The rise of the service sector in China

Abstract

This paper analyzes the underlying mechanisms that explain the rise of the service sector in China. Along with China’s unprecedented growth, the rapid expansion of its service sector is one of the fastest among emerging countries. However, the literature has yet to offer a clear understanding of such expansion. We show that distribution services first grow with the manufacturing sector, followed by personal services as per capita income rises. Motivated by this growth pattern, this paper provides a theory that describes 1) the complementarity between distribution services and the manufacturing sector, and 2) the substitution between personal services and home production. Empirics show that the personal service sector is the key to account for the early and rapid rise of the service sector in China. Quantitatively, high productivity growth and high capital intensity in the personal service sector, and labor market frictions are the most important channels. By revealing the growth pattern of the service sector in the early stages of development, the paper thereby contributes to the growing literature on the rising importance of the service economy.