Chapter 11: Growth and Productivity in India’s Services sector

11.1 Introduction
Understanding the drivers of economic growth is hugely beneficial for low-income countries like
India as it is crucial to improving the living standards of their populations. Often productivity
improvements in manufacturing industries are considered as one of the major sources of growth.
This idea is analogous to the traditional structural transformation hypothesis that as a country
develops, resources move from primary to manufacturing and subsequently to services (see
Kuznets, 1966). The experience in India, however, seems to suggest that the country has been
pioneering a stage of development that defies the conventionally hypothesised structural
transformation. The Indian economy has been witnessing a service-driven growth, particularly
since the 1990s, though it remains in the category of low middle-income emerging economies.
While the share of services in India’s GDP has risen over much of the post-independence period,
there was a marked acceleration in the trend since the early 1990s. Similarly, the relative
importance of the services sector in employment generation has also increased substantially.
Moreover, the export share of services has been large and increasing in recent years
(Eichengreen and Gupta, 2012). The economic reforms of the 1990s, which paved the way for
trade liberalisation, along with major policy changes in the domestic business environment may
have helped the emergence of the service sector as a key player in India’s growth story.
Traditionally, services have been a regulated activity. This was particularly true in areas of
banking, insurance, and telecommunication, which are among the industries that witnessed
massive improvement in the post-reform period. Further, this sector has evolved as a prominent
one in terms of contribution to national and state incomes, trade flows, FDI, and employment.

The emergence of services as the most dynamic sector of the Indian

This chapter attempts economy has in many ways been a revolution. The most visible and
to revisit the well-known dimension of the take-off in services has been in
“services-led growth” software and information technology (IT)-enabled services
hypothesis for the (including call centres, software design, and business process
Indian economy by outsourcing), which to some extent also help increase innovation
capabilities in the sector (Lema et al., 2012). However, growth in
undertaking detailed services in India has been much more broad-based than IT
analysis of the (Gordon and Gupta, 2004). There have been many studies
service industries in looking into India’s service-driven economy (Eichengreen and
terms of labour Gupta, 2009, 2010), and its sluggish manufacturing. While studies
productivity and on structural transformation suggest that the observed structural
transformation in India has been growth enhancing (McMillan and
multifactor
Rodrik, 2011; Bosworth and Collins, 2008; Vries et al., 2012),
productivity growth. evidence on services sector suggests that the observed growth
surge is mainly due to higher productivity growth in this sector
(Verma, 2012). However, there has hardly been any attempt to explain the observed
momentum in the service economy in detail, particularly by looking into how productive the sector
is and what are the factors that drive its productivity. This chapter attempts to revisit the
“services-led growth” hypothesis for the Indian economy by undertaking detailed analysis of
the service industries in terms of labour productivity and multifactor productivity growth. An
attempt is made to explore the factors that drive productivity performances in the sector. Yet
another aspect that has been overlooked in the literature is the complementarities between
service sector growth and manufacturing performance, which calls for understanding why
productivity improvement in the manufacturing sector continues to be sluggish. Examination of
the above issues constitutes the core of this chapter.

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To understand the empirics of India’s growth performance, we undertake a growth accounting
exercise based on the KLEMS production function approach due to Jorgenson, Gollop and
Fraumeni (1987). The gross output production function incorporating KLEMS as inputs allows us
to evaluate the relative significance of multifactor productivity growth vis a vis input
accumulation in accounting for output growth. Using the newly created comprehensive India
KLEMS dataset version 2019 for the Indian economy for the period 1980-2017, we compute
productivity trends for the service sector. The chapter analyses sources of labour productivity in
ten subsectors of the service economy—trade, hotels and restaurants, transport and storage,
post and telecommunication, financial services, business services, public administration,
education, health, and other services. These ten subsectors are further reclassified into market
services and nonmarket services, within which we also examine ICT intensive and non-ICT
intensive service segments separately.

This chapter makes several contributions to the existing literature. First, in contrast to previous
productivity studies in the Indian context, we use additional measures of factor inputs, which will
have important consequences for productivity analysis (see OECD, 2001, Productivity manual).
Both labour and capital inputs are measured as Tornqvist indices of different types of workers
and asset types. Labour input, which is inclusive of self-employment, is measured using five
education categories of employment, with the growth of each category being weighted by its
relevant cost share. In the case of capital input, previous studies have used a measure of capital
stock, often making no adjustment for depreciation of various asset types. Such an approach
ignores the importance of heterogeneity in capital assets due to the existence of multiple
vintages and various asset types. In our analysis, we use a measure of capital services using
three different asset types, asset-specific depreciation rates and an external rate of return (see
Diewert, 2003; Schreyer, 2002). Our second contribution is in providing a detailed sectoral
perspective on India’s service sector. Since there is substantial heterogeneity within the sector,
and the contribution of its different segments to aggregate service sector growth is substantially
different, we examine the productivity dynamics of the service sector at detailed industry level.
Our detailed focus also helps in understanding the respective position of market services as
against nonmarket based services, and ICT using and producing services as against non-ICT
services in the overall service sector performance in India. Third, at
an industry level we use a gross output production function, which Given the substantial
includes contribution of intermediate inputs in the production heterogeneity within
accounts. the service sector, and
the variation in
The period of the study pertains from 1980-81 till 2017-18 and
contribution of its
is split into four distinct sub-periods of the Indian economy. We
adopt the classification provided by Panagariya et al. (2014)174 different segments to
as period 1 (1981-93)—a period where India’s per capita GDP aggregate service
grew at an average annual rate of 2.9 per cent. The second period sector growth, we
consists of years 1994-2002, during which India’s per capita GDP examine productivity
grew at an annual rate of 3.9 per cent. Additionally, we look at dynamics at the
the ‘golden growth phase’ of 2003-07. The final period looks at
disaggregated
the global slowdown phase from 2008-17 when the per capita
GDP growth declined. industry level

The chapter is structured as follows. Following the introduction, Section 11.2 provides an
overview of the service sector liberalisation by providing a pre-reform context followed by the
major reforms and a brief discussion on the impact of said reforms. Section 11.3 looks at the
service sector performance over the entire sample period of 1980-2017 and the above-
mentioned sub-periods, with a focus on Gross Value Added (GVA) and employment. Trends in

174 Refer to Chapter 2: Growth and Development in the Indian States - An overview in Panagariya et al. (2014).

288
productivity in the services sector are analysed in Section 11.4. Using a value-added framework,
we decompose the sources of observed labour productivity growth while the role of TFP versus
factor inputs is addressed via the gross output-based KLEMS framework. The final section
concludes the chapter.

11.2 Service Sector Liberalization: An Overview

A proper appraisal of the performance of India’s service sector should be preceded with an
overview of the policies and reforms that have governed this sector. Post-World War II, India
had been historically known to be one of the most regulated economies at the time. Inward
looking policies and the “license-raj” constrained the economy to a very low growth path. This
historical trend was later overturned through a series of liberalisation policies that brought an
end to the excessive governmental monopoly and regulation, including tariff reductions and
deregulation in many sectors.

