The emergence of global value chains (GVCs) has lowered the threshold for developing countries to participate in globalisation (Stolzenburg and Quast 2017). They offer a new path for development without having to establish complete production capabilities from upstream inputs to downstream final goods and after-sales services. This relationship between GVCs and development is often discussed in the context of manufacturing or agriculture, but the past few decades have witnessed an unprecedented shift of employment and output shares toward services. As shown in Figure 1, services in developed countries employ about 75% of the workforce. In low- and middle-income countries the share averages at 45%, but many countries, including India, the Philippines, and China, have much higher shares.
Figure 1 Employment shares of macro sectors, 1995–2019
Note: HI = high-income countries, LMI = low- and middle-income countries.
Services not only create most jobs globally, they also do so earlier in the economic development process, a pattern sometimes referred to as premature deindustrialisation (Rodrik 2016). This has triggered a debate on whether services-led development can replace industrialisation (Nayyar et al. 2021). Rodrik (2016, 2018, 2021) questions this presumption and argues that services do not offer the same opportunities as manufacturing because services lack the productivity growth, spillover potential, and low-skilled labour absorption that manufacturing offers. However, this criticism has been faced with critique itself based on the argument that the nature of services is changing and they increasingly share traits with manufacturing (e.g. Nayyar et al. 2018). Moreover, Baldwin and Forslid (2020) add that the services-led development model will be boosted by the spread of automation in manufacturing and declining services trade costs due to digitalisation.
In Chapter 4 of the Global Value Chain Development Report 2021 (Nano and Stolzenburg 2021), we explore these arguments in more detail with a particular focus on services GVCs. These value chains are an important driver of the expansion of services. While the servicification of manufacturing (Lodefalk 2015) plays a key role in services growth, we highlight that services form increasingly their own value chains. In fact, the ‘production’ process of certain services allows for fragmentation similar to that of goods. Delivering software, for instance, involves many discrete steps like developing code, testing, maintenance, and training and education, most of which can be performed remotely. This enables countries to join services GVCs just as they joined goods GVCs.
With India in software services and the Philippines in business process outsourcing (BPO), we examine two examples of this strategy. Both are now among the leading countries for offshore services worldwide because of their low costs, human capital availability, and attractive business environments for services. Their experiences show that services GVCs boost economic growth and generate millions of well-paying jobs. Figure 2 highlights this by showing that employment grew more than tenfold in these two sectors over a period of about 15 years jointly with sharp revenue increases. In fact, no other sector has created as many jobs in these two countries over the studied period. This suggests that services sectors are in fact able to absorb large amounts of labour.
Figure 2 Employment and revenue growth of the BPO/IT sector in the Philippines and India
And the two cases offer more insights for other developing countries. Most importantly, human capital accumulation is essential for both joining and upgrading along services value chains, as the relative importance of human relative to physical capital is more important in services than in agriculture or manufacturing. This holds especially in the context of automation, which threatens labour in some services sectors just as it does in manufacturing. India and the Philippines both have relatively large English-speaking populations with sufficient technical skills. The two cases also highlight that the skills needed are relatively easy to attain which is why services value chains could provide an important opportunity for English-speaking Africa.
We complement the case study evidence with a broader review of the literature to assess the (1) innovation and productivity growth, (2) spillover, and (3) job creation potential of services value chains more generally.
- We find that the case of services as a drag on productivity growth is far from clear. Services are very heterogenous and some services like finance or IT have seen rapid productivity growth and innovation. Recent research suggests that a certain substitutability between high- and low-productivity services is enough to prevent declines in aggregate productivity growth rates (Duernecker et al. 2018). More importantly, the services that have seen sluggish productivity growth could benefit most from services GVCs. The impact on the productivity of teachers, doctors, architects, or lawyers offshoring routine tasks to focus on the most important aspects of their jobs, such as the interpersonal relationships, is likely tremendous. Notwithstanding all its ills, the Covid-19 pandemic has shown that many tasks in these sectors can be performed remotely. And if something can be done remotely, it can be traded. This is reflected in the rapid growth of trade in health and education services (WTO 2019).
