SERVICE SECTOR : INDIA’S ENGINE OF GROWTH * Dr. Pranav Saraswat Abstract This paper analyzes the factors behind the recent growth of India’s services sector. The high growth of services output in the 1990s was mostly due to the rapid expansion of Communication, banking, business services (including the IT sector) and community Services. While factors such as a high income elasticity of demand for services, increasing input usage of services by other sectors, and rising exports, were important in boosting services growth in the 1990s, supply side factors including reforms and technological advances also played significant roles.
Going forward, the growth potential of Indian services exports is well known, but the paper also finds considerable scope for growth in the Indian service economy provided that deregulation continues. In addition, the paper shows that employment growth in the Indian services sector has been quite modest, thus underscoring the need for industry and agriculture to also grow rapidly. INTRODUCTION A striking feature of India’s growth performance over the past decade has been the strength Of its services sector. It found that the average services grew more slowly than industry Between 1951 and 1990.
Growth of services picked up in the 1980s, and further accelerated in the 1990s, when it averaged 7. 5 percent a year, thus providing a valuable prop to industry And agriculture, which grew on average by 5. 8 percent and 3. 1 percent respectively. two Most Forecasters expect that services will grow at similar if not higher rates over the next few years. Growth in the services sector has also been less cyclical and more stable than growth in industry and agriculture. The emergence of services as the most dynamic sector of the Indian economy has in many ways been a revolution.
The most visible and well-known dimension of the take-off in services has been in software and information technology (IT)-enabled services (including call centers, software design, and business process outsourcing). However, growth in services in India has been much more broad-based than IT. In fact, although IT exports have had a profound impact on the balance of payments, the sector remains a small component of GDP. *Assiatant Professor, Shrinathji Institute of Management, Nathdwara As of 2003, business services (which includes IT) were only about 1? percent of GDP, ccounting for just 3 percent of total services output. The paper shows that almost all service sub sectors in India have grown faster than GDP over time, but the pick-up in growth in the 1990s was the strongest in business services, communication, and banking services,3 followed by hotels and restaurants and community services. These activities together account for the entire acceleration in services growth in the 1990s. The growth in public administration and defense, real estate, storage, transport, and personal services in the 1990s was broadly similar to that in the previous decades.
Rapid growth of the services sector is not unique to India. The existing literature shows that as an economy matures the share of services in output increases consistently. To begin with, the increase occurs along with an increase in the share of industry. Thereafter, the services share grows more rapidly, accompanied by a stagnant or declining share of the industrial sector. In this paper, banking services includes activities of commercial, post office, and savings banks, as well as nonbank financial institutions, cooperative credit societies, and employee provident funds. It excludes the insurance sector.
This paper explores the factors behind the dynamism of the services sector in India. One explanation suggested in the literature for fast growth in services is that the income elasticity of demand for services is greater than one. Hence, the final demand for services grows faster than the demand for goods and commodities as income rises. Another explanation is that technical and structural changes in an economy make it more efficient to contract out business operations that were done internally by individual firms. This type of outsourcing has been called the “splintering” of ndustrial activity. Splintering results in an increase in net input demand for services from the industrial sector, and the services sector growing proportionately faster than other sectors. The empirical evidence presented in this paper shows that while splintering and high income elasticity of demand for services have served to stimulate services growth in India, it is necessary to look beyond these factors to fully explain the growth acceleration . In particular, important roles also seem to have been played by economic reforms, andgrowing demand for services exports.
Analytical study suggests that the Indian services sector may experience an extra impetus to growth in coming years from exports and from liberalization. New markets for Indian services exports are just beginning to be tapped and there is substantial scope for further high growth rates in tradable services. There is also scope for considerable growth from liberalization and the associated productivity gains in some of the services subsectors where growth has lagged behind in the 1990s. The distribution sector seems to be a prime candidate in this regard. A number of explanations suggest themselves: (i) poor infrastructure has acted as a bottleneck to industrial growth (on the other hand, some service sectors such as transport, storage and communications would have been equally affected); (ii) labor restrictions and small-scale reservations have disadvantaged industry more than services; (iii) the service sector has received more generous tax incentives; and (iv) faster growing services activities seem to be more intensive in skilled labor, with which India is well endowed.
I-AREA COVERED BY SERVICE SECTOR IN TATAL OUTPUT Such a pattern of growth is visible in the cross-country data on shares in GDP presented in Table . These data suggest two stages of development. In the first, both industry and services shares increase as countries move from low income to lower middle income status, while in the second, the share of industry declines and that of services increases as the economy moves to upper middle and higher income levels. How does the Indian experience fit in with this pattern?
Through the 1980s at least, the fit is quite close. In the first four decade period, 1950–90, agriculture’s share in GDP declined by about 25 percentage points, while industry and services gained equally. The share of industry has stabilized since 1990, and the entire subsequent decline in the share of agriculture has been picked up by the services sector. Thus, while over the gain in the services sector share over the four decades, 1950s–1980s, was 13 percentage points, the gain in the 1990s alone was 8 percentage points.
