One of the few things politicians agree on is that we need more economic growth. Almost every country sputtered into the 21st century: Japan and Germany in the mid-1990s, the United States and United Kingdom in the mid-2000s, China from the mid-2010s. After two decades of successive crises, most economies are sluggish shadows of former selves, and leaders have thrust growth to the top of their priorities.
This paper examines the role of the service sector in driving productivity growth in the past and the extent to which service sector reforms can support productivity and growth in future. It finds that structural transformation has positively contributed to economy-wide total factor productivity (TFP) growth and innovation in the last 20 years in China. Partly, this is because the decline in value added share of the secondary sector was led by low TFP subsectors, such as oil and gas. Partly it is because, TFP growth of market services exceeded that of the secondary sector. However, despite the relatively strong TFP growth in market services, there is a substantial and growing misallocation of capital and labor in the sector, which has been masked by high innovation. Sector- and firm-level analysis suggests that further opening up to trade, greater labor mobility, and state-owned enterprise (SOE) reforms could improve allocative efficiency, unleashing higher TFP growth overall, and particularly in the service sector.