61289 POVERTY THE WORLD BANK REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise APRIL 2011 · Number 55 Sophistication in Service Exports and Economic Growth Saurabh Mishra, Susanna Lundstrom, and Rahul Anand Services can now be stored and traded digitally, and they are not subject to many of the trade barriers that physical exports have to overcome. Services are no longer exclusively an input for trade in goods, but have become a "final export" for direct consumption. It is important to note that services not only have become more tradable, but also can be increasingly unbundled: a single service activity in the global supply chain can now be fragmented and done separately at different geographic locations. This has led to a new channel of growth--what we call "service exports sophistication." What drives growth has frequently been debated in the eco- titude of interpretations, but it broadly aims to capture the nomic literature, and the recent growth of China and India productivity level associated with a country's production, has rekindled this debate. Those two countries have taken empirically mirrored in exports data. We have developed a two different routes to achieve annual growth rates of nearly new index of service exports sophistication to examine its 7 percent. Whereas China has followed a more traditional relationship to growth. manufacturing-led growth strategy, India's growth has been The growing importance of services and sophisticated driven by expansion in the service sector. The Indian expe- service exports is reflected in such success stories as the rience has led researchers to challenge the conventional no- Nigerian film industry; call centers in Kenya; business con- tion that industrialization is the only plausible route to rapid sulting and knowledge-processing offices in Singapore; ac- economic development (Felipe et al. 2007; Ghani and Kha- countancy services in Sri Lanka; human resources processing ras 2010). In the last decade, services have grown as a share firms in Abu Dhabi; and the growing internationalization of of the world's GDP, accounting for 70 percent of global innovation, research and development, design, and market- GDP; and service exports in developing countries have al- ing. These are all different forms of the same phenomenon. most tripled between 1997 and 2007.1 Even though manu- facturing continues to be a dominant driver of growth, re- Why Sophistication in Service Exports? cent developments suggest that we must include the service sector in the debate. Services are no longer exclusively an in- As per capita income increases, most countries witness a ris- put for trade in goods; rather, they have become a final ex- ing share of services in their total output. The exact cause of port for direct consumption. In view of these changes in the this shift and its implications for future growth has not been nature of services and their growing importance, we have ex- very well researched. The neglect of services as drivers of amined whether growth in service exports and its sophisti- growth in the policy and research debate stems from the no- cation can provide an additional route for rapid economic tion that services are associated with low productivity and growth in developing countries. "Sophistication" has a mul- are merely inputs in the production of goods. However, 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise technology has been changing the very nature of the produc- there are available data. Service EXPY (sEXPY) is then the tion frontier for services, leading to an increasing share of weighted income value of services exported by a country, services in GDP growth and, particularly, to a rapid increase computed as the sum of PRODYs weighted by the share of in service exports. The mid-1990s saw two seemingly sepa- the particular service in the country's total service exports rate but related developments: the revolution in information basket. Service EXPYs are constructed for each country and and communication technology; and rapid developments in for each year of available data. Table 1 shows the average those global forces often referred to as the 3Ts--technology, PRODYs for different service exports categories. To look at transportability, and tradability (Ghani et al. 2010). Those the evolution of service exports sophistication over time, we two developments had a profound impact on the nature, plot selected countries' sEXPY in figure 1. In figure 2, we productivity, and tradability of services. They resulted in rap- plot the average-level correlation for 2007. One can see the id growth of what can be called "modern impersonal pro- relative position of each country. Interestingly enough, the gressive services," such as information technology, business- mean and variance of this measure is increasing over time. related services, medical records transcription, call center operations, education services, entertainment production