The pursuit of export-led growth through manufacturing has become increasingly difficult in the face of growing global competition. A shift towards service export-led growth offers new opportunities, but it also demands investments in human capital, infrastructure, and institutional capacity. This second column in a three-part series explores the emerging service export model, its potential for growth, and the policy strategies needed for countries in the EBRD regions to successfully navigate this transition.
The traditional 20th century path to development involved manufacturing-led growth and a shift from agriculture to manufacturing. Over the past decades, however, manufacturing’s share of value added has declined across most emerging economies, particularly in Eastern Europe and Central Asia. This reflects both global competitive pressures and a trend of premature deindustrialisation (Nayyar et al. 2023). With China accounting for 35% of global manufacturing production in 2020 (up from 5% in 1995), newcomers face stiff competition in establishing manufacturing bases (Baldwin 2024a).
At the same time, the rise of digital technologies, improved infrastructure, and fewer policy barriers have made services more tradeable across borders, with the cost of services trade dropping by 9% between 2000 and 2017 (WTO 2019). Within services, digitally enabled, tradeable services – especially global innovator services such as information and communication technology (ICT) services, financial services, insurance services, professional services, and scientific and technical services – have a high growth potential (Baldwin, 2024b). In recent work (EBRD 2024), we document the shift to the service sector and discuss policies to support the shift towards high value-added services.
Is manufacturing export-led growth still possible?
While data suggest that growth is often still export-led, it is now more likely to be led by exports of services (Figure 1). Our analysis shows that, since 2008, EBRD economies in the EU have increasingly shifted toward services-led growth, and in a significant percentage of other EBRD economies growth has become less likely to be led by manufacturing exports. In other emerging market economies, growth is now almost as likely to be led by services exports as non-export-led.
This shift toward service-led growth has been enabled by digital technologies making services more storable, codifiable, and transferable, reducing the need for the producer and the consumer to be in close proximity at the time of delivery, as well as improving their linkages to other sectors. Global innovator services, in particular, can be traded internationally through remote cross border delivery, they mostly employ skilled workers, and they have strong links to other domestic sectors. While they typically do not yet account for most value added in the service sector in emerging Europe, several economies have positioned themselves as major exporters of computer and information services. Estonia, Ukraine, Serbia, Armenia, North Macedonia, and Moldova were among the world’s top ten exporters of computer services relative to GDP in 2022, alongside established tech hubs like Israel and India. These countries have leveraged their strong technical education systems – a legacy of their communist past – to develop competitive advantages in IT services.
Figure 1 Growth is often still export-led, but it is now more likely to be led by exports of services
Source: OECD TiVA database and authors’ calculations.
Notes: Growth led by manufacturing exports is defined as a situation where the domestic value-added content of manufacturing gross exports grows faster than GDP. Growth led by service exports is defined as a scenario in which the domestic value-added content of gross exports of global innovator services grows faster than GDP. “Other EBRD economies” comprises Egypt, Jordan, Kazakhstan, Morocco, Tunisia, Türkiye and Ukraine. “Other emerging market economies” comprises Argentina, Belarus, Brazil, Chile, Colombia, Costa Rica, Indonesia, Malaysia, Mexico, Peru, the Philippines, Russia, Saudi Arabia, South Africa and Thailand. “Advanced Europe” comprises Austria, Belgium, Cyprus, Denmark, Finland, France, Germany, Iceland, Ireland, Italy, Luxembourg, Malta, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom. “EBRD economies in the EU” comprises Bulgaria, Croatia, Czechia, Estonia, Greece, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic and Slovenia.
Strong governance and high human capital are required for service export-led growth
Not all countries are equally well-positioned to pursue service-led growth. Economies with stronger governance, more educated workforces, and more liberalised service sectors are better able to succeed in high-value service exports (Figure 2). While many EU member states have both the human capital and institutional capabilities required, other economies face varying challenges. Countries like Jordan, Kazakhstan, Moldova, Serbia, and Ukraine could benefit from improving their regulatory environments, while Egypt, Morocco, Tunisia, and Türkiye confront a dual challenge: they must enhance both their skills base and institutional frameworks to fully leverage services export opportunities.
Figure 2 Economies with stronger governance and higher levels of human capital are more likely to achieve service export-led growth
Source: Barro-Lee Educational Attainment Dataset, World Bank WGIs, World Bank-WTO Services Trade Restrictions Index (STRI) database and authors’ calculations.
Note: For each economy, this figure plots average years of schooling in 2010 against a score calculated as the first principal component of (i) a set of WGI indicators measuring voice and accountability, political stability and the absence of violence, government effectiveness, regulatory quality, the rule of law and control of corruption, and (ii) STRI scores for trade in computer, communications, financial and professional services derived from the World Bank-WTO STRI database.
Services are increasingly vital within manufacturing itself
In advanced European economies, service-related occupations accounted for 55% of all manufacturing-sector occupations in 2019, up from about 45% in 2000. This ‘servicification’ of manufacturing reflects the growing importance of pre- and post-production activities such as R&D, design, marketing, and after-sales services. Hungary, where participation in global value chains (GVCs) accounts for 62% of gross exports, provides an insightful case study (Bisztray et al. 2024).
