According to current OECD and ABS definitions, the services sector includes a wide diversity of economic activities, ranging from personal services such as hairdressing to scientific research; services, in other words, include everything “from fast food to brain surgery”3. Clearly, the types of skills, technologies and knowledge that underpin innovation, and drive future economic growth, varies widely over such a heterogeneous group of economic activities.
It is also increasingly recognised that the boundaries between industries are shifting and becoming less distinct, as knowledge continues to become more important as a source of economic value and growth. Widespread diffusion of information and communication technologies (ICTs) and increasingly globalised markets have opened up significant opportunities – and competitive pressures – for the creation of new specialisations and sources of competitive advantage, with many services becoming more ‘product-ised’4 and many manufacturing firms, especially in developed economies, focusing on services for increased differentiation and creation of customer value5.
The ‘weight’ of services in developed economies, however, is now recognised as representing an unambiguous shift in the organisation of capital, employment and knowledge6. Unpacking the diversity of services and what makes them unique is therefore vital. In order to make a more useful distinction between different types of services activities, the OECD has recently refined the general classification with the notion of ‘knowledge-intensive services’ (KIS). KIS are considered to be knowledge-intensive because they use more R&D, more technology7, and more highly skilled workers compared to other types of services industries.
The OECD defines knowledge-intensives services as:
Scientific research, computer, legal, accounting, architectural, marketing, mining and operational leasing services.
Under this approach, service industries such as tourism, wholesale and retail trade and accommodation, restaurants and cafes are excluded from the definition of knowledge-intensive services, even though innovation does occur in these industries, and they are an important source of employment. However, their growth opportunities on a global scale are often limited due to the generally non-tradable nature of the services involved. Where global expansion does occur in non-knowledge intensive services industries, it is often primarily through recruitment of local, and typically non-highly skilled, employees8.
In addition, while it is recognised that the education and health sectors are knowledge-intensive in some respects, these sectors are typically classified as non-market knowledge-intensive services as, in most OECD countries, they are largely provided by public sector agencies9,10.
For these reasons, the focus of this report is on market-based,knowledge-intensive services as they are currently defined; that is, those economic activities, conducted by private firms, that combine technology, knowledge (such as R&D) and highly skilled employees to provide a service to a market.
Services are different because, compared to manufacturing and resource-based industries such as mining and agriculture, they are more reliant on people - and the skills and knowledge that they embody - for their growth and success. Services are distinguished by the fact that their delivery requires some form of human involvement, whether face-to-face or, increasingly, electronically. This contrasts with ‘goods’ industries, where the product is effectively delivered to market once it leaves the farm or factory gate.
Across OECD countries, services now account for more than 70% of total employment and value added. There is ongoing debate in the economics literature with regards to the source of productivity, and therefore sustained economic growth, in these services-based economies, which increasingly also characterise many rapidly-growing, ‘developing’ economies. The two concepts that are central to this debate are:
The current size and significance of services in most modern economies confound these concepts, as evidence grows that services can be highly productive while creating jobs. As well as being the main contributor to employment creation across the OECD, it is now increasingly recognised that the services sector is a key source of productivity growth in many OECD economies, mainly due to the fact that firms in this sector tend to be rapid and productive adopters, and adapters, of technological innovations, especially with regards to ICT. Figure 1 shows that services contributed a significant proportion of labour productivity growth over the past decade in countries including the United States, the United Kingdom, Japan, Canada and Australia.
Figure 1: Contribution of the services sector to productivity growth (value added per person employed) 1990-2002)
The recognition that services are a significant source of productivity growth overturns the historical perception that services suffer from a productivity ‘disease’13. It is the interaction, however, between productivity improvement and employment growth that sets services apart, and it is now acknowledged that, in services, ‘employment and productivity growth can go hand-in-hand’14. Services firms must employ people- and increasingly highly-skilled people – if they are to grow, but also need to maintain their competitiveness through increased use of technology to automate processes and operations where possible. The ability to both create jobs and achieve productivity growth through technological innovation is the defining characteristic of the ‘shift to services’, which is now recognised (but not yet completely understood) as a key source of economic growth for developed economies15.
