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The impact of policy heterogeneity on trade and direct investment in services. Arjan Lejour, Henk Kox. Frankenstein visits Lisbon. Why so little trade in services?. Technical reasons: most service products cannot be shipped in boxes
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The impact of policy heterogeneity on trade and direct investment in services Arjan Lejour, Henk Kox
Why so little trade in services? • Technical reasons: • most service products cannot be shipped in boxes • physical proximity of service producer and consumer often required • Alternative international supply form: setting up a local subsidiary (FDI) • Regulation-based trade barriers • Directly trade barriers (non tariff) • Non-tariff barriers caused by regulation of service markets
Regulation-based trade barriers for services • Many different types • additional diplomas, certificates, licenses, requirements on input use, marketing, local professional insurance, membership of professional association, juridical form, etc. (EC, 2002) • common element: qualification costs • Different motives for regulations: • ensure quality of the service or • reliability of the service provider • protect incumbent firms • satisfy special domestic interest groups
Nature of regulation-caused trade cost barrier • Qualification costs for service providers: mainly fixed costs • Form an entry barrier that also affects domestic service providers • Like all fixed costs, regulation-caused costs could be a source of scale economies...... if borders were open!
Main barrier for service trade: not regulation as such but regulation heterogeneity • Each country regulates in a different way • Foreign service regulation comes on top of regulation in home market • Causing fixed compliance costs, specific for that export market • Compliance costs are independent of firm size → press hardest on SME
The effects of regulation heterogeneity on trade and FDI • Prior work: OECD researchers developed relative measures of regulation intensity level per country (Nicoletti et al.) • They found negative impacts of regulation levels on bilateral trade and FDI in services • Problem with levels: two countries with same regulation level may have very different regulations in place • causes additional costs for exporters
Indicator for bilateral policy heterogeneity • For explaining bilateral trade and direct investment patterns we need a quantitative measure for bilateral policy heterogeneity • Use OECD International Regulation database • Database: 1600 regulation items • Selection of 200 items in product market regulation • For each regulation item pair-wise comparison of countries • yields a matrix of bilateral indicators for policy heterogeneity
Refinements • Heterogeneity indicator: • an indicator for regulation-caused NTBs • increases in the level of policy heterogeneity between countries • specific for each country pair • Decomposable for separate regulation domains: • Barriers to competition • Administrative burdens on startups • State control • Regulatory and administrative opacity • Explicit barriers to trade / investment
Bilateral commercial services exports (ln), 1999-2001, 480 obs
Results for trade regressions • "Traditional" gravity variables: • all were significant and had the expected signs • Heterogeneity in market regulation has a strong negative impact on bilateral trade in commercial services • strongest effect: sub-indicator for 'barriers to competition' • Several methods (OLS, FE, TLS / SUR) used for testing robustness
Results for bilateral FDI • Non-policy variables: • gravity variables all significant and expected sign • Technology variable (service productivity in origin country): significant positive effect • Heterogeneity in market regulation has significant negative impact: • strongest for regulation domain "Barriers to competition“ • and FDI restrictions • Some policy heterogeneity domains affect choice between exporting and FDI
Policy context: • EC (2004): new proposals that should boost internal service market by 2010. Principal instruments: • reduce regulation heterogeneity • Country of origin principle • abandon discriminating regulations • single point of contacts for foreign service firms • Use our regression results for quantifying possible effects of EU proposals • Close reading of proposals and establish their probable impact on heterogeneity
Simulated effect of new EU proposals on service trade and investment
Conclusions • Heterogeneity in regulation hampers trade and FDI in services • In particular barriers to competition • Analysis of effect non-tariff barriers was always elusive (NTBs difficult to quantify) • our analysis from perspective of policy heterogeneity seems fruitful • Follow-up: test its explanatory power for the OECD as a whole • Results may have implications for future GATS negotiations • More emphasis on mutual recognition