Service Sector in India

Group 3 (M Nitinvarman PGP34067, Mahendra Singh Kaviya PGP34068)

Service sector growth in India - Service Sector Amounts to More than 50 % of India's GDP. There
has been a Rise of 11% point in Service sector share in GDP from 1950-1990. There have been
same increase post-reform era as well. Until 1990, Industry share grew faster than Services,
Industry grew nearly by 100%, while Services grew by 37% but in 1990, there was a deceleration
in Industry growth. During 1995-2005, compared to the industry average, the service sector had
exceeded by greater than 2.5%. On an aggregate level, in the 1970s and 1980s around 48 and
49% of GDP growth respectively were contributed by service sector while during 1995-2005 it
rose up to more than 66%. Overall, services’ contribution to the GDP growth is comparatively
higher than that of the other two sectors.

Services and industry do not have the same share in investment and GDP. Agriculture gets the
lowest share in Investment, which only comprises 10% of the total investment and Over the year,
investment share for agriculture has further reduced. The industry had the highest share in total
investment which is after followed by Services. For the agriculture sector, there has been a
positive correlation between share in investment and GDP for agriculture, but comparatively, it is
still very less. On the other hand, for Industry and services, there is a disproportionate share in
investment and GDP exists, where 50% of the investment, yields only 25% of the GDP. Total
volatility of agriculture was ~8 times that of Services in Pre-Reform Era. The variation in GDP
share for services has increased, but since it is a modest level, it will result in more stable Stable
GDP growth after reforms compared to in the 1970s and late 1980s. India is way ahead in terms
of exporting merchandise and services to the world and it has increased continuously.

Interaction in manufacturing and Value added services - There is uncertainty about

cost-effectiveness, and desirability of country's economic growth be service driven. Inter sectoral
demand and supply-side fluctuations will be explored to identify key factors that are likely to be
important in terms of production and GDP in the services sector. Growth in the service sectors
and the share in GDP is not indicative of the surplus of services but the value added, but of
production below the average used in production, where supply and demand are almost linked to
production capacity, rather than value-added analysis of the impact of these two sentences on
manufacturing Impact on GDP. Some demand areas are the same as the result is very important
in the demand-side delivery areas besides supply, final demand (purchase of ideal user services,
including home use services, government spending, services and export) and interactive demand
(companies require production service).

For a sustained GDP growth, there are few factors which we need to understand, like I)
Intermediate demand is related to output of all sectors which require services as inputs, II) Final
demand for one sector’s product requires a combination of output of all the three sectors to meet
both the direct demand and the direct cum indirect inputs of different sectors needed, III) Changes
in the regulatory framework or the nature of economic reforms implemented by authorities can
have impact on growth of aggregate GDP as well as its sectoral composition, and IV) Evolution of
a country’s comparative advantage as well as trade policies determines the relative performance
of different sectors.

Service revolution in India needs to be understood to identify the point at which there was a break
from the earlier trend in growth of the sector and in its relative share compared with that of the
industry. In the mid-1990s, there was a major divergence between the performance of the tertiary
and secondary sectors. There was a decline in industry growth from 6.1% to 5.4% points whereas
services saw an increase to 8.2% points. Since the important component of final demand for
services is public consumption, which increased in the period as a result of hikes of government
and semi-government employees. The emergence of foreign demand is perhaps the major source
of services growth. In the 2000s, public consumption saw a decline whereas services GDP was
still increasing, showing that it is not a significant factor in the Services revolution. The largest
component of final demand for both goods and services is private consumption with household
purchases of services amounting to 40% of services GDP, this can be a major factor.

Some of the Supply Side Factors are Input-Output Coefficient, Capital accumulation, Technical
progress etc. They shift production possibility frontier outward. But there are problems in Supply
Side Explanation like I) Capital formation is less in service sector as compared to its GDP growth,
II) Incremental capital-output ratio, If it was purely demanding determined growth, employment
rate would be similar to GDP growth rate, III) Implies that productivity improvements had a major
part to play since labour coefficient and ICOR both went down in this period, and IV) India’s share
in world services exports increased from 0.57% in 1995 to 2.32% in 2005 indicating efficiency
gains.

There are some historical reasons for Service Sector Growth such as Less capital intensive, it
was a new sector and switch over to or adopt new technology was easier for entrepreneurs (it
was easier to focus on minimizing cost as well as quality). From the start, Services except for
trade, banking and insurance were lightly regulated (there was large expansion due to the entry of
private players in telecommunications and air transportation services played an important role in
preventing supply bottlenecks in the process of growth especially for IT and ITES services).
Government policies regarding FDI was always less restrictive in this sector, and there were tax
concessions on export earnings, facilities for setting new production units. High growth service
sector employed highly educated rather than unskilled labour, hence value added was higher than
the employment rate.