As economic development continues and specialisation intensifies, the demand for customised solutions from businesses and consumers can only grow. Furthermore, the strong performance of services is not only important for their own sake; it also helps underpin growth in those sectors, including manufacturing, that use services as an input’16.The services revolution, therefore, is both real, and of increasing importance17. As productive knowledge-intensive services firms grow, in other words, so too does the number of highly skilled jobs.
As well as relying on human capital, the competitive strength of many services sectors depends on a body of knowledge that may be held within a related scientific research base, embodied in physical technology used in the industry or exhibited in general industry knowledge of a particular application domain. These different types of knowledge are poorly represented by current statistical collections, and the relationship between the knowledge-intensity and innovativeness of services firms and their expenditure on R&D, in particular, is less than clear.
It is now generally accepted in Australia and across the OECD that the productivity growth experienced in the services sector is mainly attributable to the adoption and adaptation of new technologies, especially those related to ICT. Many services firms are recognised as leading-edge innovators in the development of new IT applications, such as FedEx’s package-tracking system and the development of interactive television by Endemol. ICT is also allowing brand new business models and cross-over specialisations to be created by services firms, as exemplified by Tata Groups’ recent move into bio-informatic drug discovery18. In general, there is consensus that services firms tend to innovate by adopting, rather than creating, new knowledge and technologies, ‘through deployment of new technology, notably ICT, training and investment in intangible assets, e.g. design, marketing or organizational change’19.
Firms in the services sector do, however, account for a significant proportion of business expenditure on R&D (BERD). In 2004-05, for example, services BERD accounted for over 30% of total Australian BERD, compared to around 41% in the manufacturing sector, with the bulk of services BERD (19% of the economy-wide total) occurring in property and business services. Evidence suggests, however, that expenditure on R&D per se may significantly under-represent the types of knowledge and innovation outcomes pursued by services firms, with process, organisational, and marketing innovation considered to be as important as scientific or technical knowledge development in many cases20.
While there is growing evidence that innovation in services, and the knowledge on which it is based, relies on more than R&D as it is currently defined, there is also an emerging consensus that public R&D can, and should, play a more significant role in services innovation. Recent work by the OECD emphasises that ‘public spending on basic R&D, in both public laboratories and universities, does not typically address the long-term knowledge requirements for services, e.g.improving the understanding of how technology should be deployed and used or how people work in groups.’21 In Australia, the lack of applicability of much public R&D to services innovation has been reported anecdotally22, in the general context of the very low proportion of business R&D outsourced to the public sector research base23.
The sources and types of knowledge required for ongoing innovation in the services sector are varied, and only beginning to be understood and reflected in official statistics. It is clear, however, that the value-adding capability of many services incorporates a broad conception of knowledge, and that innovation in these domains can rely as much on the development of new business models, organisational structures and ICT-enabled processes as it does on the creation of new scientific or technical knowledge through traditional R&D. Understanding of the way in which innovation occurs in services, and the types of knowledge that underpin this process, is still being developed, but the link between knowledge development and services growth, especially in an environment of increasing globalisation and changing comparative advantage, is clear.
Services are becoming increasingly tradable, with knowledge-intensive services exports, in particular, growing in significance for many highly innovative economies (e.g. Luxembourg, Switzerland and the United States)24. The rapid globalisation of services is occurring as firms increasingly source their services inputs internationally (also known as services ‘offshoring’), facilitated by the rapid deployment of broadband networks and the growing scope for digitisation of services25.
The reliance of services on knowledge and innovation, combined with the effects of globalisation, means that the locus of many parts of the services value chain is increasingly moving to offshore locations. While some manufacturing firms have managed to retain operations in Australia through increased specialisation in design, branding, marketing and logistics (which are essentially services activities themselves), there is growing evidence that the knowledge base of high value-adding services sectors, especially where R&D is concerned, is increasingly mobile. As well as having implications for jobs, this trend suggests that services firms cannot necessarily rely on local specialisations in the high-value adding part of their operations26.
