The service sector employs the majority of workers worldwide and surpassed agriculture as the largest employment sector in low- and middle-income countries in 2012. Recent work has documented growing service productivity in low-income settings, including in labour-absorbing consumer services. It remains unclear what drives these productivity increases. But there are striking differences in the composition of consumer services for countries at different income levels. The service landscape in developing countries is dominated by traditional micro-entrepreneurs like street vendors and food hawkers. In mature economies, these micro-scale service providers are almost entirely absent; instead, the same service needs are met by modern supermarkets and restaurants. Why does the traditional service economy disappear with development, and how does the shift to modern services contribute to growth of productivity and welfare?
This project uses data from Brazil and a new model to show that the transition to modern services is a powerful source of productivity growth. The study draws on three main sources of data: panel data on workers, consumer expenditure data, and Census data on the allocation of employment and earnings in services for every microregion of Brazil in 1991, 2000, and 2010. There are two key empirically motivated elements of the model. First, consumer demand for services is subject to income effects: they demand more modern services as their incomes rise. Second, the labour market is imperfectly competitive, so that some workers remain self-employed in traditional services even though they would be more productive in the modern sector. When these workers move into modern service jobs, they generate gains to aggregate income. The study uses the model to understand how labour market imperfections and local economic development drive the shift to modern services, and what the aggregate benefits from this shift are.
The project makes two central policy-relevant insights. First, imperfections in the labour market have repercussions for the organisation of the product market: workers who struggle to find wage work become traditional service entrepreneurs instead, which creates drag on modern services. It therefore brings a new perspective to the impact of labour market policies such as regulations or job search assistance. Second, local economic development in sectors outside of services can still cause growth in the service sector. For example, improvements in the production or export of tradable goods increase local income and therefore shift demand towards the more productive modern service sector. This generates add-on growth in the service sector, amplifying the effects of any local policy. It therefore documents a new potential benefit of trade and industrial policies: they have a strong impact on the service sector’s composition and productivity through the consumer demand channel.
