The Underdevelopment of Service Industry in China: An Empirical Study of Cities in Yangtze River Delta

The service industry in China is underdeveloped, in comparison with not only the past experience of developed countries at the similar level of GDP per capita, but also other similar developing countries at present. We define this deviation of China¡¯s service industry from the development trend in other countries as the ¡°development deviation puzzle,¡± and propose a conceptual framework based on the ¡°manufacturing cost disease¡± hypothesis to understand the reasons behind this puzzle. We test our hypothesis using the data from the urban cluster in Yangtze River Delta. The results indicate that labor productivity growth in service industry is driven by capital investment and the ¡°development deviation puzzle¡± is indeed rooted in the ¡°manufacturing cost disease.¡± Our analysis suggests that, to correct the underdevelopment of service industry, the strategy of investment-driven industrialization and urbanization must be changed. Expansion of producer services is important in increasing the intensities of human capital and foreign investment.