Asia moves from being the world‘s manufacturer into an entirely new sector
The service sector is fast becoming developing Asia‘s new growth engine as the world‘s factory moves from manufacturing to services such as tourism, outsourcing, IT, healthcare and insurance.
Throughout the region, more than 45 percent of the workforce is now employed in the service sector and it has been estimated that within the next few years, services will contribute more than 50 percent of the region‘s GDP.
Earlier this year, the service sector in China eclipsed the industrial sector in size for the first time.
Among the countries that form the Association of Southeast Asian Nations (ASEAN), services now comprise 45 percent of GDP.
Economists say the Asian growth story is moving into the second phase of development. Manufacturing is playing less of a role in driving growth, while consumption and demand for services is becoming the key driver.
According to Frederic Neumann, HSBC‘s co-head of economic research for Asia, the reality is that the region that has long been known as home to the world‘s manufacturing sector is turning into an economy driven by services.
“This is a trend that will shape Asia‘s future,” he says.
Donghyun Park, principal economist at the Manila-based Asian Development Bank (ADB), says this is a “natural consequence of Asia becoming wealthier“.
“Millions are joining the middle class every year and are demanding more services,” he adds.
Such a demographic change has also been noted by HSBC‘s Neumann. “It doesn‘t mean that consumption patterns will resemble those of the West overnight,” he says. “Nor does it mean that manufacturing will cease to be important.”
He explains that the “intangible nature” of services means it is sometimes hard to know what is being referred to.
“There are the more traditional services that constitute important building blocks of any society: Education, healthcare, basic telecommunications and hospitality-related industries.
“These exist alongside the more modern services such as information technology, finance and business services,” Neumann says.
In the region, it is India and the Philippines that stand out as providers of these modern services, which are largely export-focused.
Over the last two decades, India has emerged as the world‘s leading exporter for information and communications technology-business process outsourcing (ICT-BPO), while the Philippines has also grown into a major ICT-BPO hub.
But according to Neumann, Asia still has a long way to go as it “reaches for high productivity services industries“.
In a paper last year, called The Service Sector in Asia: Is It an Engine of Growth?, the ADB estimates that what it calls modern services (not including banking and financial services) occupy between 8 and 12 percent of regional GDP. This compares with between 17 and 25 percent in the countries that make up the Organization for Economic Co-operation and Development, giving Asia plenty of room for improvement.
“Services industries are a feature of modern, rich economies,” says Peter Drysdale, emeritus professor of economics at the Crawford School of Economics and Government at the Australian National University in Canberra, in an article on the East Asia Forum website.
“High levels of professional skill and research and innovative capability, and the educational and commercial infrastructure that underpin them, make the difference between middle-income and really high-income economies,” he said.
According to Neumann from HSBC, Asia will benefit from three important side-effects of service sector growth.
“First, the (service sector) is less volatile than industrial growth. Second, services are relatively more labor intensive than industry — which should help absorb future labor flows from the primary sector on the back of urbanization.
“And services growth tends to result in more inclusive and gender-balanced growth — a key factor for future regional stability.”
Neumann also says that a highly productive service sector delivers benefits that can boost productivity in other industries — contributing to economy-wide increases in overall productivity.
“This offers some respite in a time of jittery markets and uncertain growth trends,” he adds.
In China, services are gaining more importance as the country continues to urbanize. Analysts say that this trend is having a major impact on services and employment in the sector.
The services infrastructure necessary to allow for cities to cope with the increased population as people move to urban centers is immense, says Neumann.
“Under the most ideal policy scenario, a reform of the hukou household registration system would normalize the status of approximately 260 million migrant workers in cities and give them rights to certain services,” he says.
Hukou is the system that ties benefits to place of birth, meaning that migrant workers in cities are not able to access healthcare or education for their children, for example.
And this trend of urbanization is showing no signs of slowing. Qu Hongbin, HSBC‘s chief China economist, says an additional 100 million rural residents might leave for cities over the next decade, which should provide plenty of ammunition to sustain growth in the sector.
According to Changyong Rhee, chief economist at the ADB, upgrading the sector with a focus on services such as business processing, tourism, and healthcare “could play a critical role in the region‘s future growth“.
Traditional services such as restaurants, taxis and barbers still dominate in developing Asia, he says in a paper recently.
Modern services — such as Internet connectivity technology and financial, legal and other professional business services — account for less than 10 percent of Asia‘s service economy, well below the 20–25 percent in advanced economies, according to Rhee.
He agrees that a vibrant service sector can have broad economic benefits.
“Synergies between services and industry could improve overall productivity,” he says. “For example, industrial design, marketing and legal services could facilitate investment and development of new manufactured products.
“The service sector also tends to be more effective in job creation, particularly for women, thus supporting inclusive growth.”
Developing the service sector could also diversify the production base, he argues, enhancing economic resilience and boosting growth.
“Modern services are becoming increasingly tradable, providing new export opportunities,” he says, citing India and the Philippines which have become world leaders in the export of outsourced business processes.
Rhee says that skill gaps and a lack of infrastructure are frequently cited as factors that hinder service-sector dynamism in Asia. Although he argues that “burdensome regulations” are the biggest barrier.
“Excessive regulation that protects incumbent firms and other vested interests undermines market competitiveness and limits prospects for improved productivity and efficiency,” he says.
He gives examples of legal markets that are dominated by rich lawyers, schools controlled by teachers‘ unions and a medical sector that is influenced by powerful doctors. This leads to higher business costs that also hamper industrial development. “Many service firms in Asia are owned by the public sector, so governments have less incentive to deregulate services. But the same authorities have already opened their economies‘ manufacturing and agriculture sectors for the common good, even at the expense of minority groups like farmers and factory workers.
“Why, then, are they maintaining policies that protect the special-interest groups that dominate the service sector?” Rhee asks.
The East-West Center, a Honolulu-based institute, published a paper earlier this year calling for more support for modern services in Asia.
“Asian economies must support their service sectors to improve employment opportunities and both internal stability and international relations,” it said.
The report said that while traditional services still dominate the lower income Asian economies, modern services such as business process outsourcing and IT are becoming increasingly significant in the higher income economies.
“The intangible nature of many services takes nothing away from the very real economic effects in employment and broader economic dynamism,” the paper said. “Efficient energy, distribution and transportation networks boost productivity in manufacturing.
“Strong modern services — especially business services such as design, marketing and prototyping — can stop Asian economies from becoming trapped at the middle-income level and lead them into higher value-added activities generating higher incomes.”
Economists say the development of services further helps in the reduction of poverty in a region which, despite great progress, still remains home to almost two-thirds of the world‘s poorest people.
Like ADB‘s Rhee, the paper points to the fact that for modern services to take off in the region, governments will need to remove “policy and structural constraints” to allow the sector to better serve as an engine to employment and growth.
Specific changes have to be tailored to fit local circumstances, however, because of the region‘s vast diversity. One answer will not fit all in identifying what reforms need to be made.
According to the East-West Center paper, some themes, however, appear common to all countries, such as removing restrictions protecting local interests. Allowing greater competition brings variety, lower prices and increased employment.
“Overall the guiding principle for Asian policymakers must be to create a more competitive environment for their service industries,” the paper said.