Should Latin America rely on services for growth?

Despite the popular reference to the primarisation of exports in most Latin American commodity exporters, the term that better describes the dynamics of supply in recent years is ‘tertiarisation’.1 Propelled by domestic demand and appreciating real exchange rates, economic activity gradually shifted from manufactures to services, which went from representing an average 60% of total value added in 2000 to about  64% in 2011 (Figure 1).2

Figure 1. A comparative look at Latin American countries’ (LAC’s) growth pattern: The supply side

Panel A. Real value added across sectors

Panel B. LAC-7 real value-added growth

Notes: Value added is in constant 2005 LCUs. In Panel A, LAC-7 & Uruguay (excl. Brazil and Mexico): Argentina, Chile, Colombia, Peru, Uruguay, and Venezuela. EE MICs: Croatia, Estonia, Hungary, Lithuania, Poland, Romania, Slovakia, and Turkey. SEA MICs: Indonesia, Malaysia, Philippines, South Korea, and Thailand. PCEs: Australia, Canada, New Zealand, Norway, and Sweden. In Panel B and C LAC-7: Argentina, Brazil, Chile, Colombia, Mexico, Peru, Uruguay, and Venezuela. In Panel A and C, Agriculture, Forestry, and Fishing corresponds to the sectors A & B in ISIC Rev. 3 Classification; Mining & Utilities includes sectors C and E; Manufacturing includes sector D; Construction includes sector F; Skilled Services include sectors J-P. In Panel A, Wholesale, Retail and Restaurant includes sector G and H, and Transport, Storage and Communications includes sector I. In Panel B, Primary Sector includes ISIC sectors A-C, and E, and Services includes sectors G-P. In Panel C, Other Services includes ISIC sectors G-I.
Source: UN Statistics.

Does the region have too many services? Should we worry about de-industrialisation? In principle, no. For starters, the share of manufacturing in the GDP typically declines with the degree of development (Figure 2, Panels A and B). Thus, tertiarisation appears less a particular by-product of the commodity boom than a more general consequence of the region’s development. Indeed, a quick glance at the share of services over GDP across the globe suggests that Latin American countries have been converging towards the expected path (Figure 2, Panel C).

Figure 2. Are Latin American countries becoming too service intensive or just converging?

Panel A.  Services value added 2010

Panel B. Employment in services late 2000s

Panel C. Share of services and GDP

Panel D. Share of employment in services and GDP

Notes: Value added is in constant 2005 LCUs. In Panels A and C we run a regression of the share of value added from services on a polynomial of log GDP Per Capita on a sample of countries with available data in 2000 and 2010. Fitted values are the predicted value of the share of value added from services according to this regression. In Panels B and D we run a regression of the share of employment in services on a polynomial of log GDP Per Capita on a sample of countries with available data in early 2000s (2000 or 2001) and late 2000s (2007 or 2008). Fitted values are the predicted value of the share of employment in services according to this regression. Share of Services is the ratio between the value added in sectors G through S (ISIC Rev. 3) over total value added.
Source: UN Statistics.

In addition, measures of the industrial share may not be comparable over time. Vertical disintegration through outsourcing and offshoring implies that many activities that in the past were performed within the industrial firm (transportation, telecommunications, security, catering, health services, mailing, etc.) are now provided by outside service firms, and are accordingly grouped under services at the expense of the industrial product. Thus, part of the measured tertiarisation may be due to a ‘reclassification effect’ (Berligieri, 2014).3

Tertiarisation in Latin America: A balanced scorecard

The debate about the good and the bad of tertiarisation is perhaps most pertinent for natural resource-rich Latin American countries that, now that the global tailwind faded, face a growth conundrum, as they look too rich (i.e., too expensive) to compete with the new Asian tigers, and too poor (i.e., not productive enough) to emulate high-income commodity producers like Australia or Canada. Can services complement natural resources and agribusiness to outline a sustainable growth pattern for the region? Or is tertiarisation simply a Dutch Disease-related substitution towards less sophisticated non-tradable activities, as it is often regarded?

Services, skill composition, and productivity

A casual look into the service sector shows that the contributions to value-added growth in Latin America has not been circumscribed to low-skilled activities or construction; on the contrary,

It is in high-skilled services that growth contributions have been more significant in the past decade, in line with both Asian economies and PCEs (Figure 3).