The service sector remained largely state-dominated before the

Gross output and
early 1990s due to a variety of restrictions on foreign and private
value added of the domestic players. Telecommunication services were solely provided
service sector by the Department of Telecommunications (DoT) till the entry of
remained stagnant licensed private players started in 1992. The banking sector
witnessed nationalisation of large private sector banks in 1969,
in the pre-reforms leading to public sector dominance complemented with a host of
period, while there regulations (credit direction, interest rate determination by the
was a clear upward government etc.). The sector became vulnerable to moral hazard as
banks expected government bailout in case of failure (Reddy,
trend starting early 2004). The banking sector would later undergo liberalisation under
1990s—a period of the RBI in 1994 with the aim of increasing efficiency and competition.
liberalisation for Prior to the 1990s, transport services were also subject to public
sector dominance in the form of public monopolies in air transport,
the sector state control over ports, registration requirements for different
vehicle types and a variety of other regulations. The insurance sector
was mainly operated by four public sector entities under the Ministry of Finance with negligible
private competition before the reforms of mid 1990s. To put things in perspective, Figure 11.1
shows the trend followed by gross output and value added of the service sector (at 2011-12
prices) over the 1980-2017 period. It is observed that both these variables remained stagnant
in the pre-reforms period, while there was a clear upward trend starting from the early 1990s—
a period of service sector liberalisation.

Hoekman et al. (2007) point out that the pace of reforms in different sectors was mainly
determined by political considerations—sectors that would face large-scale transformation
following liberalisation saw a slower pace of reform than the sectors that were flexible enough
to accommodate greater competition without lowering profits or employment. Within the sectors
that have been liberalised, public sector incumbents have remained competitive with a stake in
the growing market—for example, -MTNL and BSNL have remained as major telecom providers
in the telecommunication sector, a sector which saw large-scale removal of restrictions in the
early 1990s. Table 11.1 provides a comprehensive summary of major reforms in the services
sector.

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Figure 11. 1: Service sector Gross Output and Value Added, 1980-2017 (in lakh crores of Rs.,
at 2011-12 prices)

120

100

80

60

40

20

0
1986

1992

1998
1980
1981
1982
1983
1984
1985

1987
1988
1989
1990
1991

1993
1994
1995
1996
1997

1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
VA GO

Source: India KLEMS dataset version 2019

Table 11. 1: Major reforms/milestones of India’s service sector liberalization

Year(s) of
Major reforms/milestones
achievement/ Sector
Telecommunications Introduction of National Telecom Policy (NTP) paved the way for
1994 systematic liberalisation of the sector.
1997 TRAI, an independent statutory regulatory body is set up; Entry of private
participants in a duopoly basis; Rationing of Licenses; Foreign equity
participation in mobile services permitted up to 49%.
1999 New NTP introduced with the stated commitment to independent regulator
and clear definition of TRAI’s role; licensing fee made more favourable for
private operators.
2000-04 National and International long-distance telephony opened to private
players; removal of restrictions on the number of operators; disinvestment
of public sector telecom providers in some metros.
2005 Foreign holding limit raised from 49% to 74%; FDI permitted up to 100%
in value-added services; greater flexibility to existing and reductions in
entry and licensing fee shares.
Banking RBI allowed entry of private sector banks; FDI up to 20% allowed; banks
1993 given more freedom to allocate their inventories and receivables.
1996 Guidelines issued for setting up private local area banks.
2000-01 Discretionary barriers to entry are lowered; 40% limit for non-resident
participation and associated borrowers from overseas increased to 49%.
2001-02 Above mentioned limit is raised to 49% from all RBI’s automatic route;
Interest rate deregulation allowed banks to set prices freely.
2004-05 Above mentioned limit is raised to 74%; foreign banks allowed to operate
through branches, fully owned subsidiaries and subsidiaries.
Transport Public monopoly in domestic air services abolished; prices in maritime
1993-94 freight and passenger transport liberalised.

290
 Year(s) of
Major reforms/milestones
achievement/ Sector
1997-98 FDI up to 40% allowed in air transport (foreign airlines excluded); Private
sector engagement in road infrastructure with the ‘Build, Operate,
Transfer’ scheme; Majority FDI allowed in construction and operation of
ports.
2004-05 Private airlines allowed to serve international routes; increased competition
for public sector airlines from private players.
Insurance Insurance Regulatory and Development Authority (IRDA) Bill formally
1999 liberalised the sector to allow private entry; foreign equity participation
up to 26% allowed; Pricing freedom given with supervision.
2000 IRDA constituted as a statutory body; sector opened up to private and
foreign players with 26% foreign ownership.
2002-03 Entry of 12 new private players put pressure on the incumbent insurance
providers.
2015 Foreign investment cap increased from 26% to 49% under the Insurance
Laws (Amendment) Bill.
Health Limited decentralization of healthcare system allowed some local
1990s governments more control over resource allocation; introduction of user-
fees under the eighth five-year plan (1992-97); paradigm shift with focus
on delivery to underprivileged groups.
2000s Contracting out of health services to private providers; increased
geographic coverage; introduction of public-private mix.
Education Foreign equity participation allowed up to 100% for entry through
2000 franchises, twinning arrangements, study centres and programme
collaboration; 49% foreign equity participation for research and teaching
activities; regulatory environment requires establishing entity to be non-
profit.
2010 Introduction of the Foreign Educational Institutions Regulation of Entry and
Operations Bill under UPA-II for allowing foreign education providers to
offer degrees and diplomas to Indian students, however, the Bill would
later lapse.
2016 Proposal by the Commerce Ministry to allow foreign universities to set up
campuses in SEZs, however, the idea was not supported by the HRD
ministry.
2019 ‘Internationalisation’ included as a focus under the five-year plan of the
HRD ministry called Education Quality Upgradation and Inclusion
Programme; ideas to revisit the Foreign Education Bill previously
introduced under UPA-II.
2020 National Education Policy (NEP) approved by Union Cabinet with the vision
to restructure the education system from elementary to higher education by
the year 2040.
Source: Authors compilation based on J.M. Arnold et al. (2016) & R. Chanda and Pralok Gupta (2011).

On a more conceptual level, the different policy aspects governing the service sector in India
can be categorised into: (1) general issues and (2) sector-specific issues. General issues are
broadly connected with foreign direct investment (FDI), tariff and taxes, credit and finance.
Additionally, issues connected with domestic regulation, market access, bilateral and multilateral
negotiations are significant policy issues when addressing reforms in the Indian service sector.
Major sector-specific issues are primarily connected with the level of permissible FDI and thereby
the extent of foreign competition allowed. Prasad and Sathish (2010) provide comprehensive
analysis of the policies undertaken in the service sector in recent years (see Table 11A.1 of
Annexure 11A). To take a few examples, entry of foreign firms through partnerships/joint
ventures in insurance firms and through FDI in health insurance has characterised the banking

291
and insurance sector in recent times. In the banking sector, though foreign investment cap of 74
per cent is allowed, issues remain regarding licensing requirements, etc. Healthcare has no FDI
cap, but there remain barriers on foreigners providing medical services for profit. Education
services in India come under the jurisdiction of both state and federal governments and there
are regulations on setting up of new education services in some fields such as medicine. Thus, as
it stands now, there are regulators for some services (banking, insurance, telecom, and ports),
whereas most professional services lack independent regulators resulting in unevenness of
standards across professional services.175

The large-scale liberalisation measures have shown a positive impact in the contribution of
services to India’s trade flows. Figure 11.2 below shows that services accounted for 51.7 per
cent of India’s gross exports in 2015 (OECD-TiVA, 2018), although this is lower than the OECD
average of 54 per cent. Despite the impressive performance of services trade in India, it is
important to note that exports of services remain constrained by domestic and external barriers
(infrastructure, technical, standards financial) and regulatory aspects.

