Services now represent approximately 25 per cent of world trade. In the United States in 2000, and despite the negative trade balance, there was a US$ 81 billion trade surplus in services (Bach, 2001). One reason for the increasing trade in services is that economic growth in many developing nations is fostering a rising demand for consumer and business services, ranging from fast food outlets to professional consultancy. In addition, the hollowing out effect observed in the industrial economies in the 1980s and 1990s is beginning to appear in some of the ASEAN economies. However, the trend is not restricted to manufacturing, as some service organizations in higher wage countries are beginning to outsource work at an increasing scale to those countries that have highly skilled labour available at lower charge-out rates. For example, recently an Australian accounting firm has transferred some of its basic accounting tasks to Malaysia and then electronically transferred the completed data sets back to its head office.

Similarly, the manufacturing sector has also expanded in several parts of the developing as well as the developed world, albeit at a slower pace than the services sector. While this growth has been seen to benefit the services sector as an array of services are required to satisfy the demand for the knowledge and skill-intensive business sector, the benefits have not flowed one way. The increase in the growth of the services sector has also triggered a growth in demand for a variety of manufactured goods such as computers, cell phones, digital scanners and optical linkages. The close connection between the service and manufacturing sectors is likely to have spillover effects in each of these sectors; however, research into the spillover effects of services and manufacturing has been sparse. Thus, the investigation of such spillover effects is an area that warrants investigation. In order to determine whether the growth of services has a spillover effect on manufacturing growth and vice versa, we examine the ASEAN economies.

The ASEAN economies attracted considerable international attention prior to the 1997 Asian crisis, primarily as a result of their phenomenal GDP growth rates. Much of their robust growth was driven by the rapid expansion of both the services and the manufacturing sectors. In the next section, we begin by looking more closely at the global sectoral composition of GDP. This is followed by a discussion of ASEANs sectoral composition and links between services and manufacturing. We then discuss the implications of the main issues followed by the presentation of our findings and we present our conclusions in the final section.

30Asia-Pacific Development Journal V ol. 10, No. 2, December 2003

I. GLOBAL SECTORAL COMPOSITION

The internationalization of business is one of the most notable global developments that have taken place over the past two decades. A wide variety of indirect and direct international transactions are becoming part of daily economic life for people of most nations. The increased internationalization of the world economy, combined with the relatively free flow of goods and services across several borders has also resulted in the changing production structures of several countries. Most countries are now focusing on marketing an increasing number of their goods and services outside their borders. One evidence of this change is reflected in the massive increase in the global values of exports which stood at US$ 5.5 trillion in 1999, compared to approximately US$ 2 trillion in 1985 (World Bank, 2000).

Developments in global merchandise and service exports are directly related to changes in the production structures of the individual nations of the world. Increases in global exports have been largely concentrated between two sectoral outputs: exports of manufactures and exports of services. For example, trade in manufactures accounts for over 75 per cent of international trade (World Bank, 2000). Trade in manufactures includes the following category of goods: machinery and transport equipment, with automotive products as a major sub-category. Other trade in manufactures includes chemicals, textiles and clothing.

Trade in services has also been growing rapidly leading to the expansion of the service sector in several countries around the globe. According to the World Bank (2000), trade in services is estimated to be around US$ 1.3 trillion. The services sector is also a large contributor to income and employment in several countries. According to the International Standard Classification (ISIC) system, services include wholesale and retail trade, restaurants and hotels, transport, storage, communications, financial services, insurance, real estate, business services, community services, social services and government services.

The development of the global business environment has led to changes in the domestic production structures of many nations where production activities are targeted toward goods and services that have an international demand, whether manufactures or services, and where prices are internationally competitive. Further evidence of the sectoral development in services, as well as manufactures, is revealed by data on the composition of world production. Available sectoral production data reveal interesting patterns (table 1). According to data in table 1, the trend reveals that in the last thirty years there has been a rapid expansion of the services sector globally. However, during the same period, agriculture has gradually lost its dominance as the main production sector in most parts of the world. The manufacturing sector has also expanded in several regions; however, it has been expanding at a slower pace than the services sector.

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expansion of both of these sectors. These control variables include the growth rate of real output (y), the growth in exports (x), the growth in imports (i), and the role of government (g). As such, the structural equation for the services sector is represented by equation (1).

ss it = α0 + α1y it + α2ms it + α3x it + α4m it + α5g it + u it (1)

In equation (1), i is the country, t is the time period and u is the random error term.

We also formulate our testable equation for the spillover effects of service expansion into the manufacturing sector. However, the growth of the manufacturing sector is also influenced by several variables other than the growth of the services sector. Our control variables are the same as those in equation (1). Hence, the structural form for the manufacturing sector is represented by equation (2).

ss it = β0 + β1y it + β2ms it + β3x it + β4m it + β5g it + u it (2)

Our theoretical justification for the use of the right-hand-side variables is as follows.

