THE SERVICE SECTOR AS A DETERMINANT OF

ECONOMIC DEVELOPMENT

Ms Amita MarwhaLecturer, Deptt. of Economics

Isabella Thoburn College

• The growth of India’s services sector, its contribution to GDP, and its increasing share in trade and investment has drawn global attention. Unlike other countries, where economic growth has led to a shift from agriculture to industries, in India, there has been a shift from agriculture to the services sector.

• In the post reform period India did experience robust economic growth rate which although was lower than china but still made India the 12th largest economy in the world by nominal value and 4th largest by Purchasing Power Parity .It also resulted in lower inflation ,and significant increase in foreign investment. Foreign portfolio and foreign reserves have increased significantly since reform began in 1991 and have contributed to healthy foreign currency reserves ($ 284.1 billion in 2010).

Service Sector• Definition of Services sector • Earliest attempt to define service sector was made by Hill (1977,

p.336) who argues that “goods and services belongs to different logical categories”. For Hill (1999), ‘the original intangibles consist in additions to knowledge and in new information of all types and new creations of artistic or literature nature’. These originals exist independently from the creators and from how they are registered. They have no spatial coordinates and belong to ideas and information. Property rights on originals, so-called intellectual property rights, can be defined. These products are immaterial or intangible goods, according to Hill (1999). Once an original is produced, it can be used during a long period of time on a copy form. According to Hill ‘services are heterogeneous by essence, but not so heterogeneous that they include all intangible goods’

• Hill divided services into • Services Affecting Goods -Examples of services affecting goods are the

transportation of goods, postal deliveries, repairs, cleaning and maintenance. In each case goods which already belong to some economic unit are transformed in some way as a result of the activity of the producer unit.

• Services Affecting Persons- These consist of changes in the physical or mental condition of the consumer which are the direct consequence of the activity of the producer, such changes being at the request of the consumer. For example, services, such as passenger transportation, hairdressing, and various forms of medical treatment involve changes in the physical condition of the consumer, while services such as education and communication involve changes in mental condition.

• Bhagwati(1984) argues that services can be divided into two categories ;first those that necessarily require the physical proximity of the user and the provider; and second, those that do not essentially require this though it may be useful. Services that require essential physical proximity have been further categorized into three groups that are:

• Mobile provider and immobile user, e.g., shifting labor to the concentration site in other country.

• Mobile user and immobile provider, e.g., hospital services.• Mobile user and mobile provider, e.g., lectures, haircut, etc.

• For the purpose of classifying international transactions in services the most commonly used classification is provided by Sampson and Snape(1985) and modified by Sapir and Winter(1994).This classification which is based on the constraints on the physical location of producers and consumer in realizing the transaction has been adopted by World Trade Organizations (WTO) under the general agreement on trade in services(GATS) the agreement applies to four ‘modes of supply’

• Mode 1:cross border supply of services(that is not requiring the physical movement of supplier or customer)

• Mode 2: Provision implying movement of the consumer to the location of the supplier.

• Mode 3: services sold in the territory of a member by legal entities that have established a presence there but originate in the territory of another member.

• Mode 4: provision of services requiring the temporary movement of natural person.

Service sector contribution to growth• What explains Growth in India’s Service Sector? • The literature states that the process of economic

development has been associated with structural changes. Work done by Fisher (1935), Clark (1940) and Kuznets (1971) states some stylized facts related to industrialized countries. Rowthorn and wells (1987) states a pattern of similar structure in which most of the industrialized countries when reach to the advanced stages of development, experience a shift in the structural framework of the country, in which the share of manufacturing sector declines, where as the share of service sector increases in total output and employment which is attributable to both demand side and supply side factors operate that lead to higher growth in the service sector as compared to the other sectors.

• A. Supply-Side Factors: Trade Liberalization and Reforms • Increased trade.• Higher foreign direct investments in services and • Improved technology. • B. Demand-Side Factors • High income elasticity of demand for final product services.• Contracting out of services from firms in the manufacturing sector.• The increased demand for services by the producers of goods and

services ‘is in part due to firms externalizing service functions that previously had been performed internally (Kirn 1987).

• Stanback et al (1981) have argued that multinational firms that compete in increasingly complex business environments ‘have expanded the amount of effort devoted to activities such as planning, coordination, and control and consequently have increased their use of services’ (Stanback et al 1981, cited in Kirn 1987).

Stylized Facts

• Demand for services is income-elastic• High-income elasticity of demand for final

product services implies that at any relative price of services the quantity absorbed rises more than the quantity of commodities as real income per capita increases.

