Think Services, Not Only Manufacturing

Increasingly the services sector, including business process outsourcing, is becoming an important driver of economic development. Photo: ADB
Increasingly the services sector, including business process outsourcing, is becoming an important driver of economic development. Photo: ADB

By Matthias Helble, Sameer Khatiwada, Ben Shepherd

To offset the declining benefits of manufacturing, governments must increase the productivity of the services sector. This will boost growth and offer employment opportunities.

Building up a strong manufacturing sector was long considered to be the silver bullet to achieve robust economic growth and escape the middle-income trap. Yet, developing countries aiming to increase growth on the back of industrialization are facing an increasingly uphill battle. In fact, many developing economies are seeing a decline in manufacturing before reaching a similar threshold of industrialization achieved by today’s developed countries in the past.

There are three main reasons behind this trend. First, the manufacturing sector is increasingly more capital intensive than labor intensive, hence can no longer absorb large amounts of labor as it did in the past. Furthermore, countries specializing in a low-skill and low productivity manufacturing such as garments (e.g. Cambodia) and food processing (e.g. Indonesia) find it increasingly difficult to diversify into a medium or high-tech manufacturing. And finally, many economies, especially smaller ones, face the challenge to compete in foreign markets dominated by big players, such as the People’s Republic of China.  

Given this new global context, it is important to re-think the role of the service sector in economic development. In traditional models of development, the manufacturing sector was considered the sector with the highest productivity and therefore a country’s economic success hinged on the competitiveness of manufacturing. Services were perceived as low-productivity and not susceptible to technological advances. However, many service sectors today are the most dynamic sectors. Some service sectors, such as IT or financial services, have a higher productivity than manufacturing.

  What three things can governments do to boost the services sector?

What can government do to make services an engine of sustained growth? First and foremost, the productivity of services needs to be increased. This can be achieved by tackling three areas:

  • First, many service sectors are not fully open to competition. Vested interests keep them closed, resulting in high prices, but low quality and low availability. As a result, the competitiveness of the entire economy suffers, including manufacturing. Healthy competition not only needs to be ensured among domestic service providers, but also foreign service providers. However, many economies have only partially liberalized their service sector. Trade in services is therefore far below its potential.
  • Second, the competitiveness of the service sector is closely correlated with the available skills. The service sectors with the highest productivity are the ones that have a highly skilled workforce. Governments need to develop curricula that respond to the demands of the services industry. For example digital literacy is particularly important for services compared to other sectors. For those workers that are currently still in agriculture or manufacturing, governments need to ease the transition towards services, which requires a large effort in re-skilling.
  • Finally, a pre-condition of a competitive service sector is the availability of necessary infrastructure. Whereas in the past the manufacturing sector required investment to facilitate the transport and shipping of physical goods, the service sector needs access to reliable electricity, fast internet, and a transparent and simple regulatory framework.

Today, it is estimated that about two-thirds of economic activity worldwide consists of services and half of the world’s workforce are in the service sector. Every day, more jobs are created in services than in manufacturing and this holds equally for developed and developing countries. For example, according to a recent survey by the PHD Chamber in India, more than 75% of jobs newly created in India over the past five years were in services. The manufacturing sector was responsible for less than 20% of new jobs.

This is true for not only for developed countries, but most developing countries in Asia. A good example of nurturing a service sector is the IT-BPO industry in the Philippines. It has grown out of little in 2000 to one of the most important industries in the Philippines today, accounting for close to 10% of GDP and employing over a million workers in relatively high-paying jobs.

With new technology, new industries and occupations are emerging, and countries need to be able to capture these new growth sectors rather than making ill-advised policy interventions to support manufacturing.