services, and so forth. These services differ significantly from Table 1. Global PRODY by subservices for the world traditional personal services that demand face-to-face inter- action. A rising number of services now can be stored and 1990­95 1996­99 2000­07 Mean SD traded digitally; they have become similar to manufacturing Transportation 8,161 10,464 10,798 10,189 1,870 goods in that they benefit from technological advancement Travel 7,433 8,033 8,106 8,222 846 and their costs depend on economies of scale, agglomeration, Communication 6,261 6,713 6,871 6,862 1,172 networks, and division of labor. More important, these so- Construction 14,510 10,015 9,808 11,828 2,541 phisticated services mostly require digital labor mobility that Insurance 8,167 12,031 12,321 11,292 2,885 Financial 18,590 23,206 23,263 22,763 3,925 provides an opportunity for relatively innovative, high-tech Computer and 14,916 17,950 17,093 17,791 2,770 job creation in low- and middle-income economies. information A single service activity in the global supply chain can be Royalties and 10,263 13,342 13,361 12,912 3,047 license fees fragmented and done separately at different geographic lo- Other business 7,883 11,172 11,865 10,575 2,784 cations. Fragmentation in service exports activities has also services provided prospects for specialization that did not exist pre- Personal, cultural, 12,185 13,367 13,484 13,550 2,792 and recreational viously. services What Is Sophistication in Service Exports? Source: Authors' calculations. There are two aspects of this new channel for growth--spe- Note: SD = standard deviation. cialization within service exports and the sophistication of service exports. Whereas increasing trade volumes in niche products or services fuel growth, the more interesting ques- Figure 1. Service EXPY for selected countries tion is whether growth can be achieved by improving the so- phistication of service exports. This is in line with the exist- 18,000 ing literature on how sophistication of goods exports affects 16,000 growth. Hausmann, Hwang, and Rodrik (2007) have shown 14,000 that it is not the specialization alone, but the sophistication EXPY of goods exports that matters for growth. To examine this 12,000 phenomenon for service exports, we create an index called 10,000 "service exports sophistication." 8,000 We first construct an index named PRODY that was pre- viously created for each category of goods exports, reflecting 6,000 the income/productivity level associated with each good; 19 0 19 1 19 2 19 3 19 4 19 5 19 6 19 7 19 8 20 9 20 0 20 1 20 2 20 3 20 4 20 5 20 6 07 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 19 and we do the same for each category of services present in year the International Monetary Fund balance of payments. PRODY becomes the weighted average of per capita GDP, Brazil Ireland United States China Singapore Indonesia where the weights represent the revealed comparative ad- India Sri Lanka Paraguay vantage in service j for each country.2 PRODYs are con- structed for each service category in each year for which Source: Authors' calculations. 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 2. Service EXPY against GDP per capita, 2007 10.2 · LUX 10.0 ·· 9.8 GBR · · · · IND SAU · ·· ·· USA 9.6 · · · · · · ·· ·· · · · · CYP · NOR · PRY · ··· · · · · COG · · EST · · · ISL · ·· · GUY CHN · LKA · · · · · 9.4 · · CIV· · ··· · · · · PRT LTU · · AUS · · · · SLE · · ·· · · MDA PHL ·· ·· ·· · · · · · KAZ · · UGA · · · ·· · · · ·· · · NZL MOZ · · · · SDN GMB · · · · · · LCA · · LBY · · STP CPV · · · VEN SYC MAC 9.2 · HND · BLZ In service EXPY 2007 NGA GTM · KEN · · NIC TON · CMR 9.0 · RWA · · YEM ·HTI · 8.8 · BGD 8.6 · LBR · DJI 8.4 8.2 BDI 8.0 · 7.8 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 In real GDP per capita 2007 Source: Authors' calculations. Relationship to Growth service sector, goods sophistication, financial development, We conducted empirical growth regression analysis to test rule of law, and country time-invariant factors. The results whether sEXPY is positively associated with growth (see hold dropping advanced countries and India from the sam- Mishra, Lundstrom, and Anand [2011]). The results indicate ple. Our global results suggest that this phenomenon is that exports' "quality" in services is positively associated growing in importance over time. Service exports and an in- with growth performance. The results hold even after con- crease in their sophistication may be an additional channel trolling for income per capita, skills, the size of the domestic for sustained high growth. 