Leading High-Quality Development of Service Industry with Institutional Innovation

3.1 Institutional Reform and Service Industry Development

Over the years of reform and opening up, the reform of the government administrative approval system and other deregulation reforms have continued to advance, releasing the vitality of market players and playing an important role in driving economic growth and optimizing the economic structure (Xia and Liu, 2017). Scholars generally believe that government deregulation can boost economic development and increase total factor productivity (TFP). For example, Olley and Pakes (1996) argue that reducing government regulation is a prerequisite for increasing companies’ willingness to invest and capital flows to productive areas, thereby increasing society-wide productive capacity and company efficiency. Using the data of Chinese industrial enterprises over the period of 1998–2007, Aghion et al. (2015) find empirically that monopoly is the source of inefficiency of companies and low welfare of the population, and that policy initiatives in favor of “full competition” can reduce the cost and increase the productivity of enterprises.

However, the direct research on HQDSI is rare, mainly because the data availability of service industry is worse than that of manufacturing industry (Xu, 2000). Most previous research literature agrees that institutional reform is the key to the development of service industry. Mattoo et al. (2020) investigated 24 transitioning countries in Eastern Europe and Central Asia, confirming that the free entry to and opening of service industry is the key to development. Some Chinese scholars have found that the reform of administrative monopoly industries, the marketization of production factors and the reform of cadre promotion system are effective ways to solve the problems of inefficiency, poor brand and poor structure of China’s service industry (Jiang and Li, 2004). Jiang (2019) discussed the connotation and requirements of HQDSI, pointing out that an inclusive and prudent regulatory framework and policy system is the key path to promote HQDSI.

3.2 Institutional Reform Promotes Professionalization of the Service Industry

Industrial division of labor and deep specialization are the endogenous driving forces of economic development and industrial structure upgrading, and the trend of service industry specialization is also very obvious. In his book The Wealth of Nations, Adam Smith first made a systematic study on the changes of industrial structure. He pointed out that the exchange of goods leads to the division of labor, and the scope of division of labor is restricted by factors such as market size, market scope, exchange capacity and enterprise organization form. According to the theory of specialized division of labor, with the continuous expansion of market scale, specialized producers will appear, so manufacturing and service enterprises will focus on their respective core competitiveness, thus improving the competitiveness of all links in the value chain. High-end services such as product design, technology R&D, market research, supply chain management and customer service are all highly specialized knowledge-intensive services, each of which requires a different composition of technology, skills and human capital. Although these high-end services can also be internally provided by manufacturing enterprises themselves, it is almost unnecessary or impossible for them to set up highly specialized service teams due to limited scale of the enterprises. However, if these services are outsourced to specialized service providers, the overall level of specialization will be significantly improved. Buera and Kaboski (2012) found that the share of added value of high-skilled services in the entire service industry had increased significantly.

Although we have been advocating specialized division of labor for many years, the level of specialization in China’s service industry is still hovering at a low level. Service industry is a derivative industry, whose development speed and quality often depend on the growth and release of intermediate demand in the process of economic development. As far as the industrial and value chains are concerned, most manufacturing enterprises, whether big or small, are still all inclusive, where the level of specialization in intermediate products and intermediate services is quite low. This situation has not changed over the years, most likely because the contractual environment for the development of services specialization in China is not yet robust enough. The incompleteness of the contractual environment exposes manufacturers to risks, as a result of which, the higher the specificity of assets is, the lower the matching rate of upstream and downstream producers in the market will be (Grossman and Helpman, 2002), and the more likely transactions are to be completed within the enterprise. Many empirical studies have demonstrated the significant role of contractual and transactional costs on the division of labor and specialized production of enterprises. Hanson (1997) found a significant positive correlation between outsourcing and the degree of standardization of products and intermediate goods. All of these prove that the more complex, intermediate and specialized links are, the less likely they are to be separated out, and the contractual institutional environment is an important constraint to industrial specialization and value chain upgrading. All these prove that the more complex, intermediate and dedicated the production links are, the less likely they are to be separated from the manufacturer, and that the contractual and institutional environment is an important factor constraining industrial specialization and value chain upgrading. In other words, the refinement of division of labor, the specialization of industry, and the upgrading of the value chain all depend on the institutional environment to a large extent. However, administrative protection, market segmentation, and market access restrictions are serious in most parts of China, leading to industrial fragmentation and structural convergence.