Consequently, at current levels, India’s services share of GDP is higher than the average for other low income countries. A comparison of shows that the size of India’s services sector, relative to GDP, is closer to the average of lower middle income countries. Is India an outlier? The evidence suggests that though the Indian services sector is somewhat higher than the average, India is not that unusual. Figure 2 relates the share of services in GDP to the per capita income in 1990 and 2001 using data for various countries from the World Bank’s World Development Indicators (WDI).
II- AREA COVERED BY SERVICE SECTOR IN EMPLOYMENT Even though India has experienced profound changes in output shares, the same is not true for employment shares ). A striking feature of India’s development is that in contrast to the substantial decline in the share of agriculture in GDP, there has been rather little change in the share of employment in agriculture (Bhattacharya and Mitra, ). Similarly, although services rose from 42 percent to 48 percent of GDP during the 1990s, the employment share of services actually declined by about one percentage point during the decade.
Thus, while output generation has shifted to services, employment creation in services has lagged far behind. India’s relatively jobless service sector growth is unlike the experience of other countries, where the service sector has also tended to gain a larger share of employment over time. India, in fact, has an exceptionally low share of services employment, when compared with other countries. An. The normal pattern is thus for the share of services employment to rise faster than the share of output. This implies that labor productivity in ervices tends to fall as the service sector increases. In sharp contrast, since the labor share in services employment has been flat, labor productivity in Indian services has been increasing over time. In addition, the increase in labor productivity in Indian services has not been due to an increase in the relative capital intensity . This suggests that other factors have been at work in raising labor productivity, which could include the growth of services being concentrated in subsectors that are more dependent on skilled labor than on unskilled labor or capital.
This trend has no doubt been reinforced by technological improvements, as well as by efficiency gains resulting from liberalization III. REASONS BEHIND THE RAPID GROWTH OF SERVICE INDUSTRY In this section we identify the drivers of the acceleration of growth in the services. The data on annual growth rate over the past fifty years (Figure 4) suggest a structural break in growth in services starting .. By contrast, the growth path for industry, which exhibited a declining trend between 1954–80, has been flat over the past two decades.
The acceleration in services growth in the 1990s and 2000s was not uniform across different activities. Some sub-sectors grew at a much faster rate than in the past, while for other subsectors, growth rates were similar to the past trend . To identify the growth-drivers within the services sector, we compare the growth rates of various activities in the 1990s with their previous trend growth rates -AN EXPRESS GROWERES Based on the above criterion, express growers were as follows: • Business services (including IT) was the fastest growing sector in the 1990s-2008, with growth averaging nearly 20 percent a year.
Though disaggregated data for this category are not available, export and software industry data indicate that the growth was mainly on account of the IT sector. Despite being the fastest growing sector, business services, particularly IT activity, was growing off a low base and its contribution to the services sector and GDP growth was quite modest • Communication services, which registered growth of 14 percent a year during The last decade , made a significant contribution to services growth.
The growth in communication was mostly due to telecom, which accounts for 80 percent of output. • In the banking sector, growth jumped from about 7 percent over the period 1950–80, to 12 percent in the 1980s, and 13 percent in the 1990s to 2005. Growth was most rapid in the NBFIs (which grew by 24 percent in the 1980s and 19 percent in the 1990s and around 20% in 2006. • Community services and hotels and restaurants increased at the trend growth rate through the early 1990s, but experienced a pick up in growth in the latter part of the decade.
In community services, this was due to both education and health services (70 percent and 23 percent of value added, respectively) growing at an average rate of 8 percent Among the trend growers, the growth rate of distribution services (the largest service subsector in India), averaged about 6 percent in the 1980s, higher than in previous decades, and accelerated further to about 7 percent in the 1990s and 9% in 2008—just below the threshold for fast growers. The rate of growth of public administration and defense in the 1990s averaged 6 percent, which was similar to the growth experienced in previous decades. CONRIBUTION OF EXPRESS AND DRIFT GROWERS The fast growing activities accounted for about a quarter of services output in the 1980s, but because of their relatively fast growth, these activities represented one-third of services output by 2005. services growth as the trend growing sectors. In fact, since the growth of trend growing sectors was about the same in both decades, the fast growers collectively accounted for almost all of the higher services growth . This is consistent with new activities and industries having sprung up in the fast growth sub-sectors, but not in the trend growth ones.
ELUCIDATE : SERVICES SECTOR GROWTH Services activity can also be stimulated by technological advances, whereby new activities or products emerge as a result of technological breakthrough—such advances are likely to be particularly relevant in the case of the IT and telecommunication sectors and to some extent in financial services (credit cards, ATMs etc. ). Liberalization can also provide a boost to services. In India, important policy reforms which were conducive to the growth of services sector, such as deregulation, privatization and opening up to foreign direct investment (FDI).