Figure 11. 2: Services content of India’s gross exports, 2015

Source: OECD TiVA, December 2018

It is also important to keep in mind that the service sector provides crucial inputs to other sectors
and hence generating more efficiency in the services sector via policy reforms could enhance
competitiveness in the overall economy. Nowhere is this truer than for the manufacturing sector
i.e., an efficient service sector is an important precursor for manufacturing competitiveness.
Figure 10.2 shows that services value added accounted for around 25 per cent of total
manufacturing exports in 2015. There are several studies in the context of services-
manufacturing linkages, for example, Arnold et al. (2016) used firm level data for India and
found a positive link between services liberalisation and performance (TFP) of manufacturing
industries.

11.3 Service Sector Performance: 1980-2017

Unlike the East Asian model, the service sector played a predominant role in the transformation
of India from its “Hindu rate of growth” phase to one of the fastest growing countries in the
world. This unique feature of the Indian economy makes detailed analysis of the service sector

175 Prasad and Sathish (2010) argue that lack of a proper all-India accredited system legitimises foreign
restrictions. This is particularly true in case of services such as Bar Council of India, Medical, Dental and Nursing
Councils of India and Institute of Chartered Accountants of India, to name a few.

292
a pertinent topic in the literature. In what follows, we first discuss some of the basic concepts of
the service sector in the Indian context. This is succeeded by the reforms and policies that have
been aimed at this sector. We end this section by giving an overview of the performance of the
service sector in India and comparing it with the traditional driver of economic growth—
manufacturing.

The service sector encompasses a plethora of diverse and heterogeneous economic activities. It
is for this basic reason that it has become increasingly difficult to give a precise definition to the
activities pertaining to this sector. In India’s National Accounts Statistics, the sector consists of:
wholesale and retail trade, hotels and restaurants, transport services, storage services,
communication services, financial services, real estate, ownership of dwellings and renting
services, business services and other social, community and personal services. In terms of
measurement, it is probably more difficult to measure than goods, as services often represent a
process by which a consumer is charged—hence there are conceptual problems in both
“quantity” and “quality” of services (Melvin, 1995), as well as determining the price of the
service. For collection of data and analysis, the subsectors are further categorised into public,
private organised, and private unorganised. The public sector estimates of gross value added
are obtained from data on output and intermediate outputs from budget documents. For some
sectors of the private organised segment and most of the private unorganised segment, value
added is computed using the ‘labour input’ method—multiplying the estimates of value added
per worker in a benchmark year with the estimated labour force from census surveys (Nayyar,
2012). However, each of the methods of measurement has its own problems. Given that the
output of service sector is often measured in terms of employee compensation, an increase in
wages would imply an increase in real output even with the same actual activities. On the other
hand, the quality of the crucial components of the ‘labour input’ method—estimates of the
workforce and estimates of value added per worker—are quite low (Tendulkar, 2007). Lastly,
the lack of a suitable service sector price index depletes the precision of constant price estimates
of this sector.

With these limitations and concepts in mind, it is interesting to

ascertain the role of the service sector as the primary driver of Unlike agriculture,
India’s growth performance. Table 11.2 provides a services’ contribution to
comprehensive analysis of its contribution to Gross Value Added employment remains
(GVA) and employment. It shows services contribution to GVA at
around 54 per cent per annum in 2017 compared with 37 per low and non-
cent in 1980, with market-based services as the largest commensurate with the
component with a share of 32 per cent in 2017. Within market movement in services’
services, ICT-intensive services considerably dominated ICT-non
intensive services in terms of GVA share, for each decade of the share in GVA. Variation
study period. At the outset, it may be argued that the growth in in educational
services can be attributed to increase in relative prices or to a requirements across
result of outsourcing of activities (or splintering), causing the
services might be
growth of final demand for industrial or agricultural products to
raise the share of services in GDP. Yet, the data does not indicate manifesting as low
any of these arguments holding true—implicit GDP price quality of employment
deflators during 1993-2010 did not increase noticeably.
Moreover, increase in the use of services inputs by other sectors
over time cannot explain the recent surge in the growth of the services sector (Gordon and
Gupta, 2004; Nayyar, 2012). Thus, services growth in India was real rather than a statistical
artifice. Unlike agriculture, services contribution to employment remains low and non-
commensurate with the movement in services’ share in GVA. Yet we find a consistent upward
movement as far as “jobs in service sector” is concerned from 17 per cent share in total
employment in 1980 to 34 per cent in 2017. Similar to the case of value added, we find that

293
the employment share of market services (22 per cent) exceeded that of non-market services
(12 per cent), with a higher share of ICT-intensive services (15 per cent) over ICT non-intensive
services (7 per cent), in 2017. There may be various reasons for the low employment absorption
in the overall services sector relative to its share in GVA. Nayyar (2012) finds that educational
requirements vary across different subsectors in the service sector and manifests itself through
low quality of employment.

Table 11. 2: Relative contribution of services industries to gross value added and employment
share

1980 1990 2000 2010 2017

GVA EMP GVA EMP GVA EMP GVA EMP GVA EMP
Description
share share share share share share share share share share
46.5 24.3 28.6 53.5 33.8
All Services 36.77 16.94 40.30 19.98 48.55
7 3 7 0 0
25.3 15.1 18.5 32.0 22.1
Market Services 15.19 9.12 18.76 11.81 28.39
9 4 2 9 8
ICT Intensive 19.3 10.6 12.8 26.2 15.2
11.29 6.43 13.64 8.33 22.54
Services 8 3 1 7 4
10.0 10.8 10.9
Trade 6.92 5.80 7.45 7.34 8.49 9.08 9.42
2 5 1
Financial Services 2.65 0.31 3.38 0.51 4.79 0.57 6.03 0.91 5.44 1.13
Post and
0.75 0.14 1.17 0.18 1.97 0.33 1.56 0.38 1.56 0.39
Telecommunication
Business Services 0.97 0.18 1.63 0.30 4.13 0.65 5.53 1.50 8.42 2.82
ICT non-intensive
3.90 2.70 5.13 3.49 6.01 4.50 5.85 5.71 5.82 6.94
services
Hotels and
0.58 0.80 0.68 0.91 0.95 1.17 1.06 1.64 0.99 1.95
Restaurants
Transport and
3.32 1.90 4.45 2.57 5.06 3.34 4.78 4.06 4.83 4.98
Storage
Non-Market 21.1 10.1 21.4 11.6
21.58 7.81 21.54 8.16 9.19 20.16
Services 8 5 1 2
Public
Administration &
Defence; 5.20 2.75 6.00 2.84 6.70 2.47 6.15 1.79 6.17 1.70
Compulsory Social
Security
Education 1.96 1.58 2.34 1.62 3.10 2.15 3.30 2.95 4.12 3.77
Health and Social
0.84 0.58 1.04 0.56 1.35 0.72 1.43 0.97 1.69 1.29
Work
10.0
Other services 13.59 2.90 12.15 3.14 3.86 9.27 4.44 9.43 4.87
3
Source: Authors’ computation from National Accounts Statistics, Government of India, and India KLEMS
database, 2019

Given the variety of economic activities that the service sector encompasses, it is worth looking
at the trends at the subsector level. We observe from Figure 11.3 that service sector growth is
widespread across various activities. In accounting for growth in value added in different
subsectors, we find that business services show the maximum growth (around 12 per cent per
annum), for the 1981-2017 period. If we consider the period of 2003-07, we find post and
telecommunications and business services exhibiting high growth rates of around 11 per cent
and 13 per cent, respectively. The telecommunication liberalisation began in 1994 with the
private sector being allowed to offer telecom services. The rapid innovation in IT makes it a
dynamic contributor to the growth of the Indian economy by itself (Singh, 2014). The domestic

294
IT and hardware market has also become substantial in size and scope, although the value
added for the latter is probably less than software and ITES. On the contrary, the employment
generating potential of service sector in India has been the subject of intense debate on
sustainability of service sector growth in India. Issues related to skilled versus unskilled nature of
labour force requirements have been at the core, based on access to education and training. A
glance at the panel B of Figure 11.3 shows that financial services and business services have
been the major providers of employment, for the 1981-2017 period. Further, majority of the
sectors show an employment growth of around 3 per cent for the period of 1981-2017.

