Industrialization Trends Essay Example
Industrialization Trends Essay Example

Industrialization Trends Essay Example

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235 Services-led industrialization in India: Assessment and lessons Nirvikar Singh*

1. Introduction In the past two decades, India's economy has seen significant growth due to economic reforms. This growth has been primarily fueled by the service sector, particularly information technology (IT) and IT enabled services (ITES). However, the manufacturing sector has not experienced similar levels of strength.

In the 1990s, the service sector had a significant impact. There was not only rapid growth, averaging over 6 per cent since 1992, but also a high contribution - over 60 per cent - from services (Hansda, 2001). This growth pattern, referred to as "services-led" industrialization or a "services revolution" (Gordon and Gupta, 2004), stands out from the traditional development path of agriculture to manufacturing, where services usually become significant later on.

India's GDP saw a notable increase in the services sector,

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with its proportion rising from 37% in 1980 to 49% in 2002. Meanwhile, manufacturing remained consistent at 16%. This has raised concerns about India's development model and its sustainability. In this article, we examine India's recent growth path, identify the key factors influencing its development pattern, and explore the potential for further industrialization driven by the services sector.

The analysis will utilize theoretical models and case studies of the Indian experience. The paper is organized as follows: the next section presents a conceptual framework for examining the Indian experience. Specifically, we discuss the characteristics of services, their differentiation from products, and their classification. We contend that it is crucial to consider the specific nature of the services under scrutiny to analyze their impact on growth. Consequently, it is necessary to go beyond general national income accounts categories in order t

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comprehend the role of services in industrialization.

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Purely Monopolistic Seller,

Section 3 provides an outline of India’s overall growth experience. This is followed by a more detailed analysis of the service sector's contribution to growth in Section 4, as well as the comparative performance of manufacturing and agriculture. In Section 5, the potential for spillovers from IT, ITES, and other service sectors like financial services to the rest of the economy is examined.

Based on econometric work on productivity growth and input-output analysis of linkages, we can speculate that India's manufacturing sector development may have been limited by weaknesses in key service sectors like transportation and electricity. Additionally, evidence suggests that telecommunications reforms played a crucial role in the rapid growth of the IT and ITES sectors. In Section 6, we examine the specific impact of international trade in services.

This paragraph requires exceptional attention due to its increasing significance and the historical hindrances that balance of payments limitations have posed on developing nations' sustainable growth. In Section 7, we address the influence of various growth trajectories on employment, along with the educational and human resources obstacles faced in supporting and perpetuating India's developmental journey. Additionally, Section 8 briefly examines the social and environmental concerns linked to adopting "services-led" or alternative paths of development.

In this section, the main subject is regional inequality issues and their impacts that may not be reflected in national income accounts and growth statistics. Section 9 connects the analysis of the Indian experience in this paper to recent discussions on industrial policy and development policy in general. Section 10 provides a summary conclusion of the paper's findings. Additionally,

the conceptual framework of service-led growth often starts with general national income accounting categories.

However, it is crucial to separate services in order to determine significant distinctions within that category. Additionally, it is important to step back from the accounting aspect and comprehend the fundamental ways in which services vary from products, which are categorized as outputs of the manufacturing sector. Analyzing the precise nature of services in relation to other types of productive activities serves as a solid starting point. The distinctions will be observed to rely on the nature of market transactions and intrinsic characteristics of services versus products. Both of these aspects are susceptible to change as economies and technologies progress.

The classical writers, such as Adam Smith and, earlier, the Physiocrats discussed services from the perspective of a distinction between productive and unproductive labour. Smith’s idea of "unproductive labour" included the servants of wealthy individuals and government employees, as well as the military, the clergy, lawyers, doctors, writers and musicians, all of whom are now included in the service sector. Of course, modern economics, based on utility and demand theory, has jettisoned this view, and services, however defined, are counted as productive activities.

Various modern conceptual discussions of the unique nature of services share similar observations. For instance, Hill (1977) highlights the inability to store services, meaning they must be consumed when produced. Griliches (1992) defines services as outcomes of labor that do not result in tangible goods. The lack of tangibility is the root cause of non-storability and non-transferability (Economic Council of Canada, 1991). Nevertheless, in the digital era, the concept of intangibility must be interpreted with caution.

