China’s Service Sector Challenge

Barry Eichengreen has an excellent column on the difficulties China will likely face transitioning into a more service-oriented economy. He notes that the precedent from other rapidly developing Asian nations like Korea and Japan is not inspiring in this regard:

In both Korea and Japan, to cite two key examples, the problem is not simply that productivity in services has grown barely a quarter as fast as it has in manufacturing for a decade. It is that service-sector productivity growth has run at barely half the rate of the United States. […]

In both Korea and Japan, large firms’ entry into the service sector is impeded by restrictive regulation, for which small producers are an influential lobby. Regulation prevents wholesalers from branching downstream into retailing, and vice versa. Foreign firms that are carriers of innovative organizational knowledge and technology are barred from coming in. Accountants, architects, attorneys, and engineers all then jump on the bandwagon, using restrictive licensing requirements to limit supply, competition, and foreign entry.

Of course the mere fact that China is “Asian” doesn’t mean China has to follow this path. Indeed, one can only hope that they won’t. This is also a reminder that the world’s long-term economic fortunes would be drastically improved if Korean and (especially) Japan would rethink their positions in this regard. In the short term, these restrictions look to be cushioning Japanese employment. But if foreign firm with better techniques came in and delivered the same quantity of services with fewer personnel, then in the long-run Japan could switch people out of its low-productivity service sector and add many more people to its high-productivity manufacturing sector. That way lies more overall production and more overall income. And the foreign firms doing more business in Japan would mean that foreigners can afford more Japanese exports.