Figure 11. 3: Growth rates of value added and employment, 1981 to 2017 (% per annum)
Panel A: Growth rates of gross value added

1980-93 1994-02 2003-07 2008-17 1980-17

25.00

20.00

15.00

10.00

5.00

0.00

Panel B: Growth rates of employment

1980-93 1994-02 2003-07 2008-17 1980-17

12.00
10.00
8.00
6.00
4.00
2.00
0.00
-2.00
-4.00

Source: Authors’ computation from National Accounts Statistics, Government of India, and India KLEMS
database, 2019

295
While there is a broad agreement about the dynamism of the service sector, questions have
been raised about the sustainability of services growth (Acharya, 2002; Bosworth, Collins &
Virmani, 2007; Panagariya, 2008). Singh (2006A) argues that services had proportionately
the largest inducing effect in terms of backward linkages as well as forward linkages (albeit
weaker than backward linkages). These linkages, the author argues, had an important impact
in the reduction of transaction costs during the 1980s and 1990s and subsequently stimulated
the entire economy to an extent. Moreover, introduction of a range of rural ICT services (ICTS)
provides spillovers from ICTS through knowledge acquisition and information access (Singh
(2006B)). Several policy implications emerge from the analysis—tackling education and
technological bottlenecks and some labour market reforms that improve the innovation
capabilities in the economy can go a long way to solve the problems of the service sector to
increase its scope and labour absorption abilities, while continuing to remain dynamic for
leading India’s economic growth. We need to infer if the driving force behind the service sector
growth in India can be explained through improvements in resource use efficiency (both labour
and total factor productivity growth). The rest of the chapter will make an attempt in this
direction.176

11.4. Productivity Trends in India’s Service Sector

Several empirical studies (Balakrishnan and Parameswaran, 2007; Bosworth et al., 2007;
Rakhsit, 2007; Bosworth and Maertens, 2010) have identified the service sector as the driver
of India’s economic growth. Using growth accounting tools, some of the studies also analysed
whether such observed growth was led by efficiency of resource use (TFP) or input accumulation.
Nayyar (2012), however, argues that such studies are only at the aggregate level and hence
do not take into account any intra-industry group differences within services. These differences
could arise because of structural characteristics—(i) organised-unorganised, (ii) intermediate-
final, and (iii) public-private. In addition, these industries differ
Our measure of labour due to barriers to entry for job seekers, technology in use, and
input incorporates factor use — (1) capital intensity and (2) skill intensity.
qualitative aspects of the Therefore, it is essential that we figure out the channel via
which growth is taking place across these industries — Growth
labour force in terms of through increases in capital accumulation or through
education while defining employment expansion or even some sectors in unorganised
a new measure of labour services boosting growth by employing unskilled workers.177
input as the product of The present empirical analysis is thus an attempt towards
labour person and the recognising that service industries are heterogeneous in
quality index. The capital several respects and, thereby, a disaggregated industry level
perspective is needed to understand productivity—both
input defined in terms of labour and multifactor as well as the role of productivity in
capital service takes explaining overall growth in services.
asset heterogeneity into
account. In this section, we provide estimates of labour productivity
growth using a value-added framework for various subsectors
of services in India. Using this approach, we also detail the sources of labour productivity growth.
Measurement and analysis of productivity at the disaggregate as well as aggregate levels,
when based on the value-added version of the production function, ignores the explicit role of

176 Rubina Verma (2012) attempts to account for the rapid growth of the service sector observed in India during
1980-2005. A growth accounting exercise shows that total factor productivity (TFP) growth was the fastest for
services sector.
177 Refer to Tables 5.13 and 5.14 in Nayyar (2012) for exploring the heterogeneity of services and listing of
services as clusters across sectors and characteristics and the documenting of different services industries into
multiple characteristics prevailing within Indian service sector.

296
intermediate inputs in the production process. In the present chapter, we have considered three
intermediate inputs—energy, material, and services, and this is important as we may find that
intermediate inputs are the primary component of some industries’ outputs.178 Failure to quantify
intermediate inputs leads us to miss both the role of key industries that produce intermediate
inputs and the importance of intermediate inputs for the subsectors that use them (Jorgenson, Ho
and Stiroh (2005), Productivity, volume 3). Our measure of labour input incorporates qualitative
aspects of the labour force in terms of education while defining a new, refined measure of
labour input as the product of labour person and quality index. The capital input defined in
terms of capital service takes the asset heterogeneity into account as against a measure of
capital stock which is devoid of it. In the following subsections, we discuss the estimates and
sources of labour productivity and output growth using the value added and gross output version
of the production function, respectively.

Sources of Labour Productivity Growth

The service sector’s performance in terms of labour productivity is summarised in Table 11.3.
Our main observation is that labour productivity in India’s service sector has been growing
substantially over the decades of the study period, and much of this productivity gain is accruing
through acceleration in non-market services productivity. In the pre-reforms phase (1981-93),
non-market services showed higher labour productivity growth relative to market services, with
the opposite happening in the reform phase (1994-02) and the golden growth phase (2003-
07). However, market services fell behind non-market services in terms of labour productivity
growth in the global slowdown phase (2008-17). A closer examination further suggests that ICT
intensive sectors, in particular trade and post & telecommunication have driven much of the
market services productivity growth, while non-market services growth has been led by public
administration. For the entire study period, labour productivity in services grew at the rate of
close to 4 per cent per annum. Turning attention to the individual industries within services, we
find that a majority shows labour productivity growth lower than the sectoral average, the
exceptions being post and telecommunication, public administration, and health and social work
which register high labour productivity growth in the region of 5 to 6 per cent.

Table 11. 3: Labour productivity growth in service industries by subperiod: 1981–2017 (%

per annum)

Description 1981-93 1994-02 2003-07 2008-17 1981-17

All Services 2.89 4.41 4.97 5.43 4.23

Market Services 1.72 4.91 5.38 4.71 3.80

ICT Intensive Services 1.85 5.69 5.08 4.91 4.05

Trade 1.19 4.35 5.89 6.97 4.16

Financial Services 3.22 6.31 2.61 2.55 3.71

Post and Telecommunication 1.73 9.14 7.86 7.43 5.90

Business Services 1.64 5.48 3.82 2.29 3.04

178 Consider the semi-conductor (SC) industry, which is a key input to the computer hardware industry. Much of the
output is invisible at the aggregate level because semi-conductor products are intermediate inputs to other
industries rather than deliverables to final demand-consumption and investment goods. Moreover, SC plays a
role in the improvements in quality and performance of other products such as computers, communication
equipment, and scientific instruments.

