A Comparative Study of the Role of the Service Sector in the ...

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.

http://indiabudget.nic.in/es2005-06/esmain.htm

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.

http://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

http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/TRADE/0,,contentMDK:20211428~pagePK:64020865~piPK:149114~theSitePK:239071,00.html

http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/TRADE/0,,contentMDK:20211428~pagePK:64020865~piPK:149114~theSitePK:239071,00.html

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


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


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


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



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)

http://www.indiaonestop.com/economy-fdi.htm#FD

http://www.indiaonestop.com/economy-fdi.htm#FD

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


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


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


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


Note: Mobile telephone costs is US$ per 3 minutes in peak

hours(local)


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



GATS.

Medical and dental

services

FULL FOREIGN OWNERSHIP

NOT ALLOWED AND NEEDS

BASED QUOTAS


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


COMPUTER AND RELATED SERVICES

Consultancy services

related to the installation

of computer hardware

Data processing and

tabulation Time-sharing

FULLY LIBERALIZED




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




Chinese authorities

Systems design

Programming

Systems maintenance

Data processing

Input preparation

FULLY LIBERALIZED




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


investment limit to 35%

By 2004 FOREIGN

INVESTMENT LIMIT TO 49%

By 2006 no geographic restriction

FDI allowed up to 74%


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


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


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




Chinese authorities

100% FDI is allowed

Environmental services FULLY LIBERALIZED




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).


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



GATS. Travel agency and tour

operator

FULLY LIBERALIZED BY

2007

TRANSPORT SERVICES

A. Maritime Transport

International transport FULLY LIBERALIZED




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




Chinese authorities

100% FDI allowed for most maritime

auxiliary services.

46


B. Internal waterways FULLY LIBERALIZED




Chinese authorities

100% FDI allowed

C Air transport

Aircraft repair and maintenance

FULLY LIBERALIZED




Chinese authorities



GATS.

Computer reservation FULLY LIBERALIZED




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


2002)

100% FDI allowed.

H Services auxiliary to all modes of transport

Storage and warehousing FULLY LIBERALIZED BY

2004


2004)

Freight forwarding agency services

FULLY LIBERALIZED BY

2005


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

http://www.dipp.nic.in/manual/manual_03_05.pdf

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