The Central Role of Services in Economic Development: Externalities, Growth, and Public Policy

Strategic services play a pivotal, but largely unrecognized, role in the early growth and development of market economies. The failure to appreciate their importance at early stages of development has led to the selection of policies which often fail to support the growth of service industries, thus limiting the development of all sectors. It is well recognized that division of labor is a major source of economic development and growth. In this paper, strategic (or organizational) services are shown to be an integral part of this progressive division of labor, and therefore of development itself. In addition, strategic services generate positive externalities which affect all other sectors in the economy, and therefore create an opportunity for supportive public policies. These positive externalities are eventually overwhelmed by the negative effects of the service network congestion and rising average costs as the service industry matures. Industrialized countries are in a unique position to offer information concerning the evolution of services throughout the entire market development process from the early stages through maturity. The United States, having arguably traveled farthest down the road toward deregulation of its service industries, provides a particularly good case study for determining the role of services in market development as well as the evolution of public policy relating to services during the development process. An empirical study of forty years of U.S. service data supports the theoretical assertions regarding the early importance and the dynamic path of service industry development and therefore the changing policy prescriptions. The lessons are then applied to the case of developing countries.