297
 Description 1981-93 1994-02 2003-07 2008-17 1981-17

ICT non-intensive services 1.25 2.47 6.23 3.65 2.87

Hotels and Restaurants 2.95 4.49 5.92 2.36 3.57

Transport and Storage 0.97 2.13 6.31 3.94 2.78

Non-Market Services 3.61 3.19 3.55 6.00 4.14

Public Administration and Defence;
3.80 6.52 6.45 7.91 5.93
Compulsory Social Security
Education 3.30 3.62 1.23 7.43 4.21

Health and Social Work 5.21 3.42 6.31 5.11 4.90

Other services 3.22 0.71 1.20 3.97 2.54

Source: Authors’ calculations based on India KLEMS dataset version 2019

The disaggregated picture in Table 11.3 offers a few interesting observations: Four market
services sectors—hotels and restaurants, post and telecommunications, trade and transport and
storage showed large improvements in productivity from a very low base in the decade of
1980s. All the service industries mentioned above had significant changes in their business
environment beginning from the 1990s covering regulation as well as policy measures. For road
transport, we find reforms from early 1990s covering entry of private players, amendments in
motor vehicle laws, setting up of National Highways Act. Domestic air transport was liberalised
in 1993 with the monopoly of Indian Airlines’ being abolished, leading to greater competitive
pressure in domestic air services. In the case of telecom services, most manufacturing services
were completely under governmental domain and private firms were allowed to provide
telecommunication services in 1992 with the introduction of cellular service licences. In 1994, the
government announced a new National Telecom Policy that provided guidelines for the private
sector’s involvement. In financial services, especially banking, substantial reforms were
undertaken pertaining to new banks and licensing policies. In 1993, the government issued
guidelines for allowing entry of new private banks, although approvals remained difficult due
to stringent RBI regulations. Reforms in the insurance sector commenced in the latter part of
1990s and securities markets were also streamlined.

Next, we look at the contribution of individual industries to aggregate labour productivity

growth in the service sector for the period of 1981-2017. The aggregate productivity growth
is the weighted sum of industry productivity growth plus a reallocation term R. The reallocation
term is positive if value added shifts from low productivity industries towards high productivity
industries. Table 10.4 summarises the contributions of major service groups (market services—
ICT and non-ICT intensive, and nonmarket services) and reallocation effect to labour productivity
growth in the service sector.

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Table 11. 4: Industry contributions to aggregate labour productivity growth by subperiod;
1981-2017
2003-
Description 1981-93 1994-02 2008-17 1981-17
07
All Services 2.89 4.41 4.97 5.43 4.23
Market Services 0.74 2.59 3.05 2.72 2.04
ICT Intensive Services 0.58 2.27 2.21 2.29 1.67
Trade 0.22 0.83 1.14 1.39 0.81
Financial Services 0.25 0.69 0.30 0.29 0.38
Post and Telecommunication 0.05 0.39 0.34 0.27 0.23
Business Services 0.06 0.36 0.43 0.34 0.26
ICT non-intensive services 0.16 0.32 0.84 0.43 0.37
Hotels and Restaurants 0.05 0.09 0.13 0.04 0.07
Transport and Storage 0.11 0.24 0.71 0.39 0.30
Non-Market Services 1.95 1.39 1.26 2.32 1.82
Public Administration and Defence;
0.56 0.92 0.78 0.93 0.78
Compulsory Social Security
Education 0.18 0.22 0.07 0.50 0.26
Health and Social Work 0.12 0.09 0.19 0.15 0.13
Other services 1.09 0.16 0.22 0.74 0.65
Reallocation 0.19 0.42 0.66 0.38 0.36
Source: Authors’ calculations based on India KLEMS dataset version 2019

Labour productivity in the Indian service sector has been growing substantially over decades,
and much of this gain has accrued through acceleration in the contribution of market services
labour productivity to aggregate service labour productivity growth. While the nonmarket
services productivity contribution declined from about 2 per cent in the pre-reform period
(1981-93) to around 1.3 per cent in the two post-reforms decades, market services witnessed
an increase in its contribution from less than 1 per cent (1981-93) to above 3 per cent (2003-
2007). Market services retained its lead over non-market services even in the global slowdown
phase (2008-17), albeit with a very small margin. A closer look at this suggests that within ICT
intensive services—business services, trade, and financial services led much of the service sector
productivity growth. Within ICT non-intensive services, the transport and storage sector
contributed a major part of aggregate productivity improvement. Almost all nonmarket services,
except public administration and education, showed a deceleration in their contribution to
aggregate service sector productivity in the reform phase (1994-02). However, these services
would go on to improve their contribution in the 2000s. Aggregate service labour productivity
improved in the 1990s (4.41 per cent) compared to that of 1980s (2.89 per cent). However,
the contribution of market services to aggregate service sector productivity growth increased
both in 1990s and 2000s, with the ICT intensive services maintaining their lead over non-ICT
intensive services. Notably, in the global slowdown phase (2008-17), the contribution of ICT
intensive services to aggregate labour productivity increased, while that of ICT non-intensive
services fell behind. This increase in the contribution of the market services, and in particular ICT
intensive services, to aggregate service sector productivity might indicate the increasing role of
ICT in contributing to labour productivity growth. The labour reallocation effect is positive in all
sub periods and for the full study period. The labour reallocation effect increased in the 1990s
and 2000s following the reforms of early 1990s, suggesting a growth-enhancing structural
transformation, with resources apparently moving from less productive to more productive
services. However, this reallocation effect took a step back in the global slowdown phase of
2008-17.

299
Finally, we investigate the sources of observed labour productivity growth across different
components of services. The standard growth accounting exercise attributes the main source of
increases in labour productivity per person employed to TFP growth and capital deepening.
Figure 11.4 provides a decomposition of labour productivity growth in terms of total factor
productivity (TFP), capital deepening and labour quality.

Figure 11. 4: Sources of labour productivity growth by services industry, 1981-2017, (% per
annum)

Other services
Health and Social Work
Education
Public Administration and Defense; Compulsory Social…
Business Service
Financial Services
Post and Telecommunication
Transport and Storage
Hotels and Restaurants
Trade

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0

Capital-Labour Ratio Labour Composition TFP

Source: Authors’ calculations based on India KLEMS dataset version 2019

We observe that TFP growth accounts for much of the improvement in labour productivity in
financial services, public administration, and overwhelmingly for transport and storage. For the
rest of the services, except for education (where the contribution of TFP growth and capital
deepening is very close), the contribution of TFP growth is mostly small. For non-market services,
we find very low or negligible contribution from overall productivity growth in accounting for
labour productivity growth. We also report negligible role of labour quality in explaining
labour productivity in services, while capital deepening remains large for many sectors, including
health and education.

