Why should we care about services?

Some time ago we learned that the contribution of the services sector to GDP was associated with the stage of economic development, which is a result, among other factors, of the process of economic transformation, urbanization and income growth. But some time has passed and services have become prevalent even in poor economies. We learned then that mattered not only the contribution but also the structure and composition of the services sector. And this should be so, because the already high heterogeneity of the sector has continued to increase. After all, they range from simple, personal services like hairdressing to sophisticated services like R&D.

We have also learned that more advanced economies have a higher share of B2B services, or companies operating with companies, while less advanced economies show a higher number of B2C services, or businesses that cater end-consumers. And we also learned that the composition of B2B services also mattered because of the different uses and functions of those services. One of these sets of functions covers conventional production and distribution support services such as transportation, security, and retail. Another set covers product differentiation and value-added services, such as R&D, branding and design.

We have also learned that the profile of services offered has an impact on the competitive advantages and aggregate productivity of the economy. This is because different service activities have a significantly different productivity: In general, B2C services have lower productivity than B2B, and among them, conventional services have lower productivity than product differentiation and value-added services.

Therefore, when we think about the contribution of services to economic growth, we can conclude that services alone come up short in boosting efficiency of current production. We also need to improve efficiency or offer services with greater impact on the competitiveness of other sectors.

Given Latin America’s needs for greater economic growth and greater competitiveness and productivity, how does the region rank on the services agenda? To answer this question, we use OECD data (2015 input-output matrices) to compare the United States, which has the largest, most sophisticated services sector, with the three largest economies in the region, Argentina, Brazil and Mexico (ABM), which together account for approximately two-thirds of GDP and the regional population.

Data show that services accounted for 79% of U.S. GDP while in ABM, it accounted for 64%, not much lower than Germany and Japan, with 69%. Although the share of B2B services in GDP was much higher in the United States, the composition differs: In the U.S., 53% of B2B services were conventional services and 47% were product differentiation services; in ABM, these were 70% and 30%, respectively, a considerable difference.

This situation reflects, at least in part, differences in the production structure and supply and demand profiles of services. In fact, the U.S. manufacturing industry demanded substantially more services for its production chains than in ABM. But the differences did not stop there: U.S. industry demanded relatively more product differentiation services, while ABM demanded relatively more conventional services, which is a reflection of the different stages of technological and managerial development in the two regions.

A similar picture was observed in agriculture. In the United States, this industry demanded more services than ABM and, in particular, relatively more sophisticated services, while ABM agriculture required relatively more conventional services. In mining, ABM demand showed some parity with that of the United States, strongly influenced by Brazil’s indicators.

Food, hospitality, retail and transportation services are among the least productive segments. The problem is that they have almost twice the share of ABM’s GDP as in the U.S., which helps explain the huge productivity gap between regions. Although these services are largely provided by micro, small and medium-sized enterprises, in Latin America the share of these companies is disproportionately high and involves many informal companies, which also helps explain the difference in productivity between regions.

It seems reasonable to consider that, given its size and systemic implications, the services sector should receive greater attention from the region’s sectoral policies. But despite the challenges, there are positive changes in the pattern of Latin American services. First, the industry has incorporated digital technologies and new management technologies. Second, startups and other innovative initiatives are identifying market failures in industries as diverse and important as freight transport, the credit market and data services, and are helping increase the supply of new and better services, boosting competitiveness of the entire economy.  

The region will benefit from sector-based policies articulated across the services sector and industry, agriculture and mining. It will also capitalize on policies that help scale innovative service initiatives, attract new businesses, increase competition, improve professional skills, foster regulatory and institutional framework, develop technologies and improve access to credit.