Why Should People’s Republic of China Unlock Services?
It is up to policy makers to unlock the enormous potential of services in the People’s Republic of China.
A well-developed services sector plays a major role in improving production efficiency and promoting technical progress and innovation. The services sector has expanded rapidly in the People’s Republic of China (PRC) since economic reform was launched in 1979, and particularly after PRC joined the World Trade Organization in 2001. However, the size of the sector as a share of GDP appears to be significantly smaller than expected based on PRC's income level and development stage.
The relative underdevelopment of the services industry is a direct consequence of the growth model adopted by PRC during the last three decades, which favors manufacturing with focus on manufactured exports. As a result, fiscal incentives have directed investment into the production and export of goods, discouraging investment in services.
Besides, while manufacturing greatly benefited from liberalization brought about by the successful opening-up policy, openness has been limited in the services sector. The restricted exposure of the services sector to overseas direct investment, and its implicit technological transfer, has limited the expansion of the sector and the quality of the services provided.
The relative underdevelopment of the services industry is a direct consequence of the growth model adopted during the last three decades.
Moreover, the dominant presence of state-owned enterprises (SOEs) in the services industry constrains the sector’s competitiveness. The high market concentration limits the entrance of new domestic and foreign players reducing the benefits of higher competition and liberalization. This is aggravated by the inefficient allocation of financial resources in the economy, which is biased toward large SOEs perpetuating their monopoly in the provision of services.
Wide-ranging reforms are needed to turn services into an efficient and competitive sector, that would strengthen domestic sources of growth and support government efforts to rebalance the economy. For instance, by reducing market concentration in the sector, the resulting liberalization and improved competitiveness would lower production costs and prices and increase the quality of the services provided to both consumers and producers.
More openness toward foreign participation, in particular in banking, telecommunications and professional services, will foster liberalization efforts. A reliable intellectual property rights regime, which is crucial for the development of services where copyrights and trademarks are important, would help attract more overseas direct investment into the sector and encourage domestic firms to innovate.
It is important, too, to deepen financial sector reform for the improvement of capital allocation to move toward an innovation-based economy and grant wider access to finance. Given the superior performance of private companies in PRC, more efficient capital allocation would translate into higher GDP growth. More sophisticated capital markets will bring benefits to self-employed entrepreneurs and small-and-medium-sized enterprises, which are critical players in a vibrant services sector-based economy.
A larger services sector, underpinned by supportive policy measures, including investments in education and vocational training, will absorb surplus labor from manufacturing and agriculture, foster employment generation and make income distribution fairer. Greater urbanization will help develop services. With urbanization featuring prominently in the government's reform agenda, and with a more flexible household registration system (hukou) already in place, it is up to policy makers to unlock the enormous potential of services in PRC.