Thus, software programs and

various forms of digital electronic content have limited physical presence but can be stored and transferred. The creation and delivery of these digital products are often considered as services. The marketing literature extensively discusses the nature of services, and these dimensions distinguish services from products: (1) intangibility, (2) heterogeneity, (3) simultaneity of production and consumption, and (4) perishability (e.g., Parasuraman, Zeithani, and Berry, 1985; Rust and Chung, 2005). These characteristics have various economic implications. For instance, intangibility, perishability, and simultaneity hinder inventory management. Heterogeneity and simultaneity (where the consumer is involved in service creation) make it challenging to achieve economies of scale. All these features make it difficult to display and assess service attributes for consumers. However, it is important to note that using these four characteristics to distinguish services from products has certain limitations.

In terms of differences, the discrepancies primarily stem from the degree, particularly when comparing services to specific types of products. Additionally, the differentiation between products and services is commonly established based on the contractual nature of the market transaction. Essentially, every product, at its core, either provides services directly or is combined with other products to generate services. Consequently, while an automobile is initially acquired as a product, its worth is determined by the continuous stream of services it will offer over time.

All types of durable goods can be leased or rented, making the service agreement more explicit compared to a product transaction. As the product becomes more expensive, such as an airplane rather than a car, it is less feasible or economical for an individual to obtain the services through purchase. In fact, engaging specialist providers for services is often

a method to achieve economies of scale in offering services (or producing the underlying products) that would otherwise be unattainable.

The text highlights that the distinction between products and services is often determined by market and economic factors, rather than the inherent attributes of what is being traded. Previous studies acknowledge that the practical classification of services takes into account the contractual nature of the transaction. For instance, when it comes to utilities, Melvin (1995) notes that they are generally categorized as services in national income records, despite their tangible nature as gas, electricity, and water.

In these cases, the distribution systems play a crucial role in allowing the consumption of these goods, and the primary contractual relationship is focused on delivery services utilizing the distribution systems. One exception to this blending of products and services is found in personal services. For instance, a practitioner of Ayurveda, a traditional Indian medicine, can diagnose a patient using only an examination that includes visual inspection and pulse reading, without the need for any tools.

No product is involved in this service provision. However, pure personal services, which are devoid of any capital or tools, are becoming less common. For example, modern doctors heavily rely on expensive equipment in their services. Similarly, lawyers and accountants also utilize physical capital in delivering their services, similar to utility services discussed earlier. A central theme in this section is the growing industrial or manufacturing nature of these personal services.

Knowledge services, which have typically been provided to individuals one-on-one, are now being transformed through the use of information technology. This process is referred to as "industrialization" and is further elaborated upon in this section.

When discussing these explanations, we are specifically addressing how standardization, routinization, scalability, and replicability are incorporated into the delivery of these services. Furthermore, the distinction between products and services has been extensively studied in the field of international trade. These classifications greatly influence the development of international trade policies and agreements.

In 1984, Bhagwati proposed a classification of services in international trade based on the need for physical proximity between the user and provider. These services can be divided into two groups: those that require physical proximity and those that do not. The category of services requiring physical proximity can be further subdivided into different situations, including:
1) when the provider is mobile and the user is immobile, such as transporting labor to a construction site;
2) when the user is mobile and the provider is immobile, such as a patient going to a hospital;
3) when both the user and provider are mobile, such as students and professors gathering in a university for lectures.

The World Trade Organization (WTO) categorizes services trade using different "modes of supply" (Sampson and Snape, 1985; and Sapir and Winter, 1994). Advancements in technology have made knowledge-based services more tradable by reducing the need for physical proximity. Bhagwati (1985) and Melvin (1989, 1990) have both noted how technological change has eliminated the requirement for proximity due to improved long-distance communication affordability and ease. Melvin also differentiates between time/location-constrained services and those that overcome these constraints such as storage services or transportation services. He further acknowledges that knowledge or information services surpass the limitation of ignorance. The emergence of digital communications technology has played a crucial role in facilitating international trade of

information or knowledge services.

The skill content of services in international trade varies depending on the type of service. Some low-skill services can be automated or routinized, while others cannot. The easier to trade are those that can be unbundled or "splintered" to allow for offshore outsourcing of lower skill components like software testing in software development. There is also an emerging trend of trading services with higher skill content such as financial analysis or patent preparation.

Measurement and classification of services in practice focus on operational approaches rather than definitions, examining what is considered services in national accounts and related statistical sources. The Central Statistical Office in India provides a standard breakdown of services into 15 sub-sectors for their country, as shown in Table 1.7. The Indian classification does not include utilities, unlike other classifications that often categorize them as services.