The intangibility, asymmetry and non-storability of service supply and service consumption determine that the development of service industry relies more on the completeness of external contractual rules and institutional arrangements for strict compliance with contracts. On the one hand, the service industry is contract-intensive (Clague et al., 1999), and a sound institutional environment is an important factor to ensure its development. Many production services exist throughout the entire process of production and operation, unlike component manufacturing and processing that can be performed independently. For example, the development of new products has to be matched with the capacity of each department of the enterprise. Outsourcing these services to external service providers requires repeated communication among various internal departments of the enterprise, which involves a high transaction cost. On the other hand, the quality of service is difficult to compare with that of other industries, especially the manufacturing industry (Holmstrom, 1985) because the output of service industry is mostly intangible and service consumption and supply are often simultaneous (Hill, 1999). The intermediate inputs in the manufacturing industry are parts and components with clear quality and technical specifications that can be clearly specified in the contract, so unqualified products are easy to be identified. However, the service industry is obviously different in that the quality standards of many intermediate inputs cannot be accurately stipulated in the contract, so the more knowledge-intensive and specialized the service is, the greater the uncertainty between input and output, making it difficult to set standards in advance. Examples of such services include R&D of new technologies and products, marketing, management activities, etc. Ni et al. (2016) found that the service industry has a relatively low degree of production segmentation due to its intangibility, low tradability, poor interindustry linkage, and relatively short industrial chain. Wang et al. (2020) empirically found that the level of specialization of China’s service industry is generally lower than that of the manufacturing industry and it is in a backward position in the world.

In reality, there are countless examples of promoting the specialization of service industry through institutional reform. For example, when the system of paid-in registered capital is implemented, intermediary services survive mostly by advancing capital; when a large number of pre-approvals are required, they focus on getting approvals or getting fake approvals. After the reform of the commercial registration system, the market demand for advancing capital and getting approval is reduced, and intermediary services are gradually standardized and specialized, focusing more on providing services such as agent registration, agent bookkeeping, agent declaration of enterprise annual reports and business information consulting. Along with the institutional reform, business services such as intermediary services have become standardized, professionalized and specialized. In terms of measurement and identification, the measurement of TFP for Chinese enterprises, industries and regions is mainly centered on manufacturing industries, and most of the relevant research literature uses the data from China Industrial Enterprise Database and the OP method. For example, using the raw data from China Industrial Enterprise Database, Shi and Li (2020) defined the degree of enterprises’ participation in specialized division of labor as the proportion of the value of outsourced intermediate products in the total output value of enterprises, and calculated the total industrial intermediate inputs and total industrial output for this indicator.

3.3 Institutional Reform Promotes Servitization of Manufacturing

The “Ford model” is the cornerstone of the development of modern large industries, with economies of scale and scope as the goal, where product design, manufacturing, sales and after-sales service are carried out by the manufacturers themselves (Jiang, 2011). With the development of science and technology and the increasingly fierce competition in the market, this all-embracing traditional model gradually loses its competitive advantage in many aspects, and it has become an inevitable choice for industrial enterprises to focus their efforts on core areas while outsourcing non-core business to specialized companies. In fact, the boundary between manufacturing and service in the traditional sense has gradually become blurred, and the value chain of manufacturing industry has gradually extended and expanded to service links. Vandermerwe and Rada (1988) were the first to put forward the concept of servitization of manufacturing and regarded it as an inevitable trend of manufacturing development.

Constrained by the planned economic system, historical inertia and old concepts, China’s production services, which should have been market-oriented, industrialized and socialized, have become self-sufficient services for industrial enterprises, which not only affects the development of industrial enterprises towards high end and high quality, but also inhibits the growth of service enterprises at source. For a long time, China’s manufacturing industry has practiced a vertically integrated business model, where production services are not sufficiently separated from manufacturers, but embedded in them. For example, in the 1990s, two-thirds of large and medium-sized industrial enterprises ran their own transport fleets, and almost all manufacturers of consumer durables undertook their own after-sales service for their goods.

