Look before you leap: is the service sector lead growth model sustainable for India?

Conventional economic theory would argue that development progresses by climbing up the industrial ladder : starting at agriculture, moving onto manufacturing, and finally into services. However India has gone from being a largely agrarian economy into a service lead economy; leapfrogging the manufacturing stage in its economic transition. Especially at a time when India is facing its lowest growth in two decades, it begs the question; is India’s service sector lead growth model sustainable? Economist Yasheng Huang [1] thinks it’s not . In an interview for a new book by McKinsey & Company: “Reimaging India”, he  argues that the service sector alone would not be sufficient to maintain a healthy growth level for India in the coming decades .It would need to tap more into  its comparative advantage in labor intensive manufacturing if it is to achieve sustainable and broad based economic growth.

In 2012 the services sector accounted for as much as 56% of India’s GDP , as compared to just 26% by  the industrial sector [2]. In comparison the major developing Asian economies has on average a 40-47% share in industry [3]. While the service sector, especially it’s vibrant IT industry, has been at the heart of India’s development, its precedence is also a symptom of the problems within India’s industrial landscape.  As Huang [1] argues, the manufacturing sector is in its weakened state because of the burdens placed on it by India’s onerous labor regulations. On the other hand most of the service sector industries were largely insulated from the more restrictive labor laws , which were designed specifically for factory workers [4].

The issue of recalibrating India’s growth model is particularly significant, in light of the demographic prospects for this young nation. A report by The Economist [3] notes how the impending demographic windfall could mean that up to a fifth of the global working age population would be living in India . Furthermore, everyday thousands of young villagers are migrating to India’s urban centers in the pursuit of better opportunity.  Yet, far from becoming the fodder for an East Asia like manufacturing boom, vast numbers of young Indians are underemployed: in low productive and unskilled service sector jobs. The Economist [3] points to the now ubiquitous site of thousands of young men working as security guards, across India’s major cities. While the high end service sector sector industries such as the IT sector is not sufficient to generate a substantial volume in jobs, the majority of the industrial value added comes from the large manufacturing companies, which tend to be more capital intensive. What is missing is the small scale manufacturing sector that could generate much more bulk in terms of employment. Yet this is what India needs the most. A young country of 1.2 billion people needs an industry that could provide productive employment to a large share of it’s population [1].

Making his contribution to the economy

Making his contribution to the economy (source:The Hindhu)

While no one is yet writing off India’s prospects for a full recovery, many commentators suggest that India is now in need of a fresh round of economic reforms. Key among reforms should be  labor reforms that would do away with India’s crippling and often antiquated labor regulations. Without reforms manufacturing would remain squeezed, and without  a viable manufacturing sector, India would not only miss the opportunity to capture a once in a generational demographic windfall, but failure could have potentially disastrous social and economic costs.

1.            Huang, Y. A conversation with Yasheng Huang. Reimagining India 2013 November [cited 2014 February 9 ]; Available from: http://www.mckinsey.com/insights/asia-pacific/reimagining_india_a_conversation_with_yasheng_huang.

2.            World Bank, World Development Indicators 2013, The World Bank: Washington D.C.

3.            The Economist. India’s demographic challenge : Wasting time. 2013 May 11  [cited 2014 February 9 ]; Available from: http://www.economist.com/news/briefing/21577373-india-will-soon-have-fifth-worlds-working-age-population-it-urgently-needs-provide.

4.            Panagariya, A., Part 1 : Growth and Economic Reforms in India: The Emerging Giant. 2008, Oxford University Press: New York.

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