a comparative study of the role of the service sector in the
TRANSCRIPT
A Comparative Study of the Role of the Service
Sector in the Economic Development of China and
India
(Revised report)
June 19, 2006
By
Deunden Nikomborirak
Thailand Development Research Institute
Introduction
As tariffs have fallen to very low levels in many economies, trade in services
has become the focus of interests for the studies of both trade and development in lieu
of trade in goods. Experiences show that an economy – regardless of the level of
development -- cannot maintain its competitiveness in the long run without an
efficient service sector.
China and India, the two largest emerging economies undergoing rapid
economic transformation and growth, too, have been witnessing an increasing role of
their service sector. The sector contributes to bout two fifths of China’s GDP and
roughly a half of that of India as can be seen in figure 1.1.
Figure 1.1 Service Sector GDP share (1995 – 2004)
33 33 34.4 36.5 38 39.3 40.7 41.7 41.5 40.742 4246 45 46 48 48 49 49
45
0
10
20
30
40
50
60
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004year
(%)
China Services 1/ India Services 2/
Source: 1/ India' data from World Development Report 2005. China's revised GDP data from
Quarterly Update, February 2006, World Bank Office, Beijing
2/ IMD World Competitiveness Yearbook
The drivers of the service sector growth in the two countries differ, however. .
China has a solid domestic manufacturing base from which services grow, while
India’s economy appears to leap directly from agriculture to services, driven by
external demands for IT related services. Looking into the future, China’s broad and
deep WTO accession commitments will have significant implications to the country’s
service sector development. India’s unilateral liberalization, on the contrary, is likely
2
to be much more gradual due to political sensitivities of certain service sub-sectors.
What are the implications of this policy divergence to the future role of the service
sector to the economies of India and China?
This study shall review and compare the role of the service sector in China and
India in the context of the development of the domestic economy and integration with
the global economy. At the same time, it also seeks to make rough predictions with
regard to likely future trends given the current policy environment.
The organization of the paper is as follows. The first chapter provides an
overview of service sector’s contribution to national income and employment in both
countries. The second chapter looks at services in the context of international trade
and investment in order to gauge the extent to which foreign markets and capital
played a role in the development of both countries’ service industry. The third
chapter examines and compares the two countries’ policies with regard to service
sector liberalization in order to be able to speculate future trends and patterns of their
respective service sector growth. The final chapter concludes on the findings of a
comparative study of China’s and India’s service sector development.
1. Service Sector’s Contribution to Economic Development
Empirical studies in development economics reveal that most developing
countries undergo a similar economic structural shift through the course of economic
development with shrinking agricultural sector and expanding manufacturing and
service sector. For example, Chenery and Taylor (1968) found that a country’s
industrial GDP and employment shares tend to rise as it becomes richer at the expense
of agricultural sector’s share, except for economies that rely heavily on exports of
primary products. At higher income level, income and employment shift to services.
These findings are based on empirical tests that employed large cross-country data
sets1.
The reason for such a structural shift can be explained from both the supply
and the demand side. From the supply side, growth in manufacturing and services
may outpace that in agriculture because of the employment of technology and capital
1 Chenery, Hollis, B. and Lance Taylor (1968). "Development Patterns: Among Countries and Over
Time," Review of Economics and Statistics, November 1968, 391-416
in these sectors can overcome the law of diminishing return faced by the agricultural
sector that relies on fixed factor, namely land. As the industrial sector grows, demand
for particular services, such as transportation, housing and construction naturally
increases, giving further stimulus to the service sector.
On the demand side, the expanding share of manufacturing and service sectors
is believed to be contributed by higher income demand elasticity for manufacturing
products, and even higher for services products. That is, as income rises, the
population demands proportionately more of manufacturing and service products and
proportionately less of agricultural products.
Available secondary macroeconomic data collected in this study reveals that
the development of the service sector in China seems to closely follow the historical
pattern experienced by both developed and developing countries, while India’s shift
out of agriculture directly into services appears to diverge from the common path.
1.1 Contribution of the Service Sector to GDP
As can be seen in figure 1.2, during the past 10 years, China’s service sector’s
GDP contribution increased significantly. In the year 1995, service sector contributed
to just 3 per cent of China’s GDP. The figure changed to 40.2 per cent in 2004, an
increase of 7.2 percentage points. Manufacturing sector’s share, however, decreased
marginally by 2 per cent from 48 to 46 per cent during that time.
The expanding service sector GDP share came mainly at the expense of the
agricultural sector share, which declined from 0 per cent to 13 per cent as shown in
figure 1.2. It is therefore clear that, during the last decade, the manufacturing sector
boom in China has led to an even higher growth in the tertiary sector and that service
sector growth has been facilitated by the release of resources from the least dynamic
sector, the agricultural sector.
In contrast, India's service sector growth has clearly been the engine of
growth of India’s economy during the last decade. Service sector contribution to the
national GDP increased from 42 per cent in 1995 to 49 per cent in 2003, before
4
declining to 45 per cent in 2004 can be seen in figure 1.3. India’s manufacturing
sector’s GDP contribution seemed to have fallen over time from 28 per cent in 1995
to 27 per cent in 2004. Unlike China, however, India's manufacturing has never
experienced double digit growth. Mitra, Devashish (2006)2, found that rigid labor
market due to state labour rules and regulations3 and lack of infrastructure
development are the two key factors hindering labor productivity improvements,
employment and capital accumulation that would spur progress in India's
manufacturing sector.
It is interesting to note that, while India’s sectoral GDP share appears to
indicate a declining agricultural share, the annual figures appear rather unstable as can
be seen in figure 1.4 below. This is due mainly to the inherent volatility of India’s
agricultural output due to its heavy dependence on the monsoon. Consequently,
service sector’s GDP share also appears to vacillate. For example, the marked decline
l in the service sector GDP share in the year 2004 resulted from a particularly good
agricultural year. According to the Centre for Monitoring Indian Economy (CMIE)4,
agriculture sector grew by 9.3% in 2003-2004, against 8.9 % for services. However,
the sector’s growth, as unpredictable as it has been, is likely to be less than 1 per cent
in 2005-2006.
Another interesting point about India’s sectoral development is the rising
prominence of the manufacturing sector. Figure 1.4 illustrates how industrial sector’s
growth is catching up with that of the service sector. According to the CMIE, during
2 Mitra, Devashish (2006), INDIAN Manufacturing: A Slow Sector In a Rapidly Growing Economy,
Department of Economics, The Maxwell School of Citizenship and Public Affairs, Syracuse
University, New York3 The Industrial Disputes Act (IDA) requires firms employing more than 100 workers to obtain a
permission from state governments in case of layoffs. Obtaining such a permission may be difficult
due to political reasons. Also, the Industrial Employment Act stipulates that employers with 100 or
more workers (50 in some states) must specify the terms and conditions of employment for each
employee. This can pose a major hurdle in the event where a firm needs to respond to changing market
conditions and intra-company transfer is required since modification of the terms and conditions cannot
be amended without the consent of the employee.4 South Asia,” India Mills Get Busy”, July 15, 2005.
http://www.atimes.com/atimes/South_Asia/GG15Df01.html
the first 5 months of the year 2005, manufacturing GDP growth reached a record of
10.5% against 8.1% during the same period a year earlier.
The rising prominence of the manufacturing sector is also underscored by the
sudden surge of FDI into the industrial sector in 2004 as will be discussed in chapter
2. Industries that are major recipients of FDI include automobile and components,
pharmaceutical, electronic devices and industrial equipments. While it may be
somewhat too soon to conclude, these figures signal that India’s manufacturing may
finally be emerging out of its long dormancy, following a series of economic reforms
that have gradually taken place in India over the last decade.
