Asia moves from being the world's manufacturer into an entirely new sector

The service sector is fast becoming developing Asia's new growth engine as the world's factory moves from manufacturing to services such as tourism, outsourcing, IT, healthcare and insurance.

Throughout the region, more than 45 percent of the workforce is now employed in the service sector and it has been estimated that within the next few years, services will contribute more than 50 percent of the region's GDP.

Earlier this year, the service sector in China eclipsed the industrial sector in size for the first time.

Among the countries that form the Association of Southeast Asian Nations (ASEAN), services now comprise 45 percent of GDP.

Economists say the Asian growth story is moving into the second phase of development. Manufacturing is playing less of a role in driving growth, while consumption and demand for services is becoming the key driver.

According to Frederic Neumann, HSBC's co-head of economic research for Asia, the reality is that the region that has long been known as home to the world's manufacturing sector is turning into an economy driven by services.

"This is a trend that will shape Asia's future," he says.

Donghyun Park, principal economist at the Manila-based Asian Development Bank (ADB), says this is a "natural consequence of Asia becoming wealthier".

"Millions are joining the middle class every year and are demanding more services," he adds.

Such a demographic change has also been noted by HSBC's Neumann. "It doesn't mean that consumption patterns will resemble those of the West overnight," he says. "Nor does it mean that manufacturing will cease to be important."

He explains that the "intangible nature" of services means it is sometimes hard to know what is being referred to.

"There are the more traditional services that constitute important building blocks of any society: Education, healthcare, basic telecommunications and hospitality-related industries.

"These exist alongside the more modern services such as information technology, finance and business services," Neumann says.

In the region, it is India and the Philippines that stand out as providers of these modern services, which are largely export-focused.

Over the last two decades, India has emerged as the world's leading exporter for information and communications technology-business process outsourcing (ICT-BPO), while the Philippines has also grown into a major ICT-BPO hub.

But according to Neumann, Asia still has a long way to go as it "reaches for high productivity services industries".

In a paper last year, called The Service Sector in Asia: Is It an Engine of Growth?, the ADB estimates that what it calls modern services (not including banking and financial services) occupy between 8 and 12 percent of regional GDP. This compares with between 17 and 25 percent in the countries that make up the Organization for Economic Co-operation and Development, giving Asia plenty of room for improvement.

"Services industries are a feature of modern, rich economies," says Peter Drysdale, emeritus professor of economics at the Crawford School of Economics and Government at the Australian National University in Canberra, in an article on the East Asia Forum website.

"High levels of professional skill and research and innovative capability, and the educational and commercial infrastructure that underpin them, make the difference between middle-income and really high-income economies," he said.

According to Neumann from HSBC, Asia will benefit from three important side-effects of service sector growth.

"First, the (service sector) is less volatile than industrial growth. Second, services are relatively more labor intensive than industry — which should help absorb future labor flows from the primary sector on the back of urbanization.

"And services growth tends to result in more inclusive and gender-balanced growth — a key factor for future regional stability."

Neumann also says that a highly productive service sector delivers benefits that can boost productivity in other industries — contributing to economy-wide increases in overall productivity.

"This offers some respite in a time of jittery markets and uncertain growth trends," he adds.

In China, services are gaining more importance as the country continues to urbanize. Analysts say that this trend is having a major impact on services and employment in the sector.

The services infrastructure necessary to allow for cities to cope with the increased population as people move to urban centers is immense, says Neumann.

"Under the most ideal policy scenario, a reform of the hukou household registration system would normalize the status of approximately 260 million migrant workers in cities and give them rights to certain services," he says.

Hukou is the system that ties benefits to place of birth, meaning that migrant workers in cities are not able to access healthcare or education for their children, for example.

And this trend of urbanization is showing no signs of slowing. Qu Hongbin, HSBC's chief China economist, says an additional 100 million rural residents might leave for cities over the next decade, which should provide plenty of ammunition to sustain growth in the sector.

According to Changyong Rhee, chief economist at the ADB, upgrading the sector with a focus on services such as business processing, tourism, and healthcare "could play a critical role in the region's future growth".

Traditional services such as restaurants, taxis and barbers still dominate in developing Asia, he says in a paper recently.

Modern services — such as Internet connectivity technology and financial, legal and other professional business services — account for less than 10 percent of Asia's service economy, well below the 20-25 percent in advanced economies, according to Rhee.