Industrial Development

Services and Development

We already saw in Section 2 that the share of economic activity devoted to services rises continuously with aggregate income. Several theories can explain this fact, including those based on income effects and relative price mechanisms. As consumers grow richer, they devote a growing share of consumption expenditures towards services rather than agricultural or manufactured goods (Kongsamut et al. 2001, Herrendorf et al. 2014, Boppart 2014, Comin et al. 2021, Fan et al. 2023). Agriculture and manufacturing experience faster productivity advances than services, so that as production in these sectors becomes more efficient, they ‘shed’ labour and other economic resources towards the service sector (Baumol 1967, Ngai and Pissarides 2007, Acemoglu and Guerrieri 2008). Other explanations include rising marketisation – services are only counted in economic statistics when they are provided by the market and not by household members (Ngai and Petrongolo 2017) – and the growth of specialised human capital, which is tailored towards service provision (Buera and Kaboski 2012).

All of these explanations imply that a maturing economy will see a rising service share, but it is not clear what the implications are for productivity growth. The pessimistic view, famously argued by Baumol (1967), is that a rising service share spells a productivity slowdown: it is hard to imagine the haircut industry advancing at the same rate as the automotive industry. But more recent work finds that the service sector can share several of the features that were long thought to make manufacturing an engine of growth. For example, many services are tradable across space, making them a potential export (Breinlich and Criscuolo 2011), and even non-tradable services can scale up production by replicating service processes across many locations (Hsieh and Rossi-Hansberg 2023). Some service industries make significant investments in R&D (Nayyar et al. 2021), and many of them, like IT, have strong sectoral linkages that can improve the productivity of other sectors (Manelici and Pantea 2021).

Much of the existing research on productivity in services has focused on high-income economies, because services were not thought to be a central sector up until later stages of the income ladder. But the trend towards premature deindustrialisation has placed a spotlight on services in lower-income economies. Whether or not this trend should be concerning to policymakers is an open question. Some analyses based on development accounting methods have measured significant growth in overall service productivity in India and China (Fan et al. 2023, Chen et al. 2023). These studies employ a macro-level approach that uses a model to infer changes in service productivity from sectoral employment shifts while accounting for some of the other explanations above, such as shifting consumer demand and rising productivity in agriculture and manufacturing. Essentially, the accounting approach argues that if service employment increased more than can be explained by reasonable estimates of productivity growth in agriculture and manufacturing, then this is a sign of rising service productivity. On the more cautious side, Rodrik and Sandhu (2025) argue for vigorous policy interventions to raise productivity in specific service industries and provide an overview of 20 such interventions. While many of the interventions were successful, not all of them were subject to formal evaluations from rigorous microeconometric techniques.

Our aim in the rest of this section is to summarise a broader set of research on productivity in services, most of which uses administrative microdata to assess the causes and consequences of growth in the service sector. A limitation of administrative data, however, is that it typically contains information only on the formal sector of the economy, while the service sector contains a large share of the informal economy. Research on these informal service providers must typically rely on survey data, which are typically not representative at fine geographical levels, especially outside of large urban areas.

Another challenge is that the service sector is broad and varied. Any activity that cannot be categorised as agriculture, resource extraction, or manufacturing is classified as a service - from cleaning to healthcare to banking. In this review, we divide our detailed discussion of the evidence into two broad service categories: production services, which share many characteristics with manufacturing despite their less tangible nature, and consumption services, which are less akin to manufacturing and make up the majority of the service sector in low- and middle-income economies. Within each category of services, we review the literature on three key lines of questioning: first, how demand for these services materialises; second, what we know about productivity growth; and third, the implication of growth in these service industries for the distribution of income in low- and middle- income economies.

Production (Business) Services

The demand for production services

What generates the demand for production services in the context of low- and middle-income countries? In contexts with a stagnant industrial sector, demand for business services might be low, but an increase in market access can trigger demand for upstream services. Avdiu et al. (2025) find that improvements in the road sector in Turkey allowing manufacturing firms to grow larger ended up in a higher demand for business services activities nearby. Similarly, Amodio et al. (2025a) show that an export boom in one specific industry (beef production in Uruguay) benefitted firms upstream, many of which offer business services (e.g. transportation, ICT, real estate).