6
Figure 1.2 Percentage of GDP by Sector, China
19.8 19.5 18.1 17.3 16.2 14.8 14.1 13.5 12.5 13.1
47.2 47.5 47.5 46.2 45.8 45.9 45.2 44.8 46 46.2
33 33 34.4 36.5 38 39.3 40.7 41.7 41.5 40.7
0
10
20
30
40
50
60
70
80
90
100
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
year
(%)
Services
Industry
Agriculture
Source: World Bank Office, Beijing (2006), Quarterly Update: February 2006
Figure 1.3 Percentage of GDP by Sector, India
30 28 27 25 28 28 25 25 25 28
28 3026 30 26 25 27 26 26
27
42 4246 45 46 48 48 49 49 45
0
10
20
30
40
50
60
70
80
90
100
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
year
(%)
Services
Industry
Agriculture
Note: Data year 1999 from WDI, Data other years from IMD
Source: 1. IMD World Competitiveness Yearbook
2. World Development Indicators (WDI) database
Figure 1.4: India’s Annual GDP Growth by Sector
Source: Center for Monitoring Indian Economy (CMIE)
Coming back to India’s service sector, looking at growth figures of various
service sub-sectors reveals the following:
(1) the sector’s growth has been concentrated in a few service sub-sectors,
namely, business services, communications, banking and hotel and
restaurant services.
(2) service sectors experienced highest growth rates are those most open to
FDI, perhaps with the exception of banking that still maintains certain
restrictions concerning foreign ownership of local banks. The high
correlation between market openness to foreign investment and growth
in India’s service sector was evidential in a report published by the
World Bank5. This may be the case because of India’s particularly
heavy reliance on foreign investment given the limited pool of
domestic savings6.
(3) legal services, real estate and transport services that are very much closed
to foreign investment experienced lower growth.
(4) With the exception of banking, these fast-growing service sub-sectors are
relatively small in size compared to other services such as trade,
5 The World Bank (2004), Sustaining India’s Services Revolution: Access to Foreign Markets,
Domestic Reforms and International Negotiations. Available at http://web.worldbank.org 6 According to McKinsey Quarterly, January 22, 2006, India’s financial stock in 2003 totaled only 0.9
billion (137% of GDP) compared with China’s 5.1 billion (323% of GDP).
8
community services, public administration, real estates and transport.
Hence, despite all the hypes about India’s service-sector led growth,
growth potentials of the country’s service sector are barely realized.
Should these major service sectors become more open to domestic or
foreign competition, service sector growth could be much higher than
witnessed in the past.
Table 1 Average Annual Growth Rate and GDP shares of Service Sub-sectors
Source: Reproduced from Gordon and Gupta (2004).
1.2 Employment in the Service Sector
Stylized facts reveal that GDP and employment shares are usually closely
related. Mobility of labour ensures that productivity levels across different sectors of
the economy are equalized. However, in practice, labour is not perfectly mobile
across sectors due to many obstacles such as skill requirements, relocation of labour,
1980s 1990s
Service Sub-sectors Growth (%) GDP
share (%)
Growth
(%)
GDP
share (%)
Business Services 13.5 0.3 19.8 1.1
Communications 6.1 1.0 13.6 2.0
Banking 11.9 3.4 12.7 6.3
Hotels and Restaurant 6.5 0.7 9.3 1.0
Community services 6.5 4.3 8.4 5.5
Trade (Wholesale and retail
trade)
5.9 11.9 7.3 13.7
Other services 5.3 1.0 7.1 1.7
Insurance 10.9 0.8 6.7 0.7
Public Administration, defense 7 6.0 6 6.1
Legal services 8.6 0.0 5.8 0.0
Dwelling, Real estates 7.7 4.8 5 4.5
Personal services 2.4 1.1 5 1.1
Railways 4.5 1.4 3.6 1.1
Storage 2.7 0.1 2 0.1
etc. This is often the case for countries that are in a transitional period in economic
restructuring.
Once again, on the employment front, China seems to follow the common
pattern experienced by most other developed and developing countries, while India
stands out as a unique case.
As can be seen in figure 1.6, since 1995 China’s service sector’s employment
share has been on the rise continuously, roughly in keeping with the sector’s GDP
contribution. In the year 1995, service sector contributed to 33 per cent of the
country’s GDP and 28.2 per cent of employment. Seven years later in the year 2002,
the figures were 41.7 and 33.5 respectively. That is, an increase in service sector
value added share by 8.7 percentage points was accompanied by an increase in labour
share by 5.3 percentage points. China's service sector employment elasticity during
this period is calculated to be 1.6.
Such has not been the case in India. In 1995, service sector contributed to 42
per cent of the country’s GDP and 67 per cent of its total employment. This would
indicate a relatively low labour productivity in the service sector. The figures in
2002 were 49 and 69 respectively. That is, while service sector’s GDP contribution
rose by 7 per cent, its contribution to employment merely increased by only 2 per
cent. This implies that the employment elasticity of India’s service sector is roughly
0.3, which is extremely low compared with China’s figure of 1.64.
Looking into each country’s sectoral employment data shown in figure 1.7, it
became obvious that the increase in China’s service sector employment was made
possible by the inter-sectoral shift of labour supply mainly from the manufacturing
sector, and, to a lesser extent, the agricultural sector. The decline in employment
against rapid output growth in China’s manufacturing sector indicates a marked
productivity gains.
Figure 1.6 Service sector contribution to Employment
10
33 33 3437 38 39
41 4242 4245 46 494846
48
28.2 28.9 29.8 30.5 30.6 31.6 32.2 33.5
67 67 67 6869686867
0
10
20
30
40
50
60
1995 1996 1997 1998 1999 2000 2001 2002
GD
P s
har
e (%
)
0
10
20
30
40
50
60
70
80
Em
plo
ymen
t sh
are
(%)
GDP (China) GDP (India) Employment (China) Employment (India)
Source: Service sector employment share calculated from data appeared in tables 1.7 and 1.8 below
Figure 1.7 Employed Persons in China
0
100
200
300
400
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002year
Million Person
Agriculture Manufacturing
Services Government Agencies etc
Source: China Statistical Yearbook 2004
Turning to India, a striking feature of the employment data during 1993-2003
shown in figure 1.8 is that the number of persons employed in agriculture,
manufacturing and services barely changed in a decade. The absence of a fall in
employment in the agricultural sector is contradictory to most countries’ experience.
India’s jobless service sector growth stems from the fact that the sector’s
growth has been driven largely by only a few service sub-sectors – i.e., banking,
telecommunications and IT-enabled services. Additional employment generated by
these sectors was not able to offset the rapidly falling labour demand elasticity faced
by other service sub-sectors as productivity level rises from extremely low levels as
discussed earlier.
The study by Banga (20057) reveals that in the nineties India experienced a
sharp fall in the employment elasticity in certain large, fast growing service sub-
sectors, namely government and banking services. For example, the employment
elasticity of government services fell from 0.5 during 1983-84 – 1993-94 to 0.07
during 1993-93 – 1999-2000, while that for financial services fell from 0.92 to 0.73.
This is because of major improvements in technology employed by new entrants to
the market as well incumbents helped cut down labour input and boost productivity.
A report by McKinsey and Co (2001) 8 confirmed large productivity gains
contributed to the unspectacular employment record of India service-sector led
growth. The report estimated labour productivity in 6 service sectors, namely, energy
distribution, housing construction, retail distribution, retail banking, software and
telecommunications. It found that India’s software services that experienced the most
rapid growth have the highest productivity levels, followed by telecommunications,
banking and construction. On the contrary, retail distribution, energy distribution and
hosing construction that are closed to foreign investment experienced significantly
lower productivity level.
Figure 1.8 Employed Persons in India
7 Banga, Rashmi (2005), Critical Issues in India’s Service-led growth. Working paper No. 171, Indian
Council for research on International Economic Relations. Paper available on line at www.icrier.org8 McKinsey & Co. (2001), India: The Growth Imperative: Understanding the Barriers to Rapid Growth
and Employment Creation.
12
0
5
10
15
20
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003year
Million Person
Agriculture
Manufacturing Services
Source: Economic Survey 2005-2006. Ministry of Finance, India.
Http://indiabudget.nic.in/es2005-06/esmain.htm
Looking closer at the sub-sector level in table 2, one finds that the only two
service sub-sectors that experienced high employment growth in the nineties are
telecommunications and computer-related business.
Again, these three services represent “islands” in the large sea of the service
sector that remain highly protected. It is also noteworthy that the banking sector,
which has experienced relatively healthy growth, did not contribute much to
employment. This is due to the displacement of workers from inefficient public
sector banks as the country gradually liberalized its banking sector after a spade of
nationalization of banks in 1969 and 1980. In light of the banking sector experience,
the opening of the India’s other service sub-sectors occupied by state-owned
enterprises saddled with excessive employment is likely to have a small impact on
employment prospects.
