Growth of the Service Sector and Economic Fluctuations: A Production Network Perspective

Abstract This paper examines the impact of growth of the service sector on economic fluctuations and its underlying mechanisms from the perspective of global production networks. We analyze this mechanism by constructing general equilibrium model of production networks and empirically test it by using nearly three decades of global input-output data and simultaneous equations model. The results show that 10% increase in the share of initial inputs and final consumption in the service sector leads to reduction in the sparsity of the production network by 0.42% to 1.34%; 10% reduction in the sparsity of the production network results in decrease in the magnitude of economic fluctuations by 0.79 to 1.56 units. This indicates that the rise in the share of initial inputs and final consumption in the service sector associated with the growth of the service sector tends to reduce the sparsity of production network linkages, thereby helping to smooth economic fluctuations. Counterfactual analysis reveals that if China’s service sector share, industry intermediate input share, service sector productivity fluctuations are replaced with the corresponding data from the United States, China’s overall economic fluctuations would decrease to varying degrees, with the largest contributions coming from changes in the service sector share and industry intermediate input share (69.8% and 73.6%, respectively). This study implies that actively promoting the development of the service sector has profound strategic significance for stabilizing growth, adjusting structures, and reducing fluctuations in the Chinese economy.