Trends of FDI and Production in Service Sectors: A Dynamic Panel Exercise with Indian Data

Introduction

Service has been emerged as one of the largest and fastest growing sectors in the global economy, contributing more than 60 percent of global output, even larger share of employment in many countries (Hoekman & Mattoo, 2008) since last two and half decades. The growing share of services in global transactions has also accompanied the growth in service sectors. It is a fact that during the same time period trade in services has grown as fast as trade in goods is the cause of rise in international supply of services. The ratio of global trade in services to goods has increased to 27 percent in 2010 from 20 percent in 1980 (WDI, 2011). Service sector has also attracted huge amount of inflow of foreign direct investment (FDI). Sector wise data of FDI stock provided by UNCTAD (2015) highlighted that the prominent role of services in global FDI. The services has accounted for 63 percent of global FDI stock, more than twice of the share of manufacturing, at 26 percent in 2012. There is a shift of ongoing sector level composition of FDI from manufacturing to services because the share of services in global FDI stock has gained 14 percent with a corresponding decrease in manufacturing to 26 percent from 41 percent since 1990.

Like global economy, India has also experienced a major improvement in services led economic growth since economic reform. Indian services sector assumed a central role in its remarkable growth story and grew at an average annual rate of 8 percent during 1990s. According to Economic Survey 2014-15 published by government of India, service sector is contributing nearly 65 percent to the overall economic growth since 2010. There has been satisfactory growth in Indian service sectors like Information Technology, Business Process Outsourcing and Knowledge Based Activities. Further, productivity growth in India, unlike other regions of the world, has been the strongest in services (IMF, 2006; Bosworth & Collins, 2007). A common phenomenon in economic growth theory is service-led growth (Kuznets, 1957; Chenery, 1960). Traditionally a major part of demand for services comes from the secondary phase of growth in manufacturing sector. But the growth of Indian service sector is having an altogether different story, largely independent of manufacturing sector.

Along with a large-scale expansion of output and employment in the services sector, India’s trade in services has also been an outstanding during the post-reform period. Due to various measures of economic reform, India’s service trade has been growing rapidly since the early 1990s. Banga (2005) and Dash and Parida (2011) found that high growth in Indian service sector in 1990s relates to higher growth of trade in services. India’s services trade has registered a remarkable growth of 19.7 percent, which was fairly higher than the rate of growth of goods trade (13 percent) during 1990-2010. According to Handbook of Statistics on Indian Economy published by RBI, there has been a rapid growth of India’s trade in services in the past two decades. It reached to US$ 240 billion in 2010 from US$ 6 billion in 1980s. India’s service export has not only grown more rapidly than its merchandise export, but also it has grown faster than global service exports. Contribution of India’s trade in services to total trade has increased from 20 percent in 1980s to 30.4 percent in 2010. A substantial part of the growth of service export (21.7 percent) was in the post-reform period. India was having a negative balance of trade in services in 1980s and 1990s, but from 2004 it has been positive. Share of India’s trade in services to world has increased to more than 3 percent in 2010 from less than 1 percent in 1980, while the same in goods trade has remained constant at around 1 percent.