Historically, some of the key industries in the services sector (e.g. financial or transportation) have been under state control and more restricted to (foreign) competition. Furthermore, higher barriers to trade in services are currently in place. According to the OECD Services Trade Restrictiveness Index (STRI), the average level of restriction of non-OECD countries is 1.5 times larger than the OECD countries. Early evidence on service liberalisation policies offer an ideal context to study the rise of producer services (and their implications) in a quasi-experimental setting. For instance, early episodes related to the removal of restrictions in the services sector have been found beneficial for manufacturing firms, especially those more reliant on such services (Arnold et al. 2011, Arnold et al. 2016, Bas 2014, Fernandes and Paumov 2012). Demand increases as new or better services are introduced, or just because the entry of additional providers reduces prices. As a consequence, countries can alter their comparative advantage in favour of those manufacturing sectors that are intensive in business services, as shown by Liu et al. (2020).

In many cases, firms can only access a limited amount of business services, and at lower quality relative to the frontier. Industrial policy can incentivise the demand for specific types of business services. For instance, Manelici and Pantea (2021) analyse a policy that supports the IT sector in Romania and find that this has indirectly supported downstream firms that were more intensive in IT usage to start with.

Finally, firms might have incomplete information on the returns to specific services and/or their availability. An example of this is consultancy services. In an experiment in India, Bloom et al. (2013) provide local firms with support from an international consultancy regarding their management practices. They report that large firms either do not believe that established management practices affect their performance, or do not have information about the availability of less established ones. A related issue is how to facilitate the adoption of such business services, especially in smaller firms, and whether business services should be incorporated through outsourcing or internal strategies. Two experimental works suggest policy avenues. Anderson and McKenzie (2022) show that for smaller firms (subsidised) insourcing or outsourcing are more impactful than introducing services through internal training. In a sample of Colombian small firms, Lacovone et al. (2022) showed instead that group-based consulting can be an effective model for delivering producer services.

Productivity growth and production services

There are different channels through which production services can support productivity growth, both directly and (especially) indirectly, through linkages with other sectors. Most of the available evidence is related to the effect of some specific types of business services provision on the productivity of firms downstream. Introducing new or more sophisticated services (e.g. ICT) can contribute to enhancing market opportunities and the knowledge capital of a firm. For instance, Hjort and Poulsen (2019) show that the arrival of high-speed internet cables in Africa had an effect on local employment, as access to ICT services promoted firm entry, R&D and productivity growth.

Consulting services aimed at improving management practices affect operational efficiency, as emphasised by a now large body of evidence, including from small firms in low-income countries (refer to McKenzie et al. 2025). This happens through several mechanisms, which mostly occur through filling knowledge gaps in adoption of (standard and non-standard) organisational routines, and learning by doing.

Stronger competition in the provision of production services also allows downstream firms to reduce production costs. For instance, Bas (2020) studies India's liberalisation of communication and energy services, and shows that this affected firms' productivity through an increase in innovation activities, which the author relates to an increase in profitability due to the lower prices of upstream inputs.

While evidence convincingly shows productivity spillovers downstream, little is known about the drivers of productivity growth for firms in the production services sector itself. There is some evidence that providers of business services are especially reliant on (soft and hard) infrastructures, such as high-speed internet. Hence, the provision of such infrastructures can improve the availability of key business services and affect their performance, with overall benefits to productivity growth. For instance, Mensah and Traore (2024) use the staggered entry of high-speed internet in Africa to show that it has contributed to attracting new foreign investors, and especially those offering advanced business services. Relatedly, D'Andrea and Limodio (2024) show evidence of credit expansion in Africa due to access to fast internet and attribute this better performance to the possibility of adopting technologies that lower transaction costs, enable smoother interbank coordination, and increase liquidity efficiency within banking networks.

Finally, there is very little evidence on the role of the distribution and retail sector, despite the sector representing a large share of firms' costs, and its market structure having important consequences on the size and the distribution of welfare. For instance, Peter and Ruane (2022) show that, across Indian firms, distribution costs account for a substantial share of revenues (about half the size of labour costs), and that low TFP in the distribution sector amplifies welfare losses by constraining firms' ability to reach markets. Understanding the sources of inefficiency in distribution, while also accounting for the trade-offs in sector organisation (as in Grant and Startz 2022), is a promising avenue for research, particularly in countries where remoteness remains a central challenge (Atkin and Donaldson 2015).

Distributional Effects 

While the development of production services may be a source of growth, it may also accentuate inequality in at least two ways. The first are agglomeration economies: since business services are more likely to cluster geographically, their development may reinforce regional differences. For instance, the work by Kirui et al. (2026) - using finely disaggregated administrative data for Kenya – shows that formal employment in production sectors is largely concentrated in main cities and metropolitan areas, and almost absent in small cities and rural areas. Chatterjee et al (2025) show that high-skill service employment exhibits a higher regional concentration than other sectors, including other services, manufacturing, or agriculture. This is consistent with models of urban agglomerations driving urban premia, which in high income countries were driven by the boom of IT-related business services (Eckert et al. 2022). Second, production services generally employ more highly educated workers (Chen et al. 2023), and their development is likely to widen income disparities across workers. For a sample of thirteen African countries, Baccini et al. (2023) report that while the services sector generally employs the largest share of better educated workers, it is exactly in producer services (along with health and education) that skilled workers in more complex occupations are concentrated.

