Services diversification and economic growth.

• Author: Gnangnon, Sena Kimm

1. Introduction

   For a long time, the services sector has been considered as a small (if not no) contributor to economic growth and development. This is because this sector has been associated with low productivity and low wage compared to the manufacturing sector (e.g., Baumol, 1967; Kaldor, 1966). Nowadays, the tradability and contestability (1) of services markets is now well established, particularly in light of the rapid technological changes and the globalization in various services sectors (2), notably through global value chains (e.g., Cali et al., 2008; Hoekman and Shepherd, 2017; Schettkat and Yocarini, 2006; Riddle, 1986). The growing importance of the services sector in the economy has been emphasized recently by UNCTAD (2016), which has noted that the services sector represents now the main destination of foreign direct investment (FDI) flows, as FDI flows to services sectors stand for about two-thirds of the global FDI stock, whereas it amounted to less than 50 per cent in 1990 and 25 per cent in 1970.

   The significant renewed interest in services trade is exemplified by the topic addressed in the 2019 World Trade Organization (WTO) report: the report issued in October 2019 is titled "The future of services trade" (WTO, 2019). The main objective of this report is to help the international community, in particular the trade community better understand the issue of trade in services (as part of global trade). In that respect, it has provided a detailed analysis on today's landscape of trade in services, and has also considered how services trade might evolve in the coming years, particularly as new technologies make some services increasingly tradeable (see WTO, 2019: page 4). Among the key messages conveyed by the report are: the fact that services trade has become the most dynamic component of international trade and will continue to expand in the coming decades, in particular in the context of enhanced cooperation; trade in services ranging from distribution to financial services can contribute to boosting economic growth, enhancing firms' competitiveness and inclusiveness; the share of services in global trade would likely rise by 50 per cent by 2040, thanks to lower trade costs, increasing digitalization that would reduce the need for face-to- face interaction, and lower barriers to services trade; and finally that developing countries (3) could particularly experience a rise in their world trade in services share by about 15 per cent by 2040 if they adopted digital technologies.

   The role of services for economic growth, poverty reduction and development is also exemplified by its increasing role in global and regional value chains as intermediate inputs to manufacturing (phenomenon known as 'servicification' whereby the development of manufacturing activities and competitiveness is increasingly depending on services) (e.g., Adlung, 2007; Balchin et al., 2016; Baldwin et al. 2015; Bas, 2014; Daude and de la Maisonneuve, 2018; Fiorini, and Hoekman, 2018; Francois and Hoekman, 2010; Heuser and Mattoo, 2017; Hoekman, 2017; Hoekman and Shepherd, 2017; Hoekman and Mattoo, 2008; Lanz and Maurer, 2015; Lodefalk, 2012; 2013; 2014; McGuire, 2002; Su et al., 2019; WTO, 2019).

   The few existing studies on the effect of trade in services on economic growth have reported a positive effect on economic growth (4) on services exports (e.g., Alege and Ogundipe, 2015; Dash and Parida, 2013; El Khoury and Savvides, 2006; Gabrielle, 2004; 2006; Hoekman and Mattoo, 2008; Lorde et al. 2011; Thomas, 2019). Other studies on the relationship between services exports and economic growth have rather looked at the effect of services export sophistication on economic growth (Anand et al., 2012; Mishra et al., 2011; Stojkoski et al., 2016). These studies are close in spirit to the topic on the impact of services export diversification on economic growth. Anand et al. (2012) have examined empirically both the determinants and growth impact of services sophistication as well as goods sophistication. As far as services exports are concerned, the authors have shown empirically the importance of modern services, and the sophistication of service exports for economic growth in countries, notably developing countries (and low-income countries among them). Mishra et al. (2011) have found empirical evidence that services export sophistication is positively associated with economic growth, and consequently suggested that growth in services exports and services export sophistication may be alternative ways for spurring economic growth in the context where there exist some limits of the traditional industrialization to ignite global growth. Stojkoski et al. (2016) have obtained a positive effect of growth in service exports, and services export sophistication on economic growth. They have concluded that both services exports and services export sophistication represent an additional avenue for economic growth in both developing and developed countries.

