China's service sector - composition, not size, matters

Based on the service sector’s share of GDP, China ranks 32 out of 42 upper-middle income economies and is likely to grow 7.4 per cent year-on-year in 2019, representing 52.6 per cent of real GDP.

" There is a point beyond which increases in the service sector’s share of GDP become less effective in boosting growth and productivity.”

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Mere expansion of the sector does not, however, guarantee sustainable growth and economic stability in the long term.

A closer look shows financial services (14.7 per cent) and real estate (12.7 per cent) make up relatively large portions of China’s service sector. These sectors are both highly leveraged and pro-cyclical, implying heightened sensitivity to the business cycle.

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That does not bode well for stable growth.

There is a point beyond which increases in the service sector’s share of GDP become less effective in boosting growth and productivity. In ANZ Research’s view, the composition of China’s service sector has to be altered to achieve more stable economic growth.

A plausible approach could be the development of high value-add services such as professional and commercial services as well as information and technology – parts of the ‘new economy’ industry.

Accounting for 12.1 per cent of service GDP in 2018, these industries are less financially leveraged and thus more acyclical. To boost growth, future reforms should focus on removing entry barriers, reducing state ownership and building the innovative capacity of these industries.

China’s service sector expanded rapidly in the 1990s but the pace of growth slowed in the 2000s as the manufacturing industry took centre stage.

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When China’s per capita GDP entered the upper-middle income bracket in 2008-09, expansion picked up again. The Chinese government accorded strategic importance to the service sector in its 12th Five Year Plan in 2011. However, despite the policy push, the sector’s real GDP expanded by 6.7 per cent (compound annual growth rate) over 2012–18, lower than the 9.8 per cent CAGR between 2005 and 2011.

As the external outlook for China sours – dampening the manufacturing and mining sectors – the government is keen to spur domestic demand.

This bodes well for the service sector.

Raymond Yeung is Chief Economist Greater China & Kanika Bhatnagar is Economist at ANZ