Dani Rodrik is skeptical that “a services-led model can deliver rapid growth and good jobs in the way that manufacturing once did”. Excerpts from a recent article on why productivity gains in services sector activities are self-limiting and mostly lower than in manufacturing sector. It has to do with the nature of services activities, which are mostly low value added, low productivity and non-tradable type in low-income countries.
Two things make services different from manufacturing. First, while some segments of services are tradable and are becoming more important in global commerce, these typically are highly skill-intensive sectors that employ comparatively few ordinary workers.
Banking, finance, insurance, and other business services, along with information and communications technology (ICT), are all high-productivity activities that pay high wages. They could act as growth escalators in economies where the work force is adequately trained. But developing economies typically have predominantly low-skilled labor forces. In such economies, tradable services cannot absorb more than a fraction of the labor supply.
That is why, for all of its success, the ICT sector in India has not been a primary driver of economic growth. By contrast, traditional manufacturing could offer a large number of jobs to workers straight off the farm, at productivity levels three to four times that in agriculture.
In today’s developing countries, the bulk of excess labor is absorbed in non-tradable services operating at very low levels of productivity, in activities such as retail trade and housework. In principle, many of these activities could benefit from better technologies, improved organization, and greater formalization. But here the second difference between services and manufacturing comes into play.
Partial productivity gains in non-tradable activities are ultimately self-limiting, because individual service activities cannot expand without turning their terms of trade against themselves – pushing down their own prices (and profitability). In manufacturing, small developing countries could thrive on the basis of a few export successes and diversify sequentially through time – t-shirts now, followed by the assembly of televisions and microwave ovens, and on up the chain of skill and value.
By contrast, in services, where market size is limited by domestic demand, continued success requires complementary and simultaneous gains in productivity in the rest of the economy. Focusing on a few sectors yields no quick winning opportunities. Growth therefore must rely on the much slower accumulation of economy-wide capabilities in the form of human capital and institutions.