Table 2 India’s Service Sector Output and Employment Growth at a Disaggregate Level
Service Sub-sectors Value-added Growth in 1990s (%)*
Employment Growth between 1993/1994 &
1999/2000**
Business Services 19.8 Computer related services
– 20.6 % Other business services –
11.6%
Communications 13.6 Telecommunications - 33
% Postal – 6% Courier – 6.2%
Banking 12.7 4.3
Hotels and Restaurant 9.3 7.3
Community services 8.4 NA
Trade (Wholesale and retail
trade)
7.3 Wholesale – 6.4% Retail – 7.1%
Other services 7.1 NA
Transport 6.9 Air transport – 6.2% Water transport – 2.6% Road transport – 6.5%
Insurance 6.7 3.8
Public Administration, defense 6 NA
Legal services 5.8 6.2
Dwelling, Real estates 5 6.2
Personal services 5 NA
Railways 3.6 3.2
Storage 2 NA
Source: * from table 1;
** from The World Bank (2004), Sustaining India’s Services Revolution: Access to Foreign
Markets, Domestic Reforms and International Negotiations. Available at http://web.worldbank.org
1.4 Summary
The role of the service sector in the economic development in China and India
during the last decade has been markedly different as follows. First, the role of the
service sector in China has been mainly to facilitate domestic production and trade in
goods, while growth in service sector in India was triggered by external demand for
software and IT-related services. It should be noted, however, that while China's
14
initial demand for services was largely derived demand from rapidly expanding
manufacturing sector whose average annual growth during 1978-2005 was a
spectacular 17%9, higher income levels among its population eventually spurred
growth in other consumers-oriented services such as tourism.
Second, China’s service sector growth is highly employment elastic, while that
in India, employment contributions fell far behind that of income. This has been the
case because the sector's growth engine, which concentrates narrowly on a few
export-oriented sub-sectors, was not able to generate sufficient employment to offset
the sharp fall in employment elasticity experienced in other service sub-sectors
resulting from productivity improvements.
It is probable that the rising prominence of India's service sector preceding
that of the industrial sector is nothing more than a temporary blip in the country's
development path. The long overdue industrial reform that has been holding back the
manufacturing sector growth is finally producing some visible results with recent
statistics showing impressive industrial sector growth coupled with strong FDI
figures.
In other words, the dynamism of India's service sector led growth is only
relative, rather than absolute. That is, if manufacturing industries were free from
stifling state rules and regulations and were more open to foreign investment, the
service sector would certainly not have attracted all the limelight. The local
manufacturing sector would have been able to fully exploit the wealth of skilled and
semi-skilled labour that India had to offer foreign multinationals. And India would
have gained a strong comparative advantage in many of its manufacturing products, in
particular those that employ IT and business services more intensively.
Nevertheless, the role of the service sector during the last decade should not be
overlooked. According to an empirical work by Banga and Goldar (200410), growing
use of services had a significant favorable effect on growth of output of Indian
9 India' data from World Development Report 2005. China's revised GDP data from Quarterly
Update, February 2006, World Bank Office, Beijing
10 Banga, Rashmi and B.N. Goldar (2004), Contribution of Services to Output Growth Productivity in
Indian Manufacturing: Pre and Post Reform, ICRIER Working paper No. 139.
manufacturing in the 1990s. Specifically, service input contribution to output growth
in manufacturing increased from a mere 1 per cent in 1980s to 25 per cent in 1990s.
The end of India’s service-sector led growth will be welcomed by many critics
of India’s IT-service led export growth. The limitation of such a growth pattern is
well recognized in many studies, in particular that by Papola (2005)11. He noted that
since service exports represent only 6 per cent of the service sector output12, very high
growth is required to sustain the imbalance between the goods and the services
account13. Moreover, sustaining such high export growth can prove elusive, given the
emergence of many alternative outsourcing centers among low-wage countries. India
is in dire need to diversify its export base.
11 Papola, T.S. (2005), “Emerging Structure of India Economy: Implications of growing Inter-Sectoral
Imbalances”, Presidential Address, at the 88th Conference of Indian Economic Association, Andhara
University, Vishakhapatram, Sec 27-29, 2005.12 Papola ibid.13 Already, India is experiencing sharp deterioration in its trade account. Trade deficit rose from US$
15.4 billion in the year 2002-2003 to US$ 38.1 billion in 204-2005. The figure for the first quarter of
2005-2006 has already reached US$ 16 billion according to the article “India as a Global Power”,
Aspects of India Economy, No.41, December 2005. The paper is available at
www.rupe-india.org/41/reality.html
16
2. Service Sector Trade and Investment
In the previous chapter, the role of the service sector in the context of China’s and
India’s economic development is assessed. In this chapter, the focus will shift instead
to the extent to which these countries’ service sector growth and development rely on
foreign markets or capital and technology.
Perhaps it is important to begin by pointing out the fundamental difference in
the formation of India’s and China’s trade and investment policies during the last
decade. As a centrally planned economy, China has been able to steer its economy
along a more liberal path with little political hurdles. Since 1978, the country took
steps to gradually opening up its domestic market to foreign trade and investment,
culminating into its accession to the WTO in 2001. In a democratic political system,
liberalization policy is bound to attract opposition from many interest groups.
On the contrary, India’s economic reform since the eighties has been
piecemeal and intermittent. This is likely due to the country’s political environment
since, unlike the centrally-planned China, India is a multiparty democracy. Hence,
external policy must tune itself to the delicate political balances. Coalition
governments are often made up of parties with dissimilar economic philosophies and
beliefs. Frequent changes in government also disrupt the continuity of economic
reforms.
Nevertheless, it should be noted that India’s commitment to economic reform
since the early nineties has remained in tact until now, despite a few changes in the
government along the way. It is against the backdrop of this general political and
economic environment that the services trade and investment performances of the two
countries will be assessed in the following sections.
2.1 Trade
There is not doubt that China’s astounding manufacturing export growth
economy has done much to integrate the country with the global economy. In terms
of services trade, however, India has a higher share of services trade to GDP figure.
During the year 1995 – 2002, both experienced rising share of services trade to GDP.
India’s figure almost doubled from 4.65 per cent in 1995 to 8.57 cent in 2002.
China’s figure changed marginally during this period from 6.33 to 6.81 as can be seen
in figure 2.1 below. These figures seem to indicate that services trade still plays a
very limited role in the overall development of India’s and China’s economy, even for
India where services export contributed to 34 per cent of total export in 200414.
A striking difference between China’s and India’s service trade is that while
India recorded continuous improvement in the service trade balance from over US$ 4
billion in deficits in 1995 to US$ 6 billion surplus in 2002, China’s figure
deteriorated. It began with a deficit of approximately US$ 6.5 billion in 1995 and
ended up with almost US$ 7 billion in 2002 as can be seen in figure 2.2. These
figures are consistent with the analysis in section 1, which describes the service sector
as India’s economic growth engine, while that in China is secondary to the
manufacturing trade.
Figure 2.1 Services Trade as a Percentage of GDP (1995 – 2002)
6 . 3 35 . 2 9 5 . 8 5 5 . 3 4 5 . 8 3 6 . 1 5 6 . 2 66 . 8 1
4 . 6 5 4 . 7 7 5 . 1 46 . 2 2
7 . 0 6 7 . 6 5 7 . 6 38 . 5 7
-
2 . 0 0
4 . 0 0
6 . 0 0
8 . 0 0
1 0 . 0 0
1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2
C h i n a In d i a
Source: Calculated from services trade data from Balance of Payments Statistics. Part 1: Country
Tables. IMF Yearbook 2003
Figure 2.2 China’s Net services trade and GDP (1995 – 2002)
14 Karmakar, Supana (2005), Indian-ASEAN Cooperation in Services – An Overview, ICREAR
Working paper No 176, pp 16. The paper is available on line at www.icrier.org/WP176.pdf
18
-
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
1995 1996 1997 1998 1999 2000 2001 2002
year
GD
P (
US
mill
ion)
-8,000
-7,000
-6,000
-5,000
-4,000
-3,000
-2,000
-1,000
-
Serv
ices
(U
S m
illio
n)
GDP Net services
Source: 1. Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003
2. International Financial Statistics Yearbook 2004. IMF.
Figure 2.3 India’s Net services trade and GDP (1995 – 2002)
-
100,000
200,000
300,000
400,000
500,000
600,000
1995 1996 1997 1998 1999 2000 2001 2002
year
GD
P (
US
mill
ion)
-6,000
-4,000
-2,000
-
2,000
4,000
6,000
8,000
Serv
ices
(U
S m
illio
n)
GDP Net services
Source: 1. Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003
2. International Financial Statistics Yearbook 2004. IMF.
A closer look at the composition of the services trade in the two countries
reveals that while China’s trade in services covers a broad range of service sub-
sectors, that of India is highly concentrated in software and IT services15. Figures 2.4
(a) and (b) demonstrate that China experienced an increase in the export of tourism,
business services and transport services. At the same time, it imported a wide variety
of services supporting its manufacturing production activities, such as transportation,
other business services, insurance and royalties and license fees. It also recorded a
surge in tourism import as overseas travel increases with rising income levels. The
trend and composition of China’s services trade confirm the role of services as
facilitating trade and production of manufactured goods.
