Debunking myths about Asia's service industries

By Diana Farrell

The emphasis on boosting offshore services risks overlooking a far larger, though less fashionable, opportunity for Asian nations—that of stimulating their domestic-services sector.

Asian economies have much to gain from an agreement on trade in services at the World Trade Organization's mid-December meeting in Hong Kong. Many understandably look to service exports as a source of employment and economic growth. Yet, important though this is, the emphasis on boosting offshore services risks overlooking a far larger, though less fashionable, opportunity for Asian nations—that of stimulating their domestic-services sector.

Domestic services are essential to growth. They account for more than 60 percent of all jobs in middle-income and developed economies, and virtually all net new job creation. Given labor-saving new technologies, manufacturing is not a sustainable source of job growth for any economy. Even China, the so-called "factory floor" of the world, has shed more than 15 million manufacturing jobs since 1995.

The problem is that Asian policy makers have long preferred to promote high-tech sectors, manufacturing exports, and now trade in services. For them, domestic services conjure up an image of small-scale, low-wage ventures like shoe repair and fast-food vending. But such jobs by no means form the whole picture: domestic services also comprise huge sectors crucial to economic development, including power supply, transport, retail, construction and telecommunications, as well as a range of high-skill, high-wage occupations, from accountants to advertisers and movie stars.

The sheer size of domestic-service sectors makes them powerful drivers of overall GDP growth, and their share of the economy rises as countries develop. Services comprise roughly half of GDP in India and the Philippines, but a full 68 percent in Japan and 75 percent in the United States. And the quality of those services impacts growth rates in other sectors because every enterprise must use them. Efficient, good value domestic services also help to attract foreign direct investment. India's offshoring sector, for instance, did not take off until telecom reforms were adopted in the early 1990s.

Yet productivity in domestic services lags far behind productivity in export sectors in nearly every Asian economy. Four prevalent myths held by Asian policy makers and propagated by some in the media are to blame.

Myth number one is that reforming domestic services won't do much for productivity because they offer so little scope for innovation. History shows otherwise. The late 1990s boom in US productivity, for instance, was due mostly to innovations in service industries like retail, wholesale, and financial services, not just high-tech sectors.

Myth number two is that manufacturing jobs are higher skilled and better paid than service work. On the contrary, service industries create more high-skilled occupations than manufacturing. In the US, for instance, more than 30 percent of service jobs are in the highest skill category of occupations, which includes managers, researchers, and engineers, in contrast to only 12 percent of all manufacturing jobs. And the distribution of wages across US service and manufacturing sectors is similar.

The third myth says that manufacturing jobs are more stable than jobs in services. That can't be right, since manufacturing employment is shrinking world-wide. What is true is that service industries tend to have higher job turnover than manufacturing. Service industries as a whole create more jobs than they lose. So creating a dynamic service sector guarantees lifetime employment opportunities for everyone, if not the same job for life.

The final myth is that reforming service sectors will lead to more unemployment. This fear is centered on the retail sector, where big modern stores could drive out smaller, traditional ones. But this is precisely how economies develop, resulting in a bigger national income for everyone to share and higher overall employment. This fear ignores the fact that larger stores offer lower prices and better services, which boosts demand and causes stores to hire more people. This is why the US, with its highly productive retail sector, employs proportionally more people in this sector than countries where traditional stores prevail.

Believing these myths can hobble a country's growth. Take Japan. By 2000, its world-class export manufacturers were legendary. Yet output from the likes of Sony and Toyota comprised only 10 percent of GDP. Productivity in the rest of the economy—most of it in domestic services—was only 63 percent of US levels. This is one reason why Japan's economy has stagnated since the early 1990's. It also helps explain why recent deregulation in telecoms, transport, energy, finance and retailing are estimated by Japan's Cabinet Office to have boosted GDP by 4.6 percent in 2002.

To harness the power of domestic services, policy makers need to do three things: Recalibrate regulations across the economy, lighten them, and enforce them fairly and firmly in every sector.

Recalibrating regulations means giving equal treatment in fiscal, financial, and development policies to all businesses, regardless of which sector they operate in. That means no more cheap loans or tax breaks for pet industrial projects; no more punitive taxes on domestic services; and an end to barriers to competition, for instance, restrictions on foreign direct investment in services.

Lightening the regulatory load means setting taxes at a level that all businesses accept as fair and will pay. It means cutting red tape to simplify business registration and ownership and bankruptcy procedures, so innovators can enter markets and grow, and failures can quickly exit. And it means revising labor laws so that employers can hire and fire in line with the business cycle, giving workers more jobs overall to choose from.

Boosting enforcement means making sure that businesses play by the rules. In many Asian countries, services like retail and construction are often provided by companies operating in the gray economy. Such players prevent more productive companies that operate in the formal sector from gaining market share. Only by ensuring that all firms pay tax and protect workers can policy makers encourage the fair competition that creates more and better quality jobs.

Given the right competitive environment, domestic services can be a powerful source of wealth creation and jobs for Asian economies—more powerful than service exports will ever be.

Ms. Farrell is the director of the McKinsey Global Institute, McKinsey & Company's economics think-tank.

Reprinted from The Wall Street Journal Asia  © 2005 Dow Jones & Company, Inc. All rights reserved.

MGI In the news
Article - McKinsey Quarterly

What’s missing in leadership development?

Article - McKinsey Quarterly

Culture for a digital age

Article - McKinsey Quarterly

The CEO’s guide to competing through HR