Shifting Gears: The Promise of Services-Led Development. By: Valerie Mercer-Blackman There are rapid changes occurring as we emerge from the pandemic. Virtual services and digital technologies not only are here to stay, but innovation in these areas has accelerated in ways that we do not yet understand. In the latest South Asia Economic Focus, we argue that this seismic shift in economic transformation due to the pandemic could provide a fantastic opportunity for South Asia. In parallel, economists’ views about the contribution of services to value added are changing amid improved data and measurement techniques. Until recently, the assumption was that most services could never expand because face-to-face encounters were required to consume the service (think haircuts). That is why services were synonymous with so-called ‘non-tradables’. A 2020 thought-piece by Richard Baldwin and Rikard Forslid argues that with digital technologies and globalization, the opposite is happening: services are becoming much more tradable internationally due to telecommuting, 5G, etc.; and manufacturing goods less tradable due to 3-D printing and customization needs. If we believe this hypothesis, it means services-led development may be the only development path possible in the future. What does this mean for South Asia, which is already a major service exporter? We first establish the types of conditions required for services-led development to be feasible, shadowing the elements that made most high-income countries of today successful via the manufacturing-led growth path. We do this by looking at three attributes that have to be present in the production process for an economy to develop: international tradability of its main products, ability to increase productivity, and appropriate skills development. • Tradability: As mentioned, the argument in the past was that goods were tradable and uniform so they could be easily mass-produced and exported. Language barriers were not an issue. However, remote work and digital technologies have broken down communication barriers globally, so this physical presence requirement no longer holds for most high-value services. They have become tradable. Moreover, many services are exported indirectly because they are embodied or bundled in goods. • Productivity and scale: Advocates also noted that factory production requires a well-organized executive structure, unlike the “disorganized� informal sector which tends to provide services in South Asia. But digital platforms automatically provide structure, access to the market and to related logistics at low cost, while providing workers more flexibility in terms of where and when they do their job. In manufacturing, economies of scale are easily acquired through investment in physical capital. But network externalities in digital technologies and infinite divisibility in services supply provide economies of scale and scope with less investment. For example, an e-commerce platform will be more successful the greater the number of buyers and sellers. • Skills requirements: The labor and skills requirements of the two development paths are quite different. Manufacturing had the ability to absorb large amounts of low-skilled labor and provide stable jobs that through time could raise incomes. In the new service economy, human capital accumulation, business networks and skills acquisition matter much more. That does not mean that everyone requires a high-level university degree to get started in a services-led economy. It means that a successful economy will have much more opportunities for workers to learn on the job. For example, a young person may teach themselves to become an amazing web-page designer, and this may be a more sought-after skill than a mechanical engineer who built exhaust engines. This is all great, but these phenomena are very difficult to measure because services tend to be embodied in goods. Our report looked at a myriad of factors using different techniques: text-mining, location- matching of firms, identification of the global ultimate owner of production units, and measurement of inter-sectorial linkages using multiregional input-output tables. We designed and analyzed surveys of e- commerce adopters in India and Bangladesh. Finally, we derived changes in occupations of South Asians to understand what jobs they perform, how those jobs changed in the last 10 years, and whether—in the process—average skills improved. Through these analyses, the trend that emerged is that South Asia is steeped in services activities and very much embarked on a path of services-led development. Some of it we knew about. The Oxford Internet Institute’s iLabour Project estimated that the number of online gig workers in software development services who completed projects on the five largest English-language labor platforms increased fourfold between June 2017 and October 2020, and about half of all such freelancers were based in India, Bangladesh, and Pakistan. But we found new evidence that the region is embracing digital platforms including home-grown ones. Firms and individuals adopting e-commerce saw a significant improvement in their business income, tending to innovate and improve their business practices as a result. More importantly, South Asian workers are increasingly moving into service occupations, even those that are mapped to the manufacturing sector, particularly high-skilled service occupations. In the process, the labor force as a whole has seen an upgrading of skills due to on-the-job learning. The message overall for policy makers in South Asia is to turn their attention to the new realities in the services sectors, as the tendency has been to implicitly support manufacturing activities. One of the main results is that India and the four countries that are major tourism exporters—Maldives, Sri Lanka, Nepal, and Bhutan--have an important comparative advantage globally exporting services. What about others? Some may say that Bangladesh, and to some extent Pakistan have seen substantial growth in the past few decades precisely because they pursued a successful manufacturing-led model through exports of textiles and garments. So why shift gears? It turns out that it is much harder to move from a middle-income status to high-income status if a critical mass of home-grown skills is lacking, and these seem to be easier to nurture in occupations such as business services, not in fabrication. Therefore, Bangladesh and Pakistan do not have to abandon the know-how they have created in developing those industries, but instead use them to develop related services.