Economic theory would suggest that services would be less productive.4 Proxying TFP by sectoral labour productivity (value added over employment), while a long-run perspective places productivity in services behind manufactures (which, in turn, lags the primary sector, the beneficiary of the important technological advances in production methods, machinery, and inputs in the late 1990s), the past decade shows a new and brighter story for the service sector (Figure 4, based on Pages-Serra et al. 2010).5

Figure 3. Sectoral contributions to real value-added growth

Notes: Value added is in constant 2005 LCUs. LAC-7 & Uruguay (excl. Brazil and Mexico): Argentina, Chile, Colombia, Peru, Uruguay, and Venezuela. EE MICs: Croatia, Estonia, Hungary, Lithuania, Poland, Romania, Slovakia, and Turkey. SEA MICs: Indonesia, Malaysia, Philippines, South Korea, and Thailand. PCEs: Australia, Canada, New Zealand, Norway, and Sweden .Agriculture, Forestry, and Fishing corresponds to the sectors A & B in ISIC Rev.3 Classification; Mining & Utilities includes sectors C and E; Manufacturing includes sector D; Construction includes sector F; Skilled Services include sectors J-P; Other Services includes sectors G-I.
Source: UN Statistics.

Figure 4. Annual labour productivity growth in Latin American countries by Sector

Notes: LAC includes Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico, Peru, Uruguay, and Venezuela. Primary Sector includes ISIC sectors A-C, and E in ISIC Rev. 3; Manufacturing includes sector D; Construction includes sector F, and Services includes sectors G-P. Labour productivity is measured as the ratio between value added and total employment in a given sector.
Source: Timmer and de Vries (2007).

Furthermore, a quick glance at the skill composition by sector indicates that services is the sector in Latin American countries that uses, by far, the higher share of educated labour – more than 50%  of the labour force employed in services – has at least a secondary degree (20% have a tertiary degree).

These numbers are 10 percentage points larger than in manufacturing, the second most skill-intensive (if we use education as a measure of skills) sector (Figure 5, Panel A and B). Moreover, looking at the evolution of skill intensity over time we see that, if anything, the service sector (especially if one excludes construction services) has become more skill-intensive than the manufacturing sector (Figure 5, Panel C and D).6

Figure 5. Share of educated workers across sectors over time in LAC-7

Panel A. Education intensity across sectors over time (Tertiary); Panel B. Education intensity across sectors over time (Secondary +)

Panel C. Education intensity relative to manufacturing (tertiary); Panel D. Education intensity relative to manufacturing (Secondary +)

Notes: All variables are calculated using simple averages for Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Uruguay. We used two definitions of education intensity. The first, (called Tertiary) measures education intensity as the share of workers with a college degree. The second definition (secondary +) measures education intensity as the ratio of workers with a High School degree or more. LCRCE from SEDLAC.

Tell me what you export and I will tell you what you will become seems to be the conclusion of a recent body of literature positively linking export sophistication, on the one hand, and economic performance and labour market dynamism, on the other.7

Can we extend the argument of exported value added to the exports of services? A cursory look at Latin American countries’ exports of services relative to those of comparable economies reveals that, while exports of services with a high degree of sophistication and high skill content (computer and information services, other professional and business services) have been on the rise, exports of services are still far from what their income level would predict.8

Figure 6. Export of services, excluding tourism

Panel A. Exports across different types of services

Panel B. Exports of skilled services

Panel C. Exports of services, excluding tourism

Notes: In Panels A and C LAC-7: Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Uruguay. EE: Croatia, Estonia, Hungary, Lithuania, Poland, Romania, Slovakia, and Turkey. SEA: Indonesia, Malaysia, Philippines, South Korea, and Thailand. PCE: Australia, Canada, New Zealand, Norway, and Sweden. Averages for each group are calculated using countries with available data.
Source: LCRCE from Haver Analytics.

Who´s afraid?

Tertiarisation advocates point at sophisticated services as a source of high quality jobs and growth (Ghani et al. 2011), particularly when it comes to new emerging economies –as it is the case of the so called Lions of Africa that have been “benefitting from increases in productivity in the service sector, while the agricultural sector remains unproductive” (Ghani, 2014).9 In turn, tertiarisation sceptics warn that tradable services “typically are highly skill-intensive sectors that employ comparatively few ordinary workers” (Rodrik, 2014)10

The right balance is perhaps halfway between the conventional industry-based model of the Asian Tigers and the yet untested service-led model proposed by some for the industry-less African Lions. In Latin America, in particular, services have been evolving rapidly to become a key growth driver as well as a value enhancer of industrial activities, and are likely to be essential to the next development phase –provided education and training do not lag behind. In that context, rather than a growth concern, tertiarisation should be seen as part of the solution.

References

Antràs, P, L Garicano and E Rossi-Hansberg (2006), “Offshoring in a Knowledge Economy,”Quarterly Journal of Economics, Vol. 121 (1), pages 31-77.