Figure 2.4 (a) Export Service: China
-
5,000
10,000
15,000
20,000
25,000
1995 1996 1997 1998 1999 2000 2001 2002 year
US
mil
lion
Transportation Service TravelCommunications ConstructionInsurance FinancialComputer and information Royalties and licence feesOther business services Personal, cultural, and recreationalGovernment, n.i.e
Source: Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003
15 India’s data does not isolate IT related services from “other services” category. However, India
exports of IT-enabled services include call centers, medical transcription, data entry, credit card
administration, etc.
20
Figure 2.4 (b) Import Service: China
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
1995 1996 1997 1998 1999 2000 2001 2002 year
US
mil
lion
Transportation Service TravelCommunications ConstructionInsurance FinancialComputer and information Royalties and licence feesOther business services Personal, cultural, and recreationalGovernment, n.i.e
Source: Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003
Turning to India’s figures, the picture is markedly different. The only service
that showed a remarkable growth in export is software services. Travel,
transportation, communication and management experienced less dramatic increase in
export growth as can be seen in figure 2.5 (a). A similar pattern can be found on the
import side where the “other services” stood out as the single service category that
saw a surge in import as can be seen in figure 2.5 (b). This service category includes
a very broad range of business services such as professional services, computer
related services, research and development services, real estate services, rental
services and other business services such as advertising services, market research and
polling, etc16. Although a more disaggregate data on the import of the “other
services” category is not available, the import of computer-related services would
expectedly dominate this category due to the prevalence of transnational companies
operating in this business in India.
Figure 2.5 (a) Export Service: India
16 See list of service sectors and sub-sectors for India’s export and import classification
inhttp://dgftcom.nic.in/exim/2000/appendicies/appendixword/app-36.doc.
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
1997 1998 1999 2000 2001 2002 2003year
US
mil
lio
n
Travel TransportationInsurance Government Not Included ElsewhereCommunication services Construction servicesFinancial services Software servicesNews agency services Royalties , copyright and license feesManagement services Other services
Source: 1. Data year 2001-2003 from RBI Bulletin. India’ Invisibles. March 2005. http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=5978
2. Data year 1997-1999 from Aaditya Mattoo, Deepak Mishra and Anirudh Shingal. Sustaining India's Service Revolution, Access to Foreign Markets, Domestic Reform and International Negotiations, World Bank, 2004. http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/TRADE/0,,contentMDK:20211428~pagePK:64020865~piPK:149114~theSitePK:239071,00.html
Figure 2.5 (b) Import Service: India
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
1997 1998 1999 2000 2001 2002 2003year
US
mil
lio
n
Travel TransportInsurance Government n.i.e.Communication services Construction servicesFinancial services Software servicesNews agency services Royalties , copyright and license feesManagement services Other services
Source: same as figure 2.5 (a)
22
It should be noted that India’s service sector export does not defy basic
economic theory of comparative advantage. After all, much of India’s service exports
rely on “cheap labour”, be they call-centre services, data entry services, credit card
administration, etc. Even higher-value work being outsourced to India such as
animation, web design, medical transcription, India is still competing on “wage costs”
rather than technical innovation, at least for now.
To conclude, China’s and India’s trade in services differ as follows. First,
China’s continues to experienced a deficit in services trade as the economy grows,
while India came out of deficit and has been in surplus ever since the year 2000. This
can be taken to imply that China generally displays a comparative disadvantage in
services, while India a comparative advantage. But things are not so simple in case of
India. The services trade surplus has been driven mainly by strong growth in just two
isolated service sub-sectors, mainly software and IT-enabled services. Services
import, on the other hand, has been contained by strict FDI controls and a sluggish
industrial activity. Indeed, India’s service account surplus may dissipate if and when
its manufacturing sector begins to grow at a faster pace.
Second, the composition of services traded in China and India is markedly
different, reflecting the fundamental difference in the underlying economic structure.
China’s services trade cover a broad range of “manufacturing related services” such
as transportation, insurance, royalty fees, business services, etc. At the same time,
with rising income level, consumption-related services such as tourism also
experiences healthy growth. Services trade in India, on the hand, concentrated solely
on the export-oriented service sector – i.e., outsourcing businesses. In the absence of
a vibrant manufacturing base and an increase in the level of income of the general
population17, India is deprived of trade in services related to production and domestic
consumption.
2.2 Investment
In the era of globalization, trade and FDI would likely be highly correlated
for both goods and services. The “splitting up” of the production process within
17 Indeed, there is much criticism that wealth generated from service-sector is highly concentrated not
only in terms of the industry and its employment, but also in terms of geography as there are only a few
IT and software centers in India.
vertically integrated industries with different processes taking place in different
countries according to the cost advantage of the specific location is a boon to both
investment and trade. While globalization of the production of goods is now
commonplace, that in services has only recently been made feasible by advancement
in communications technology.
The globalization of service is known as the “business process outsourcing
(BPOs)” in services, which is gaining importance in many service sectors such as
travel services, software, banking and health. As businesses decide to outsource
certain activities, they would often invest in the host country to set up facilities and
purchase the services from the local suppliers contributing to both FDI and trade.
Mann (2004)18 pointed out that the bulk of growth in cross-border services trade
involves affiliate sales. In this chapter, the extent to which FDI contributes to the
growth in services trade and development in China and India will be examined.
There is no doubt that China has been and still remains the magnet of foreign
investment. According to the World Investment Report 200519, China received US$
60 billion from a total of US $ 648 billion worth of global FDI, while India only US$
5 billion. That is, China received roughly a tenth of global FDI, and India receives
less than a tenth of China’s FDI. These figures illustrate clearly that FDI’s role in
India’s economy has been limited.
As can be seen in figure 2.6, inward FDI flow was equivalent to 5.36 per cent
of the China’s GDP in 1995. The figure declined to 3.8 in 2003 as China was able to
better tap the large pool of rapidly expanding domestic savings to finance economic
growth with rapidly rising income and more efficient financial intermediaries. The
FDI to GDP figure for India was a mere 0.59 per cent in 1995 and 0.75 per cent in
2003.
It is ironic that China has been receiving more FDI than India, when the
latter is clearly in dire need of FDI much more so than the former. According to a
18 Mann, Catherine (2004), Summary: Brookings Data Workshop: Service Offshoring: What do the
data tell us? Paper available at www.brookings.edu.pge/20040622/summaryfinal.pdf.19 World Investment Report (2005) published by UNCTAD. Available at
www.unctad.org/en/docs/wir2005_en.pdf
24
research brief by McKinsey (2006)20, India’s national savings rate at roughly 20 % is
only half of that of China’s whopping 40%. FDI could have compensated for India’s
savings shortfall. But these figures reveal that FDI widens rather than closes the
savings-investment gap between China and India. India’s restrictive foreign
investment policy has denied the country much needed financing to overhaul
dilapidated infrastructure that has -- for a long time – posed a major obstacle to
economic growth.
