Attributable to Services Inputs

Embodied Services: “Upstream” Enabler

Services Embodied in Exports of Manufactured Goods In 2015, about one-third of the value of gross manufactures’ exports among OECD countries was attributable to the value added of embodied services, with distribution and business services making the largest contributions. The corresponding share for low- and middle-income economies was about 29 percent (figure 4.15). The aggregate services value added in exports of manufactured goods for high-income economies remained largely unchanged between 2005 and 2015, but it increased in Asia, particularly because of the higher domestic services content in China’s manufactures’ exports (WTO 2019).

These estimates of services value added embodied in manufactures’ exports, based on arm’s-length transactions, is a lower bound for the servicification of manufacturing since these services are often produced “in house” by exporting companies (Low 2013). Using a combination of labor force surveys and the OECD-WTO Trade in ValueAdded (TiVA) database, Miroudot and Cadestin (2017) estimate for a sample of

FIGURE 4.15 About One-Third of the Value of Gross Manufactures’ Exports Is Attributable to Services Inputs

Services value added in exports of manufactured goods, OECD and non-OECD economies, by services subsector, 2015

0 2 4Share of services value added in manufactures' exports (%) 6 8 10 12 Professional, scientific,and technical Finance ICT Accommodation and food Transportation Wholesale and retail Arts and entertainment Real estate Education Health

Global innovators Low-skill tradables Low-skill domestic

OECD Non-OECD Skill-intensive social services

Source: Calculations based on the Trade in Value Added (TiVA) database of the Organisation for Economic Co-operation and Development (OECD). Note: “Non-OECD economies” include Argentina; Brazil; Brunei Darussalam; Bulgaria; Cambodia; China; Colombia; Costa Rica; Croatia; Cyprus; Hong Kong SAR, China; India; Indonesia; Kazakhstan; Malaysia; Malta; Morocco; Peru; the Philippines; Romania; the Russian Federation; Saudi Arabia; Singapore; South Africa; Taiwan, China; Thailand; Tunisia; and Vietnam. ICT = information and communication technology.

31 economies18 that the share of services value added in manufacturing exports increases from 37 percent to 53 percent when manufacturing firms’ “in-house” services activities are added.

How Services Boost Manufacturing Productivity A substantial body of evidence shows that the services “embodied” in manufactured goods have a significant impact on manufacturing productivity (Arnold et al. 2010; Arnold, Javorcik, and Mattoo 2011; Arnold, Mattoo, and Narciso 2008). This evidence spans a range of countries and relates mainly to the global innovator services and lowskill tradable services. A study of OECD countries, for example, finds that the density of telecommunications services makes them crucial inputs for the competitiveness of manufacturing (Nordås and Kim 2013). Similarly, access to financial services matters for manufacturing productivity, notably in LMICs (Bas and Causa 2013). In Colombia, the productivity of manufacturing firms increases with linkages to services firms (Alfaro and Eslava 2020). In Ethiopia, improvements in transportation services have enabled the time-sensitive cut flowers industry to flourish, increasing its exports from US$12 million in 2005 to US$662 million in 2014 (Hoekman and te Velde 2017).

Much of this productivity boost has been attributable to reforms that have liberalized upstream services. Firm-level data from the Czech Republic show a positive relationship between services sector liberalization and the performance of domestic firms in downstream manufacturing sectors (Arnold, Javorcik, and Mattoo 2011). Furthermore, liberalization in banking, insurance, telecommunications, and transportation services improved the productivity of manufacturing firms in India (Arnold et al. 2015). This result is reinforced by Bas (2014), who finds that the liberalization of telecommunications and transportation services in India resulted in a 6–8.5 percent increase in manufacturing firms’ probability of exporting. And increased openness to services trade has increased manufacturing productivity among OECD economies (Francois and Woerz 2008).

Greater trade openness that facilitates the import of key enabling services—mainly through foreign direct investment (FDI)—is a key channel through which services liberalization helps improve the manufacturing sector’s performance. For instance, FDI inflows (a proxy for foreign-owned firms’ establishment of “commercial presence”) in producer services enhanced the productivity of manufacturing firms in Chile (Fernandes and Paunov 2012). Similarly, Bas and Causa (2013) find that if the regulation of financial services in China were improved to the average level observed in OECD economies, the country’s manufacturing productivity would increase by 6.5 percent. In fact, imported financial services can compensate, at least in part, for an underdeveloped domestic financial services sector to boost manufacturing productivity and exports (Liu et al. 2018).