The diversity of activities classified as services is important to note, as they vary in terms of capital intensity, skill requirements, need for physical contact, and the importance of tangible products within the service.

Understanding the nature and scale of India's growth experience is crucial. Although there are many in-depth analyses on the growth of India in recent decades, we will only provide a concise overview.India's growth rate experienced a substantial surge during the 1980s, as mentioned earlier. It has maintained its position as one of the leading performers worldwide.

Although numerous reviews examine the reasons behind the increase in growth, they frequently do not incorporate formal econometric modeling. The impact of economic reforms on this boost in growth remains a contentious subject. Some studies have employed econometric methods to detect significant changes in the growth process but

have failed to include any causal modeling (e.g., Wallack, 2003). In this section, we address both the general performance of growth and research that specifically investigates the service sector's performance.

The work of Panagariya (2005) provides a comprehensive assessment of India's growth experience in the 1980s and 1990s. In contrast, DeLong (2003), Rodrik (2003), and Rodrik and Subramanian (2004a) offer an alternative viewpoint. According to these authors, the economic policy reforms implemented in the 1990s did not have a significant impact on India's growth performance during that time period. They propose that India's growth acceleration actually began in the 1980s, before the introduction of economic reforms in 1991 and beyond.

After analyzing the data, Panagariya draws three conclusions about India's growth in the past 25 years. First, during the 1980s, growth was unstable and only the final three years contributed to a 7.6% annual growth rate. Without this growth, the performance of the 1980s would have been slightly better than that of the previous three decades. Second, significant economic reform took place before or at the same time as high growth in those last three years of the 1980s. This reform involved liberalizing trade and industrial policies. Third, expansionary policies that drove growth in the 1980s resulted in accumulating a substantial external debt and ultimately causing an economic crisis. Consequently, Panagariya concludes that market reforms implemented in 1991 and subsequent policy changes for liberalization sustained growth. Ultimately, even proponents of a revisionist perspective recognize the favorable impact of economic policy reforms.

For instance, Rodrik and Subramanian (2004b) utilize a growth accounting methodology to assess and forecast India's growth performance, diminishing the significance of economic liberalization policies. However, they

do not completely disregard these policies. Instead, they center their attention on "meta-institutions" such as democracy and the rule of law, along with traditional economic inputs like human and physical capital, and productivity growth. By emphasizing these fundamental aspects, they draw attention to the infrastructure and human capital developed during the pre-liberalization policy regime.

Although their assumptions about policy impacts differ, Panagariya's and the authors' beliefs align in that they both suggest that policy liberalization will gradually diminish corruption and patronage caused by the license-quota-permit system, which has negatively affected public institutions. In addition to this indirect effect, they also credit reforms that have lifted restrictions on the private sector with directly contributing to productivity growth. The IT industry serves as an example of the positive outcomes resulting from the reforms implemented in the 1990s, particularly in the telecommunications sector due to reform and liberalization efforts.

One notable participant in the industry has conducted a study on the positive effects of liberalization and how it simplifies business conduct (Murthy, 2004). Panagariya emphasizes that average growth rates are influenced by how the period is divided, suggesting that the data should reveal when growth acceleration occurred in India rather than being subjectively determined. Time series methods are utilized to test for structural breaks in order to achieve this. Wallack's (2003) comprehensive study is focused on services-led industrialization in India from 1951-2001. These tests are applied to both overall GDP data and sector-specific data, which is valuable for understanding India's recent economic development. Although these estimations rely solely on time series analysis without any structural explanatory variables, the identified break dates can be compared with known policy changes or macroeconomic

events.

Table 2 presents the possible connections between growth and economic environmental changes, including low interest rates, increased investments, and the IT boom. Wallack acknowledges that the results are not as robust as expected since in other years, F-statistics often approach the highest values. Nonetheless, two important conclusions can be made. Firstly, there is proof of a shift in the overall GDP growth rate in 1980 (and in 1987 for GNP).