Figure 2.6 FDI Inflows as percentage of GDP
5.36 5.11 5.04 4.804.07 3.77 4.04 4.17 3.80
0.59 0.65 0.86 0.62 0.48 0.50 0.70 0.68 0.720
2
4
6
8
10
1995 1996 1997 1998 1999 2000 2001 2002 2003year
(%)
China India
Source: UNCTAD Statistical Databases On-line. http://www.unctad.org/Templates/Page.asp?
intItemID=1888&lang=1
Turning to the composition of FDI inflows, one finds that, in keeping with its
economic structure, FDI inflows into China have been channeled mainly to the
manufacturing sector. In 1997, 63 per cent of FDI went to the manufacturing sector,
35 to the service sector and the remaining 2 per cent to agriculture as can be seen in
figure 2.7(a). In 2003, the service sector’s share was further reduced to 29%, while
that of manufacturing reached 70 % due to the continuous boom in the industrial
sector.
In terms of volume of FDI, China experienced an influx of FDI into its
manufacturing sector, while inflows into the service sector remained flat. As can be
seen in figure 2.7(c), FDI figure for the manufacturing sector increased from US $ 28
20 McKinsey Quarterly, 22 January 2006, “India’s Lagging Financial System”. Available on-line at
www.mckinseyquarterly.com
billion in 1997 to US$ 37 billion in 2003, while that for the service sector remained
flat at US$ 15 billion.
A closer look at the FDI inflows into the Chinese service sector in figure
2.7(d) confirmed that no service sector stood out as the key attraction to FDI during
1997 - 2003. This seems to indicate that, in comparison to its manufacturing sector,
China’s service sector has been less engaged with the global economy. But this may
all change because of the country’s broad and comprehensive accession commitments
in liberalizing its service sector that will be discussed in greater details in Chapter 3.
Since 2002, China has taken measures to open up several service sectors, such as
relaxing foreign ownership restrictions and geographical limitations of foreign
operation in the financial, education, media and distribution sectors.
Figure 2.7 (a) China’s FDI Share By Sector (1997 – 2003)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1997 1998 1999 2000 2001 2002 2003year
Services
Manufacturing
Agriculture
Source: China Statistical Yearbook 1998-2004
Figure 2.7 (b) China’s FDI Share By Industry (1997 – 2003)
26
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1997 1998 1999 2000 2001 2002 2003
year
Farming, Forestry , Animal Husbandry and Fishery M ining and Quarry ing M anufacturing Electric Power, Gas and Water Production and Supp lyConstruction Transportation,Storage, Postal and Telecommunications ServicesWholesale & Retail Trade and Catering Services Banking and InsuranceReal Estate M anagement Social Services Health Care, Sports and Social Welfare Education, Culture and Arts, Radio, Film and TelevisionScientific Research and Poly technic Services Other Sectors
Source: China Statistical Yearbook 1998-2004
Figure 2.7 (c) China’s FDI Inflows By Industry (1997 – 2003)
Actually Utilized FDI by sector, China
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
1997 1998 1999 2000 2001 2002 2003
year
US$ Million
Manufacturing Construction Transportation,Storage, Postal and Telecommunications ServicesWholesale & Retail Trade and Catering Services Banking and InsuranceReal Estate Management Social Services Other Sectors
Source: China Statistical Yearbook 1998-2004
Figure 2.7 (d) China’s FDI Inflows By Service Activities (1997 – 2003)
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
1997 1998 1999 2000 2001 2002 2003year
US$ Million
Electric Power, Gas and Water Production and Supp ly Construction
Transportation,Storage, Postal and Telecommunications Services Wholesale & Retail Trade and Catering Services
Banking and Insurance Real Estate M anagement
Social Services Health Care, Sports and Social Welfare
Education, Culture and Arts, Radio, Film and Television Scientific Research and Poly technic Services
Other Sectors
Source: China Statistical Yearbook 1998-2004
Turning to India, service sector FDI share stands at roughly half of total FDI
inflows, a figure comparable with the GDP share. But service FDI share has been
experiencing a gradual decline as evident in figure 2.8 (a), however. In the year 2004,
48 per cent of FDI inflow into India went into its service sector, a marked fall from 55
per cent only 2 years earlier. The simple reason for the slack in FDI in India’s service
sector is that the software and IT-related businesses that are the main drivers of the
sector’s growth are labour or skill-intensive, rather than capital intensive. Much of
India’s capital-intensive service sector, such as transport and real estate remain very
much closed to foreign investors.
Examining the FDI inflows in greater level of industry disaggregation reveals
that construction, financing, insurance, real estate and business services and computer
services have been receiving the lion’s share of the FDI. In monetary terms, besides
manufacturing, computer services and finance, insurance , real estate & business
services were recent FDI attractions as can be seen in figure 2.8 (c-d).
Figure 2.8 (a) India’s FDI Inflows By Sector (2002-2004)*
28
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2002 2003 2004
year
Services
Manufacturing
Agriculture
Note: * Data in this table exclude FDI inflows by way of acquisition of shares by non-residents under
section 6 of FEMA, 1999
Source: Reserve Bank of India Annual Report 2004-05. http://www.indiaonestop.com/economy-
fdi.htm#FD
Figure 2.8 (b) India’s FDI Inflows By Major Activities (2002-2004)
Share of FDI: Industry-wise inflows*, India
Manufacturing ManufacturingManufacturing
ConstructionConstruction
Construction
Financing, Insurance, Real Estate & Business Services
Financing, Insurance, Real Estate & Business Services
Financing, Insurance, Real Estate & Business Services
Computer ServicesComputer Services
Computer Services
Others OthersOthers
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2002 2003 2004
year
Fisheries MiningManufacturing Food & Dairy ProductsElectricity ConstructionTrade, Hotels & Restaurants TransportFinancing, Insurance, Real Estate & Business Services Computer ServicesEducational Services Research & Scientific ServicesHealth & Medical Services Other ServicesOthers
Note and Source: Same as figure 2.8 (a)
Figure 2.8 (c) India’s FDI Inflows By Major Activities (2002-2004)
0
100
200
300
400
500
600
700
800
900
1,000
2002 2003 2004year
US$ Million
Manufacturing Construction
Trade, Hotels & Restaurants Transport
Financing, Insurance, Real Estate & Business Services Computer Services
Health & Medical Services Other Services
Note and Source: Same as figure 2.8 (a)
Figure 2.8 (d) India’s FDI Inflows By Major Service Activities (2002-2004)
0
100
200
300
400
2002 2003 2004year
US$ Million
Electricity ConstructionTrade, Hotels & Restaurants TransportFinancing, Insurance, Real Estate & Business Services Computer Services
Educational Services Research & Scientific ServicesHealth & Medical Services Other Services
Note and Source: Same as figure 2.8 (a)
The declining service sector’s FDI share will likely to continue given the
emergence of India’s manufacturing industry from its long dormancy against the
30
perpetual unpredictability with respect to the opening of its service markets.
Although the UPA government attempt to mobilize private foreign investment into
the construction of electricity, energy, roads, airports and seaports21, by lifting foreign
ownership restrictions in many service sectors, the policy has faced with public
opposition in the cases of retail business and airport modernization project and in the
case of an investment in the steel industry, from the National Advisory Council22.
To conclude, comparing China’s and India’s trade and investment policies, the
following conclusions can be drawn. First, FDI plays a much more important role in
the development of China’s economy, including its service sector, than in the case of
India. Second, both China and India has been experiencing rather sluggish FDI
growth in the service sector, perhaps because of the relatively closed service sector in
both countries. Third, India is beginning to see large volume of FDI flowing into its
manufacturing sector for the first time in 2004, while China will likely see healthier
FDI inflows into its newly open service markets, in particular financial services.
Thus, both India’s and China’s FDI trend may reverse their past trends respectively.
2.3 Conclusion
China’s economy, including its service sector, is generally more integrated
into the global economy than that of India. This is mainly because of China’s
economy has been, and will likely be, more open to foreign investment than India.
Bar software and IT-related services, and to a certain extent, the financial business,
India’s service sector remains very much detached from the global markets with little
FDI and cross-border trade.
China’s cross border services trade and investment growth thus far have been
driven mainly by the country’s booming industrial activities. India’s cross border
services trade, on the other hand, has been concentrated in a few export-oriented
services, while foreign investment has been severely constrained by the domestic
investment regime that restricts foreign ownership in many services. The FDI gap is
likely to widen as China continues to implement its WTO accession commitments that
21 Invest in India. http://www.indiainbusiness.nic.in/invest-india/introduction.htm22 The Hindu Business on Line, October 11, 2005. “World Investment Report 2005
India: Not quite yet the investors' darling”. Available on-line at
http://www.thehindubusinessline.com/2005/10/11/stories/2005101100701000.htm.
involve extensive liberalization of the service sector until the year 2007. India
potential gains from broader service sector liberalization will likely be held back by
domestic political constraints. This is the subject of discussion in the next chapter.