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise / / We highlight a need to refocus policy debate on the driv- Notes ers of growth. Learning from this phenomenon in develop- ment policy practice will depend on country-specific factors 1. The global value of cross-border services exports in and is an area of our future work. 2007 was $3.3 trillion (20 percent of total world trade). Countries may benefit by adopting policies that increase However, the share of services rises to almost 50 percent if the value added by service exports, improve productivity, transactions are measured in terms of direct and indirect val- eliminate obstacles to increasing sophistication in niche serv- ue-added content--that is, if measured in terms of process- ice activities, and promote export performance. Neither the ing of imported components into final products for export manufacturing-led growth strategy of China nor India's in- (Escaith 2008). If we add the sales of services by foreign af- formation technology­enabled service exports growth can be filiates of multinational firms, then the value of trade in serv- a universal standard for growth and economic development, ices rises further. Data for 15 Organisation for Economic Co- but there are lessons to be learned from their experiences. operation and Development countries put the value of such sales at some $1.5 trillion in 2007 (WTO 2009; François and Concluding Remarks and Hoekman 2010). Policy Considerations 2. See Mishra, Lundstrom, and Anand (2011) for details on construction of the sEXPY measure: The major contributions of this work are to bring the service xij Xi xij exports channel of growth forward in the discussion of PRODYj = · i x Yi EXPYi = · PRODYj growth drivers and to show that the channel may be an al- · i ij jXi Xi ternate route for developing countries. Another contribution References is to develop a dynamic index of service exports sophistica- tion that can be used to explore these questions in detail and Escaith, Hubert. 2008. "Measuring Trade in Value Added in the New Indus- to understand more country-specific growth patterns. trial Economy: Statistical Implications." Unpublished manuscript, World The distinctiveness of increasing service exports sophisti- Trade Organization, Geneva, Switzerland. cation and growth is twofold: (1) traditional service activities Felipe, Jesus, Miguel Leon-Ledesma, Matteo Lanzafame, and Gemma Estra- gain in productivity from technology, transportability, and da. 2007. "Sectoral Engines of Growth in Developing Asia: Stylized Facts and Implications." Economics and Research Department Working tradability; and (2) there is a host of new service activities Paper 107, Asian Development Bank, Manila, Philippines. that have emerged (as a result of unbundling and technolog- François, Joseph, and Bernard Hoekman. 2010. "Services Trade and Policy." ical innovation). Journal of Economic Literature 48 (3): 642­92. Increasing sophistication in service exports has important Ghani, Ejaz, ed. 2010. The Service Revolution in South Asia. New York: Ox- implications for countries that are stuck in a "middle-income ford University Press. Ghani, Ejaz, and Homi Kharas. 2010. "The Service Revolution in South trap" (such as Malaysia and Vietnam) and for countries that Asia: An Overview." In The Service Revolution in South Asia, ed. Ejaz wish to sustain their rapid growth (such as India and Sri Lan- Ghani, 1­32. New York: Oxford University Press. ka). Furthermore, reigniting growth in the United States and Hausmann, Ricardo, Jason Hwang, and Dani Rodrik. 2007. "What You Ex- in the G-20 economies will partially rely on the innovation port Matters." Journal of Economic Growth 12 (1): 1­25. and competitiveness of sophisticated service­exporting Mishra, Saurabh, Susanna Lundstrom, and Rahul Anand. 2011. "Service Ex- firms. It also offers a prospective route for growth in Africa. port Sophistication and Economic Growth." Policy Research Working Paper 5606, World Bank, Washington, DC. In the global rebalancing, service exports might be an imper- WTO (World Trade Organization). 2009. International Trade Statistics 2009. ative channel through the lens of India-China, South-South Geneva, Switzerland. trade, advanced-emerging trade clusters, or possible new trade networks. About the Authors The Indian experience shows that even with a very small share of the population (about 1 percent) engaged in high- Saurabh Mishra and Susanna Lundstrom work for the Eco- productivity service exports, the sector can make a signifi- nomic Policy Unit in the South Asia Poverty Reduction and Eco- cant contribution to overall growth. Various factors may pro- nomic Management Network, World Bank, Washington, DC. mote competitiveness among countries exporting services, Rahul Anand is an economist in the Asia Pacific Department of thus driving specialization and sophistication in service ex- the International Monetary Fund, Washington, DC. ports. Countries should continue to build on specialization, This note is based on Mishra, Lundstrom, and Anand (2011). but also extend this idea to sophistication in service activities as a potential route to economic growth. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. It is produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at www.worldbank.org/economicpremise.