I D R C - T T I I n s t i t u t e o f R u r a l M a n a g e m e n t A n a n d G u j a r a t

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1 I D R C T T I P a p e r P r e s e n t a t i o n I D R C - T T I Wo r k s h o p o n R u r a l - U r b a n L i n k a g e s 21 st & 2 2 nd A u g u s t I R M A A n a n d S e r v i c e S e c t o r G r o w t h a n d S e r v i c e C o n s u m p t i o n o f U r b a n C l a s s e s i n I n d i a P r o f. A t u l a n G u h a S w a t i P i l l a i I D R C - T T I I n s t i t u t e o f R u r a l M a n a g e m e n t A n a n d G u j a r a t

2 Service Sector Growth and Service Consumption of Urban Classes in India Atulan Guha & Swati Pillai

3 Existing Theories on Growth Structure of the Economy Theoretical literature emphasise on interaction between both the supply and demand side factors to explain the structural change Baumol s Explanation for Growth Structure differences in productivity price and income elasticity of demand a sizeable degree of integrated labour market where increase in wage rate in one sector increases the wage rate of the other sector, the sector with higher labour productivity will grow and the sector with lower productivity will increasingly disappear if the price elasticity of demand for both the sector is unitary and the low productive sector is not highly income elastic

4 Kaldor s 3 Laws First law : faster the rate of growth of manufacturing output, the faster the rate of growth of GDP, strong input-output linkages Capital accumulation and technical progress are strongest Second Law: a strong positive relationship (both way causality) between the growth of manufacturing production and manufacturing productivity Third law: when manufacturing grows, the rest of the sectors will transfer labour to manufacturing, raising the overall productivity of the economy

5 Characterisation of Different Sectors Behind Kaldor s laws At high levels of per capita income, Income Elasticity of Demand: Agriculture < Industry < Services Growth of Productivity: Agriculture Industry > Services because of the fact that the technical progress in agriculture tend to be both land saving and labour saving. Movement of labour from agriculture to industries will ensure similar high labour productivity. However, because productivity rises faster in industries than services, the terms of trade change in favour of services. The lower relative price of manufactures should lead to some increased demand which may or may not offset the advantages of services on account of their greater income elasticity of demand. The leading sector in contemporary Indian economic growth has increasingly been services rather than manufacturing. Many of the characteristics of service sector as envisaged by Kaldor is not true for the Indian economy. Also questions- does services replacing industries as engine of growth

6 Empirical Literature on Growth Structure of Indian Economy- Supply Side Explanations Supply Side Explanation is dominated by growth accounting framework. There are many studies, most well sited Boswaorth, Collins &Virmani TFP of services is much higher than industries in post period. In fact, the TFP of agriculture is more than industries. So following Baumol, Service should dominate the growth structure and then followed by agriculture Though the first one is happening, not the second one Also, for the Baumol transformation the wage rate in services should push up the wage rate in other sectors

7 TFP of Different Sectors

8 Baumol Transformation? Does it really happening? Are we sure of wage pulling power of service sector Specially, when there exist a very large reserve army of labour in widely heterogeneous service sector, there may exists certain sector that is not so productive, but people are taking shelter because people are evicted or pushed out of, say, agriculture Further, the growth composition of the service sector shows, more than half of the growth is coming from the traditional sector. And they constitute 60 per cent of the service GDP. We don t have TFP measures at this sectoral level, but have labour productivity data not so strictly divided between modern and traditional sector- Within the services sector, the highest labour productivity growth has happened in Community, social, personal and Govt. services followed by transport, storage and communication. The labour productivity in trade and hotel-restaurant is low, but it is lowest in Finance, insurance and real estate. (Valli and Saceone (2009) But it at least indicate, the labour productivity in many traditional sector is higher than many modern sector

9 Growth in Various Service Sector Modern Services Total Communications Finance Business Services Edu. & Med Traditional Services Total Share of Total Output in Services (%) Trade Transportation Annual Average Percentage Rate of Change Other Service s Service s less Dwelling Percentage Contribution to Total Services Growth

10 Demand Side Explanations of Service Growth The demand components of Services- Consumption, intermediate inputs, external demand more than 55 per cent of our GDP is constituted by the service sector, only 32.4 per cent of our consumption basket are consists of services. (NAS, 2007) So there is a substantial mismatch between the contribution of services in GDP and the private consumption demand for services. This indicates the other sources of demand for services; exports and use as intermediate input are important. But are they causing service growth? If it is at what extent?

11 Competing arguments the major component of incremental demand is coming from the external economy. the major component of incremental demand of services is coming from increasing consumption demand which is caused either by increasing income of all or by much large increase in the income of the richer section of the society. Historically it has been seen countries at the level of India s per capita income, dominated by industries So it is the income inequality not growth increasing consumption demand the demand for services has increased due to greater use of it as intermediate factor in production, especially outsourcing of many services by the companies whose core activity is manufacturing

12 Demand as Intermediate input..1 The dominant view : consumption and exports growths are the main factors behind the service growth, not the intermediate use input-output coefficient of use of services in agriculture, industries and services has not changed much in last three decades (Nayyar, Eichengreen & Gupta, Singh).

