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The Great Services Illusion

In the wake of COVID-19, some economists are calling for developing countries to shift from industrialization to services, or even to bypass the manufacturing stage of development altogether. But blind faith in services-led growth is a dangerous illusion, and the arguments supporting it are deeply flawed.

CAMBRIDGE – As the world prepares for the post-pandemic era, the quest for sustainable economic growth is becoming ever more intense – especially for developing countries. It is tempting to call for these countries – the main engine of global growth in recent decades – to shift their development strategies from industrialization to services. As new technologies increasingly allow services to be produced and traded just like goods, some economists even suggest that low-income economies should skip the manufacturing stage of development altogether and go directly from traditional agriculture to the new “growth escalator” of services.

The belief that services represent the new holy grail for developing countries stems in part from empirical studies showing that trade in services has increased faster than trade in manufactured goods since 2000, and in particular since 2011. The disruption of global value chains caused by COVID-19 has only reinforced this belief.

Moreover, new technologies such as 5G networks and cloud computing are fragmenting service processes and opening up new possibilities to outsource high-wage and costly activities. These trends are driving a so-called “third unbundling,” whereby some previously non-tradable services become tradable. With the world’s largest economies engaged in tariff wars and global trade declining sharply, many regard services as the most appropriate growth and employment engine, because they can be digitized and are less susceptible to customs and other logistical barriers.

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