By Sarah Watson —

The ongoing negotiations for the Regional Comprehensive Economic Partnership (RCEP), a free trade agreement among countries in the Indo-Pacific, took a belligerent tone recently. Indian trade negotiators expressed their intention to take an aggressive posture on goods tariffs while its counterparts advised India to open up or leave the talks. Although many economists believe that inclusion in global value chains is necessary for India’s future growth, uncompetitive Indian industries will undoubtedly suffer a shock should India open further to trade. Widespread concerns over increasing India’s trade deficit and India’s ability to follow a path of growth through manufacturing exports mean that trade lacks a domestic constituency. Service exports are a relative bright spot in India’s trade picture, but without major investments in human resources India will struggle to grow its service exports sector and to spread the benefits to wide sections of society.

Unlike in the goods trade, where India maintains a massive deficit, service exports provide India with a modest surplus. India’s historic growth in this area provides reason for optimism that the services route could offer as promising a path to growth as the more traditional manufacturing route. (A view expressed most prominently in the 2014-15 Economic Survey.) The value of India’s information and communications technology (ICT) service exports grew from $35 billion in 2005 to more than $105 billion in 2014. ICT services alone account for more than two thirds of India’s total services exports and nearly 24 percent of India’s total exports by value added. The growth in this industry made India the 7^th-largest service-exporting nation in the world in 2014.

As significant as India’s income from service exports is, however, modern services (including ICT related services as well as banking and insurance) employ only about 5 percent of Indian non-farm workers. The success of the ICT sector also has the effect of concealing the comparatively weak growth of non-ICT service exports. The two sectors started from nearly the same base. But by 2014 the value of ICT services had risen more than 1000 percent, compared to about 700 percent for non-ICT service exports.

Furthermore, the period of explosive growth is past; growth in total service exports dropped from 22.3 percent from 2000-07 to 9.1 percent in 2008-13. Preliminary data from the Reserve Bank of India suggests that in 2015 growth in the sector nearly stopped, falling to .2 percent, down from just over 5 percent in 2013-14.

A rapidly-expanding services sector could theoretically provide a cushion for the dislocation that accompanies a changing economy — especially for the hundreds of millions of workers currently employed in the highly unproductive agricultural and unregistered manufacturing sectors. But unless India makes major changes to its educational system, the vast majority of India’s population will be unable to take advantage of a continued boom. Conversely, India’s human resources limits could cap future growth.

India’s human capital deficits severely limit the workforce available for exportable services: 84 percent of workers in the financial services and insurance sector have at least a secondary education, for instance, but only 59 percent of Indian boys of high school age, and 49 percent of Indian girls, attend secondary school at all. The 2014 Annual Status of Education Report (ASER), which measures outcomes in rural schools, found that more than 50 percent of grade 5 students in public schools could not read at the second-grade level—and that performance on this metric had actually worsened over the past several years in both public and private schools.

Poor outcomes at the primary and secondary levels are reflected in the low quality of India’s tertiary educational opportunities. India’s National Skill Development Corporation (NSDC) rates only 40 of India’s engineering colleges as top quality, 141 as second-tier, and more than 3,000 as of varying quality. A private-sector report on employability of engineers found that less than 18 percent of engineering graduates were employable in the software services sector and only 3.2 percent in the higher-value software development sector. A recent ASSOCHAM study found that only 7 percent of Indian of business school graduates are employable. These quality challenges come at a time when India is desperately trying to increase spots in college courses; if India is to reach its goal of a 30 percent college enrollment rate, it will have to add 14 million college places by 2020.

The federal government’s commitment to education, as shown in federal budget allocations, is shaky, and the Human Resources Development Ministry has focused more on ideological warfare than on building top-class institutions. State governments, which provide just under three-quarters of total spending on education, devote only 19 percent of their budgets on education, in comparison with over 30 percent in the United States. The diversity in state government approaches means that outcomes vary widely; in rural Kerala, which has historically had superior educational outcomes, two-thirds of fifth-grade students could read a second-grade text; in Madhya Pradesh the equivalent figure was 34 percent.

If India can succeed as a service exporter and expand the size of its trade surplus, its success might lead it to embrace a wider spectrum of trade. At the very least, success in services exports could cushion any short-term shock caused by lowering its barriers to goods imports. But India will not retain its hard-won competitive advantage in services without a serious investment in improving its human resources pipeline.

Ms. Sarah Watson is an associate fellow with the Wadhwani Chair in U.S.-India Policy Studies at CSIS. Follow her on twitter @SWatson_CSIS.