   To the best of our knowledge, there is no published study on the economic growth effect of services export diversification. The current article aims to fill this void in the literature by investigating how services export diversification affects economic growth. The analysis has used a set of 131 countries, including both developed and developing countries over the period 1985-2014, and shown that services export diversification promotes economic growth in developing countries, whereas in high-income countries, it is rather services export concentration (specialization) that fosters economic growth. Additionally, services export diversification always promotes economic growth when countries experience an increase in the services export growth. Finally, countries with a low degree of trade openness experience higher economic growth if they diversify their services export items, whereas countries with a high degree of trade openness benefit from higher economic growth by enhancing their services export specialization.

   The rest of the article contains five sections. Section 2 elaborates on how services export diversification (or concentration) could affect economic growth. Section 3 presents the model specification and the econometric methodology that helps address empirically the issue at hand. Section 4 discusses empirical results, and Section 5 provides a robustness check analysis. Section 6 concludes.

2. Literature review and theoretical discussion

   In this section, we discuss how services export diversification (or specialization) could affect economic growth. Thus, in the first sub-section (sub-section 1), we first provide a brief literature review on the importance of services activities for economic growth. In sub-section 2, we then discuss how services export diversification (or concentration) can affect economic growth.

   2.1. How are services activities linked with economic growth?

   According to the economic theory, the quantity and productivity of capital and labour inputs are critical for aggregate economic growth, with technological progress playing an essential role in promoting long-run (steady) economic growth. In contrast, little attention has been paid by the growth theory to the role of services activities, except from the work by Goldsmith (1969) who has shown that financial services contribute to enhancing output and incomes growth by helping to channel investment funds towards their most productive uses. Other studies (e.g., Bernier and Plouffe, 2019; Levine, 1992; Marchiori and Pierrard, 2017; Wilson and Smith, 1996; Zhu et al., 2020) have demonstrated that financial services can affect economic growth through enhanced capital accumulation and/or technical innovation. Several other works have emphasized the role of other services activities in spurring economic growth. For example, Li et al. (2003) have noted the important role of services trade in technological diffusion, given the knowledge intensive feature of services sectors such as financial services, computing and information processing, or management consultancy. Mattoo et al. (2006) and Hoekman and Mattoo (2008) have argued that low cost and high-quality telecommunications generate economy-wide benefits, because communication networks allow channelling information services and other digitizable products, including through the Internet. The benefits of transport services, especially for economic growth has also been highlighted in the literature (e.g., Hoekman and Mattoo, 2008; Li et al. 2003). For example, transport services facilitate the efficient distribution of goods, and the movement of workers within and between countries. Likewise, business services (e.g., accounting, engineering, consulting services and legal services) help to reduce the transaction costs related to the operation of financial markets, and ensure the respect of contracts. As a result, they act as a crucial conduit of business process innovations across firms in an industry or across industries (see Hoekman and Mattoo, 2008). Along the same lines, software development is the backbone of the information-based economy (see Li et al., 2003). Finally, firms' competitiveness in the domestic and international markets can be significantly improved thanks to the margins that apply to the provision of retail and wholesale distribution of services.

   Above these potential effects of services activities on economic growth, many services (including as inputs into production) could also exert a powerful effect on economic growth (e.g., Baldwin et al., 2015; Bas, 2014; Daude and de la Maisonneuve, 2018; Heuser and Mattoo, 2017; Hoekman and Mattoo, 2008; Hoekman and Shepherd, 2017; Lanz and Maurer, 2015; Li et al. 2003; Lodefalk, 2012; 2013; 2014; Su et al., 2019; WTO, 2019). Hoekman and Mattoo (2008) have underlined two aspects of the "input into production" role of services: the first aspect relates to the fact that services help to ease...