13 Demand as Intermediate input 2 Doubts: the use of services as input per unit of output in industries and services has peaked in the year and thereafter, it has declined continuously. This goes completely against the popular belief that the production process of industries and services has become more service oriented from 90s. Post-1993, the highest 4 growing service sectors are Communication, Business Services, Education & health and trade. business services external demand trade - intermediate inputs. Education & health - primarily consumption service. Communication has use both as consumption and intermediate input. Trade alone has constituted more than 1/3 rd of the total service growth. So we need a much greater scrutiny in this claim.

14 Demand from External Economy Till the year , the service exports and PFCE has grown at a similar rate; but there after the exports has grown at a much faster rate. 50 per cent of India s service exports comes from computer services Business services contribution to total services growth (8 percent) is 0.5 percentage. Though increase in exports of services is a important factor behind the increase in demand for services; may be its contribution is bit exaggerated

15 Demand from Consumption A very substantial demand for increasing services is coming from consumption Why the service consumption is increasing Due to price effect? Due to income effect?

16 The relative price of services has a decreasing trend, except in between to Indicates the possibilities that the demand for services to go up during the period of to and to and to come down during the period of to for the change in relative price of services. It can happen where there is a possibility of substitution exists

17 Can Service Sector take the role of industries in Kaldorian Sense? Backwards Linkage Years Agriculture Industry Services Source: Input-Output table, CSO Forward Linkage Years Agriculture Industry Services

18 Can Service Sector take the role of industries in Kaldorian Sense? Many Economists argue (Singh, 2006) that service sector has a very substantial production linkages with the other sector, so it can perform as engine of growth Dashgupta & Singh (2005) argued the Information technology sector is playing the role of engine of growth According to this input-output table service is a weaker engine of growth than the industries. Both the forward and backward linkages in the production system for services is weaker than industries For the industries both the forward and backward linkages in the production system is getting stronger over the year. Whereas, for the services it has become weaker from the early 90s. Services is having stronger backward and forward linkages than the agriculture sector. Service sector s backward and forward linkage has remained similar between the period and However, the economy s growth scenario was completely contrasting, which is similar with substantive increase of the forward and backward linkage of industries.

19 Income Elasticity of Service Demand As income is going up it should increase the demand for service if it is not the inferior goods. Nayyar (2010) estimates the Engel curve for the period and using NSSO household survey data on consumption. Using censored quantile regression estimates, he found upward sloping Engel curves for six categories of services (education, health, entertainment, personal services, communication and transport) and for services in the aggregate. Further, he showed that as total household expenditure increases, the increase in the household budget share allocated to a particular service increases more for high consumption (conditional on household size, social group, religion, age-sex composition, and age, gender and level of education of household head) relative to low consumption (conditional on the same set of variables) households. Since, these six services account for a little less than half of India s services GDP, it can be argued that high expenditure or income elasticity of demand for services are an important explanation for the increasing importance of the services sector in India.

20 Who are Consuming more Services? Is the urban people consuming more services or it is the rural people? If the urban people are consuming more services, the increasing urbanization will increase the service sector growth. Which are the urban classes are consuming more services and what kind of services? So the class pattern of urbanization will also influence the composition of service sector growth.

21 Service Consumption by Classes, MPCE On Services Total MPCE Share in MPCE Agricultural Workers Rural Non-Agric Workers Rural small peasants Rural Elites Urban workers Urban skilled Urban owners and managers Urban Professionals The rural classes expenditure on services is much lower than the urban classes. The share of services in total expenditure is also much lower for the rural classes than the urban classes. This indicates as the urbanisation increases, the demand for services will go up and the growth structure of the economy will be more service dominated

22 Service Consumption by Classes, The consumption expenditure by the urban professionals is highest in aggregate as well as on services. Followed by urban owners and managers and urban skilled (Associate Professional and clerks) Even in terms of share in aggregate expenditure, the similar class pattern exists. So as the number of people in these classes goes up faster compare to other classes the service demand will go up Or, if the expenditure of these classes are going up faster compare to other classes, then also service demand will go up. But in the first case, it will be more equal society and in the second case it will be more unequal society.

23 Service Expenditure Pattern of Different Classes Education Medical Entertain -ment Consumer service Telephone Conveyance bill Agricultural Workers Rural Non-Agric Workers Small peasants Rural Elites Urban workers Urban skilled Urban owners & managers Professionals Indian urban upper and middle classes are spending mostly on education, consumer services and telephone services. Rural population is spending mostly on conveyance and consumer services Rural non-elite spend more on health than education

24 Luxury Service Expenditure Pattern of Different Classes Luxury Service MPCEShare in Service Expenditure "Agricultural Workers" "Non-Agric Workers" "rural small peasants" "Rural Elites" urban workers "Urban skilled" "owners and managers" "Professionals" As expected the luxury consumption share is higher for urban upper classes So if the urban upper classes expand the demand for luxury services will go up.

25 Departing Remarks Both the supply and demand side factors are responsible for the service sector dominated growth structure Increase in External demand, intermediate use as well as the consumption demand are the main components for high service growth Consumption demand for services is increasing due to increasing income inequality and urbanisation There are contradictory evidence to both Baumol and Kaldor s transformation We need deeper empirical investigation to find out exact nature of the transformation

26 Thanks