‘Services or Industry’: the Debate is on the Wrong Track

India's unemployment problem, in spite of the official claim of us being the fastest growing large economy, needs explanation. Some argue this is due to the services sector becoming the dominant sector in India (56% of GDP) while industry has stagnated and/or declined. But this is simplistic since it does not take into account some key complexities of the Indian economy.

Structural changes

The organised sector of the economy, employing 6% of the workforce, is growing rapidly but generates little additional employment due to rapid automation and mechanisation. The rest of the economy, the unorganised sector, is providing the bulk of employment but getting progressively marginalised. So, that component of the economy which generates little additional work is growing while the rest, which employs the vast majority, is declining.

Next, the sectoral composition of the economy is changing. The services sector's share in GDP at 56% has been rising. It became the dominant sector in India in the early 1980s. Its growth has been at the expense of agriculture, whose share in GDP has declined. Industry's share has largely been stagnant since the 1980s. It is argued that industry has far more backward and forward linkages than services and so its stagnant share in the economy is not good for employment generation.

India has not followed the traditional development path, where the dominance of agriculture in GDP gives way to industry. At Independence, agriculture dominated with a contribution of 52% of GDP, while the share of services was at around 29%, which in turn was larger than the share of industry at 19%. The colonisers did not promote industry in India in order to enable British industry to capture Indian markets.

Industrialisation

During colonial rule, the Indian economy deindustrialised between 1860 and 1890. Some industry came up in the inter-war years. But this was too little compared to what a country of India's size needed. Plus, most Indian businessmen were traders and not industrialists. Further, education was hardly promoted during colonial rule, so that literacy was 16% in 1950 and there was little by way of research and development (R&D).

The Purushottamdas Thakurdas Committee consisting of prominent Indian businessmen like J.R.D. Tata and G.D. Birla proposed the Bombay Plan in 1944, giving a blueprint for industrialisation post Independence, wherein the public sector would play a prominent role in providing much-needed infrastructure. After Independence, trade, transport, drinking water, education, health, etc. were prioritised and urbanisation accelerated, fuelling the growth of the services sector.

Industrialisation was based on big industries, big dams, etc. – the temples of modern India. Reservation was provided to small industries but investment was preempted by the big sector. This led to the growing concentration of production. The same happened in agriculture from the mid-1960s, as production became concentrated in regions driving the Green Revolution.

As production gets concentrated, demand for finance, transportation, storage, trade, etc. grows rapidly as produce is sought to be sold in the rest of the country. These are all services. For example, wheat and paddy goes from Punjab and Haryana to the rest of the country. Cars produced in Tamil Nadu sell all over the country. Coal has to be hauled to the big thermal power plants, etc.

As technology changes, more and more R&D is required and in turn more higher education is needed. Nowadays, many white goods like cars have substantial amounts of embedded software and electronics (30% in a standard car and 50% in an EV). Royalties also rise. All this increases the services component of final industrial products.

Two kinds of services

Services can be divided between consumptive and productive services. The services mentioned above, which are required to get goods and services to consumers or producers, are productive services.

Further, specialisation has resulted in the growth of the services sector. Earlier businesses used to have their own security, advertising, transportation, trading, etc. Hence these were counted under industry. Over time, these services are increasingly provided by specialised services companies. Hence what was earlier counted under industry is now counted under services.

Consumptive services like tourism, entertainment, eating out in restaurants, etc. have grown rapidly. So have education, health, public services, etc. People migrate in search of opportunities and the poor migrate to find higher-paying work in urban areas. In effect, growth in both productive and consumptive services has led to the rising share of services in GDP.

Black economy's impact

The growing disparity in India, with the well-off doing much better than the rest, has fuelled the growth of consumptive services. The black economy, concentrated in the hands of at most 3% of the population, has further added to the income of this well-off class and to demand for consumptive services.

Public expenditure on health and education have risen but private expenditure has soared with high fees, tuition and other out of pocket expenditures, adding to the growth of the services sector. The illegalities committed in these sectors, like fake degrees, question paper leakages, unnecessary medical tests, caesareans, etc. generate black incomes and boost the services sector.

Black incomes are generated by under-invoicing revenue and over-invoicing costs, especially overheads. This also fuels the growth of the services sector. Further, black incomes are siphoned out via trade, which is a service. So, the black economy independently also boosts services. Consequently, the black economy's growth increases the share of services in the total economy (the black and white economies).

The black economy further marginalises the agriculture sector. Since agricultural incomes are not taxed, this sector does not generate black incomes. Whether these incomes are declared or not, they are not black incomes.

No doubt incomes are misclassified as agriculture incomes to escape taxes. But these are black incomes generated in non-agriculture and need to be counted in the sector where they are generated.

So, including black incomes, the share of the services sector in the Indian economy is not 56% but upward of 70%, like in the advanced economies. The share of the services sector in the US economy is 79% and its employment share is 80%. So, India, at about 3% of the per capita income of the US, has an economic structure similar to that of the advanced economies.

The black economy also leads to the degradation of the environment and speculation in real estate. The former leads to a rising burden of ill health due to the pollution of air, water and rivers, and the destruction of hills and forests. This increases health costs in society over and above the costs incurred by patients due to malpractices in the health sector, like tests that are not needed, needless caesareans for child delivery and spurious medicines. Cleanup of the damaged environment adds to the demand for services.

Speculation in real estate boosts investment in this sector and it has grown rapidly in India. Both the black economy and the surplus generated in the economy boost real estate. All this boosts the services sector.

Does the existence of the black economy mean that India's GDP is higher than what is officially announced (the white economy)?

The black economy produces a lot of ‘social bads’ that ought not to be counted in GDP. And it adds to social waste that should also not be counted. It causes policy failure by making policies ineffective and causing expenditures not to lead to outcomes. So, GDP is over-counted due to these factors. Worse, the black economy lowers investment productivity so that the economy works at below its potential.

In brief, only a part of the large black economy needs to be added to the official GDP, and most of it adds to the share of services.

Conclusion

To push up the Indian economy's growth, prioritisation is required. Asking whether to do so in services or industry would be asking the wrong question, as it misses a) the complexity of the Indian situation, b) the technical change taking place and c) the changing sectoral composition.

These are given and cannot be changed by policy. Further, because of definitional changes, services will appear to be growing faster than industry. And productive services are complementary to industry, so they will continue to grow even if industry is prioritised. Finally, the recent rapid advances in AI are pushing technical change towards the greater use of services.

India's real challenge is the black economy, which leads to poor governance, failure of policies and undermining of risk-taking and research. If manipulation can lead to higher profits, why take the risk inherent in R&D? These are key causes of unemployment.

If so, India's concern should be the growing and large black economy (which also fuels the services sector), and that can only be tackled through political reform. But not only that is not in sight, we are moving in the opposite direction.

Arun Kumar retired as professor of economics at JNU. This article is based on arguments in his books Indian Economy since Independence: Persisting Colonial Disruption and Services Sector and Black Economy, in addition to ‘Working Paper of School of Social Sciences, JNU, 1987’.

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