The mention of services in polite conversation among economists is sometimes met with a glazed look of indifference. The mainstream view is that services are not very dynamic, that they mainly create poorly paid jobs, that they have little or no productivity growth and that they do not innovate. Banking, retailing, business services: these are not exactly the industries everyone is talking about, unlike software manufacturing or genetic technology. Yet, a closer look shows a different picture.
For a start, services have to be taken seriously as they now account for 60-70% of OECD economies. And far from lacking dynamism, several service sectors are noted for their rapid productivity growth, while many are highly innovative. Indeed, a growing proportion of business R&D is in service firms.
The main problem is that we still do not fully understand how the services sector works. Take innovation. In manufacturing, innovation implies that a firm introduces a new or improved product or a new production process. This could be a new micro-processor, or automated production equipment. New products and processes are of course not unknown in the services sector but innovation in services more often relates to changes in how, where and when a service is delivered. For instance, electronic banking is an innovative way to provide traditional banking services at home at any time. However, services innovation need not be linked to changes in technology. Fast-food chains, like McDonalds, have applied innovative techniques to boost customer turnover in their restaurants, notably by borrowing from just-in-time assembly line methods for serving food. And services firms also often make ad hoc innovations, such as a new solution to a specific financial or business problems.
These typical service innovations (changes in delivery, organisation or ad-hoc innovations) are often more difficult to identify than innovation in the manufacturing sector and it is only recently that new statistics have emerged to help us build a clearer picture. They show that many services are innovative and that services firms spend almost as much on innovation as manufacturing firms. Indeed, some services sectors are even more innovative than manufacturing; for example in 1997, 55% of all firms in knowledge-intensive services in France showed evidence of innovation, compared with 45% of manufacturing firms.
There is other evidence that services have become more innovative. For one thing, services R&D has risen from less than 5% of total business enterprise R&D in 1980 to more than 15% in 1995. In countries that measure services R&D well, such as Canada, it now amounts to about 30% of total business enterprise R&D.
Telecommunications, computer and software services, and specialised R&D service firms are the largest spenders on R&D. The services sector is also an important user of modern technology, and among the most important users of information and communications technologies (ICT). Financial services, education and telecommunications companies, in particular, make more intensive use of ICT than the average manufacturing firm.
Now in statistics
The impact of innovation is slowly starting to show in productivity statistics. In retailing, for instance, productivity has improved substantially due to the use of ICT, notably in areas such as bar-code scanning at the till and in inventory management. Productivity in telecommunications has risen at annual rates of up to 8% over the 1990s in Australia, Finland, Italy and Sweden. And productivity in transport has grown by rates between 2 and 3% annually over the 1990s in Australia, Finland, Italy and the Netherlands. But productivity growth has been sluggish in other services, partly because there is little scope for dynamic change. It is difficult, for instance, to improve productivity in the live performance of a piece of classical music or in hair-dressing.
It can also be difficult to measure productivity gains because of a lack of basic data, or disagreement on what certain services actually produce. The use of ICT in service delivery has made measurement more difficult too, as it has enabled the customisation of services, like banking services tailored to specific client needs.
But better measurement can reveal sharply better results. A recent study by the Bureau of Labor Statistics for the US banking industry, for instance, incorporated quality adjustments for the increased convenience of banking transactions, such as those linked to the use of automatic teller machines. It showed output growth of 7.4% a year between 1977 and 1994, well above the previous official measure of 1.3% a year. And banking is not the only sector for which official measures often hide some of the productivity gains.
The increased use of ICT is a key factor driving these changes. Many services process and diffuse information – financial services, communication and public administration are good examples. Advances in ICT allow more information to be codified, leading to quicker processing and diffusion. In addition, the scope for ICT use has expanded with new knowledge technologies, such as expert systems, that complement (or replace) the intelligence provided by human experts in areas ranging from repairing a car to more complex decision making. In transport and distribution, ICT can improve logistics and automate complex processes, while it is also increasingly used in health and social services. And in recent years, the Internet and the new possibilities offered by electronic commerce have given a further stimulus to ICT investment in the services sector. Innovation surveys show that ICT is a rucial dimension of service businesses; the five most important technologies mentioned by German service firms, for instance, are personal computers, office software, communication networks, data banks and specialised software.
ICT is also making it easier for firms to co-operate on innovation, to trade services electronically and to deliver them all over the world. Electronic commerce provides a fast and potentially more cost-effective way to connect firms, making existing business processes more efficient. Significant productivity gains are possible, especially in business-to-business relations, because electronic commerce is relatively cheap and can enable automation of relatively simple but universally needed processes, such as distribution, sales, after sales service and inventory management.
A second factor that has helped to change the services sector is deregulation. In the not too distant past, many services sectors were heavily regulated. Some, such as post, telecommunications and railways, were considered “natural” monopolies, implying that they had no scope for competition and that they had to be regulated to avoid abuse of the monopoly. In others, such as road transport, unrestricted competition was considered undesirable for social reasons. In many cases, these reasons for regulation have diminished in importance and many governments have moved to introduce more competition. There is growing evidence that regulatory reform is important for improving performance since, in the absence of competition, firms have little incentive to innovate and are less willing to adapt the quality and mix of goods and services to meet changing consumer needs.
Experience across the OECD area suggests that appropriate regulatory reform can work. For proof, one only has to look at improved performances in road and air transport, distribution services, telecommunications, professional and financial services. Further regulatory reform of the telecommunications industry is particularly important for many services, as it helps to lower the costs of ICT. This encourages investment in efficiency-enhancing ICT and can provide better and cheaper access to ICT services, such as high-capacity broadband communications, which can facilitate electronic commerce. In services for which the public sector remains the key provider – healthcare and education for instance – the scope for private provision has increased, with the market starting to play a greater role.
Access to the right skills is also important for innovation. Services are typically more labour-intensive than manufacturing firms, and some are highly knowledge-intensive (e.g. business services). Understanding what customers want and responding to their needs is particularly important, and relies heavily on the motivation and training of service workers.
So, services are not as inert as they might seem, and the distinction between the services and manufacturing sectors is becoming blurred. Indeed, the manufacturing sector is becoming more like services; a large part of the sales of major manufacturing firms such as Ford Motors, General Electric and Sony now consists of services that are bundled with the manufactured product, such as financing and after-sales facilities. And some services are becoming more like manufacturing, as ICT allows more automation and enables mass production. The character of innovation in both sectors has coalesced too. Nevertheless, much of the measurement, analysis and policy debate still focuses on the distinction between services and manufacturing, which suggests that understanding the differences remains helpful as the economy becomes more complex. END
Note: The OECD is currently organising a workshop with the Australian government on innovation and productivity in services. Further information is available on the Internet site of the Australian government.
• OECD, “Promoting Innovation and Growth in Services”, OECD Science, Technology and Industry Outlook 2000, Chapter 4, Paris 2000.
• OECD, “Employment in the Service Economy: A Reassessment”, OECD Employment Outlook 2000, Chapter 3, Paris 2000.
©OECD Observer No 223, October 2000