Economics and Service Sector

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India’s Service Sector Growth A “New” Revolution
Preliminary Draft

Dinesh Khairnar

Abstract Following the trade liberalization in 1991, the Indian economy embarked on a path of rapid growth of aggregate output. In particular, it witnessed a high growth rate of service sector output while that of industry was relatively muted. As a result, the share of services in GDP has come to resemble that of a high income country while its per capita income still remains that of a low income country. Further, we also observe a sharp increase in the rate of growth of service sector trade after liberalization. In this paper, we build a quantitative model which captures a falling share of agricultural output and a rapidly increasing share of service sector output as the economy grows. We develop a three sector open economy growth model and allow the economy to trade with the rest of the world by exporting as well as importing services and industrial ∗


goods. We focus on two steady state years, 1970 and 1994, and assume trade to be balanced in these two years. In addition, we allow for exogenous productivity growth in each of the three sectors. We find that it is high productivity growth, especially in the service sector, rather than growth of trade in services which is the primary factor driving the high growth witnessed by the Indian service sector.



Figure 1

shows the evolution of India’s Real GDP (Gross Domestic Product) per capita from

1965 to 2004. During this period, Real GDP per capita increased from 186 to 538 2000 US dollars, with an acceleration starting in the 1980s and getting higher during the 1990s. In particular, Real GDP per capita grew at an average annual rate of 1.2 percent from 1965-1980 and increased to 3.5 percent during the 1980s and grew at 4 percent thereafter, starting from 1991. A careful look at the disaggregated output level in figure 2 reveals the pattern of sectoral growth between 1951 to 2005. In 1951, the share of agriculture in total GDP was about 60 percent and steadily declined over the years to account for 24 percent of GDP in 2005. While industry doubled its share in total output from 15 percent in 1951 to 31 percent in 2005, the service sector also grew rapidly. In 1951, its share in GDP was 26 percent and grew to about 48 percent in 2004 (share was about 52 percent if we include public administration and defense). A comparison between the industrial and service sector, as shares of GDP, reveals that the average growth rate of the former was slightly more than the latter during the whole period, but the picture for the three sub-periods looks very different (Table 1 in appendix). During the first and second sub-period (1951-1980 & 1981-90) industrial growth was leading service sector growth; however service sector growth overtook that in industry starting in 1991. In fact, the industrial growth rate, as a percentage of GDP, in the 90s was negative at 0.2 percent while that of services was 2 percent. The sub-sectors contributing most to the rapid growth of services in the last sub-period were communications, banking and insurance; these recorded average growth rates of 10.9 percent and 3.5 percent respectively. The year 1991 marks a watershed year in India’s trade history as the economy went through a process of formal liberalization. Major reforms were undertaken which did away with import licens1

All figures are provided in Appendix


ing on all but a handful of intermediate inputs and capital goods. A major step was taken towards tariff reduction. The reduction in tariffs was accomplished through a gradual compression of the top tariff rates with a simultaneous rationalization of the tariff structure through a reduction in the number of tariff bands. In 1991, the highest tariff rate stood at 355 percent which was drastically reduced to 85 percent in 1993-94 and to 50 percent in 1995-96. This number is...
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