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Hilal English

The Services Economy: An Engine of Structural Transformation, Inclusive Growth, and Exports

February 2023

Despite quickly outpacing the agricultural and nonagricultural sectors in terms of GDP, the services sector of Pakistan focuses majorly on domestic consumption. Tradable export-based services can go a long way in earning foreign exchange and ease foreign debt, while reducing the trade deficit.

Pakistan’s economy is currently suffering from deindustrialization, while the services sector has emerged as the largest component of gross domestic product (GDP). The services sector has become a driving force for the economy. Its recent average annual growth rate is over 6% and contributes 61.40% to the GDP and 30% in tax revenue.
Services provide 37.3% of the total employment. The participation of women in services jobs was 17.32% in 2020-21. Services-related policies are therefore relevant for inclusive employment, especially as other sectors are laying off workers.
Pakistan is ranked at 61st place in the world for services exports, with the exports of about $5.9 billion. Collectively, the export of services accounts for 19% of total exports of goods and services. Between 2008-2021, the share of services in exports of goods and services rose from 15% to 19%. During this period, services exports grew faster (3.96%) than merchandise exports (1.76%). Leading exports of services are: information and communications technology (ICT), government services (including embassies, and military, etc.) followed by transport and travel and other business services.
Services are also prevalent in foreign direct investment (FDI). The services sector received 44% of FDI in FY2022. FDI in services has grown faster than in the manufacturing sector.
The rapid expansion of the middle class, an outcome of yesteryears' economic growth, and the rising inflow of remittances have fueled the demand for education, healthcare, financial, and other private services.

Pakistan is ranked at 61st place in the world for services exports, with exports of about $5.9 billion. Collectively, the export of services accounts for 19% of total exports of goods and services. Between 2008-2021, the share of services in the exports of goods and services rose from 15% to 19%. 

Wide-ranging synergies between services and other sectors imply that services' development can improve productivity throughout the economy. Synergies are particularly prominent in services such as finance, ICT, and professional business services. Considering the growing trade in services, an outcome of technological progress, promoting services industries will increase gains from trade in services. Developing the services sector can thus yield far-reaching benefits for the economy.

Pakistan Army also plays a significant role in the services sector economy of the country. The army provides a wide range of services to the civilian population, including education, healthcare, and infrastructure development.

Despite the vast latent potential, Pakistan's services sector suffers from very low productivity levels in general. This is mainly because it remains trapped in traditional and low-productivity activities. A shift towards modern services that possess higher productivity and offer better wages will transform the services sector into a dynamic engine of inclusive growth and structural transformation. Such a shift would require overcoming impediments faced by the sector.
Pakistan Army also plays a significant role in the services sector economy of the country. The army provides a wide range of services to the civilian population, including education, healthcare, and infrastructure development.
The army runs a number of educational institutions, such as military schools and colleges, which provide quality education to the students. Pakistan Armed Forces’ educational setups are not only imparting quality and modern education, but are also contributing immensely to the national cause by educating 759,426 students up to the Higher Secondary School Certificate (HSSC) level (2 percent of the 39.58 million student population) and 71,411 students of higher education level (3.25 percent of 2.18 million student population).
Additionally, the army also runs hospitals and medical clinics, which provide healthcare services to the population. Approximately, 16,000 civilian patients are treated annually at the Combined Military Hospitals (CMHs) across the country. Pakistan Army Medical Corps contributes in the shape of provision of state-of-the-art medical facilities to the people of Pakistan through specialized institutes like Armed Forces Institute of Ophthalmology (AFIO) (corneal transplants), Armed Forces Institute of Urology (AFIU) (renal transplants), and Armed Forces Institute of Cardiology (AFIC) (transcatheter aortic valve replacement), etc.

Pakistan has experienced many phases of structural transformation—agriculture initially gave way to manufacturing industries, and now services have taken the lead as resources are moving towards it—and the services sector is expected to play a bigger role in the near term.

Pakistan Army Medical Corps has always remained the largest contributor to peace since 1960 and provided medical services in Somalia, Bosnia, Sierra Leone, Liberia, Sudan, Congo and Mali. Fauji Foundation (FF) has 74 health facilities countrywide, treating over 2 million patients annually, including 0.4 million non-military persons.
The army is also involved in infrastructure development, such as building and maintaining roads, bridges, and dams. These infrastructure projects not only benefit the local population, but also stimulate economic growth by connecting remote areas to the rest of the country and facilitating the movement of goods and people.
Pakistan Army also runs a number of commercial ventures, such as FF, which operates businesses in diverse sectors including fertilizers, cement, and food products, providing employment opportunities and contributing to the economy as well.

Services add value to production and exports in all sectors, including agriculture and manufacturing. Indirectly, services provide more than their direct contributions in production and exports. 