• Productivity growth in services is slower than that in manufacturing sector.

• Different explanations have been put forward for it. Following Verdoon’s Law, Kaldor (1966) argued that there will be a negative relationship between labour productivity growth in the economy as a whole and the productivity growth in the non-manufacturing sector because most activity outside the manufacturing sector particularly land-based activities such as agriculture and many service activities are subject to diminishing returns. Further, the unbalanced growth models by Baumol (1967) helped in popularizing the notion that because of their labour-intensive nature, service-sector activities cannot be made more efficient through capital accumulation, innovation, or economies of scale.

Subsector’s Share (%) to Services Sector, 1951-2011

1950-51

1960-61

1970-71

1980-81

1990-91

2000-01

2010-11

0

5

10

15

20

25

30

35

1. Trade, Hotel and Restau-rants

a) Trade

b) Hotel and Restaurants

1950-51

1960-61

1970-71

1980-81

1990-91

2000-01

2010-11

0

2

4

6

8

10

12

14

16

18

Transport , Storage and Communication

a)Railways

b) Transport by other means

c) Storage

d)Communication

1950-51

1960-61

1970-71

1980-81

1990-91

2000-01

2010-11

0

5

10

15

20

25

30

35

40

3. Finance, Insurance, Real Estate and Business Services a) Banking and In-surance b) Real Estate, Own-ership of Dwelling and Business Services

1950-51

1960-61

1970-71

1980-81

1990-91

2000-01

2010-11

0

5

10

15

20

25

30

35

40

Community, Social and Personal Services a) Public Adminis-tration and Defense b) Other Services

Absolute Changes In Employment (Millions) Since 1972-2010

1972-73/77-78

1977-78/80-83

1983/87-88

1987-88/93-94

1993-94/99-2000

1999-2000/2004-2005

2004-05/2009-2010

-3

-2

-1

0

1

2

3

4

5

6

7

AgricultureIndustryService

• Theoretically output is expected to have a positive long run relationship between growth and employment as according to Okun’s law 3% increase in growth rate leads to 1% fall in unemployment rate as output is expected to have a long run positive effect on labor demand.

4

5

6

7

8

9

10

11

12

1980 1985 1990 1995 2000 2005 40000

50000

60000

70000

80000

90000

100000

110000

120000

130000EMPLOYMENT (right)

serv (left)

• The methodology of this study takes after Fofana’s, and as such I specify our basic model as:

• EMPTs=f(GDP,FDI,PE)………………………(1)• Where:• EMPTs = Total Employment in service sector• GDP = Real Gross Domestic Product • FDI = Foreign Direct Investment • PE = Public Expenditure

The Model and the Method of Analysis

Assuming a linear relationship among explanatory variables the explicit form of equation (1) becomes:

EMPT = + GDP + FDI + PE + ε

VARIABLES NUMBER OF OBSERVATIONS

MEAN STANDARD DEVIATION

EMPLOYMENT

(SERVICES) IN MILLION

29 83125.0 24654.0

REALGDP

GROWTH RATE

30 6.319 2.227

PUBLIC EXPENDITURE

IN MILLION

30 4792.0 4851.0

FDI INFLOW 29 18848.0 27416.0

Correlation Matrix of VariabesVARIABLE EMPLOYMENT GROWTH

RATEFDI PUBLIC

EXP

emp 1.0000 0.6350 0.8047 0.9290

Growth rate

0.6350 1.0000 0.5789 0.6027

FDI 0.8047 0.5789 1.0000 0.9207

Public exp

0.9290 0.6027 0.9207 1.0000

Conclusion

• The above model shows that there is a correlation between employment and independent variables growth in million, public expenditure, Foreign Direct Investment. According to above regression analysis 1 unit increase in GDP growth in million will lead to 0.13% increase in employment in service sector keeping other variables fixed, which is alarmingly low percentage. Public expenditure also leads to increase in employment and have a positive correlation with employment 0.57%.

Conclusion• There is a negative correlation between Foreign Direct Investment

and employment. The explanation to this could be that as the percentage is negative it tells us that value addition being made in the service sector in India is more because of capital than labour.

• As the sector like communication, trade, banking which are showing high growth rate are generally also witnessing increase in productivity or increase total factor productivity.

• In India as a result although we are witnessing a high contribution of service sector in the Gross Domestic Product of the country but it is not resulting in increase in employment and hence India will continue to witness Jobless growth until and unless India will see growth in manufacturing sector also.

Thank You