Anand’s comment in response to a past posting prompts this one. He wrote:

The fact that manufacturing accounts for such a small percentage of India’s GDP is not a minus but a plus. All the industrialized nations have seen manufacturing as a percentage of GDP shrink.

There is much misunderstanding about the process of development and it may be worthwhile to start thinking about development. (What follows is partly from another article I had written some time ago.)

Countries, especially large countries such as the US and India, follow a very predictable development path: from agriculture, to manufacturing, to service, and finally to information technology. Large countries cannot jump any of these intermediate stages any more than an elephant can leap across a creek. Small countries are more nimble on their feet and can skip across sometimes.

So India with 70% of its population in rural areas (largely agricultural) cannot become an information technology superpower however pretty a song you sing about the internet and the world wide web. India has to have a nuts-and-bolt manufacturing base which can only exist if labor moves from agriculture to industry. Then with increased productivity of manufacturing, incomes rise and therefore consumption of services rise relative to basic consumption and so the economy moves to a service economy.

Why do countries have to go through the manufacturing stage before getting to the service economy?

Consider a large economy such as the US. Without going into the numbers, we can safely say that international trade forms a very small part of it, something of the order of single-digit percentage points. That means that most of what the economy consumes is produced within the economy— agricultural, manufactures, services—nearly all of it is domestically produced and consumed.

Any large economy when it starts off on its developmental trajectory, it is largely agricultural. Say 80% of the labor force is engaged in producing food and only 20% in manufacture and services. (It helps to consider the whole world as a large economy.)

This economy has little surplus food and therefore can only support a small service sector. Services, after all, are a sort of a luxury good. When you are poor, you don’t get fancy haircuts, don’t go to too many concerts, you don’t produce too many plays, or write too many novels, or consume too much education and art.

As agricultural productivity increases, labor moves to produce manufactures that go to increase the quality of life, which in turn produces capital goods that are invested that further increase agricultural productivity which in turn leaves more labor free to produce investment goods.

A virtuous cycle begins.

The investment in capital goods makes manufacturing more productive. Eventually you have something like 2% of the labor producing food, about 20% producing manufactures, and the rest providing services. Afterall, if 2% of the population can produce food for the rest, and if only 20% of the labor produce all the manufactures due to automation, then the rest have to produce concerts, novels, movies, provide dentistry, education, insurance, banking, and pornography.

A modern efficient large economy is a service economy only because it is also a very efficient agricultural and manufacturing economy too. Its sustainability derives from the productivity of the two older activities.

(To be continued in Part 2)