Currency Undervaluation and Economic Rebalancing towards Services: Is China an Exception?

The present study investigates the main determinants of the employment share of the service sector using a panel of 66 countries over the period 19832007. Based on alternative measures of currency misalignment, the study extends the literature by investigating the impact of an undervalued currency on services. The empirical findings show that together with productivity and income per capita, currency undervaluation significantly determines the total employment share of services. Another key finding is that conventional crosscountry determinants and the exchange rate undervaluation can only partially explain the underdevelopment of services activity in China and in other South-East Asian countries. In these countries, policies that aim at rebalancing the economy towards services should include elements to reform the domestic financial market, and the social security and healthcare systems.