Growth of real output (y)

In equations (1) and (2), the growth of real output (growth rate of real gross domestic product) reflects that it may have an impact on the growth of the services and manufacturing sectors. In general, the theoretical notion is that a country ’s state of growth and development is expected to have a favourable influence on its sectoral growth. The inclusion of the growth variable is further justified on the grounds that a faster rate of growth leads to quicker change in income and consumption patterns that positively impact both the services and manufacturing sectors.

Growth rate of manufacturing sector (ms)

The manufacturing sector includes industries like machinery, metal products,transport and equipment, electrical machinery, industrial chemicals and food industries.As discussed in section 3, the contribution of manufacturing to GDP has been increasing in the ASEAN countries. The manufacturing sector in fact has been identified as a growth engine (see for example, Mahadevan, 2002). In equation (1), we include the variable ms to account for the improvement of efficiency in the manufacturing sector that is likely to have an effect on the growth and development of the services sector.

Growth in services sector (ss)

It is important to examine if services growth has any spillover effects on manufacturing growth. The basis of our argument is that an expanding services sector, in addition to its direct contribution to the growth of gross domestic product, may also have a positive, indirect effect on the growth of manufacturing through its impact on total factor productivity. An efficient services sector should lead to improved performance of the manufacturing sector by improving distribution and information transactions. In modern economies, there is increasing demand from both consumers and business for efficient service sectors. In many cases, competitive parity has already been reached in manufactured goods making it difficult for most global corporations to differentiate their tangible outputs on product quality alone. This forces business to increasingly turn to higher levels of customer service to facilitate their homogeneous product offerings, increase their overall productivity, improve their competitive advantage and ultimately to create customer value.

Growth in exports (x)

The export variable is included since the exposure of the domestic economy to the world economy may have a positive effect on service sector growth. The export theory suggests that exports are important for growth and this has been determined even in the case of Asian countries (see for example, World Bank, 1994). Past researchers have identified positive links between export growth rates and overall economic growth (see for example, Balassa, 1978; Ram, 1987; and Fosu, 1996). The argument is that growth in exports introduces a greater degree of competition, keeps the economy connected with the latest technological developments, brings in much needed foreign income and leads to higher levels of investment. In general, a flourishing export sector may induce an improved allocation of resources in the services and manufacturing sectors. This approach is in line with the standard theoretical contention in the literature that growth in exports often reflect one, or a combination of, several factors such as a greater degree of competitiveness, achieving scale economies, improved technology, higher production according to a country’s comparative advantage and greater market outreach. Exports also facilitate the import of goods, services and capital and thereby also new technology.

Growth in imports (m)

The import variable is included as it is a means of delivering vital inputs to organizations. Its also brings in foreign technology and is expected to have a positive effect on the productivity of the services and manufacturing sectors. Technology is embodied in goods and therefore transferred in international trade. Productivity gains from imports of input goods are likely to be high. According to Sjohollm (1999),

37Asia-Pacific Development Journal V ol. 10, No. 2, December 2003 imports are one channel through which countries and establishments can benefit from foreign research and development.

Government (g)

The variable g is included because government spending, for example, on infrastructure development, can have a beneficial effect on sectoral growth. It has been noted, for example, Temple (1999), that government spending on infrastructure such as telephone networks and electricity has been found to have a significant effect on overall growth. Other researchers share similar opinions, for example, Easterly and Rebelo (1993) found that the share of public investment in transport and communications was robustly correlated with growth.

In terms of our analysis, we estimated equations (1) and (2) based on data for five ASEAN countries (Indonesia, Malaysia, Philippines, Singapore, and Thailand). Brunei Darussalam and Viet Nam are two ASEAN countries that we excluded from our analysis due to of data deficiencies. We compiled data for the years 1965-1994, averaged over six sub-periods (1965-1969; 1970-1974; 1975-1979; 1980-1984; 1985-19; and 1990-1994). Our data sources were World Development Indicators CD-ROM 2001 and various issues of Key Indicators of Developing Asian and Pacific Countries published by the Asian Development Bank.

Findings

Our findings are presented in table 4, which includes the regression results of equations (1) and (2).

The results of equation (1) confirm the positive influence of several variables on the growth of services. The ms variable has a positive coefficient and is statistically significant, providing strong confirmation that the growth of the manufacturing sector is strongly correlated with the growth of the services sector. As such, we contend that the growth of manufacturing sector is highly likely to spillover into the services sector. The findings also confirm that the growth of output, imports and government spending have a strong influence on the growth of services. Evidence of their strong influence is revealed by the coefficients of all these variables that have the expected positive sign and are statistically significant at the 1 per cent level. The results of equation 2, in table 3, show the impact of services on manufacturing. The findings show that the coefficient of services growth has the expected positive sign and is statistically significant. This supports our hypothesis that growth in services is influenced by growth in the manufacturing sector. Our hypothesis, that growth in the manufacturing sector is influenced by growth in the services sector, is also supported. In addition, our hypothesis that other variables influence the expansion of both of these sectors is also supported.

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