Rashmi Banga: Sustaining the pace of services-led growth

A coherent integrated services policy, in line with the agricultural and industrial policies, needs to be developed.

The services sector has acted as an engine of growth for India. The sector grew by almost 8 per cent a year in the past decade (1994-2004), which is way ahead of the agriculture (which grew at an annual rate of 3 per cent) and manufacturing sector (which grew at 5.2 per cent). It now contributes more than 50 per cent of GDP. Trade in services has played an important role in fuelling this growth. India's exports of services witnessed one of the fastest rates of growth in the world. India accounted for 65 per cent of the global market in offshore IT services and 46 per cent of the global BPO market in 2004-05.

In spite of this stupendous performance, doubts have been cast over the sustainability of India's services-led growth. There are two reasons for the doubts. First, unlike other developing countries, a decline in the share of agriculture sector in GDP has been picked up by the services sector rather than the manufacturing sector. The lack of corresponding high growth in manufacturing sector means low demand for services. Second, this phenomenal growth in services sector has not been followed by a corresponding high growth in employment in services sector. In 2001, services in India contributed around 25 per cent of total employment in contrast to 30 per cent in middle-income countries and around 39 per cent in some of the developing countries like Indonesia. This shows that while output generation has shifted to services, employment generation in services has lagged far behind.

Doubts cast with respect to the lack of demand for services by the manufacturing sector find little empirical support as a study by Banga and Goldar (ICRIER WP No 139) shows that contribution of services to growth in output of manufacturing sector increased from 9 per cent in the 1980s to 24 per cent in the 1990s. This indicates that growth in the services sector will create its own demand by improving the growth in the manufacturing sector. However, a lack of corresponding growth in employment is an issue of major concern, which in a country like India may lead to huge social costs.

A closer scrutiny of the disaggregated services sector shows that one of the reasons for slow growth of employment in the services sector is that the services that are growing fast, like financial and personal services, have experienced a fall in their employment elasticities. On the other hand, services with a large employment potential, like railways, transport and real estate are not growing fast enough. The employment elasticity in the services sector, as a whole, declined from 0.41 to 0.15 in this period. This trend is, however, not surprising since growth in services sector in India has been largely determined by growth in IT and IT-enabled services, which have rising labour productivity and, therefore, have corresponding fall in employment elasticity. International trade, which has fuelled the growth process in services, has also concentrated on services with low employment potential, that is, travel, communication and software services.

To sustain the dynamism of India's services-led growth, international trade can become an important instrument if used judiciously. There is now a need to make services growth more inclusive and less lopsided by identifying services that have a potential to trade and generate more direct and indirect employment. However, trade in services is hindered not only by external constraints in terms of trade barriers (mainly in the form of limits on foreign equity participation) but also by domestic constraints.

Services which have low external constraints but high domestic constraints, as a result of which they have a low share in total exports, are health, education, transport and construction services. These have a potential for generating employment and have high forward and backward linkages with other sectors. Health and education have a large potential for growth but they are on the concurrent list, that is, both state and central governments have jurisdiction over these services. As a result, a number of restrictions imposed by the state governments hinder FDI. Many domestic constraints exist in the education sector, such as lack of a strong system of regulation and accreditation, incentives for private investments and link between higher education and work force development (as pointed out by Agarwal, ICRIER WP 179). Growth in infrastructure is also hindered by a number of domestic constraints like land ceiling, unclear land titles, minimum area restrictions, minimum capitalisation norm, and restriction on repatriation, lack of capital, and low investments in R&D.

To make services-led growth more widespread and sustainable, it is important to systematically and simultaneously remove these constraints. To do this, a coherent integrated services policy (in line with the agricultural and industrial policies) needs to be developed. Reforms in services in India have evolved in an ad hoc manner rather than as part of an overall strategy. Consequently, the depth and pace of reforms lack uniformity across sectors. Given the strong inter-linkages between different services, opening a particular service sector may not yield results if not backed by corresponding reforms in other complementary services. Such an integrated services policy should also define the sequence as well as the pace of reforms to be undertaken simultaneously in different services. Liberalisation should be followed in a phased manner accompanied by social policies in sectors that have surplus labour so as to avoid creating unemployment and social unrest. This will go a long way in sustaining the dynamism of services-led growth.