The Economics of Trade Policy Reforms in Services

1. The Economics of Trade Policy Reforms in Services “Trade in Services and International Agreements”Hanoi, Vietnam, May 23-27, 2005 CARSTEN FINK

2. Overview • Global patterns of services trade and production • What explains trade in services? • Services and overall economic performance • Elements of successful services liberalization • The role of international trade negotiations

3. Global patterns of services trade and production

4. What are services? • Key characteristics • Intangible • Invisible • Non-storable • Require simultaneous production and consumption • Require physical proximity between producers and consumers

5. Heterogeneity of services • Transport of goods and people • Financial intermediation • Communication services • Wholesale and retail distribution • Hotels and restaurants • Education and health care • Construction and environmental services • Legal, accounting, and auditing services

6. Trade: four modes of supply • Cross border supply (Mode 1): analogous to conventional trade in goods • Consumption abroad (Mode 2): consumer travels to the territory of the producer • Commercial presence (Mode 3): establishment of subsidiaries, franchises or branch offices • Movement of individuals (Mode 4): services supplied through temporary relocation of individual service providers

7. Exports of goods and services Source: WTO

8. Some figures on FDI in services • FDI in services as grown by 13 percent annually from 1990 to 2002, reaching $4 trillion • In recent years, services accounted for about two-thirds of total FDI flows • Share of services in total inward FDI stock rose to some 60 percent in 2002, from less than 50 percent in 1990 • Developing countries’ share of inward FDI stock in services rose from 17 percent in 1990 to 25 percent in 2002

9. Developing countries are becoming competitive exporters of services • Cross-border sales of services (for example, data processing, software)—increasingly possible through modern information and communications technologies • Consumption abroad—mainly tourism, but also health services (e.g., Thailand, Malaysia) • Some outward FDI in services (for example, Malaysia in telecommunications and environmental services) • Movement of individual service suppliers—professional services, software programming, low-skilled services (nurses, construction workers, domestic helpers)

10. What explains trade in services?

11. Two major explanations • Trade based on differences between countries (comparative advantage-based trade) • Trade based on different forms of increasing returns to scale

12. Comparative advantage based trade • Sources of differences • Labor costs (e.g., call centers) • Natural endowments (e.g., tourism) • Technology (e.g., health services) • Regulation (e.g., financial services) • Price differences create incentives to trade

13. Welfare implications • Standard trade theory predicts: • Gains for exporting producers and consumers • Loss for import-competing producers • Overall gains from trade if markets are perfectly competitive • Income distribution: production factor that is intensively used in exports gains

14. Trade via labor mobility Source: Bacbground paper by Copeland/Mattoo

15. Trade based on increasing returns • Comparative-advantage based trade cannot explain trade between similar countries • Sources of increasing returns: • Fixed costs combined with market niches • Firm-specific intangible assets • Networks

16. Welfare implications • Gains from trade: • Greater diversity of services • Firms can reap greater economies of scale • Transfer of technology and know how • Income distribution effects less significant

17. Services and overall economic performance

18. Share of services in GDP vs. income Source: Fink (2005)

19. Explanations for positive correlation • Demand effect: • As economies grow richer, consumers spend a larger share of income on services • Supply effects: • Increased “domestic outsourcing” of services • Faster productivity growth in goods than in services (Balassa-Samuelson effect)

20. Implications • As economies grow richer, service sector typically generates the most important generator of new employment • Pace of expansion of service sector depends on the source of economic growth • Factor accumulation versus productivity growth

21. The input role of services • Service activities are key inputs into the production of goods and other services • Inefficient provision of services acts like a tax on other producers in the economy • For exporters in agriculture and manufacturing, inefficient provision of services can lead to negative rates of effective protection

22. Services performance and trade competitiveness: the case of transport • Cost and efficiency of transport services determines export competitiveness • Higher shipping costs feed into lower wages and lower returns to capital in export ventures • Poor logistics increase inventory costs. • Large costs of shipping delays for perishable commodities and goods that are traded within multinational vertical production chains

23. Transport costs often exceed tariffs Nominal tariff Transport cost incidence Source: U.S. Bureau of Census

24. Services liberalization and growth Source: Mattoo, Rathindran, and Subramamian (2001)

25. Elements of successful services liberalization

26. Measures affecting services trade • Entry restrictions (e.g., public monopolies) • Quantitative restrictions on: • Output or market share by foreign providers (e.g., cargo reservation, capacity limitations in bilateral ASAs) • The number of individual service providers (e.g., quotas on the number of foreign workers) • The type of legal entity permitted to provide services (e.g., subsidiaries, branches) • Limitations on foreign equity ownership • Regulatory measures (e.g., qualification requirements, access to networks)

27. What are elements of successful services liberalization programs? • Phasing out of explicit barriers • Development of regulatory framework to address market failures and advance social objectives • Strengthening of competition policies • Ensure credible and stable policies • Appropriate sequencing of reforms

28. Development of regulatory framework • Address market failures • Natural monopolies and essential facilities • Asymmetric information • Externalities • Promote social objectives • Universal service

29. Need for competition policies • Importance of sunk costs and economies of scale in services may lead to concentrated markets • Private practices (e.g., liner cartels in maritime transport, airline alliances in air transport) • Opening service markets to foreign providers can promote competition • Role of competition law

30. Credibility and stability of policy • In the case of infrastructure services, service providers can initially incur substantial operating losses • Investors seek assurance that policy will not be reversed in future • Difficult trade-off between stability and necessary flexibility when circumstances change

31. Appropriate sequencing of reforms • Most reforms are gradual reforms • How to best sequence • Change of ownership from public to private • Introduction of competition • Development of regulatory framework

32. Sequencing in telecommunications Source: Fink, Mattoo, Rathindran (2003)

33. The role of international trade negotiations

34. What role for trade negotiations? • Much of the reform agenda in services is the domain of domestic policy and much can be achieved through unilateral reform • International negotiations can be helpful in: • Gaining market access abroad • Overcoming domestic resistance to reform through reciprocity-based bargaining • Pre-committing to future reform • Strengthening credibility of domestic policies. • Promoting regulatory cooperation

35. Where to negotiate? • WTO/GATS • Benefit of MFN liberalization • Regional trade agreements • Examples: EU, NAFTA, ASEAN, MERCOSUL, FTAA, numerous bilateral agreements • Are trade preferences in services feasible? • Are they desirable? • Can countries bargain more effectively?