3. Service Sector Liberalization
To what extent can past assessment of China’s and India’s service sector tell
us about future trends? The answer is not a lot. This is because much of service
sector’s development and performance will be shaped by the country’s policy
concerning privatization, regulation and liberalization. China has made broad and
deep commitments in opening up its service markets as part of its WTO accession
process beginning in 2002 until the year 2007. India, on the other hand, has also
made unilateral moves to open up many of its closed service sub-sectors. The pace of
India’s market opening is likely to be gradual given the political constraints to which
the coalition government is subject23.
This chapter will examine policy commitments in case of China and policy
directions in case of India with regard to the liberalization of the service sector in
order to make rough conjectures on the future role of the service sector in both
countries.
3.1 China’s WTO commitments in services and India’s Current Status
From 2002 to 2007, many of China’ service markets will be fully liberalized.
Some key service-sub sectors included in its WTO accession liberalization package
includes financial services, insurance, telecommunications, media, distribution,
professional services and construction. A summary of China’s commitment in major
service sectors is shown in table 3 in the appendix.
The same table also shows India’s current rules and regulations governing
access to each service sub-sectors collected from several different sources. The
reason for choosing actual rather than committed liberalization in case of India is
because liberalization commitments in the GATS tend to be much more conservative
than actual practices, except for new members. Moreover, the only official specific
23 The current Congress party-led government includes the Communist party that takes a more
conservative view of market liberalization.
32
schedule of commitment would be that which India submitted during the last round of
negotiation in 1994. Since 12 years have lapsed, one cannot expect those
commitments to reflect the current regime. More recent offers submitted to the GATS
during the on-going negotiation are not a good proxy of the future regime, since the
outcome is unpredictable given the request-offer modality in negotiating.
3.2 Sectoral Comparison
The following section will examine sector-specific commitment/regime in
major service sectors and its likely impact on the domestic economy and foreign trade
and investment.
Financial services
China will be the economic power house with most open banking sector in
the World by the year 2006. This is because China has committed to full access for
foreign banks in 5 years. Since 2001, financial sector liberalization has been phased
in by gradually relaxing foreign equity restrictions, business scope24, and geographic
restrictions. China’s commitments in financial services shown in table 3 indicate that
geographical restrictions will be phased out by 2006 and foreign banks will be able to
make local currency loans to not only Chinese, but also foreign enterprises in the
same year.
To fulfill such commitments will require most radical change in the banking
system that is currently dominated by 4 major state-owned banks all of which are
saddled with large non-performing loans extended to state-owned enterprises. The
figure for NPL of China’s banking system ranges from anywhere between the official
figure of 25% and the calculated rate of 60%25. Liberalization of the banking sector
will indeed threaten the survival of these banks, and in turn, state owned enterprises
that rely on their unfailing credit extensions. Government subsidies to prop up these
banks are also prohibited under the accession process and national treatment will have
to be observed.
24 For example, a foreign bank may not be allowed to extend local currency loans to non-resident
clients. 25 According to Matthias, Bekier, Ricjard Huang and Gregory Wilson. “How to Fix China’s Banking
System”, The McKinsey Quarterly, 2005, No. 1 pp. 110-11
According to a recent review of China's financial sector development by
Ding Lu (2006)26, the opening up of China's financial sector according to its WTO
commitment has been on schedule so far. By the end of October 2005, 138 foreign
banks have been approved for conducting Yuan-related businesses, although their
combined assets totaled to only a mere 2% of China's domestic banking sector. In
case of foreign currency loans where foreign banks' participation has not been
restricted, however, their market share is as high as 54.5% in certain pioneering cities
such as Shanghai.
The Chinese government has taken major steps in dealing with large NPLs at
the four state banks since the late nineties. This included a series of debt-equity
swaps arrangements and capital injections. Most recently in 2004, the government
has corporatized 3 of the 4 state banks and injected approximately US$ 60 billion to
prepare them for IPO. This is because it believes that only a fundamental change in
the ownership of these banks can solve the problem of bad loans. In October 2005,
the China Construction Bank (CCB) successfully launched its IPO on the Hong Kong
stock exchange, followed by the Bank of China (BoC) on the first of June 2006.
While China’s banking will eventually be fully liberalized, securities
business, however, will continue to bar foreign majority ownership. Foreign equity
limit of 49% still applies for businesses conducting domestic securities investment,
fund management business. A lower limit of 33% applies to the business of
underwriting domestic equity issues.
Turning to India, according to McKinsey 200627, the country’s financial
system is more efficient in allocating resources than that in China. This analysis is
echoed by that of the World Bank (2004)28, which found that Indian businesses have
better access to loans than do their Chinese counterparts. Fifty-four per cent of Indian
SMEs have access to overdraft facilities in 2002, compared with 26 for Chinese ones.
India’s superior banking sector can be attributed to the fact that (a) India has
allowed entries of foreign and private banks such that the market share of non-public
26 Ding Lu (2006), China's Banking Sector Meeting the WTO Agenda, China Policy Institute
Discussion Paper 5, April 2006, The University of Nottingham, U.K. 27 McKinsey quarterly, 22 January 2006. “Reforming India’s Financial System”.28 World Bank, India: Investment Climate Assessment 2004.
34
banks in India has increased to 25%; (b) foreigners are allowed to own up to 49% of
equity shares in private banks, which helped the injection of new technology and
management into private banking and (c) the government has been successful at
cutting down non-performing loans such that the current NPL rate hovers around 9%
of total outstanding loans. This figure is markedly lower than that China’s figure of
25-60%.
Nevertheless, India’s financial system still has plenty of room for
improvement. Like China, India’s banking is sprawled with state-owned banks whose
efficiency drives are undermined by state-directed lending and strict labour laws.
And, like China, liberalization of the banking sector has been retarded mainly due to
concerns about the survival of these state banks that clearly cannot compete with
foreign banks. Presently, foreign banks are not allowed to own more than 5% of
equity share in an Indian bank, except when the central bank identifies weak domestic
banks that require foreign takeover. Limitations on the opening of new branches also
apply to foreign banks so that the scale of their businesses is circumscribed.
The current plan is to open up foreign banking until the year 2009 in order
to give state-owned banks some time to adjust to prepare for competition. There are
no details with regard to how broad and deep the opening up of the sector will be.
Given China’s commitments in opening up its banking system, it is probable that
China’s financial system will soon overtake that of India, given that it is able to clear
state banks NPLs problems.
Insurance
China’s Insurance market is much more open and competitive than that of
India. Until 2003, foreign insurance companies have been able to enter China’s
market mainly through branch operations or joint ventures with 51% ownership in
case of non-life and 50% ownership in case of life insurance. Their licenses have
been granted on a city basis, however. The establishment restrictions have been lifted
in 2003 for non-life and geographical restrictions were lifted in the following year,
along with any restrictions on business scope. Foreign ownership restriction is also
abolished in 2004, with the exception of 50% limit in case of life insurance that
remains.
The insurance market contributes to 10-15% of India’s financial asset. The
market is relatively closed with 27% foreign equity ceiling. However, an increase in
the foreign equity share to 49% was announced by the Ministry of Finance in June
2004 and is expected to come into effect in early 200629.
Telecommunications sector
China clearly lags behind India when it comes to the telecommunications
sector. This is mainly because China’s telecommunications industry remains
relatively closed compared with that of India. As can be seen in table 3, according to
its accession commitments, China will continue to impose a 49% foreign equity limit
for basic telecommunications services and 50% for value added services. India, on
the other hand, allows 100% FDI into non-infrastructure value added services such as
ISP services without gateway, electronic mail and voice mail services. For basic
telecom services such as fixed line and mobile voice services, the foreign equity share
is subjected to a lower ceiling of 74%.