Consumer Services

The demand for consumer services

Classic theories attribute consumer service sector growth primarily to productivity improvements in agriculture and manufacturing, which in turn free up resources and generate downstream demand through rising incomes. Recent microeconomic evidence offers some nuance as to how these dynamics unfold at the local level. For example, exploiting plausibly exogenous shocks to industrial employment in India, Parvathaneni and Yang (2024) document the downstream effects of industrial expansion on the service sector. Wage growth and increased household income from industrial jobs translate into heightened demand for local services.

In addition to income gains from industrial wage employment, commodity booms (Gollin et al. 2016, Bernstein et al. 2022, Toews and Vézina 2022, Amodio et al. 2025a) and remittances (Dinkelman et al. 2024) have also been associated with expansions in service sector enterprises and employment. In Malawi, the inflow of capital sent home by migrants contributed to investments in physical and human capital and a resulting structural transformation towards non-agricultural sectors, mostly services (Dinkelman et al. 2024). Relying on data from over 116 locations up until 2010, Gollin et al. (2016) document how the export of natural resources can spur urbanisation and the emergence of so-called consumption cities that are centred around services. Baccini et al. (2023) show that, regardless of its underlying drivers, urbanisation more broadly is strongly associated with a shift towards service sector employment.

Even in the absence of rising local incomes, rural-urban migration can stimulate service sector growth by expanding local demand, coupled with an increase in labour supply. Using evidence from Brazil, Imbert and Ulyssea (2024) show that while most rural migrants initially enter informal employment, the resulting increase in labour supply supports firm growth and, in the longer term, facilitates formalisation within the local service sector.

A common concern surrounding consumer services is that their often non-tradable nature may impose constraints on the size of the market firms can access. This demand constraint might limit potential gains from economies of scale (Rodrik 2016). However, recent access to granular data on the geography of consumer spending and service provision has introduced several nuances to our understanding of how local consumer demand really is and the demand constraints firms face.

First, demand for consumer services can be shaped by consumers rather than goods moving across space, at least temporarily. A common example of this is tourism (Faber and Gaubert 2019). More broadly, mobile phone and credit card data reveal that a substantial share of consumer service spending by rural residents occurs in urban areas (Andersen et al. 2023, Blanchard et al. 2025). Blanchard et al. (2025)'s estimates based on mobile phone data for Kenya, Tanzania, and Nigeria suggest that 10–15% of all customers in urban service establishments are non-local visitors. This suggests that the effective demand for urban services depends not only on local population density and income, but also on patterns of intra-urban mobility and rural-urban travel. This is also reflected in the role ownership of complementary assets, such as refrigerators and personal vehicles, plays in shaping the demand for consumer services, in particular retail (Lagakos 2018, Schwartzman 2025).

Second, there is growing evidence that consumer services can themselves become engines of local demand. Schwartzman (2025) and McCullough (2025), studying Brazil and Tanzania respectively, show that employment growth in modern consumer services can generate positive income effects that reinforce local demand, setting off a virtuous cycle of expansion. The root of these income effects is the productivity gap between modern consumer services, mostly formal firms employing wage labour, and traditional services, mostly informal firms that rely on self-employment. Because of this productivity gap, the shift of workers into the modern sector generates income gains that translate into demand shifts, pulling even more workers into the modern sector.

Finally, digital platforms for accommodation services and transportation, and e-commerce for retail are reshaping the matching of service providers (or in the case of e-commerce, sometimes directly producers) and customers (Nayyar et al. 2021).

Productivity growth and consumer services

As noted in the introduction, growth in consumer services can stem not only from rising incomes, but also from productivity improvements within the sector itself. Fan et al. (2023) estimate that service-led growth accounted for roughly one-third of the increase in welfare in India between 1987 and 2011. Similarly, Schwartzman (2025) finds that a large share of the service sector expansion in Brazil during 2000–2010 can be attributed to the adoption of modern service sector technologies. Identifying the role of specific technologies, like payment systems, logistics, and studying their implications for aggregate and distributional effects of service-led growth is a promising area for future research.