De la Torre A, E Levy Yeyati and S Pienknagura (2013), Latin America and the Caribbean as Tailwinds Recede : In Search of Higher Growth, LAC Semiannual Report, World Bank, Washington, DC, April.

Baumol, W J (1967), “Macroeconomics of Unbalanced Growth: The Anatomy of Urban Crises”,American Economic Review, Vol. 57(3), pages 415-426.

Berlingieri, G (2014), “Outsourcing and the Rise in Services”, LSE Centre for Economic Performance Discussion Paper 1199

Berlingieri G (2014), “Outsourcing and the shift from manufacturing to services”, VoxEU.org, 25 September

Carranza, J E, and S Moreno. (2013), “Tamaño y Estructura Vertical de la Cadena de Producción Industrial Colombiana,” Borradores de Economía, Núm. 71.

Ghani, E (2014), “Growth Escalators and Growth Convergence”, VoxEU.org, 17 August

Ghani, E, A G Goswami, H Kharas (2011), “Can services be the next growth escalator?” VoxEU.org, 12 December

Ghani, E and S O’Connell (2014), “Can Service Be a Growth Escalator in Low Income Countries?”, World Bank Policy Research Working Paper 6971.

Lederman, D and W Maloney (2012), “Does What You Export Metter? In Search of empirical Guidance for Industrial Policy,” Latin American Development Series, World Bank, Washington, DC.

Levy Yeyati, E and S Pienknagura (2014) “Wage Compression and the Decline in Inequality in Latin America: Good or Bad?” VoxEU.org, 10 June

Rodrik, D (2014), “Are Services the New Manufactures?” Projectsyndicate.org, 13 October

Pagés-Serra, C (ed.) (2010), “The Age of Productivity: Transforming Economies from the Bottom Up”, Washington, DC: Inter-American Development Bank.

Timmer, M and G de Vries. (2007). “A Cross-country Database For Sectoral Employment And Productivity in Asia and Latin America, 1950-2005”, GGDC Research Memorandum GD-98, Groningen Growth and Development Centre, University of Groningen.

Triplett, J and B Bosworth (2003), “Baumol’s Disease Has Been Cured: IT and Multifactor Productivity in U.S. Services Industries”, in Jansen, D (ed.), The New Economy: How New? How Resilient?, Chicago: University of Chicago Press.

Footnotes

[1] Tertiarisation as a concept has been present since the pioneering three-sector model of Fisher (1939) and Clark (1940), and came back more recently in various guises (post-industrial society, knowledge economy, etc.) in the developed world.

[2] See De la Torre et al. (2013) for a detailed analysis of the data presented here.

[3] Using US data from the past 60 years, Berlingieri shows that the evolution of the input-output structure due to professional and business services outsourcing “accounts for 36% of the increase in services and 25% of the fall in manufacturing.” Along these lines and closer to the region, Carranza and Moreno (2013) estimate value added correcting for outsourcing and find no loss in industrial participation in aggregate value added. At a more general level, Antràs et al. (2006) argue that recent technological shocks have favoured vertical disintegration.

[4] Note that, although this view was backed by the US data in the 1970’s, recent work suggests that Baumol’s hypothesis has been reversed. See Triplett and Bosworth (2003).

[5] Labour productivity captures ‘true’ productivity only if the production process uses labour as its only input. If it does not, labour productivity is a function of true productivity as well as other factors, mainly capital.

[6] This casts doubt on the view that attributes to tertiarization the recent wage compression in Latin American countries (see Levy Yeyati and Pienknagura 2014).

[7] See Lederman and Maloney (2012) for a comprehensive—and critical—empirical exploration of this premise.

[8] An important caveat: Due to data limitations, the figures do not include one of the most important service exports in the region, namely, tourism services.

[9] See also Ghani and O´Connell (2014).

[10] “They could act as growth escalators in economies where the work force is adequately trained. But developing economies typically have predominantly low-skilled labor forces”, Rodrik elaborates.

This article is published in collaboration with VoxEU. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Eduardo Levy Yeyati is Visiting Professor of Public Policy at Harvard Kennedy School and Professor of Economics and Finance (on leave) at Universidad Torcuato Di Tella (UTDT) and Universidad de Buenos Aires. Samuel Pienknagura is a Research Economist in the World Bank’s Office of the Chief Economist for Latin America and the Caribbean.

Image: Employees work on the assembly line at the Renault plant in Sao Jose dos Pinhais August 2, 2012. REUTERS/Rodolfo Buhrer.