T C A Srinivasa-Raghavan: They also grow who stand and serve

OKONOMOS/ India will have to become to global services what China is to global manufacturing

Poor Simon Kuznets. He had come up with this neat theory, which had become widely accepted, that economic progress (growth? development?) comprises a movement away from agriculture into manufacturing and then finally unto the nirvana of the services sector. It was, if you will, like going first to school, then to college and then into a job.

India, ever the spoiler of neat Western theories, seems to have gone straight into services without bothering with the manufacturing pit-stop.

This happened mainly due to the fast growth in communications, banking, education and health, and business services (IT). The remaining sectors grew at the trend growth rate.

Services came into their own in the 1980s and have not looked back since. In the 1990s, the sector averaged 7.5 per cent growth a year, compared to industry and agriculture, which grew on average by 5.8 per cent and 3.1 per cent respectively. Growth has also been less cyclical.

This has baffled economists "" and perhaps only them. They have been busy looking for explanations.

A new one has just come along from James Gordon and Poonam Gupta of the International Monetary Fund (IMF). They argue* that "important roles also seem to have been played by economic reforms and the growing demand for services exports."

They give a number of reasons why services have grown so quickly. One is the splintering of demand whereby, due to changes in production techniques, the proportion of output originating in the services sector increases. Services become intermediate inputs. But the authors don't think such splintering has been an important contributor in India.

They next examine the role of final demand and it turns out that there has been a sharp rise in the growth of final demand for services in the 1990s. The income elasticity of final demand for services has been greater than one.

But then, the huge increases in ratio of output of services to GDP also involve huge increases in the elasticities of final demand for these activities.

But has such behavioural change really occurred? Unlikely, say the authors, which means there are other factors at play besides splintering and income elasticity.

There is then the role of foreign demand. It is small right now but will grow if the last few years are a guide.

Many people in India have wondered if the services sector can provide all the jobs that are needed. The general consensus is that it can't and that manufacturing will have to provide the bulk of employment.

The counter-argument, to which I subscribe, is that the world can't support two Chinas in manufacturing. India will have to become to global services what China is to global manufacturing "" cheap, plentiful and of acceptable quality.

Gordon and Gupta say "the Indian services sector may experience an extra impetus to growth in coming years from exports and from liberalisation. New markets for Indian services exports are just beginning to be tapped and there is substantial scope for further high growth rates in tradable services."

Much, however, will depend on how quickly liberalisation proceeds. "If the growth of services was previously inhibited by government controls, then policy changes may provide a positive shock that unleashes new activity and growth."

As so many have been pointing out, Gordon and Gupta say the distribution sector seems a good place to start with. True to IMF philosophy, the paper obliquely suggests that one way would be the opening up of retail to foreign direct investment. But why not encourage Indian capital to consolidate first before opening it up to foreigners?

There remains the issue of tradability. Does a service become more tradable if delivery becomes easier? Should India manage the American electrical grids? Should Americans manage Indian R&D?

In the years to come these issues will doubtless be debated and some answers found. In the meantime, the basic point remains: it makes as much commercial sense for other countries to source their services in India as it does for them to buy their manufactures in China.

The second is already happening on a huge scale. The Cabinet having become redundant, it is up to the National Advisory Council headed by Sonia Gandhi, to allow the first to happen.

*Understanding India's Services Revolution, IMF Working Paper No. 04/171, September 2004