Of all consumer service subsectors, retail is arguably the one in which our understanding of productivity drivers has advanced the most in recent years. Centralised distribution systems, such as those employed by Walmart, have been shown to generate substantial efficiency gains. Importantly, retail chains not only innovate internally but also induce productivity improvements among upstream suppliers (Javorcik and Li 2013, Iacovone et al. 2015). By providing its suppliers with access to larger markets, Walmart's entry in Mexico resulted in aggregate productivity enhancing reallocation and higher rates of innovation (lacovone et al. 2015). In both the US (Jia 2008) and Mexico (Atkin et al. 2018), Walmart's entry displaced local retailers. Atkin et al. (2018) document that at least on the metric of aggregate welfare, the adverse employment effects were offset by consumer welfare gains arising from lower prices and increased product variety.

In a similar vein, Faber and Gaubert (2019) show that aside from expanding market access for businesses in the tourism sector and their upstream suppliers, tourism in Mexico generated local agglomeration economies. Such spillovers can, for example, arise if tourism revenues loosen local business constraints or access to other business services and networks is facilitated. At a local level, agglomeration economies offset negative effects due to rising costs for local manufacturing. However, at a national level the gains from such agglomeration forces in tourist destinations are muted due reallocation of economic activity towards them and away from other parts of the country.

While cross-border trade in consumer service outputs is limited to specific subsectors like tourism, inputs of consumer services are very often highly tradable. Srhoj and Mikulić (2025) use firm-to-firm transaction data to trace input flows in Croatia's tourism sector, estimating that 54% of inputs, capturing both direct and indirect linkages, originate from imports. Qualitatively, Das Nair et al. (2018) show that regional supermarket chains in Southern Africa rely heavily on imports from South Africa. While tourism and retail thus have the potential to drive productivity in upstream sectors, integration of domestic suppliers in their supply chain is a precondition for local spillovers. At the same time, e-commerce platforms increasingly allow even small retailers to source diverse product varieties, including internationally, that better match local consumer preferences (Argente et al. 2025).

Refining the methodological toolbox of how we assess the productivity of consumer service firms is another promising route towards enhancing our understanding of where and how productivity gains and innovation arise. De la Parra and Shenoy (2024) argue that standard one-stage production models, commonly used in manufacturing, can be misleading when applied to retail, where the output is better conceptualised as a successful match between products and consumers. They propose an alternative framework that estimates productivity along three distinct dimensions: the ability to attract customers, the efficiency of sourcing and inventory management, and the selection of product mix and suppliers.

Distributional Impact 

While service-led growth in consumer services can generate welfare gains across the income distribution, these gains are often concentrated among higher-income urban households. Fan et al. (2023) find that the welfare effects from productivity improvements in services largely benefitted the top income deciles in urban areas. In contrast, welfare gains among rural households over the same period were largely driven by productivity increases in agriculture. Atkin et al. (2018) document that households in the richest income group experienced 50% higher welfare gains than households in the poorest income group as a result of Walmart's entry in Mexico.

Further, a large share of employment in consumer services occurs in informal work arrangements. However, recent studies provide evidence that service sector growth is not confined to the informal sector only, but can indeed be an important driver of formal sector employment growth (Imbert and Ulyssea 2024, Schwartzman 2025, Kirui et al. 2026). Imbert and Ulyssea (2024) provide an example for a case where a reduction in input cost allowed more firms to transition into formality. Documenting recent trends in formal sector employment between 2015 and 2024 in Kenya, Kirui et al. (2026) find that consumer service firms account for almost all newly created jobs in small towns and rural areas. This underscores the importance of consumer services for development policies focused on regions outside major urban centres. Questions surrounding which policy environments or interventions can improve employment conditions and enhance firm productivity in consumer services leave ample room for further research.

Policy Implications

The evidence outlined in this section points towards an important role for productivity and virtuous cycles in generating growth through services. Beyond its contribution to aggregate output and productivity, the service sector now accounts for roughly half of global employment (International Labour Organization, ILOSTAT, via World Bank (2025) - processed by Our World in Data), implying that it warrants more attention from policy makers and researchers alike.

Policymakers face the challenge of fostering formal service jobs that offer higher wages, greater stability, and better working conditions than informal alternatives. Another concern is how service-led growth can be shaped to deliver more equitable welfare gains across income groups and geographic areas. Services liberalisation also remains on the agenda: the sector is still more protected than manufacturing, both in traditional trade and in the rapidly expanding domain of digital trade, which is likely to be the engine of future economic growth. In addition, some countries maintain strong control over key domestic services or restrict the entry of foreign competitors.

Attention must also turn to the drivers of productivity growth in production and consumer services, especially those that extend beyond physical infrastructure. Finally, the rise of AI and large language models poses new uncertainties for service-led growth, raising the possibility that many production services will be automated with only limited employment impacts.

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