Sources of Output Growth

The major observation in the previous section is that the main contributor to labour productivity
growth across different service sectors is to be found in total factor productivity, not in
differences in the intensity of the production factors especially labour and capital. The estimates
of TFP growth in this section for various subsectors of services are calculated using gross output
as the measure of output, and primary inputs of capital (K) and labour (L), along with the input
trio of energy (E), materials (M) and services (S) together constituting intermediate inputs in what
has come to be known as the KLEMS framework for measuring productivity (the period under
consideration is 1980-2017).179

179 See for example OECD (2001), Jorgenson et al. (2005), Diewert and Nakamura (2007) and Timmer et al.
(2010) for detailed accounts of the new approach. Jorgenson et al. (2005) and Timmer et al. (2010) have

300
Figure 11. 5: Growth of total factor productivity in services sector by subperiod, 1981-2017
(% per annum)

1981-17

2008-17

2003-07

1994-02

1981-93

-1.00 -0.50 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00

Non Market Services ICT non intensive ICT intensive services Market services

Source: Authors’ calculations based on India KLEMS dataset version 2019

The TFP growth for broad categories of services is depicted in Figure 11.5. In the pre-reform
phase of 1981-93, TFP growth of non-market services outperformed that of market services.
However, we observe an improvement in the TFP growth of market services in the reform phase
of 1994-02. It is clear that market services maintained this lead over non-market services in the
golden growth phase of 2003-07 as well. However, TFP growth rate of market services fell
considerably behind non-market services in the global slowdown phase of 2008-17. The low
TFP growth of market services in relation to non-market services during the pre-reform phase
and the global slowdown phase, leads to the overall picture with higher TFP growth of non-
market services over market services for the entire period of 1981-2017. Within market
services, we observe a peculiar trend—TFP growth of ICT intensive services consistently fell
behind ICT non intensive services, after having outperformed the latter in the pre-reform phase.
This trend is explored further below.

Next, we look at the TFP growth performance for the individual sectors of services in Figure
11.6. For the entire period of 1981-2017, the subgroups with the highest TFP growth are public
administration, transport and storage, and business services neck-and-neck with financial
services. If we follow these industries through the four sub-periods, we find that public
administration consistently registered high TFP growth rates for each sub-period before coming
out on top in the global slowdown phase of 2008-17. In the case of transport and storage, it is
interesting to note that the sector started off with a very low base TFP growth in 1981-93
before seeing improvements in its TFP growth in the post economic reform era, slowing down
afterwards in the global slowdown phase of 2008-17. Both financial and business services
registered decent TFP growth in the pre-reform phase, however in the mid-1990s, the sectors

exploited the new methodological framework to address substantive issues for the American economy and EU
economy, respectively.

301
saw a great decline in TFP growth during 1994-2002—a period of Asian financial crisis and
slowing down of the global economy. The post and telecommunications sub-sector presents
another interesting case, the sector started off with a negative TFP growth (-0.86 percent per
annum) in the pre-reform phase before seeing massive improvements in the sub-periods of
1994-02 and 2003-07, only to crumble down to an even worse negative growth rate (-2.23
percent per annum) once again in the global slowdown phase of 2008-17. The performance of
other subgroups especially non-ICT and non-market services seem to broadly reflect the macro
picture of the last figure.

Figure 11. 6: TFP growth in service industries: 1981-2017

Public Administration and Defense; Compulsory…

Transport and Storage

Financial Services

Education

Post and Telecommunication

Health and Social Work

Hotels and Restaurants

Other services

Business Service

Trade

0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00

Source: Authors’ calculations based on India KLEMS dataset version 2019

Figure 11.7 provides the TFP levels180 for services and its sub-sectors along with the
disaggregated service industries for the period of 1981-2017. Panel A provides the TFP levels
for overall services and its market and non-market sub-sectors. Since the reforms in 1991-92
we find that the TFP levels of the services sector has been improving and continues to be on an
upward trajectory even after the Global Financial Crisis of 2007-08. The non-market services
sub-sector has been leading the service sector TFP performance and continues to be higher than
the overall services. Panel B provides the TFP levels for all disaggregated services industries for
the period 1980-2017. Two points important to emphasise here are (1) the rise in services TFP
levels across a majority of the industries began from the 2000s and most of these industries
show rising trends during 2003-08, the period when India’s economic growth was growing
around 8 per cent per annum, and (2) even during the phase of a global slowdown, TFP levels
for India’s services industries continued to rise. An important aspect of the rising trends in TFP
level for non-market services throughout the period of 1980-2017 is that the TFP level for public
administration was increasing as early as the late 1990s.

180
The TFP levels are shown as indices with 1980-81=100.

302
Figure 11. 7: Services sector TFP levels – Broad and Disaggregated, 1980-2017
Panel A: TFP levels, Market v/s Non-Market Services, 1980-2017

250

200

150

100

50

Market Services Non-Market Services All Services

Panel B: Disaggregated Services Industry TFP levels, 1980-2017

300

250

200

150

100

50

Trade Financial Services Post and Telecommunication

Business Service Hotels and Restaurants Transport and Storage

303
 Panel B: Disaggregated Services Industry TFP levels, 1980-2017 (Continued)

600

500

400

300

200

100

Public Administration and Defense; Compulsory Social Security

Education
Health and Social Work
Other services

Source: Authors’ calculations based on India KLEMS dataset version 2019

Table 11.5 presents the decomposition of output growth for the different sub-sectors of services
for the period of 1981-2017. The contribution of an input is defined as the product of value
share of the input and the growth rate of the input. Thus, each input contributes to output in
proportion to its value share, while TFP contributes to output growth point for point. The first
column reflects the rate of output growth, and the other columns reflect the contributions of the
factor inputs — labour, capital, material, energy and services and the final column provides the
rate of TFP growth.

We observe wide variations in output growth across different service industries, from over 12
per cent p.a. growth in public administration (the highest) to 5 per cent p.a. growth for ‘other
services’ (the lowest) for the period of 1981-2017. TFP growth comes out as the dominant source
of output growth for public administration.181 When we compare the contribution of factor inputs,
we find that capital services make the largest contribution to the output growth across different
industries—trade, financial services, health, and business services182 and the rest of the services
that make up for ‘other services’. Services input is observed to be the dominant source of output

181 The high TFP growth reflected in public administration and defence arises due to low input accumulation and
relatively high rates of growth in value added as well as output. IO tables do not provide details distribution
of material, energy, and services inputs in total intermediate inputs for public administration and defence. We
used the ratio of individual commodities to all commodities in total Government Final Consumption Expenditure
for computing each of the intermediate inputs and this may reflect possible measurement issues .
182 In case of business services, low TFP reflects the major contribution by capital input in accounting for the overall

growth. We argue that the fall in prices of capital goods industries especially office, computing and accounting
machinery and parts as reflected by the sharp fall in nominal tariff rates from around 62 per cent (1990s) to
around 17 per cent (2000s) could have been the trigger for increased role of capital input in the observed
growth.

304
growth for transport and storage. We find material input as the dominant source of output
growth for hotels and restaurants, and post and telecommunications. In the case of
telecommunications, we have witnessed major deregulation since 1992 along with the onset of
major liberalisation in manufacturing and trade sectors. Further, it may be important to note that
telecom policy reforms have recognised the need to have many more participants than the
incumbent operator in the process of telecommunications network expansion and service
development, thereby bringing in competition which made the industry efficient in terms of TFP
dynamics.183

It is evident from the decomposition of output growth that capital input,

Indian services are namely capital services, makes a significant contribution to the
becoming highly observed growth. In addition, for certain sectors namely health,
intensive in capital education, financial services, trade including wholesale and retails,
on the one hand and hotels and restaurants, capital services account for a substantial
and on the other contribution to improvements in labour productivity during the period
hand, the share of 1981-2017, as seen before in Figure 10.4. This might indicate the role
capital-intensive of increasing ICT in contributing to labour productivity growth.
sub-sectors within
the service sector is Further, we note from Table 11.5 that for market-based ICT intensive
increasing. sectors—financial services, business services and trade, capital service
contribution is overwhelmingly large when compared with other inputs,
thereby reflecting sharp inter-industry variations in the contribution of
capital deepening within services. It would suggest that Indian services are becoming highly
intensive in capital on the one hand and on the other hand, the share of capital-intensive sub-
sectors within the service sector is increasing.

