A quiet revolution in the service sector

In 2023, University of Chicago economists Chang-Tai Hsieh and Esteban Rossi-Hansberg published research that showed that the service sector in the United States was undergoing a radical transformation. It turned out that the introduction of digital technologies and organizational innovations in retail, hospitality, and personal and health care services had allowed some companies to dramatically increase productivity and expand their presence in local markets that had previously been served by small and less efficient businesses. It was a “services industrial revolution.”

According to Chang-Tai Hsieh and Rossi-Hansberg, the productivity gains in the service sector, thanks to these trends, are not fully captured in official statistics, although even the growth that is recorded is impressive. From 2000 to 2024, labor productivity in the United States grew at an average annual rate of 3% in the catering sector, 2,1% in hotels, 2,9% in retail trade, and 4,4% in wholesale trade. Compared with manufacturing, where productivity growth has virtually stagnated at 0,2% per year, the performance of the service sector seems remarkable.

This result is both unexpected and positive. It is unexpected because the service sector has traditionally been seen as a drag on productivity growth in the economy (economists call this the Baumol effect); and positive because services now dominate economic activity and provide the majority of jobs. Productivity growth is a necessary – though not the only – condition for transforming precarious jobs in the service sector into good jobs, the kind needed for inclusive prosperity.

The service sector revolution even seems to be a global phenomenon, already spreading to developing countries. Economists and politicians debate whether industrialization can still play its traditional role as an engine of economic growth in the current global and technological conditions, while in the meantime the service sector has imperceptibly transformed into an engine of economic development around the world.

In discussions of the service sector in the context of economic growth in developing countries, attention is usually focused on sectors that can participate in international trade and require highly skilled workers, including information technology, business processes, and financial services. But the very nature of such services makes them poorly suited to low-income countries. They can employ only a small fraction of the labor force - a disadvantage that modern industry suffers from from a development perspective.

The current revolution is taking place in much less glamorous but far more important services: restaurants, delivery, taxis, grocery stores, fulfillment, and even personal care. As new research shows, the expansion of the middle-class service sector has become an important driver of economic growth in India, sub-Saharan Africa, and Latin America.

For example, India’s successes in IT and business process outsourcing are, of course, important for the country’s graduates of technology institutes. But the vast majority of less educated workers are benefiting from the expansion of so-called “consumer services offered in local markets” (as Yale economists Tianyu Fani, Michael Peters, and Fabricio Zillibotti put it).

A report published by the IMF in November 2025 states that the marginal productivity of labor in India's services sector is now higher than in manufacturing, which is partly explained by the stagnation of productivity in manufacturing in recent years. If this is indeed the case, this means that the shift of workers from manufacturing to the services sector would lead to an increase in India's overall income.

Industrial companies, of course, may not create many jobs directly, but they can indirectly influence the economy through linkages with other companies and the often resulting multiplier effect. This argument is usually made as a refutation of the idea that the service sector can offer a sustainable development model. However, modern ways of organizing global production chains almost guarantee negligible multiplier effects in export-oriented industrial sectors. Since almost all intermediate and capital inputs are imported, only a small part of the total value added remains in the country, while any feedback multiplier effect tends to be minimized.

On the contrary, revived service-sector enterprises open up a whole range of opportunities for business linkages. For example, discount chains tend to operate under their own brands, which means they rely largely on products from local producers. In Colombia, retail chains D1 and Ara work almost exclusively with local producers. They collaborate with hundreds of local suppliers of food and consumer goods, giving them the opportunity to grow at scale and access larger markets. Importantly, such production chains encourage technological modernization in areas such as packaging, traceability and cold chains, as well as stricter control of quality standards. They have been shown to increase formal employment in industry and agriculture by several percentage points, without having a negative impact on overall employment.

An unpublished paper by Victo Silva, a researcher at Harvard University’s Center for International Development, notes a similar phenomenon in food delivery services in Brazil, particularly on the iFood platform, which serves 400.000 restaurants of all sizes. In addition to food delivery, it also provides restaurants with tools for managing finances, logistics, and services, as well as market analysis, helping to increase productivity across the sector.

All of this data shows that the potential for productivity gains in the labor-intensive service sector is real and significant. However, there is a risk that the benefits will be captured by employers, especially large chains and platforms, which can use their market power in their relationships with employees, customers and suppliers. In the US, Uber drivers or Amazon warehouse workers are not seeing significant wage growth or improved working conditions, despite the strong productivity gains that these platforms are achieving.

This is reminiscent of the early stages of industrial development. To ensure that the benefits of productivity growth are shared more fairly, corporations must be counterbalanced. Antitrust, regulation, and worker empowerment will all be as important in the service sector as they were in manufacturing. Without productivity gains, demands for higher labor standards will begin to conflict with the overall labor market. But if the productivity revolution in the service sector continues, it could help both developed and developing countries avoid this harsh choice.

The author is a professor of international political economy at Harvard University

Copyright: Project Syndicate, 2026.