Global competition will lead to pressures to outsource operational functions, including those that are knowledge-intensive, to those locations which are most cost-effective, especially as the highly-skilled workforces of countries such as India and China become more accessible. The OECD has estimated that close to 20% of jobs in countries such as the US, Canada, Australia and within Europe could be affected by the trend towards global outsourcing27. For the US alone, it has also been shown that up to 50% of current services jobs are potentially ‘offshorable’28.
The globalisation of services, while a real and growing phenomenon, currently represents only a small proportion of overall international trade for OECD countries. Figure 2 shows that the trade to value-added ratio of the services sector compared to that in the good producing sectors is currently still low29, and it is estimated that services trade accounts for only about 20% of total OECD trade.
Figure 2: Trade to value added ratios of the services- and goods-producing sectors, 200230
It is expected, however, that the globalisation of services will continue as more countries liberalise their trading regimes in services, the mobility of highly skilled workers increases and technological development continues to expand the opportunity for digitisation of many services activities 31. Business models that understand and take advantage of these dynamics are the key to creation of sustainable competitive advantage in the services domain.
The globalisation of services creates both new opportunities and new competitive pressures for existing firms and industries. The rapid restructuring of the sources of comparative advantage - as changing cost structures and the mobility of knowledge bases and human capital lead to increasingly specialised market niches - generates both opportunities and adjustment costs, which ‘may not be equally distributed across workers, industries and countries’32.
In this changing landscape, it is crucial that firms strive for, and achieve, global competitiveness. The capability to export to – and compete successfully in – world markets is especially important for Queensland-based firms due to the relatively small size of the domestic market. It is primarily through delivery to world markets that economies of scale and scope, which underpin innovation and productivity growth in services, are usually best achieved. Firms that export are more likely to be exposed to new technologies and ideas, to have more efficient production processes, and to be alert to new opportunities and competitive pressures as the global economic environment continues to change.
Leveraging Queensland’s unique strengths to create sustainable sources of competitive advantage is therefore key to generating the revenue growth that leads to high-value job creation in the services sector. Scaling up Queensland’s knowledge intensive services sector - by focusing on global exports and competitive strengths - provides a robust route to future high-value job creation, and an important component of Queensland’s economic transformation in the context of rapid restructuring of global comparative advantage.
Strengthening the performance of services is considered crucial to the growth of employment, productivity and innovation in developed economies33. Fostering the growth of services, however, requires a comprehensive understanding of their nature. Not all types of services activities generate high-value jobs, for example, and similarly not all are conducive to international trade.
At present, the standard industry classification system fails to distinguish those service activities which are both knowledge-intensive and have the potential to be traded globally. In order to provide conceptual clarity, a definition of ‘smart services’ has been developed based on the following characteristics:
These four characteristics are common to all services which are both knowledge-intensive and potentially exportable. In particular, the ‘global need’ characteristic of smart services emphasises that they are only potentially exportable (and therefore considered to be ‘smart’) if a market demand exists outside the domestic context in which the service was initially developed.
This definition of smart services is proposed as a more explicit characterisation of knowledge-intensive services that face high potential growth through global exports, and can therefore have a significant impact on the transformation of Queensland’s economy. It is suggested that, compared to current classifications, this definition of smart services can provide a more useful conceptual basis for industry discussion, strategy and ongoing policy development and implementation.
Although the current industry classification system provides an incomplete definition of smart services, the statistics that are available can be used to derive a broad sketch of the nature of the knowledge-intensive, market-based services sector in Queensland as compared to other economies35.
A fuller analysis of current data, provided in Appendix B, suggests the following:
While it is likely that data collections (both nationally and internationally) remain incomplete in reflecting the true value of knowledge-intensive services, it is clear from this broad statistical sketch that Queensland has a relatively small knowledge-intensive market services sector compared to other modern economies, and that, even adjusting for differences in industry structure, exports from this sector are at about half the national average.