and value added in services is extremely difficult to measure. But the little evidence that exists points to a slowdown in productivity growth in services after 1973. To quote a recent study by economists at the Brookings Institution: "From 1949 to 1973, the Bureau of Labor Statistics (BLS) estimates that U.S. non-farm multifactor productivity grew at 1.9% per year. After 1973, multifactor productivity grew only 0.2% per year. Despite a 20-year intensive research effort to find the cause, no convincing explanation of the post-1973 productivity slowdown exists.
Whatever the ultimate cause, circumstantial evidence suggests that services industries play some important role in the slowdown. In the first place, the aggregate numbers indicate that the productivity slowdown is greater in the non-goods producing portions of the economy. While no official estimate of productivity in services is published by the Bureau of Labour Statistics, nonfarm multifactor productivity slowed by 1.7 percentage points (from 1.9% per year to 0.2%), and manufacturing productivity fell by 0.6 percentage points (from 1.5% per year to 0.9%). Because manufacturing accounts for about 22% of non-farm business, this implies a 2 percentage point slowdown in the non-manufacturing sector.
If the data are right, one might infer, as did Baumol many years ago, that productivity improvements in services are harder to achieve than in goods producing industries. If so, the shift of the economy toward a larger share of services implies a reduction in the national rate of productivity improvement."
With regard to research and development there is little evidence that the volume of R&D has increased just because of the specialisation that outsourcing results in. And finally the last of the above begs the question of the source of the income increases needed to stimulate the demand for services, which in turn simulate the demand for various manufactures.
Thus, all told, the argument that the service sector has become a major driving force for economic growth is suspect even in the context of the developed industrial countries, where the expansion is in the area of finance, insurance, real estate and business services. In developing countries like India, where the growth of government "services", particularly public administration and defence, dominates the growth of services many of these benefits are not even potentially available. Any attempt to justify the slow pace of output and productivity growth in the commodity producing sectors based on tenuous arguments regarding the benefits of the service economy in the West merely provides an apology for an economic growth process that liberalisation has failed to invigorate.
© MACROSCAN 2000