Can Services Sustain the PRC's Economic Growth?

A cook at the Yangguang Hotel in Taiyuan, PRC.
A cook at the Yangguang Hotel in Taiyuan, PRC.

By Donghyun Park

Beijing must be far bolder if the services sector is to become a more powerful and sustainable engine of economic growth and job creation.

The service sector in the People’s Republic of China (PRC) grew by an average of 10.7% per year from 1978 to 2013. Services greatly contributed to both growth and employment. The share of services in GDP increased from 23.9% in 1978 to over 46.1% in 2013 – the latest year for which full annual data are available - exceeding the share of manufacturing for the first time. At the same time, the share of services in employment grew rapidly from 12.2% in 1978 to 38.5% in 2013, generating most of the country’s new jobs.

And it has continued to grow. Services accounted for 56.9% of the PRC’s GDP in the first quarter of 2016, an increase of 2 percentage points year-on-year and 19.4 percentage points more than industry, according to the figures released in April by the PRC government.

Despite these achievements, the development of the service sector in the PRC has lagged behind that of other countries at similar stages of development, not only in terms of the sector’s relative contribution to GDP and employment but also in the kind of industries that make up the sector and raise its overall productivity and competitiveness. 

The underdevelopment of the service sector manifests itself in a number of ways:

  1. The percentage of GDP generated by services is still low relative to other countries at similar income levels. In 2013, the share of services in the PRC’s GDP was 46.1% – about 13 percentage points lower than other economies with similar GDP per capita.
  2. The share of services in employment lags behind the sector’s contribution to GDP, and is also below middle-income economies like Brazil and Malaysia. This suggests there is sizable scope for services to be an even bigger engine of job creation.
  3. The structural upgrading of the service sector—the move from low-end services such as wholesale and retail trade, transport, and storage to high-end services such as finance, computer services, business services, communications, and legal and technical services—is still at an early stage.
  4. The PRC’s service sector lacks international competitiveness. Exports of knowledge-intensive services are a good example. For instance, finance accounted for only 0.5% of the PRC’s service exports in 2011, compared to to 12.7% for the US.
  5. Productivity in the PRC’s service sector remains relatively low. It has lagged behind other countries with similar income levels, in part because of the dominance of traditional, low-productivity services. For example, labor productivity was about 49% that of Malaysia and 82% that of Thailand.

The following obstacles and constraints explain why the PRC’s service sector remains relatively backward, notwithstanding its impressive progress.

  • Policymaking has traditionally discriminated against the service sector. The bias toward capital-intensive manufacturing growth largely explains the underdevelopment of services. For example, the total tax burden on the top five taxable service industries averaged 30.3%, while the corresponding figure for manufacturing was only 20.5%.
  • It is difficult for new private firms to enter the PRC's service sector due to complex and unclear regulations. Entry into all service industries is significantly more restrictive for the PRC than for the OECD.

Service Trade Restrictiveness Index: PRC and OECD comparison. Source: OECD.

  • While the PRC has opened up some service industries to competition, key industries such as railroad transportation, education, healthcare, news and publishing, broadcasting, and television are still dominated by state-owned enterprises.
  • Service sector providers lack effective and fair legal protection. For example, there is no clear, unified, legal definition and standard to regulate nonprofit organizations in the PRC.  
  • The service sector still suffers from heavy-handed government intervention. The government retains significant power to allocate land, capital, and human resources, and to set the price for services—for instance, school tuition and medical fees.

Overall, while the PRC’s service sector has made great strides in recent years, it must overcome a number of major obstacles if it is to help the PRC sustain its economic growth. In light of the PRC’s growth slowdown since the global financial crisis, fully unleashing the potential of the service sector has taken on an added sense of urgency. Precisely because it is underdeveloped, service sector development can serve as a new engine of growth. Services cater largely to domestic demand at a time when the PRC is rebalancing away from excessive dependence on exports. Furthermore, services tend to be labor-intensive and can thus be a major source of new jobs.

There are already some promising signs that policy-makers are beginning to implement helpful reforms. For example, since July 2012, the PRC has been replacing its steep turnover tax with a value-added tax that allows for deductions in selected service industries. This should help to reduce the tax burden on services and level the playing field with manufacturing. But Beijing must be far bolder if the services sector is to become a more powerful and sustainable engine of economic growth and job creation.

Above all, Beijing must create a more competitive environment for services by dismantling regulatory barriers that protect vested interests from new market entrants.

This blog is based on the paper Beyond Manufacturing: Developing the Service Sector to Drive Growth in the PRC, co-authored by Donghyun Park, Jurgen Conrad, Gemma Estrada, Sang-Hyop Lee, and Wei Wang.