Monday, February 28, 2011

The Service Sector as India's Road to Economic Growth

While India is distinctive among developing countries for its fast-growing service sector, sceptics have raised doubts about the quality and sustainability of this service-sector growth and its implications for economic development. We show, consistent with the views of the sceptics, that while growth of the sector has been unusually rapid, it started 15 years ago from unusually low levels. That the share of services has now simply converged to the international norm raises questions about whether it will continue growing rapidly. In particular, whether service-sector output and employment continue to grow in excess of international norms will depend on the continued expansion of modern services (business services, communication and banking) but, also, on the application of modern information technology to more traditional services (retail and wholesale trade, transport and storage, public administration and defense ). The second aspect obviously has more positive implications for output than for employment.

We also show that the modern services that are growing most rapidly are now large enough where their future performance could have a significant macroeconomic impact. The expansion of modern service-sector employment is not simply disguised manufacturing activity. Finally, we show that the mix of skilled and unskilled labor in manufacturing and services is increasingly similar. It is no longer obvious therefore that manufacturing is the main destination for the vast majority of Indian labor moving into the modern sector and that modern services are a viable destination only for the highly-skilled few. We conclude that sustaining economic growth and raising living standards will require shifting labor into both manufacturing and services.

That’s the abstract from Eichergreen and Gupta (2011) paper.

U-curve in economic development

Relative productivity of agriculture exhibits a U-shaped pattern over the course of development, argues Rodrik. Labor productivity first falls and then rises, as countries get richer.

Within countries as well, the trend is consistent.

Why does this happen? Because new, high-productivity activities (typically outside agriculture) are needed for development to happen. Relative productivity in agriculture falls. Labor tends to move from low to high productivity activities as economies grow. The gap between productivity in agriculture and non-agriculture reduces. Diminishing marginal returns (in terms of productivity) gradually kicks in on non-agriculture sector. Relative productivity in agriculture sector again rises and the curve starts to slope outward.

economic development requires both new activities (diversification) and ongoing transfer of resources from traditional to modern activities. Some countries are stuck with no new industries, so they never grow. Others get a few new industries (e.g. mining and other natural resource-based industries), but these do not expand sufficiently and absorb much labor, so development gets stuck at an intermediate level of income. The real successful countries are those that pull off both tricks.