Servicification is the key to India’s $5 trillion economy target

Manufacturing is considered the growth engine of a nation due to its inherent ability to generate large-scale employment, and inclusive growth. Even though this may not be far from the truth, going by the post-pandemic (COVID-19) trend, tides are shifting away from manufacturing, towards services-led growth.

In India’s case, manufacturing’s contribution to GDP has stagnated at 15-17 percent over the last two decades (2004-2018). During the same period, services contributed 63 percent to GDP, and nearly 77 percent to GDP growth. It is also pertinent to note that services exports have gained prominence over the past decade, playing a pivotal role in the country’s export performance.

Data obtained from RBI’s Database on Indian Economy documents 38 percent contribution of services exports to India’s total exports. Moreover, within the services exports, exports of software, business, and financial services have driven the surge in service exports contribution (contributing around 60 percent of the service exports). The figures unambiguously highlight the key role played by the services sector in propelling the growth trajectory.

However, the critics of the services-led economic growth often question about its ability to generate large-scale employment. For instance, the second quarter report of the Quarterly Employment Survey (QES) highlights that the manufacturing sector accounted for 39 percent of the employment as opposed to 10 percent employed by IT/BPOs (modern services). Moreover, jobs generated via the services industries are relatively skill-intensive in nature in a country that has unskilled labour in abundance. The mismatch of skills implies a possibility of an unabsorbed labour force.

According to the CMIE estimates, the jobless rate has climbed to 7.8 percent in June, predominantly driven by an increase in the rural unemployment, which increased to 8.03 percent in June.

Another concern associated with the service sector is its regulatory aspects. According to the OECD’s Services Trade Restrictiveness Index (STRI), India’s overall score exceeds the world average. Therefore, dependence on services alone cannot be the way forward.

In this regard, with the rapid advancements in production fragmentation, and the rise of global value chains (GVCs), a rising phenomenon of ‘servicification’ is observed where manufacturing firms are increasingly engaged in services activities that adds value to their core competency of manufacturing firms. For example, a World Bank research highlight the success of the servicification phenomenon using Amazon echo, which allows consumers to undertake many activities (listening to music, and adjusting calendars, among others), and through these services increases the value of the manufactured devices.

Using data from OECD-Trade in Value Added (TiVA) database, we observe that services value addition to India’s gross exports in 2016 was well over 50 percent, which is highest among the Asian economies. The figure from the TiVA database also highlights that most of the value added from services to manufacturing exports was domestically generated highlighting the significant boost to exports that can be achieved through synergies of manufacturing and services activities.

Research in this regard documents significant productivity gains for manufacturing firms that are increasingly ‘servicified’. In a paper published in The World Economy, we show that ‘servicification’ enabled Indian manufacturing firms to increase their presence in GVCs. These findings are of immense significance for India since there is a concerted effort to expand its global presence to achieve the target of becoming a $5-trillion economy. Moreover, the findings also highlights that greater ‘servicification’ is a crucial channel through which small and medium firms (SMEs), and firms operating in low-technology intensive industries can increase their presence in GVCs.

Hence, by creating an infrastructure that enables complementarity between manufacturing and services activities, manufacturing firms can increase their global presence. By creating a complementarity between the two sectors, India can not only absorb more workers in the manufacturing process but also reap its global advantage in the services sector.

To this end, it is important that India improves upon its Services Trade Restrictiveness Index since services trade is often subjected to high trade barriers. Such barriers limit the expansion of the service sector, and hamper its growth. Therefore, tackling these barriers is a panacea for establishing the ‘servicification’ link between manufacturing and services.

Moreover, given India’s initiatives towards signing more Free Trade Agreements, it is essential that services and aspects of ‘servicification’ are looked upon carefully, which results in trade-enhancing agreements. Hence, leveraging the robust domestic services setup, and enabling a greater interlink with manufacturing could aid India’s $5 trillion economy trajectory.