The Indian economy's behavior requires further investigation to fully comprehend it, as there is limited evidence suggesting that the slowdown was caused by a decline in any specific sector's growth. Instead, it is more likely that the change in growth rate resulted from a shift in activity from slower-growing sectors to faster-growing ones (Srinivasan, 2003). However, statistical tests indicate exceptions to this observation (Table 2), such as breaks in financial, real estate, and business services in 1974 and 1980 influenced possibly by low interest rates in 1974 and an investment boom starting in 1980 according to Wallack (2). Another break occurred in trade, transport, storage, and communication services in 1992 which may be attributed to telecommunications reform and the growth of IT but these factors might have had a delayed impact. Further exploration is necessary for a complete understanding of the behavior of the Indian economy. Additionally, besides identifying structural breaks in certain service sectors through time series evidence, other empirical observations indicate service sector growth in India. For instance, the share of services in gross capital formation decreased from 57.8% in 1950-51 to 48.8% after ten years and further declined to 43.7% by 1970-71.The share of this stock has stayed steady at around 40% since

then. However, the data presented in Tables 7 through 9 (Hansda, 2002) make it challenging to come to clear conclusions about the shifts in capital and labor productivity in the service industry. This challenge arises from the fact that the sector's composition has experienced notable changes over time, leading to different degrees of capital intensity within its sub-sectors.

Hansda mentioned that the service sector experienced a decrease in the late 1990s due to unfavorable terms of trade. The decline was observed across various industries, including finance, insurance, real estate, business services, trade, transport, storage, and communication. Factors such as liberalization, competition, and technological advancement may have played a role in this trend. To gain a deeper understanding of India's service sector growth, it is suggested to conduct a thorough analysis using the CSO classification outlined in Table 1 (Gordon and Gupta, 2004), rather than relying solely on formal time series analysis.

Gordon and Gupta (Table 5) discovered that in India, between 1951 and the present, 12 out of 15 sub-sectors in the service industry had a higher growth rate compared to GDP. However, the most notable increase was observed during the 1990s, setting India apart from other developing nations with similar income levels when it comes to the proportion of the service sector. The primary acceleration was seen in business services, communication, and banking services. In addition, there was significant growth in hotels and restaurants as well as community services. These five sub-sectors were solely responsible for propelling overall expansion of services during the 1990s.

In the 1990s, the growth of the service sector was comparable to or less than previous decades, as discussed in Sections 4 and

5. These sections contain extensive information about the role and connections of the service sector within the economy. Furthermore, India's service sector performance has two noteworthy elements. Firstly, there has been a transition in foreign direct investment (FDI) away from manufacturing towards services, in line with a worldwide trend. Secondly, there has been an upturn in overall FDI inflows to India.

According to Figure 7 in Banga (2005), the streams of focus have primarily been telecommunications and financial services. Additionally, India's tax structure has historically imposed minimal or no taxation on services due to constitutional tax provisions. As a result, the recent growth in the service sector has led to a lower tax-GDP ratio compared to countries with similar income levels. According to Table 11 in Hansda (2002), services constituted over 50% of GDP during the 1990s but only contributed approximately 10% of total tax revenue.

The situation is evolving as constitutional tax assignments are revised and new services added to the indirect tax base. In addition to previous analyses on overall growth and sector-specific growth, Kochhar et al. (2006) conducted a recent study that investigates India's development patterns, specifically focusing on skill intensity. The study uncovers that India's economic policies after gaining independence have resulted in a unique specialization pattern, distinguishing it from other developing countries with similar income levels.

India's development pattern was affected during the post-1980 reform era. The manufacturing sector diversified and required skilled workers, decreasing its dependence on unskilled labor compared to the norm. Notably, data indicates that prior to the early 1980s, India had a smaller service sector than usual. Hence, although skill-intensive growth has continued in recent decades, there has been

a shift from previous trends with the rapid expansion of services since the 1980s (primarily skill-intensive).

Kochhar et al. examine the economic performance of India during the 1980s and 1990s, with a specific emphasis on the distinctive circumstances of the 1980s. In this period, there was notable growth in both GDP per worker and total factor productivity (TFP) compared to the previous decade. When conducting cross-country level regressions for the year 2000, it was discovered that India's services as a percentage of GDP were considerably higher than the average for that year (by 3.8 percentage points), but only when considering a country size variable.

Historically, services employment in India has been significantly lower compared to the average by 17 percentage points. This aligns with the previous observation of skill-biased development before 1980. An analysis using regression on the change in services share further confirms this finding, demonstrating that India deviated from the norm between 1981 and 2000 (Kochhar et al., Table 5). The analysis suggests that there was an increased skill bias in India's manufacturing sector, including the informal sector, during the 1980s and 1990s.