183 Refer to the Annex III–The chronology of Telecom Deregulation in India by Singh, et al. (2005).

305
Table 11. 5: Contribution of factor inputs and TFP to gross output growth, 1981-2017 (% per annum)

GO Contribution of Contribution of Contribution of Contribution of Contribution of

Industry description TFPG
Growth Labour Input Capital Service Material Input Energy Input Service Input

Trade 6.97 1.33 4.04 0.31 0.21 0.96 0.09

Hotels and Restaurants 6.08 0.61 1.05 3.20 0.18 1.05 0.00

Transport and Storage 7.08 1.10 0.80 1.14 1.49 1.80 0.66

Post and Telecommunication 9.97 0.70 2.18 4.09 0.76 1.49 0.45

Financial Services 8.72 1.63 2.97 0.44 0.22 1.64 1.44

Business Service 12.40 2.34 4.94 1.63 0.40 3.35 -0.47

Public Administration and Defence;
5.94 0.33 0.82 0.31 0.02 1.33 3.07
Compulsory Social Security
Education 7.86 2.56 2.32 0.24 0.03 1.05 1.49

Health and Social Work 6.62 1.50 1.98 2.07 0.03 0.29 0.57

Other services 5.56 1.63 1.90 0.59 0.02 0.63 0.61

Source: Authors’ calculations based on India KLEMS dataset version 2019
The share of ICT intensive sectors (trade, post and telecommunication, financial services) within
market services stands at almost 40 per cent of total services (2009-10). This may be due to
several reasons, including import of capital goods following liberalisation of trade policy,
especially lowering of tariffs and easing of nontariff barriers in the capital goods sector.184 It
may also reflect the onset of many new technologies (ICT) that enhances capital deepening
through liberalisation of trade in services. Table 10.6 captures changes in trade policy—nominal
tariffs as well as resultant import competition brought about by such changes. Das (2015)185
finds that for all categories of capital goods, there has been substantial downward shifts in
nominal tariff rates as captured by nominal rate of protection. We find across-the-board
decline in tariff rates from around 50 per cent to almost below 20 per cent during the decades
of 1990s and 2000s. We find that for office and other computing machineries there is a
substantial decline of more than 50 percentage points.

Table 11. 6: Trade policy indicators for capital goods sector: 1990s versus 2000s
Import Penetration Nominal Rate of
Industry Description
Ratio Protection (%)
Capital Goods Industries 1990- 2000- 1990- 2000-
1999 2009 1999 2009
350 Agri machinery and equipment and parts thereof 0.01 0.03 44.76 18.10
351 construction and mining industries 0.71 1.24 44.39 17.45
352 Prime movers, boilers, steam generating plants 0.42 0.92 44.39 17.45
nuclear reactors
353 Industrial machinery for food and textile industry 0.41 0.82 45.10 17.76
354 Industrial machinery other than food and textile 0.56 1.12 44.39 17.45
356 General purpose Machinery 0.61 1.24 50.54 17.98
357 Machine tools parts and accessories 0.09 0.27 46.51 17.39
358 Office, computing and accounting machinery and 1.16 1.05 62.73 12.37
parts
359 Special purpose machinery and equipment 0.93 1.45 50.54 17.98
/component/accessories
360 Electrical industrial machinery 0.07 0.17 48.87 17.72
361 Insulated wires and cables 0.02 0.09 71.80 19.45
362 Primary cells and primary batteries 0.03 0.12 79.63 21.02
365+3 Radio and TV apparatus 0.20 0.43 63.38 12.78
66
368 Electronic valves and tubes 0.71 0.75 63.38 12.78
369 X-ray Machines and Electrical equipment nec. 1.18 0.97 63.38 12.78
370 Ship and boat building 0.31 0.89 52.19 18.93
371 Locomotives and parts 0.15 0.42 46.88 18.15
372 Railway/tramway wagons and coaches 0.05 0.12 46.88 18.15
379 Transport equipment and parts 0.01 0.01 72.46 21.27
Source: Das D K (2015): Trade Liberalization Indicators by Industry—India DATABASE— unpublished

184Das (2007) shows that effective rate of protection for capital goods sector declined from an average 62 per
cent in 1980s to around 30 per cent by the end of 1999. In case of nontariff barriers, the decline was even
steeper from a near 100 per cent to around 8 per cent by the end of the decade 1990-2000. In another related
study, Das (2015) has shown that the trade policy changes have further consolidated to low levels with a band of
0-10 per cent for tariff rates for major industry categories.
185 Das, D.K. (2015) Trade Liberalisation Indicators by Industry—India DATABASE — unpublished

307
The observed growth pattern in the service sector has not been uniform across all services in
India. The performance of market-based ICT intensive sectors is impressive, especially
telecommunications and financial services. However, by and large, we find dominance of capital
deepening in accounting for growth. We need to ascertain if information and communication
technology (ICT) remained an important source of both capital deepening and total factor
productivity growth within services in India. We conclude that import liberalisation has been a
principal component of the economic reforms undertaken in India and complementary policies
such as technology import policy have, to a large extent, contributed to the import and
adaptation of ICT equipment and technology in the observed capital deepening within services.

Services and Aggregate TFP

The trajectory of growth in TFP is a key determinant of long-run economic growth of an economy.
Further, the service-led growth momentum in India has been questioned on the grounds of
‘sustainability’ against the backdrop labour-abundance and capital-scarcity. To this end, we
examine the contribution of different sectors to productivity growth at the aggregate economy
level. The decomposition of output growth into its sources is shown for all broad sectors of the
economy. The whole period 1980-2017 is considered for the analysis. The contributions of
different inputs to output growth are shown in Table 11.7. TFP has played an important role in
the growth of the services sector. TFP growth accounted for about a fourth of the real GVA
growth achieved by the services sector. Besides productivity growth, labour and capital input
growth also contributed to services sector growth while capital input growth emerged as
relatively more important.

Table 11. 7: Contribution of factor inputs and TFP to GVA growth by broad sectors: 1981 to
2017 (% per annum)
Real value- Contribution
Contribution of Contribution of TFP
BROAD SECTOR added of Capital
Labour persons Labour quality growth
growth services
Agriculture 3.06 -0.0017 0.17 1.79 1.10
Mining and
5.02 0.30 0.39 5.43 -1.10
Quarrying
Manufacturing 6.84 0.71 0.25 5.80 0.07
Electricity, Gas and
6.76 0.89 0.21 4.46 1.21
Water Supply
Construction 5.90 4.77 0.31 2.23 -1.42

Services 7.31 1.69 0.34 3.67 1.61

Total economy 6.03 1.28 0.27 3.60 0.87

Source: Authors’ calculations based on India KLEMS dataset version 2019

The aggregate TFP growth is impacted by the vast heterogeneity that exists across industries in
the form of a few subgroups dominating the growth of output and productivity over extended
periods of time. This can often result in a distorted scenario, as the role of the leading industries
can dramatically shift the TFP scenario observed over a period of time.

