Much of the debate on economic transformation in low-income countries (LICs) has centred on moving out of agriculture and into manufacturing, but this fails to appreciate the role services can play in driving growth in developing countries. This paper examines the role of services in economic transformation, by discussing the main conceptual issues and applying these to the case study of Kenya. The analysis suggests we need to update our traditional, often negative, views on the role of services in economic transformation.

Presenting a new framework, the authors argue that services can lead economic transformation through direct, indirect, induced and second-order/productivity effects, depending on the specific services sector. Two observations are behind this positive view. Firstly, services are increasingly important for their direct contribution to gross domestic product (GDP), exports and employment. Secondly, a balanced view of services also considers their role in creating indirect effects through second-order productivity effects. However, there are potentially negative implications from too much focus on services when service sector development leads to an exchange rate appreciation.

This briefing applies a comprehensive framework of the services sector to four sectors in Kenya (financial sector, IT services, transport services and tourism services) and finds Kenya’s exports of services are buoyant in these sectors, providing real potential for growth and economic transformation, but the linkages with the domestic economy are too few.

The briefing concludes by arguing that there is a need to consider a more comprehensive role of services in economic transformation, in a way that is more complex than only examining the direct GDP or direct employment effects. The new way of looking is by examining the role of services in supporting other sectors through value chain development.