Success with services could make the elephant dance

This structural transformation has been successful, as India’s services sector accounts for more than 50% of the country’s GDP and employs 30% of the population.

However, a non-traditional approach to development followed in India raises big questions over its sustainability. The outlook for India’s service led growth is more sustainable from economic, social, and environmental perspectives. 

Labor productivity levels in services are well above those in industry, and productivity growth in service sectors in India match labour productivity growth in China’s manufacturing sectors. 

The services sector’s share of Indian GDP has more than doubled over the last three decades. This rising trend shows that higher real growth in services is not offset by price declines.

There is no ‘Dutch disease’ facing India’s services sector, as service prices have not fallen with an increase in its supply. This suggests that services are responding not simply to domestic demand (which would be higher in China), but also to export opportunities. 

India’s service exports grew from $53 billion in 2005 to $338 billion in 2023, almost double the rate of the rest of the world. In 2023, India’s service exports increased by 11.4%, far outpacing China’s 10.1% decline. India’s IT-ITes, travel, transport, medical and hospitality services are among the key sectors driving this growth.

India, with a large workforce, cheap labour and English language skills, has a strong foundation for services-led growth. The number of jobs being created is high, as the services sector benefits from the highest employment elasticity to economic growth. 

India has also seen a fast rise in the number of startups in the services sector. It has attracted significantly more FDI than manufacturing has. India’s service industry has also become a key centre for innovation, especially with tech services.

How will rising protectionism and changes in globalization impact India’s economic growth? Changes in global trade are likely to significantly favour services-led growth over manufacturing-led growth, as the services sector is becoming increasingly interconnected and tradable, offering greater opportunities for economies to specialize and benefit from global markets.

The rise of digital technologies allows for easier cross-border delivery of services like software development, cloud computing and online education, opening new markets for service providers. Trends of remote working and digitization, coupled with cost-cutting measures by businesses, have increased demand for service exports.

India has the potential to capitalize on new artificial intelligence (AI) global value chains, given its existing IT expertise and talent pool. While certain manufacturing tasks can be easily outsourced to lower-cost regions, many service industries require specialized skills and knowledge, making it harder to relocate them.

Services-driven economies can also diversify their export markets more easily compared to manufacturing-focused economies.

But the Indian elephant still faces several challenges that can constrain the pace of India’s economic growth. The country currently lacks a coherent and comprehensive policy for services-led growth, which has weakened the foundation for stronger future growth.

The lack of an integrated services policy has led to ad-hoc reforms at the sectoral level. For example, reforms of retail trade would have been more effective if they were supported by reforms to real estate. 

India has experienced uneven sectoral growth, as the the services sector has been dominated by IT-ITes and financial services, while other sub-sectors—such as tourism, transportation and communication—have seen lower growth. The welfare gains from services-led growth have also been heavily skewed toward high-income urban dwellers.

A new and comprehensive service growth strategy can form a new compact between the central government, state governments and cities where growth is concentrated. This will strengthen the linkages of services with manufacturing and make space for an integrated policy focus for the two sectors.

The manufacturing sector can leverage services to connect manufacturers directly with consumers, use digital services for efficient supply chain management and develop industrial clusters in lagging regions to help create balanced growth.

India also needs to diversify its export markets. It needs to expand beyond its traditional trade partners, such as the US, China, Singapore and the UAE. Exploring new markets will help India discover new customer needs and trends, which can lead to improved services. A diverse range of export partners can also help stabilize export incomes.

India can also take advantage of digitalization and generative AI to improve its service exports. The government’s Digital India initiative and infrastructural developments in transport, logistics and IT have helped India’s service exports.

India can use its large young workforce to its advantage by upskilling it. The National Skill Development Corporation has implemented skilling initiatives that combine government resources with private sector expertise.

India can also negotiate free trade agreements to improve its market access and other trading terms. The country should also create a supportive policy environment to attract FDI in the services sector.

More dynamic services could aid the development of the manufacturing sector as well.

Ejaz Ghani is a senior fellow at Pune International Development Center.