The observed pattern of growth may be influenced by incomplete labour market reforms and imbalanced spending in the education sector, suggesting that policy changes could potentially alter this pattern. Additionally, future biases in development paths may be heightened by hysteresis. State-level sectoral growth data indicates that certain states, such as Tamil Nadu and Maharashtra, exhibit growth patterns akin to advanced skill-intensive countries.

In this text, Kochhar et al. raise concerns about the uneven development in India and its impact on income and regional inequality. The focus of this exploration is on employment, education and

training (Section 7), social issues (Section 8), and the broader implications for development policy (Section 9). However, it's important to note a cautionary point regarding their analysis. While studying historical development patterns and comparing countries is crucial for empirical analysis, there may be certain types of innovation not represented in the data. One example is modern business process outsourcing, which provides opportunities at different skill levels that were previously unavailable. This example connects back to our earlier conceptual discussion. To make an imperfect analogy, Japan in 1950 was not expected to develop a world-class automobile industry due to its capital-intensive and technologically advanced nature.

Nevertheless, Japan not only succeeded, but there were arguably positive spillovers from this effort to other engineering-intensive manufacturing. The imperfections in this analogy include substantial differences in initial conditions and social heterogeneity, but the caveat on extrapolating from the past should be kept in mind.
4. Understanding service sector growth and its impacts The discussion in the last section has suggested that India’s more rapid growth in the 1980s and, especially, the 1990s has been the result of policy changes as well as initial conditions.

India's economy has witnessed an uneven development, with a concentration on the service industry and specialized skill-based activities. During the 1990s, the service sector played a significant role in India's GDP growth, surpassing its contribution in previous decades. Notably, specific sub-sectors within the service industry were instrumental in driving overall growth. Interestingly, five rapidly expanding sub-sectors accounted for almost all of the increased growth in services during that period.

The investigation in this section focuses on determining the factors that can clarify the growth of the service sector and

sub-sectors in India. One potential explanation is an increase in specialization or fragmentation (Kravis et al., 1983; Bhagwati, 1984). If this occurs across various sectors, it would result in changes to the overall economic calculation. To be more specific, if certain services within manufacturing, such as accounting, research and development, or logistics, are delegated to other companies, their contribution to GDP will be recorded as part of the service sector instead of being included in the value added by manufacturing.

Sastry et al. (2003) constructed input-output coefficients which were used by Gordon and Gupta (2004) to estimate the effect. Based on changes in those coefficients, the input coefficients of services in agriculture and manufacturing increased enough in the 1980s to contribute 0.5 percentage points to service sector growth in that decade. We were able to repeat this calculation for the 1990s using input-output coefficients constructed from 1998-99 data. This resulted in essentially no contribution of splintering in the 1990s, if measured in this specific manner (9). However, this data and methodology cannot analyze how cross-country splintering, which became more important in the 1990s, such as through offshore outsourcing of business services, would explain the observed patterns of service sector growth. In the latter case, there is a real shift in economic activity to India, whereas domestic splintering is more of an accounting change. Even in the latter case, however, when specialization leads to efficiency improvements, purely domestic splintering may reflect a positive economic change.

Another reason for the increasing share of services in GDP as an economy grows is a higher income elasticity of demand. This means that the share of services in private final consumption expenditure

grew faster between the years 1980 and 2000 compared to services as a share of GDP (Hansda, 2002, Table 5). During this period, the shares of various types of final consumption services remained relatively stable, except for a significant increase in the share of "operation of personal transport equipment" services in the 1980s (Hansda, 2002, Table 6).

According to Gordon and Gupta (2004), the consumption of services experienced similar growth rates as overall services in the 1990s, but slower growth in the 1980s. This supports our calculation and their argument that specialization and splintering were less significant factors in services growth during the latter decade. Furthermore, the accelerated growth of services in the 1990s, accompanied by a decrease in relative prices, is not in line with a purely demand-driven explanation for this growth. Another factor that could explain the performance of the service sector in India is policy liberalization. Murthy (2004) emphasizes the importance of liberalization, particularly in telecommunications reform, for the growth of IT and ITES industries. This point is also made by Gordon and Gupta (2004) through their analysis of data patterns. While there is no direct measure of liberalization, they observe that the communications sub-sector grew rapidly in the 1990s coinciding with deregulation, the private sector's share in the service sector increased during this period, and there was a positive correlation between FDI and services growth.

During this time, there was a significant surge in the exportation of service sector goods.

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