The impact of liberalization that facilitates the import of key enabling services in lower-income countries on downstream manufacturing productivity can be further enhanced through improvements in the quality of institutions and complementary domestic regulatory policies (Van der Marel 2016). This is especially important because most imported services used as inputs in manufacturing are located in the country of production—in other words, imported through the establishment of “commercial presence” in the destination market (Andrenelli et al. 2018). The importance of differences in institutional quality is reflected in Beverelli, Fiorini, and Hoekman (2017), which finds that an identical reduction in services trade restrictiveness in Canada and Tanzania would increase manufacturing productivity by 16.7 percent in Canada but by only 3.9 percent in Tanzania.

How Technological Change Strengthens the Servicification of Manufacturing The servicification of manufacturing will be further strengthened through “smart” production processes that transmit data through networks, machines, and computers connected to the internet (Hallward-Driemeier and Nayyar 2018). ICT services—such as custom computer programming services, software publisher services, telecommunications services, internet publishing, and data-processing services, including cloud computing—produce data for technology-intensive “smart” factories and share this information throughout the entire value chain.

At the same time, telecommunications, information services, and publishing services are also the most data-intensive users. Other services that are strong users of data include office support and business services, computer programming services, engineering services, advanced data analytics, advertising and market research, and R&D services. These services use real-time information through equipment logs, smart meters, or manufacturing sensors to optimize production processes (Dijcks 2013; Opresnik and Taisch 2015; Van der Marel 2021). ICT service sectors, as the predominant producers and users of data, can therefore play a crucial role in boosting manufacturing competitiveness through the Internet of Things (IoT).19

In fact, these increasing complementarities between services and production tasks (Grossman and Rossi-Hansberg 2008; Healey and Ilbery 1991) might influence location decisions in manufacturing GVCs. The possibility of reshoring production to where the professional services are located reflects the concern that separating production from R&D harms a firm’s long-term ability to innovate. This might be more relevant for research- and skill-intensive manufactures (such as pharmaceuticals, semiconductors, and microprocessors) with little labor-intensive assembly. For example, the manufacture of certain capital goods and advanced inputs (such as semiconductors, doped wafers for semiconductors, and fiberoptic cables) stayed in high-income economies during the twentieth-century ICT revolution, while the

assembly of high-tech goods such as laptops and mobile phones did move to low- and middle-income economies. Therefore, the production of advanced manufactured goods (such as wearable tech, autonomous vehicles, biochips and biosensors, and new materials) are most likely to colocate with R&D services facilities in highincome economies as they are being developed (Hallward-Driemeier and Nayyar 2018).

Embedded Services: “Downstream” Complement

The Bundling of Manufactured Goods and Services Services are increasingly bundled with (or added to) manufactured goods, thereby adding value postproduction (Vandermerwe and Rada 1988). This close interaction of “manufacturing” and “services” means that the boundaries between these sectors in the broader production process are becoming increasingly blurred, to such an extent that it is difficult to assign firms exclusively to one sector.

Examples abound: Xerox has restructured itself into a “document solution” company, offering not only technologically advanced printer systems but also postsales services like document managing and consulting, equipment maintenance, and financing that represented about 75 percent of Xerox’s total revenues in 2019 (Xerox 2020). Similarly, in 2012, these complementary postproduction services accounted for 15–20 percent of turnover in SSAB (steel producer), 20–30 percent in Volvo AB (automobiles), and 42 percent in Ericsson (telecommunication networks), and these firms expected their services shares in turnover to increase (National Board of Trade of Sweden 2012).20

Technological advancements are blurring these lines still further. For example, IBM has transformed itself from a producer of computer hardware to a service supplier of cloud computing and AI-enabled scientific and business modeling and customer services (McGregor 2019).

This bundling of manufactured goods and services is increasing among firms in LMICs too. In a new study on India, Grover and Mattoo (2021) find that the share of manufacturers offering services has increased threefold—from about 20 percent of manufacturing firms in 1994 to nearly 60 percent in 2013. At the same time, the intensity of this servicification has also tripled: the average share of services revenue in total revenue increased from 7 percent to 21 percent (figure 4.16).

Consistent with the trends in high-income countries, Grover and Mattoo (2021) find that firms in high-tech manufacturing industries are the most servitized in India. They also find that the diversification of manufacturing firms spans global innovator services as well as low-skill tradable services. For instance, the share of manufacturers offering financial and business services in India increased dramatically between 1994 and 2013, while a large share of servitized firms continue to offer retail and wholesale services.