Why India’s Structural Transformation Is Unusual

Thinkstock/fabio lamanna

India is a developing country in the midst of a structural transformation. However, its path has been somewhat different from a typical transformation.

In a recent Economic Synopses essay, St. Louis Fed Economist Paulina Restrepo-Echavarria and Manisha Goel, assistant professor of economics at Ponoma College, explained that a structural transformation describes how resources are reallocated among the agriculture, manufacturing and services sectors. In particular, this transformation occurs in two stages:

• First, labor moves out of agriculture into manufacturing and services.
• Second, labor moves out of both agriculture and manufacturing into services.

The U.S.’s Transformation

In the U.S., for example, the first stage began around 1870. The break from the first stage to the second stage occurred around 1970. These changes were accompanied by changes in the shares of gross domestic product (GDP):

• The agriculture share steadily declined over the period.
• The manufacturing and services shares stayed relatively constant until the 1960s, when manufacturing began to decline and services continued to increase.

India’s Transformation

Restrepo-Echavarria and Goel noted that trends in GDP shares for India suggest that the country is in the second stage of its structural transformation. Since 1970, the services share has increased dramatically to 53 percent, while the manufacturing share has grown only from 19 percent to 23 percent.

However, the manufacturing labor share has increased faster than the services labor share. (For a chart of this increase, see the essay, “India’s Atypical Structural Transformation.”) Restrepo-Echavarria and Goel wrote: “These findings imply that productivity in the services sector is remarkably higher than in the manufacturing sector and has sharply increased over the years.”

They gave two reasons why this pattern is puzzling:

• In principle, India’s manufacturing and services sectors both operate in similar economic and regulatory environments.
• India’s services sector is four times more productive than its manufacturing sector. For most other developed and developing countries, the services sector is twice as productive at most.

Restrepo-Echavarria and Goel summed up the potential reasons for the anomalies thusly: “While some studies attribute stagnant manufacturing in India to rigid labor laws and input quotas, others argue that rapid services growth is caused by increasing demand from manufacturing.”

The authors concluded: “We still do not have a comprehensive understanding, however, of why labor keeps moving into the manufacturing sector despite the already large and still widening productivity gap between the manufacturing and services sectors.”

Additional Resources

• Economic Synopses: India’s Atypical Structural Transformation
• On the Economy: Emerging Economies’ Vulnerability to Monetary Policy Changes
• On the Economy: Obstacles and Potential Opportunities for Economic Growth in India