The interaction between Demand & Supply Side Factors - As per mainstream macroeconomic
consensus, short term growth of an economy is governed by demand-side factors whereas long
term growth is determined entirely by supply-side factors such as capital accumulation, labour
growth, and technical progress. For expansion of a sector, the outcome will be based on the
interaction of both demand and supply-side factors. In the short run, through changes in relative
prices, supply and demand conditions play a major role in affecting sectoral than aggregate GDP,
even in long run, demand plays a significant role.
Since India had services-led growth, the obvious question arises that How a large economy like
India became a service sector heavy economy bypassing agriculture and industrial development.
There can be some reasons given such as Every country need not traverse the same
development path. India acquired a strong comparative advantage in services. The growth
differential between India’s and world’s exports was higher in services than industry and
agriculture. There has been a sharp rise in Service’s Revealed Comparative Advantage from 0.94
in 1996 to 1.97 in 2005. The world economy has shown increasing openness towards Services
such as education, health, the consultancy which were previously non-tradables were now being
exported and imported. So, with higher growth and income from the tertiary sector, a country
would be in a better position to import agricultural and industrial goods. There were more
obstacles for industries than services in a liberalized economy. For Industries, tariff barriers were
higher, it required more capital and it has a reservation for small scale units, and are difficult to
restructure. Whereas regulations regarding FDI was in favour of services. Services required less
capital and there were lesser reservations. Despite all these factors, India’s merchandise export at
13.9% was 4.7% higher than that of world exports, suggesting given a level playing field, these
two sectors can play a major role in India’s economic growth.

Sustainability and Optimality of services based can be more analyzed. An economy with high
growth in the service sector where unemployment growth is low and widened wage differential
can’t be regarded as optimal. It is very difficult to have an effective social security system
encompassing the entire population without cutting investment in the service sector. A solution
could be the promotion of industries and agriculture even if it means sacrificing overall economic
growth. Rising RCA in the service sector is not inherent but the outcome of Govt. policies. It is
important to take stock of the sources of the sector’s competitive advantage over industry and
agriculture and examine whether it truly reflects comparative advantage or absence of level
playing field.

Inter-Sectoral Allocation of Resources, their efficiency, and growth - In view of a large pool of
educated and skilled labour force, low capital requirement and FDI regulations suggest that there
is strong ground for the fast growth of services. Government’s support in upgradation of
universities and institutes is also justified as average return on higher education is much higher.
But tax concessions and favoured treatment of services have been distortionary and reduced
the government’s ability to invest in agriculture and industries and to negotiate with international
markets to lift tariff barriers imposed on industrial and agricultural products exported. However, a
neutral policy will not be enough to achieve economic goals. The vast level of unemployment,
pathetic state of primary and secondary education will add huge cost for training them to be
absorbed in services. Expansion of effective credit delivery system which has proved to be a
hurdle to productive investment is a measure for allocative efficiency. Another measure is the
large scale investment in irrigation, roads, railways, communication, ports, power etc, which are
highly labour intensive and would absorb manpower whose opportunity cost is close to zero and
provision of these infrastructures would help in productive use of underutilized resources, both
human and non-human which will remove major hurdles for agriculture and industries.
Is Service Sector India’s Road to Economic Growth? - From observation, the growth rate of the
the service sector has increased consistently post-reforms, the growth rate of the agriculture
sector has decreased post-reforms and Growth rate in industry and manufacturing sector picked
up after initial slack.
Service Sector can further be divided into three groups: I) Traditional Services - Retail and
wholesale trade, transport and storage, public administration and defense II) Hybrid of Traditional
& Modern - Education, health and social work, hotels and restaurants, and other community,
social and personal services III) Modern Services - Financial intermediation, computer services,
business services, communications, and legal and technical services.
Indian exports’ contribution has a significant role to play in the growth of the services sector.
India’s share in exporting services has risen from 0.8% in 1998 to 2.7% in 2006. In the
miscellaneous segment, Software services have contributed the most.

International Comparison at similar per capita incomes, Group I) Share of Group I services in
India is likely to stabilize (assuming real per capita income growth of 5%) if we assume
that India is along the international norm, Retail trade is the main activity with significant potential
to grow, this sector has been sheltered from foreign competition and remains dominated by
mom-and-pop stores suggest that consolidation and increased competition from foreign retailers
have the potential to increase the sector’s contribution to growth. Group II) The share of Group II
services is similarly unexceptional. Need for liberalization in some activities in the sector like
health care and education, for expansion. India is ought to become net exporter of services like
education and health care only when its per capita income exceeds $5,000 (again in the year
2000 US purchasing power parity dollars), a level that will take India ten years to reach (assuming
a real per capita income growth rate of roughly five percent). Group III) India’s share in this group
has taken off at much lower incomes than in OECD countries.

In conclusion, significant growth in Traditional and Modern Services has led to an increase in the
services’ share in the overall GDP. Due to lack of infrastructure, manufacturing is not the
exclusive destination for the vast majority of Indian labour moving into the modern sector. To
provide employment for small towns and rural villages’ semi-skilled worker, there are certain
modern sector services have come into play. Employment provided by modern services can be a
good way to support manufacturing employment and alleviate the overall poverty. Due to the
requirement of skilled labour, expansion of manufacturing and services sectors will continue to be
constrained.

Reference -
1) Services-led Growth, The Indian Experience, Macroeconomics of post-reform India
2) The Service Sector as India’s Road to Economic Growth? E. Barry and G. Poonam.