India’ relatively open regime has yielded visible results. Figures 3.1 (c) and
(d) show that international telephone and mobile phone costs in India are visibly
cheaper than those in China, despite the fact that the rate of telephone and computer
penetration in India are far behind those in China as illustrated in figures 3.1 (a) and
(b).
Distribution
Distribution services consist of 3 main service sub-sectors, namely,
wholesale, retail and franchise. China’s distribution is fully liberalized except for
chain stores with more than 30 outlets selling a range of products. That is, majority
ownership is prohibited in retail chain stores, which sells multiple products and
different brands of products such as newspaper, books and pharmaceuticals that have
more than 30 outlets. It should be noted that in addition to these commitments, China
has also opened up the whole logistical chains, including delivery services, storage
and warehousing services, inventory management, refrigeration, etc.
29 The new rule has not come into effect as of March 31, 2006
36
India’s distribution sector is highly fragmented. Approximately 97% of
India’s retail market is made up of small scale mom and pops store that purchase
goods from similarly fragmented suppliers30. FDI in retail, regardless of size, and in
franchise, has been strictly prohibited, while that in wholesale is subject to approval
by the Foreign Investment Promotion Board (FIPB). However, a series of measures
have been taken since the beginning of the year 2006 to help overhaul India’s
distribution service.
First, the long standing prohibition of foreign FDI in real estate and property
has finally been lifted, paving way for a boom in the construction of new shopping
malls. Second, in February 2006, the government has partially opened up the
franchise business by allowing foreign investors to own 51 % equity share of retails
stores selling single-brand products. Third, the opening up of the much coveted large-
scale retail business is highly anticipated. After several years, Wal-Mart has been
allowed to open up a market research office in Bangalore in February 2006 31. With
these recent changes, India’s retail is on the verge of a boom.
Like China, India’s logistic businesses have been open to FDI. Despite the
legal restriction of foreign equity share at 51%, several global logistics company, such
as DHL and Courier, have been granted permission to hold almost 100% equity share
in local logistics businesses by the Foreign Investment Promotion Board. But in stark
contrast with China, India’s notorious lack of infrastructural facilities, such as roads,
rail and port, however, pose a serious constraint to the logistics business and raise
overall distribution costs32.
Professional services
Professional services consist of legal services, accounting, auditing and book
keeping services, architecture and engineering services, urban planning and medical
and dental services. China’s professional services will be very much open by the year
30 RetailME, April 4, 2006, “Passage to India”. Article available at
www.retailme.com/mewspreview.asp31 PSFK, March 14, 2006, “India’s Retail Sector Opening Up May Create a Job Boom”. Article
available at www.psfk.com/2006/03/india_retail_s.html32 The Hindu Business Line: Internet version, October 13, 2003. “Leveraging Logistics for
Competitiveness.
2007, with the exception of legal and medical services. Foreign firms are prohibited
from being engaged in local legal affairs and are confined to undertake legal affairs in
their country of origin. Foreigners are also prohibited from owning hospitals in China
and the issuance of license for operating a hospital will be decided on a need-based
basis.
India’s professional services are relatively open for architecture, urban
planning and medical services. Not so for legal and accounting services, however.
International law firms are not allowed to open offices in India and partnerships with
foreign professionals is prohibited. FDI is also prohibited in accounting, auditing and
book keeping services and foreign professionals are not allowed to undertake
statutory audits.
Figure 3.1 India’s and China’s Telecommunication Sector’s Performance: A Comparison
Figure 3.1 (a) Figure 3.1 (b)
Number of f ixed telephone lines per 1000 inhabitants
22.343.8
55.573.6
102.0
138.0 138.0
209.0
10.8 13.6 17.9 20.331.0 37.0 37.0
46.0
0
40
80
120
160
200
240
1995 1996 1997 1998 1999 2000 2001 2002 2003 year
number
China India
Number of computers per 1000 people
3.05.0
7.09.7
14.3
22.0
27.0
32.5
41.0
2.0 3.0 4.0 5.06.5
8.0 9.0 10.012.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 year
number
China India
38
Note: no data available year 1999
Source: IMD World Competitiveness Yearbook
Note: no data available year 1999
Source: IMD World Competitiveness Yearbook
Figure 3.1 (c) Figure 3.1 (d)
Note: 1. no data available year 2000
2. International fixed telephone costs is US$ per 3 minutes in
peak hours to USA, for USA to Europe
Source: IMD World Competitiveness Yearbook
Note: Mobile telephone costs is US$ per 3 minutes in peak
hours(local)
Source: IMD World Competitiveness Yearbook
3.3 Conclusion
It is clear that China’s liberalization commitments upon its accession to the
WTO are by far broader and deeper than India’s policy in the foreseeable future. This
imply that China’s service sector will likely undergo drastic transformation in the next
few years with an influx of foreign investments into service sub-sectors that were
once closed to foreign investment, in particular financial, distribution and logistics
services.
India’s service sector’s future liberalization prospects are difficult to gauge.
There are mixed signals with regard to future directions of India’s service sector.
Real estate and retail trade services have been made much more open to foreign
investment. At the same time, however, the government’s proposed “Postal
Amendment Bill” that would prevent private operators from carrying documents
weighing less than 500 grams, thereby expanding the scope of India Post’s exclusive
rights, seems to be going in an opposite direction. However, given the current
condition of the country’s service sector, a broad-based opening up of many vital
sectors, such as transport and large scale distribution, can certainly unleash
spectacular growth potentials of India’s service sector that would contribute
significantly to the growth on India’s economy.
4. Summary
This study compares the role of the service sector in two largest economies,
China and India. The analysis is based on based on readily available secondary data
at the sector and sub-sector levels. Findings indicate several fundamental
differences in the structure and policy in both countries’ service sector that can be
summarized as follows.
First, export-oriented services, namely software and computer-related
business services have been the main engine of India’s service sector growth,
overshadowing the relatively sluggish industrial sector. On the contrary, China’s
service sector has always played second fiddle to its manufacturing counterpart.
Second, India’s service sector growth, confined to a few service activities,
was not able to generate employment, and thus income, en masse. . On the contrary,
China's broader service sector growth, following many years of healthy expansion of
the manufacturing sector, contributed positively to both the country's GDP and
employment. Many critics of India’s service export-led growth believe that such
growth is unsustainable as it is too narrowly based and that only domestic reforms that
will bring out the domestic manufacturing industries out of the doldrums can provide
India with a long lasting economic prosperity.
Third, although China‘s cross-border services trade represents a smaller
proportion of its GDP than that of India, the country’s service sector in generally is
significantly more integrated with the global economy in terms of both cross-border
trade and investment
China’s services trade cover an expansive range of services, in particularly,
manufacture-related services such as transport, business services, insurance and
royalty fees. Rapidly rising income among the Chinese population also helped
40
stimulate leisure services, such as tourism. On the contrary, India’s cross border
services trade involve mainly of export of software and import of computer-related
business services. There has been very little growth in trade in other types of
services.
China service sector also receives FDI that is roughly 5 times larger than that
received by India each year. China’s more liberal investment regime, far superior
infrastructure coupled with its vibrant manufacturing activities no doubt contributed
to greater attractiveness.
Fourth, China’s service sector’s growth prospects in the foreseeable future
remain solid. This is mainly because its continued spectacular industrial expansion
will continue to generate a wide variety of production-related services as well as
strong consumer demands as the income level rises. The countries’ comprehensive
WTO commitments to open up many of its major service activities, in particularly,
banking, will also be a major boon to the sector's growth prospects.
India’s service sector growth is likely to be as promising despite inherent
uncertainties with regard to the direction and pace of the liberalization. This is
because of two main factors. First, the fact that India may finally enter a
manufacturing sector boom will be a definite boon to the country’s service sector,
whose growth has been partially constrained by the absence of a parallel growth in the
industrial sector. Second, India’s recent bold moves to open up key service sectors to
FDI for the first time -- such as real estate and property and retail -- seem to indicate
the general policy direction that welcomes FDI. Given that the present condition of
many of India’s service sectors that have been closed to foreign investment is
extremely undeveloped (due to the lack of domestic investment capital), liberalization
may unleash pent-up growth potentials that can be enormous.