Figure 11.8 depicts industry-wise contribution to aggregate TFP growth for the period 1981 to
2017. The top three contributors include agriculture, hunting, forestry and fishing, public
administration and defence, and transport and storage. Financial services and the services that
make up for ‘other services’ were significant contributors as well. This substantiates our assertion

308
about the growing importance of services in the overall economy and, to a considerable extent,
it also evident that high productivity growth in many service sectors underlies the current
dynamism in service sector growth.

Figure 11. 8: Industry contributions to aggregate TFP growth, 1981-2017

Agriculture,Hunting,Forestry and Fishing

Public Administration and Defense; Compulsory Social…
Transport and Storage
Other services
Financial Services
Education
Chemicals and Chemical Products
Post and Telecommunication
Electricity, Gas and Water Supply
Food Products,Beverages and Tobacco
Electrical and Optical Equipment
Health and Social Work
Textiles, Textile Products, Leather and Footwear
Manufacturing, nec; recycling
Transport Equipment
Hotels and Restaurants
Pulp, Paper,Paper products,Printing and Publishing
Trade
Business Service
Rubber and Plastic Products
Other Non-Metallic Mineral Products
Machinery, nec.
Basic Metals and Fabricated Metal Products
Wood and Products of wood
Coke, Refined Petroleum Products and Nuclear fuel
Mining and Quarrying
Construction
-0.15 -0.10 -0.05 0.00 0.05 0.10 0.15 0.20 0.25 0.30

Source: Authors’ calculations based on India KLEMS dataset version 2019

11.5. Conclusions
Service sector in India also grew rapidly in the third subperiod (2003-11) and its growth was,
in fact, higher than the growth in agriculture and manufacturing. It remains to be seen, however,
whether growth in services will lead to inclusive overall growth in India. This chapter is an attempt
to understand India’s service sector productivity growth dynamics observed since the 1980s.

309
We examine productivity trends in the service sector at disaggregated industry level using
carefully developed India KLEMS panel data for the period 1981-2017. We use both the VA
as well as GVO frameworks in computing labour and total factor productivity growth based on
growth accounting technique. In addition, a decomposition exercise was done to account for (1)
sources of labour productivity growth and (2) sources of output growth. Our findings suggest the
following: Labour productivity in India’s service sector has been growing substantially over the
decades, and much of this productivity gain is accruing through acceleration in market services-
based industries. This observed productivity gain in the market services, particularly ICT-intensive
services, might indicate the role of increasing ICT in contributing to labour productivity growth.
The labour reallocation effect is positive in all the sub-periods, and has increased in the 2000s,
suggesting a structural transformation that is growth enhancing. Our TFP estimates based on
KLEMS production function for the services sector indicate impressive growth in TFP for market-
based services. The nonmarket-based services, on the other hand, indicate a progressive decline
in resource use efficiency in the recent decades. It is evident from the decomposition of output
growth that capital input makes a significant contribution to the observed growth. This indicates
a dominance of capital deepening in accounting for growth. We need to ascertain if information
and communication technology (ICT) remained an important source of both capital deepening
and total factor productivity growth within services in India. We infer that import liberalisation
has been a principal component of the economic reforms undertaken in India, and along with
complementary policies such as technology import policy, have largely contributed to the import
and adaptation of ICT equipment and technology in the observed capital deepening in the
services industries.

Finally, the growth and productivity performance of services

highlighted in this chapter points to several issues that need It is evident from the
attention in the form of future research endeavours. It would decomposition of
also be useful to undertake international comparison of services output growth that
in emerging economies like India. This will require capital input makes a
internationally comparative datasets for meaningful significant contribution
comparisons. For India, this challenge has been resolved to a
large extent by the India KLEMS dataset, which follows the EU to the observed
KLEMS classification. However, problems remain with several growth. This indicates
other aspects of data pertaining to the service sector. a dominance of
capital deepening in
Nayyar (2012) has raised several concerns about the service accounting for growth.
sector data base and the present study addresses several of
these. First, the methods for measuring service sector output
have been considerably improved, although concerns persist regarding measurement of market
services output. A study by Timmer et al. (2010) analyses the issues regarding measurement of
output for different categories of market services and regarding price deflators for each of the
service industries in general. Second, we address the significant need for an appropriately
constructed variable to measure capital input for the service sector. Our construction of the
capital services variable that our study used in estimating total factor productivity is the first
such estimate of capital input for the Indian economy at an industry level and covers all the 10
subgroups of services. Third, recognising the importance of individual segments of service sector,
this study addresses the issues of sources of growth at both the broad segments of services—
market versus nonmarket services or ICT-intensive services versus non-ICT intensive services and
for different industries within the service sector.

For further research, there are several questions that need to be addressed—the need for more
data that could cover other aspects such as rural-urban decomposition of service industries to
understand where the dynamism lies; and the need for more field surveys to understand the

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occupational structure of informal sector—hawkers, transport drivers, and even domestic
workers.

Finally, it is also very important to understand the drivers of growth in services in two emerging
markets—China and India. As a part of this future research agenda, we intend to follow up on
the present study with a comparative analysis of service industries in India and China using the
KLEMS dataset for each country.

We end with the quote,

“If the data is so dodgy, should all analysis on the services sector be called off? As is evident,
this would mean the entire economy, since services account for more than a half of GDP.
Conversely, should economists be like the drunk who looks for a lost key under the lamp-post
because that is the only place where there is light? Given the need for analysis, there can be
only one answer.” (Jain and Ninan, 2010).

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Annexure 11A: Policies Relating to Services Sector

Table 11A.1: Selected policies of services in India—A schematic view

Issues Policies
FDI
- Allowing 100 percent retail trade
- Raising FDI cap in Insurance sector ( from 26 per
cent) and in Banking ( allowed 74 percent FDI+FII)
- 100 percent FDI allowed in Construction
- FDI open for entertainment sector- news and
current affairs TV channel
- FDI in air transport services
- FDI for modernization of railways

Disinvestment − Disinvestment of public sector units both within

central and state governments

Tariff and Tax specific sector issues

− Shipping services (tonnage tax issues, zero
rating input services, seafarer taxation issues,
customs duty/excise duty exemptions, withholding
tax)
− Tourism services) rationalizing tax structure, ATF
taxation, state luxury tax, per seat passenger tax,
fees for monuments and tax payment modes)
− Entertainment Services (tax credit issues)
− Health care services (zero tariff for medical
equipments; exemptions at state level for capital
goods used in hospitals)
− Telecommunications (customs bonding, taxability
of items between federal and state governments;
service tax on IT software)
− Air transport services (sales tax issues, import
duty of spare parts, turnover tax by airports)
− engineering services (customs and excise duties,
stamp duties)

Other related issues

Clarity on service tax refund policy on input
services used
− Transfer pricing issues
− Single return for service tax and excise tax
− Reduction of tax deducted at source

Credit and Finance

− Withholding tax on interest paid on ECB
− Issues connected with venture capital funding
− Extending dedicated lines of credit

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 General issues
− Showcasing India’s services overseas
− Measures for promoting service exports
− Standardization of services
− Consolidation of service providers in each
category
− Service portal
− Preferential system for overseas investor and
government

Source: Authors’ compilation from Prasad and Sathish (2010).

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