Why is it important for a country to have a stronger tertiary sector than a primary sector?

Abstract

The tertiary sector-led employment growth in recent decades in India is out of line with the experience of modern economic development. It has raised concerns about the level of earnings at which labour is being absorbed in this sector. This paper makes use of NSS data from the quinquennial rounds to throw light on whether labour is being pushed into this sector due to lack of opportunities in other activities. The movement of the distribution of the mean per capita expenditure over successive rounds shows that there has been not only an outward shift of the distribution in the tertiary sector but also an increase in inequality and "dualism" in the sector and within its critical sub-sectors.

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First published in 1949 as the Economic Weekly and since 1966 as the Economic and Political Weekly, EPW, as the journal is popularly known, occupies a special place in the intellectual history of independent India. For more than five decades EPW has remained a unique forum that week after week has brought together academics, researchers, policy makers, independent thinkers, members of non-governmental organisations and political activists for debates straddling economics, politics, sociology, culture, the environment and numerous other disciplines.

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Significance of YED for sectoral change (primary - secondary - tertiary) as economy grows

Income elasticity of demand (YED) is the responsiveness of demand to changes in income. Can you write down the FORMULA? Follow the link to check your answer.

Economic growth is the increase in productive capacity of the economy and is best measured by the increase in real GDP (output) over a period of time.

Typically, as economic growth occurs and real incomes and living standards rise over time, the primary sector tends to become relatively less important, while the secondary and tertiary sectors tend to become relatively more important. Fundamentally, this is because of the importance if YED.

In general, the products of the primary sector e.g. fruit, vegetables, raw materials and so on tend to have a low YED i.e. as real incomes rise, there tends to be a less than proportionate rise in demand for these products. No matter how rich you are, there is a limit to how much fruit and vegetables you can eat, so an increase in income may not stimulate a large increase in consumption of these goods. Consequently, the primary sector is likely to grow only slowly as living standards rise.

The demand for manufactured goods and the services of the tertiary sector, however, tend to have a very high YED. As we become better off, there tends to be a more than proportionate increase in demand for electrical equipment, furniture, banking, travel and tourism etc. Hence the secondary and tertiary sectors grow much more rapidly than the primary sector as living standards rise.

In the more developed countries, the tendency is for the tertiary sector to grow the most rapidly in response to rising real incomes. This is not because people in rich countries fail to buy more manufactured goods as they become better off. Rather, it is often the case that these goods are imported from other countries, often newly industrialised countries, which may be able to produce the manufactured goods with a comparative advantage, i.e. relatively more cheaply.

Thus YED has an important effect on resource allocation within an economy and the speed and nature of sectoral change as countries develop.

Manufacturing has been the surest way for low- and middle-income economies to reduce poverty and create good jobs. But developing nations have increasingly been redirecting their focus to the services sector to catch up with their developed counterparts.

Will the shift work?

Our research shows it can—provided countries expand trade in services, accelerate the adoption of new technologies, upgrade the skills of their workers, and pay special attention to services that can also boost manufacturing.

Countries at all levels of industrialization and income can exploit transformative opportunities from services.  In the past three decades, the services sector has grown faster than manufacturing in many developing economies. By 2019, services accounted for 55 percent of GDP and 45 percent of employment in developing economies. In developed economies, services account for an even larger share of economic growth—fully 75 percent on average. A few low- and middle-income countries were among the top 10 global exporters of services between 2005 and 2017.  

Services-driven economic transformations offer new opportunities for scale, innovation, and spillover effects similar in scope to those that made manufacturing more productive in the past. Remote delivery, branching, and franchising enable service providers to tap larger markets and providers who offer services digitally are no longer restricted to face-to-face engagements with their customers. Digital technologies are improving business processes, introducing new features to products, and creating new markets.  Far more R&D is now happen in services than in industry: big data is enabling the improvement of transportation systems and it also is spurring retail outlets to improve their offerings.

A vibrant services sector is also increasingly important for manufacturing competitiveness: manufacturers bundle goods with services (such as financial credit, advertising, and warranties), which increases value for customers. As the demand for services rises from manufacturing, agriculture, and other sectors, more workers benefit from growth.

Information technology, professional, scientific, and technical services are growing in importance. They accounted for more than half of all services exports in Ghana, India, Pakistan, and the Philippines —all countries that offer a pool of relatively low-wage English-speaking workers. Today, around 68 percent of all online freelancers worldwide are based in lower- and middle-income countries.

The increasingly blurred lines between manufacturing and services are making exports more competitive for many countries. This process—known as servicification—is illustrated by the remarkable success of Amazon Echo, a music player powered by artificial intelligence that can also perform a host of other functions, such as allowing users to order groceries with a voice command, acting as a personal assistant by keeping track of its owner’s schedule, and calculating the length of a commute. The manufactured device is even more valuable when bundled with service.

For policy makers, it’s no longer a question of whether to support manufacturing or services, but rather how they should act to take advantage of the growing potential for services to contribute to productivity and jobs. 

So, what can governments do to supercharge this force for employment and boost to economic recovery?

Our study recommends relying on “4Ts”: expanding services trade, fostering technology adoption, training workers to upgrade skills, and targeting services that provide benefits to the wider economy for public support.

First, we need to mirror the progress made on trade in goods to do more in trade in services— especially by expanding digital trade. 

Second, science, technology, and innovation policies should focus more on services.  Digital technologies expand the potential for services even more than they do for manufacturing and farming. Consider, for example, how much the pandemic has accelerated the move to more remote work and online delivery of many services.

Third, strengthening worker skills is essential to enable people to gain more productive and better-paying jobs.  In low- and middle-income countries, job creation tends to be concentrated in low-skilled work, although productivity growth is rising in high-skilled occupations.

Fourth, a policy approach that addresses the constraints faced by all the relevant activities in a particular manufacturing value chain will be more fruitful than just picking manufacturing industries for attention. In fact, enabling services that provide inputs to multiple industries can result in large-scale benefits.  

Finally, government agencies, international institutions, and private sector organizations should prioritize the collection of better data for services to enable rigorous analysis . Given the contribution of services to development, being unaware of this agenda is no longer an option. 

To learn more, download the full report: At Your Service: The Promise of Services-led Development

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