Table 3 China’s Commitments: Past, Present and Future
SERVICE SECTOR China’ Accession Commitment India’s Current Regime
PROFESSIONAL SERVICES
Legal services CONTINUED RESTRICTIONS
ON BUSINESS SCOPE
Mode 3. Geographic and
quantitative Limitations will be
eliminated by 2002
FDI prohibited
International Law firms are not
allowed to open offices in India
Legal service can only be provided
by natural person who is citizen of
India)*
Partnerships with enrolled foreign
professionals prohibited (Banga
2005)
Accounting, auditing
and bookkeeping
services
FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
FDI prohibited
Foreign service providers not
allowed to undertake statutory audits
(Banga 2005)
Architecture and
engineering
FULL LIBERALIZED
EXCEPT FOR MODE 1
RESTRICTIONS.
Mode 3. wholly foreign owned
subsidiaries permitted by 2006
100 % FDI allowed according to India’s
schedule of specific commitments in
GATS.
In case of architecture, incorporation in
India as partnership is required and
other requirements stipulated by the
Council of Architecture need to be
fulfilled.
Urban planning
(excluding general
urban planning)
FULL LIBERALIZED
EXCEPT FOR MODE 1
RESTRICTIONS.
Mode 3. wholly foreign owned
subsidiaries permitted by 2006
100 % FDI allowed according to India’s
schedule of specific commitments in
GATS.
Medical and dental
services
FULL FOREIGN OWNERSHIP
NOT ALLOWED AND NEEDS
BASED QUOTAS
100 % FDI allowed according to India’s
schedule of specific commitment in
the GATS subject to the condition
that latest technology for treatment
will be brought in. Also, publicly
funded services may be available
only to Indian citizens or may be
supplied at differential prices to
persons other than Indian citizens.
42
SERVICE SECTOR China’ Accession Commitment India’s Current Regime
COMPUTER AND RELATED SERVICES
Consultancy services
related to the installation
of computer hardware
Data processing and
tabulation Time-sharing
FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
100% is allowed except for B2B
electronic commerce that requires 26%
disinvestment after 5 years.
Software implementation
Systems and software
consulting
Systems analysis
FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
Systems design
Programming
Systems maintenance
Data processing
Input preparation
FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
TELECOMMUNICATIONS
Value added By 2002 expansion in
geographical area, and foreign
investment limit to 49% By 2003
no geographic restriction and
FOREIGN INVESTMENT
LIMIT TO 50%
100% FDI allowed subject to
Foreign Investment Promotion
Board. For the following services:
(1) ISPs without gateway; (2)
infrastructure providers providing
dark fiber; (3) electronic mail and (4)
voice mail. Investment subject to
26% disinvestment in 5 years.
74% FDI allowed for other value
added services and ISP with
gateways.
Basic telecommunications
mobile voice and data
By 2002 expansion in
geographical area, and foreign
investment limit to 35%
By 2004 FOREIGN
INVESTMENT LIMIT TO 49%
By 2006 no geographic restriction
FDI allowed up to 74%
SERVICE SECTOR China’ Accession Commitment India’s Current Regime
Basic telecommunications
fixed-line services
By 2004 through JVs with a
foreign investment limit of 25%
only in and between Shanghai,
Guangzhou and Benign
By 2006 expansion in
geographical area, and foreign
investment limit to 35%
By 2007 on geographic restriction
and FOREIGN INVESTMENT
LIMIT TO 49%
FDI allowed up to 74%
CONSTRUCTION
Construction and related
engineering
RESTRICTIONS ON
BUSINESS SCOPE OF FULLY
FOREIGN-OWNED
ENTERPRISES
Mode 3. By 2004, fully foreign-
owned enterprises permitted but
only in projects financed by
foreign investment and/or grants,
or by loans from IFIs or those
which are technically difficult for
Chinese enterprises.
100% FDI allowed
DISTRIBUTION
Commission agents and
wholesale trade, and a full
range of subordinated
services, including after
sales services
LIBERALIZED EXCEPT
CROSS BORDER DELIVERY
AND TWO PRODUCTS
Mode 3 By 2002, through JVs
subject to restrictions on
products, to be phased out by
2006 (except salt and tobacco)
By 2003, foreign majority
ownership allowed and no
geographic or quantitative
restrictions
100 % FDI in wholesale is allowed
subject to the approval of the Foreign
Investment Promotion Board. However,
certain restrictions regarding transport
and warehousing area apply.*
44
SERVICE SECTOR China’ Accession Commitment India’s Current Regime
Retailing and a full range of
subordinated services,
including after sales services
CONTINUED RESTRICTUINS
ON LARGE CHAIN STORES
Mode 3 By 2003, all provincial
capitals open and by 2004, no
more geographical restrictions,
By 2006, no restrictions on
products, foreign majority control
allowed except in chain stores
with more than 30 outlets selling
a range of products
FDI strictly prohibited.
Franchising FULLY LIBERALIZED BY
2004
Mode 3 By 2004, none
51 % foreign ownership is allowed as of
2006.
EDUCATIONAL AND ENVIRONMENTAL SERVICES
Educational services
excluding special
education (e.g. military
and political) and national
compulsory education
FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
100% FDI is allowed
Environmental services FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
FINANCIAL SERVICES
Insurance (except
statutory insurance)
By 2004, FULLY
LIBERALIZED EXCEPT 50%
FOREIGN OWNERSHIP LIMIT
IN LIFE INSURANCE
Mode 3 By 2003, no
establishment restrictions in non-
life
By 2004, no geographic
restrictions
By 2004, no restrictions on
business scope
By 2005, no cession requirement
FDI up to 26% of equity share allowed
but is currently being revised up to 49%
(March 2006).
SERVICE SECTOR China’ Accession Commitment India’s Current Regime
Banking FULLY LIBERALIZED BY
2006
Mode 3 Geographic limitations
phased out gradually by 2006
Clients local currency business
with Chinese enterprises by 2003
and all clients by 2006
74% FDI allowed in private sector
banks.
20% FDI allowed in nationalized
banks
Securities Mode 3 by 2004, 49% foreign
ownership in JVs to conduct
domestic securities investment
fund management business, and
through JVs with up to 33%
foreign ownership to underwrite
A shares, and underwrite and
trade B and H shares, as well as
government and corporate debts,
launching of funds
TOURISM AND TRAVEL RELATED SERVICES
Hotels FULLY LIBERALIZED BY
2005
100 % FDI allowed according to India’s
schedule of specific commitments in
GATS. Travel agency and tour
operator
FULLY LIBERALIZED BY
2007
TRANSPORT SERVICES
A. Maritime Transport
International transport FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
100% FDI allowed under GATS
commitment. But only registered
companies or cooperative societies under
any Central Act of State Act having its
principal place of business in India can
operate a ship under Indian flag.
Auxiliary services FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
100% FDI allowed for most maritime
auxiliary services.
46
SERVICE SECTOR China’ Accession Commitment India’s Current Regime
B. Internal waterways FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
100% FDI allowed
C Air transport
Aircraft repair and maintenance
FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
100 % FDI allowed according to India’s
schedule of specific commitments in
GATS.
Computer reservation FULLY LIBERALIZED
Except that partnerships and
incorporated accounting firms are
limited to CPAs Licensed by
Chinese authorities
E Rail transport FULLY LIBERALIZED BY
2007
(Mode 3 majority ownership by
2004)
Public monopoly. FDI prohibited.
F Road transport (freight) FULLY LIBERALIZED BY
2004
(Mode 3 majority ownership by
2002)
100% FDI allowed.
H Services auxiliary to all modes of transport
Storage and warehousing FULLY LIBERALIZED BY
2004
(Mode 3 majority ownership by
2004)
Freight forwarding agency services
FULLY LIBERALIZED BY
2005
(Mode 3 majority ownership by
2002)
Source: 1/ China’s WTO commitments from Mattoo, Aaditya (2004), China’s Accession to the WTO: The Services Dimension, World Bank Research Working Paper 2932, December 2002.2/ India’s foreign investment regime from Department of Industrial Policy Promotion, Ministry of Commerce and Industry, Government of India (2005), “Investing in India: Foreign Direct Investment Policy and Procedures. Available at www.dipp.nic.in/manual/manual_03_05.pdf and Srivastava, Ajay (2004), “GATS- The Indian Scenario”, Manila, Philippines, 21.22 October 2004. Paper available at www.intracen.org/worldtradenet/ docs/whatsnew/b4d_2004/india1.pdf