Influenced by the mechanism of division of labor and specialization, production services are being separated from the manufacturing industry and evolving into a specific industry in the form of outsourcing, which is an important path to develop a new type of industrialization and becomes an effective way to improve the efficiency of Chinese industrial enterprises. According to Yuan and Liu (2009), outsourcing of manufacturing services significantly increases the output and market potential of the service industry, thus enhancing its development space and productivity. Liu and Xia (2018) argue that the potential of service industry development in the stage of high-quality development lies in three areas: industrial integration, service innovation and transformation and upgrading of traditional service industries. Xu et al. (2021) point out that industrial integration is an important feature of modern industrial development, and the trend of deep integration of advanced manufacturing and knowledge-intensive service industries is becoming increasingly significant, which not only promotes industrial upgrading, but also significantly improves the complexity of China’s export commodities and competitiveness in the international market.

Globalization of the service industry is unstoppable, for which the service outsourcing is a major driving force. Over the years, the scale and scope of service outsourcing has been expanding, and its content has been increasingly enriched, from information system service, software programming, home working, business process outsourcing, remote diagnosis, education and other personal services. Amiti and Wei (2009) conclude that service offshoring has a 10% explanatory power for productivity improvement in the US. The study on productive service industry (PSI) has also received increasing academic attention. Technology, communication and finance are located in the upstream of the global value chain, while marketing and after-sales services are located in the downstream of the value chain. So, PSI can use its upstream and downstream industry chain linkage to influence the manufacturing industry in the middle of the global value chain, thus generating cost-saving effects and preference complementarity effects among industries. Li et al. (2017) argue that PSI, represented by ICT and scientific research, greatly contributes to both GDP and TFP and can drive China’s sustained economic growth and quality improvement. Zhu et al. (2021) empirically find that the increase in the level of service-based manufacturing in China effectively improves the resource allocation efficiency of non-exporting enterprises and those located at the lower end of the global value chain.

4.1 Lead HQDSI by Building a High-Standard Socialist Market Economy

The report of the 20th CPC National Congress emphasized the need to “build a high-standard socialist market economy and ensure that the market plays the decisive role in resource allocation and that the government better plays its role.” HQDSI depends on the continuous improvement of the socialist market economy and has higher institutional requirements for it.

4.2 Increase the Openness of Service Industry to Push Its Reform

The report of the 20th CPC National Congress emphasizes the need to “steadily expand institutional opening up with regard to rules, regulations, management, and standards to provide guidance and direction for the institutional reform of the service industry”. Compared with the open level of the manufacturing industry, that of China’s service industry is relatively low. According to Xia (2022), certain areas in the service industry are the “deep-water areas” or “key points” for its opening up, so whether substantial breakthroughs can be made in opening up these areas determines whether the all-round opening up of the service industry can be achieved.

4.3 Promote the High-Quality and Efficient Development of Service Industry with Standardization Strategy

On July 8, 2022, sixteen central departments jointly issued the Action Plan for Implementing China National Standardization Program. The Plan set out a specific implementation roadmap. In the past, China’s industry standard codes were fragmented, and there was no clear boundary between national standards and industry standards, which caused confusion among overseas stakeholders. Simplifying and integrating these standards can reduce the complexity of the standard system and improve management efficiency. Moreover, the service economy is essentially a quality economy, and the impact of quality on the service industry is more intuitive than on the manufacturing industry. Standardization provides a basis for the evaluation of service quality, solves the problems such as lack and confusion of standards, and comprehensively improves the quality and efficiency of service industry.

4.4 Promote Innovation and Entrepreneurship in the Service Industry by Improving the Institutional Environment

The dynamism of innovation and entrepreneurship is closely related to the development of the service industry. Most of the famous innovation centers such as Silicon Valley and Hsinchu were developed in traditional agricultural areas rather than in areas with developed manufacturing industries. In general, innovation and entrepreneurship are less dependent on industrial base or mature infrastructure, less sensitive to general industrial support policies such as government tax preferences, subsidies, and incentives, but more dependent on and sensitive to institutional environment.