To supplement the national economy, the Army has made significant contributions through defense productions. According to Ministry of Defense Production (MoDP), in the last five years, approximately Rs. 60 billion exports were achieved. In the year 2019 alone, Army’s defense production was able to secure the export of JF-17 to Nigeria for USD 184 million, while exporting 12 Mushshaks to Iraq worth USD 33.33 million. In terms of taxes, MoDP contributed Rs. 6 billion to the national exchequer.
The Need to Strengthen the Services Sector
Relative to manufactured goods, services tend to be less tradable and more inclined toward domestic consumption. Developing the services sector tantamounts to strengthening domestic demand, as services account for a large proportion of consumption. Development of the services sector is thus the supply-side response for rebalancing the equation.
As the manufacturing engine is stalling, igniting the services' engine can help offset the loss of thrust in inclusive growth and job creation. This would require a rebalancing of the economy by promoting modern exportable services. Low productivity in the services sector retards the overall economic growth. The growth of trade in services and the resulting emergence of global value chains presents new growth opportunities for the manufacturing industries to integrate with the global supply chain.
All of the above are necessary conditions to strengthen the services sector to play a proactive role to transform the economy, leading to an inclusive growth and higher exports.
Services-led Structural Transformation
Pakistan has experienced many phases of structural transformation—agriculture initially gave way to manufacturing industries, and now services have taken the lead as resources are moving towards it—and the services sector is expected to play a bigger role in the near term.
The contribution of services to the economy is significant as the sector provides intermediate inputs for all economic activities. Such linkages facilitate production and exports throughout productive processes including quality control and engineering services as well as in the establishment, pre and post-production, and after-sales stages. Services are also important in coordinating production processes. 
Services add value to production and exports in all sectors, including agriculture and manufacturing. Indirectly, services provide more than their direct contributions in production and exports. According to an international study, the share of direct services exports in total goods and services exports is 14% for the developing economies. However, services (indirectly) represents 32% of value-added in total exports for these economies.
By supporting productive and export capacity, services sector as a supplier industry can change the average cost and hence the prices in the sectors to whom they contribute, while impacting production, investment, employment, trade, and consumption decisions related to those sectors. This creates services-led structural transformation, whereby some sectors become more important than others by merely building on competitive services inputs. Such structural changes may be particularly beneficial if they favor sectors that tend to have higher productivity, are more technologically intensive, or have greater potential to upgrade, thus leading to a services-led inclusive growth. 
So, services should not be regarded as an alternative to industrialization, but as part of a transformative strategy for all sectors. Successful global experiences show that structural changes from low to high-productivity sectors, leading to growth, have been supported by closer linkages between internationally competitive services and other sectors of the economy. 
The services sector plays a greater supporting role in accelerating structural transformation in countries that have a dynamic manufacturing industry with fast productivity and income growth. For example, about one-third of aggregate productivity growth in Vietnam is associated with performance in the services sector.
Income and Revenue Generation
Labor productivity is low in Pakistan due to the abundance of low-skilled workers, who earn low wages compared to countries where they are scarce. Companies producing innovative and differentiated products earn a high income, which is rare in Pakistan, thus causing low income. 
The services sector mainly produces non-tradable products. Because labor is cheaper in Pakistan compared to advanced countries; therefore, it intensively uses labor in the production of non-tradable services; consequently, services are cheaper in Pakistan than in advanced countries. The dilemma is that despite their low cost of production, the share of services in total exports remains low. Thus, the policy challenge is to transform services into exportable products by improving their quality competitiveness, and to increase the much-needed foreign exchange. It will also substitute services' imports based on enhanced productivity and efficiency to bridge the trade gap. 
Pakistan has attracted FDI in telecommunications, financial, and other services. FDI is a reliable source to link domestic firms with global value chains. However, FDI remains low compared with the vast potential offered by Pakistan. Tradable services can become a major source of foreign earnings by attracting FDI.
Way Forward
In a study by the World Bank, the risk of global recession has increased manyfold. The rising inflation coupled with interest rate hikes would result in lasting financial crises and harm to the developing economies. The supply disruptions and labor-market pressures must be subsided in order to keep the interest rates low, hence easing the pressure on the global monetary policies. The estimates of mere 0.5 GDP growth rate with 0.4 percent contraction in per-capita terms would certainly be a recession. For Pakistan to ensure it counters the negative outcomes of recession proactively, it needs to ease labor-market constraints, boost global supply of commodities with regional partners and strengthen global trade networks.
The policy challenge is to remove barriers to improve productivity and develop modern services by:
▪ Pursuing a balanced growth strategy to capitalize on the growth-inducing and catalytic role of services.
▪ Easing the excessive regulations that dampen competition and innovation. In this context, introducing strong institutions to create an enabling environment for the services economy.
▪ Capacity-building of professionals and Research and Development (R&D) institutions to produce high-end exportable services to increase workers' earnings.
▪ Removing domestic market frictions and distortions to attract FDI in the services sector.
▪ Encouraging greater women's employability in the services sector.

The writer is a Professor of Economics at the School of Social Sciences and Humanities at NUST, Islamabad. 
E-mail: [email protected].

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