India’s Service Sector Growth - A “New” Revolution

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.