Economics Focus: The Service Elevator
Can poor countries leapfrog manufacturing and grow rich on services?
May 19th 2011 | from the print edition
INDIA’S services revolution has dazzled businesses in the rich world, turning Indian companies into global competitors and backwater cities such as Hyderabad into affluent, sophisticated technology centres. Yet economists have been less star-struck, clinging to the received wisdom that has prevailed since the industrial revolution: modernisation runs from agriculture through manufacturing and only later to services. Now some have broken ranks.
The logic supporting the conventional path towards an advanced economy is straightforward. Development typically involves moving workers from low-productivity activities such as subsistence farming to high-productivity sectors. That points to a shift into manufacturing because it lends itself to specialisation and economies of scale, both essential for rising output per worker. As first Japan, then Taiwan and South Korea, and now China have demonstrated, manufacturing can also accelerate development because its output can be exported to rich countries.
Services, in contrast, appear to be a graveyard for productivity. Because a haircut or a restaurant meal has to be delivered in person, there is almost no potential to exploit economies of scale and to export. People consume more services not when technological advance lowers their price but when they have reached a level of affluence that satisfies most of their other needs. Indeed William Baumol famously argued in the 1960s that as countries grew richer and their citizens became keener on buying services, their productivity growth would inevitably slow.
That conventional wisdom is now under fire, in a book edited by Ejaz Ghani of the World Bank and a related article he wrote with Homi Kharas of the Brookings Institution and Arti Grover also of the World Bank on the VoxEU website. The authors argue that technology and outsourcing are enabling services to overcome their former handicaps. Traditional services such as trade, hotels, restaurants and public administration remain largely bound by the old constraints. But modern services, such as software development, call centres and outsourced business processes (from insurance claims to transcribing medical records), use skilled workers, exploit economies of scale and can be exported. In other words, they are just like manufacturing. If that is the case, then poor countries should be able to go straight from agriculture to services, leapfrogging manufacturing.