Services sector: An alternative route to high growth?

Indonesian economic growth has been marked by the rapid growth of its services sector, as indicated in the growth of its non-tradable sectors.

This sector, including trade, services, finance, transport, communication and construction, has been growing at 8 percent each year for several years, which is higher than the overall GDP growth.

Even after the impact of global economic crisis in 2009, services sector still grew at 5.9 percent, almost doubled the rate of growth of tradable sectors that consist of agriculture, mining and manufacturing.

Because of its rapid growth, Indonesian services sector has accounted for 51.9 percent of its GDP in 2009, compared with 48.9 percent in 2006.

This means that now, more than half of Indonesian GDP comes from its services sector. This trend would continue in the coming years, and as Indonesian industrial growth continue to lag behind the growth of its services sector, the Indonesian economy will be dominated more and more by its services sector.

Some have argued that an economy with a high growth in its services sector would tend to have high GDP growth, or to put it the other way, a country that has a high economic growth tends to show high growth in its services sector.

This argument was put forward recently by Ejaz Ghani (The Jakarta Post, March 31, 2010) an adviser to the World Bank. He made the argument after studying economic growth of China and India.

China and India have achieved a remarkable economic growth in recent years, but according to Ghani, the paths and patterns of their growth have been strikingly different.

While the Chinese pattern followed conventional stages, where manufacturing took over the roles of agriculture, India’s economy has leapfrogged from an agriculture-based economy into a service-sector-dominated economy. Ghani thinks India’s pattern of growth could be an alternative for underdeveloped economies still struggling to achieve high economic growth by developing their manufacturing sector.

Ghani’s arguments have provided some intriguing questions regarding the Indonesian economy: Has the Indonesian economy entered the threshold of an advanced economy, whose primary characteristic is the dominance of service industries?

If so, would its pattern of growth divert from conventional stages — from agriculture to industry and then to services — as prescribed in textbooks on economic development?

Before contemplating these questions it is worthwhile first to know why the services sector has seen higher growth than other sectors? There are several reasons that could explain this.

The services sector is a sector that could readily benefit from information technology and globalization. The process of adapting technology in services is more automatic and less complicated than in other sectors.

The market for services is already more global. Once a business entity enters service business, it is immediately plugged into a global IT network. This is clearly the case in the finance and telecommunications industries.

Globalization and the inherent competition it brings with it, and the widespread use of IT has brought down costs, which has benefited customers worldwide and generated opportunities for higher profit and growth.

In the case of Indonesia, high growth in services sector is also the result of its far reaching liberalization that has been accorded by successive Indonesian governments in the past.

While deregulation has been resented and criticized, and has aggravated an economic crisis in the past, the fact remains that the liberalization of its service industries has served as impetus for its high growth by enabling the sector to provide cheaper and better services to customers.

The other reason is that the service industries are less prone to backlogs in physical infrastructure than other industries such as manufacturing, whose growth is highly dependent on the availability of adequate physical infrastructure.

The increasing role of the services sector in the Indonesian economy is not a result of its ingenuities, nor does it mean the Indonesian economy is entering an advanced-economy stage. The services sector’s apparent growing importance in the overall economy is because the growth of the manufacturing sector is still depressed.

The manufacturing sector in Indonesia is still facing all myriad problems ranging from uncertain regulatory frameworks to a lack of infrastructure. Even though the government is working hard to overcome these problems, given its limited competence it will take several years to its structural reforms.

So Indonesia’s economic growth would still depend on the growth of its services sector. To make growth in the services sector more sustainable would require certain conditions, the most important of which is education.

India may be a poor country but it has an excellent education system. Its technical colleges have produced thousands of highly qualified engineers. Thousands of Indian engineering graduates have returned from American universities and Silicon Valley, California, the center of US computer industries.

These are people who have pushed Indian IT services to become a global power. They have made Bangalore, a dusty town in Southern India, become a Mecca for IT services for many large international corporations.

English language, which is the second language in India, has helped its services sector expand enormously.

Indonesia does not have these kinds of advantages, yet its services sector has managed to grow rapidly. But to rely too much on the services sector growth raises questions as to the quality of growth. Service industries require a highly skilled and educated workforce, so they tend to be less labor intensive than manufacturing industries.

While the growth of the services sector could be left to the dynamics of globalization and technology, Indonesia with its huge population and workforce needs to pursue high growth policies in its manufacturing industries especially those with high labor absorption capacities.

So, even though the growth of the services sector can pull up the overall GDP growth, it should not, and could not be an alternative to growth in the manufacturing industries.