Between 2008 and 2019, the share of goods exports accompanied by services from the same firm grew by 20 percentage points. This growth was driven primarily by foreign-owned manufacturers, with two-way traders in goods and services accounting for 17.5% of foreign-owned firms versus just 0.7% of domestic firms by 2019 (Figure 3). These firms often bundle manufactured products with complementary services such as engineering or maintenance, potentially moving up the value-added ladder. The data also show significant clustering of service-exporting firms in urban areas with strong skill bases, particularly Budapest, which hosts numerous R&D centres and shared service facilities for multinationals like Deutsche Telekom, IBM, and Thyssenkrupp.
Figure 3 Foreign-owned manufacturers in Hungary dominate two-way trade in goods and services
Source: Bisztray et al. (2024), Hungarian Central Statistical Office and authors’ calculations.
Note: “Foreign-owned” firms are defined as those where foreign ownership totals at least 50 per cent. “One way trade in services” comprises firms that are one-way traders in services and either (i) trade goods one-way or (ii) do not trade goods at all.
How can we foster a shift to productive services?
The policy-light approach that worked for the shift from agriculture to manufacturing – no significant investment in workers’ skills or wide-ranging improvements to governance and regulatory frameworks – would not work as well now. Automation has reduced the benefits of having plenty of cheap unskilled labour, while innovation in manufacturing is increasing demand for specific skills (Rodrik and Sandhu 2024). Moreover, global innovator services such as ICT services and business process outsourcing require skilled labour, investment in physical capital, technology and innovation, as well as strong infrastructure, robust economic institutions and a conducive business environment (Atolia et al. 2020).
The liberalisation of trade in services may allow economies to target some low-hanging fruit in terms of facilitating a structural shift towards services with higher value added. Our analysis shows that while market access is important for service exports, liberalising your own service market has a greater impact than trade barrier reductions in destination countries. Gravity estimates suggest that reducing domestic restrictions on services trade could boost service exports by approximately 9%. For digital services specifically, the impact could be even larger, with relaxation of digital trade restrictions associated with increases in service exports of up to 20%. Adopting clear and transparent regulatory frameworks, such as GDPR-equivalent data protection legislation, can also facilitate cross-border trade in services by aligning standards and reducing compliance costs for firms operating internationally.
Other targeted industrial policies, such as investment promotion, can support the shift towards high-value-added services, but their effectiveness depends critically on state capacity. In 2023, the EBRD conducted an online survey of investment promotion agencies (IPAs), gathering data on the sectors targeted, the strategies employed and the timing of the relevant initiatives. The information collected was combined with data from the FT fDi Markets database – a project-level dataset on FDI projects – to assess the effectiveness of sector-targeting policies.
The results show that on average, sector targeting policies have significant positive effects: Ten years after implementation, targeted sectors see 2.8 times as many FDI projects as non-targeted sectors. However, Figure 4 shows that the positive effects are driven entirely by service-related projects (such as R&D centres, business services, and ICT infrastructure) in countries with relatively higher levels of state capacity, with the latter measured through indicators of government effectiveness, regulatory quality and rule of law (O’Reilly and Murphy 2022). Countries with weaker state capacity see no significant differences between targeted and non-targeted sectors, and there is no significant impact on manufacturing-oriented investments regardless of state capacity.
Figure 4 The number of service-related FDI projects increases following the introduction of sector targeting policies when state capacity is sufficiently high
Source: FT fDi Markets database, O’Reilly and Murphy (2022) and authors’ calculations.
Note: This figure shows the estimated coefficients derived from a difference-in-differences regression comparing targeted sectors with not-yet-targeted and never-targeted sectors in terms of the number of FDI projects at country-sector-year level, looking at service-oriented and manufacturing-oriented projects separately. For service-oriented projects, separate estimates are shown for countries with below-median and above-median levels of state capacity. Spikes indicate 95 per cent confidence intervals based on standard errors clustered at the country-sector level.
Conclusions
For policymakers looking to promote structural transformation toward high-productivity services, three main lessons emerge. First, fundamentals matter – investment in education, digital infrastructure, and governance are essential prerequisites.
Second, lowering restrictions on trade in services can boost service exports, particularly for digitally enabled services. However, this doesn’t mean eliminating all regulation – clear frameworks like GDPR-equivalent legislation can facilitate trade by establishing transparent rules.
Third, while targeted industrial policies like investment promotion can work, their effectiveness depends heavily on state capacity and pre-existing capabilities. Countries should therefore sequence reforms carefully, building fundamental capabilities before pursuing more activist policies.
The transition to service-led growth presents both opportunities and challenges for emerging economies. While the traditional manufacturing-led development path may be narrowing, new digital technologies and the growing tradability of services are creating alternative routes to high-productivity employment and economic growth. Success will require careful policy choices and sustained investments in human capital and institutions over the medium term.
Source : VOXeu