If the growth of services was previously inhibited by government controls, then policy changes may provide a positive shock that unleashes new activity and growth. CHARACTER OF SPLINTERING As noted, changes in production technique can cause a firm to splinter, and, as a result, the proportion of output originating in the services sector to increase. Such splintering would be reflected in an increase in the use of services as intermediate inputs but not as final demand. One way to estimate the importance of splintering to services growth in India is to measure the increase in input usage of services in other sectors
CHARACTER OF LIBRALISATION Policy changes are also likely to be a factor behind the growth in services sector activity in India, especially changes relating to deregulation, the liberalization of FDI, and the privatization of government-owned services. 11 An example would be the telecommunications industry where inefficient provision, preliminary evidence of the effect of reform-related measures on services growth is provided by analyzing the correlation between the flow of FDI and the increase in private sector participation in services to sector growth.
The relationship between the cumulative flow of FDI and services growth in the 1990s performance is found to be quite strong (even though this information is available only at a highly aggregated level, and the direction of causation is not clear a priori).. SUMMARY AND CONCLUSION This paper studies the growth of the services sector in India. It shows that in common with the experience of many other countries, the services sector in India has grown faster than agriculture and industry. As a result, the share of services in GDP has increased over time.
In the 1990s, services growth was particularly strong, and this has led to the services share in output being relatively large in India compared with other countries at similar levels of development. What is also striking about India’s growth experience is that the services sector does not appear to have created many jobs. Admittedly the employment data suffer from limitations. Nonetheless, unlike the experience of many countries where productivity growth in the service economy has tended to lag behind that of other sectors, it appears that the Indian services sector has been characterized as experiencing increasing labor productivity.
The acceleration in growth of the services sector in India in the 1990s was due to fast growth in communications, banking services, business services (IT), and community services (education and health). The remaining sectors grew at a constant or trend growth rate. We show that factors such as high income elasticity of demand and increased input usage of services by other sectors have played an important part in elevating services growth. Also important, at least in the 1990s, have been factors such as economic reforms and the growth in foreign demand for services exports.
Significant productivity gains appear to have occurred in the faster growing sectors, leading to a decline in their relative prices. Our findings suggest that there is considerable scope for further rapid growth in India’s service economy. That Indian services exports have strong future growth prospects is well known, but we also find that there is considerable scope for further rapid growth in other segments provided that deregulation of the services sector continues. Nevertheless, it is imperative that the industrial and agricultural sectors also grow rapidly.
The relatively jobless nature of growth in India’s services sector further underscores this need. Fast Growing Services Segments in India [pic] [pic] [pic] Source: Authors’ calculations using CSO data. Figure: Price Deflator of Services Relative to the GDP Deflator (Index, 1991 = 100; for Business Services and Banking, Index, 1980=100)[pic] Figure : Indian Services Exports [pic] References: • Acharya, Shankar, 2002a, “India’s Medium-Term Growth Prospects,” Economic and Political Weekly, July 13, pp. 2897–06. 2002b, “Macroeconomic Management in the 1990s,” Economic and Political Weekly, 37 (16), April 20, pp. 1515–38. • 2007, “What’s Happening in Services,” Business Standard,December 23. • Bhagwati, Jagdish, 1989, “Splintering and Disembodiment of Services and Developing Nations,” World Economy, Vol. 7, No. 2, pp. 133–43. • Bhattacharya, B. B. , and Arup Mitra, 2000, “Excess Growth of Tertiary Sector in Indian Economy, Issues and Implications,” Economic and Political Weekly, November 3, pp. 2445–5 • Francois, Joseph, F. , and Kenneth A.
Reinhart, 2005, “The Role of Services in the Structure of Production and Trade: Some Stylized Facts from a Cross-Country Analysis,” Asia-Pacific Economic Review, Vol. 2 (May), pp. 1–9. • Hansda, Sanjay Kumar, 2002a, “Services Sector in the Indian Economy: A Status Report,” RBI Staff Studies, Department of Economic Analysis and Policy (New Delhi: Reserve Bank of India). • 2002b, “Sustainability of Services and Services-Led Growth: An Input Output Exploration of the Indian Economy,” RBI Papers (New Delhi: Reserve Bank of India). Joshi, Dharmakirti, 2002, “The Public Private Balance: A Macro View,” Discussion Paper Series, (New Delhi: Crisil Center for Economic Research). • Mattoo, Aaditya, Deepak Mishra, and Anirudh Shinghal, 2003, “Trade in Services: Reserve Bank of India, 2002, Report on Currency and Finance, (Mumbai: Reserve Bank of India. • Salgado, Ranil, 2003, “India’s Global Integration and The Role of the IT Sector,” India— Selected Issues Washington: International Monetary Fund. • Sastry, D. V. S. Balwant Singh, Kaushik Bhattacharya, and N. K. Unnikrishnan, 2003, • “Sectoral Linkages and Growth Prospects: Some Reflections on the Indian Economy,” Economic and Political Weekly, June 14, pp. 2390–2397 • Slifman, L. , and C. Corrado, 1996, “Decomposition of Productivity and Unit Costs,” (unpublished; Washington: Board of Governors of the Federal Reserve System). • Virmani, Arvind, 2002, “Bhartiya Rate of Growth: The Role of Services, Planning Commission (New Delhi: Government of India).