- We also find that services have substantial positive spillover effects. There is robust evidence that relaxing discriminatory barriers on trade in services positively affects the productivity of manufacturing firms that make large use of services in their production processes (Arnold et al. 2016, Beverelli et al. 2017). Shepherd (2019), using a structural gravity model, shows that the impact of services liberalisation on manufacturing exports and output is larger than a reduction in tariffs. These results are not surprising in light of the servicification evidence that we have mentioned before showing that services are crucial inputs for other economic sectors and can thus deliver important benefits for the rest of the economy as well.
- Finally, despite the positive experiences of India and the Philippines, we find that the evidence on services trade and employment is mixed. Much of this evidence is based on developed country data where experiences might be different. In developing countries, the research points to better working conditions but greater employment volatility (Messenger and Ghosheh 2010, Bergin et al. 2011). Here again it is important to mention that services exports-based job creation in developing countries can expand rapidly in the future. If indeed labour-intensive services like health and education become more traded, the labour absorption capability of services will increase including in low-skill sectors.
Importantly, the assimilation between services and manufacturing does not encompass all traits. For instance, the growing capital intensity of manufacturing affects only some services. In addition, services are typically greener and more inclusive than manufacturing. For example, we highlight that services GVCs tend to employ more women, including in leadership positions, and that services micro, small and medium-sized enterprises (MSMEs) appear to face fewer barriers to export than manufacturing MSMEs. Services also require relatively more localised infrastructure investments, especially regarding digital connectivity, and are less dependent on large upfront FDI investments into factories and machinery than manufacturing.
Of course, services GVCs are not a panacea for development as they come with their own challenges. For instance, the services that currently exhibit established GVCs, such as IT or BPO, are spatially clustered and skill intensive. Figure 3 shows that the top 10 Indian districts in terms of employment in high-skill and highly traded (HSHT) services account for 22.4% of total employment in the sector relative to 15.2% in manufacturing and 7.8% in agriculture. These services also require substantially more education than other sectors. However, the evidence shows that the growth of these services also changes the incentives for parents. In a background paper to the report (Nano et al. 2021), we find that the growth of employment in banking, insurance, and telecommunications services has boosted educational attainment in India. And, once again, increasing the GVC integration of other services sectors could address these issues as retail or personal services are less skill-intensive and less clustered. In fact, the top 10 districts for non-HSHT services employment account for only 10.4% of these services’ employment.
Figure 3 Spatial concentration across sectors in India, 2011
To conclude, we consider that services-led development via services GVCs is a viable strategy for developing countries. As demand in high-income countries continues to shift towards services, embracing this paradigm might in fact become a necessity rather than a choice. This requires a different set of policy tools than traditional development policy targeted at industrialisation (Rodrik 2021):
- Services sectors are subject to high and persistent trade barriers. These are often rooted in regulations and are therefore less visible and concrete than tariffs on goods. Tackling these barriers is paramount for both developed and developing countries to facilitate services-led development.
- The cost of schooling, accessibility of schools, and information asymmetries are main obstacles to educational attainment, particularly in rural areas of developing countries. Low-cost policies such as providing better information on job opportunities have shown to be effective in lowering these barriers (Jensen 2012). Rolling out these policies on a larger scale, while also investing in costlier programmes, such as increasing the number of schools and investing in infrastructure for accessibility, is necessary to fully capitalise on services-led development. By focusing these programmes on rural areas, policymakers can ensure that the impact on regional inequality is dampened and that services GVCs are inclusive.
- The development of domestic markets for services and higher R&D investments is necessary to be able to move up services value chains. Countries have different tools to support these factors, including government procurement and R&D incentives.
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1 HSHT services cover banking, insurance, IT and computer services, professional services and telecommunications.
2 Low-skill services include construction, electricity and gas, mining, real estate, transport, horeca, health and education, government, support and admin, recreational, trade and repair, transport, personal and private, community and social services.
3 The COVID-19 pandemic has temporarily halted this development.