Economics of Trade in Services Aaditya Mattoo July 2008

Four questions: I.What is trade in services, how is its pattern determined? II.What are the barriers to trade and how big are the gains from eliminating them? III.What are the elements of successful reform of services trade policy? IV. What do international negotiations offer?

I.What is trade in services, and what determines its pattern?

What are Services ? 1.Business services 2.Communication services 3.Construction services 4.Distribution services 5.Educational services 6.Environmental services 7.Financial services 8.Health-related and social services 9.Tourism and travel- related services 10.Recreational, cultural and sporting services 11.Transport services

A wide definition of trade MODES 1. Cross-border Trade 2. Consumption Abroad 3. Commercial Presence 4. Movement of Natural Persons EXAMPLE Software, insurance or tele- diagnosis from country B into A A’s resident obtains hospital treatment or education in B Bank, telecommunications firm or hospital from B sets up subsidiary in A Engineer or doctor from B provides services in A

Determinants of Trade I: Comparative Advantage –Trade caused by differences between countries in technology, endowments, institutions (legal systems, regulatory systems) –Endogenous vs. exogenous differences; short run vs. long run –E.g. North-South trade in business services

Motives for Trade II: Increasing Returns to Scale Differences cannot explain all trade –Much trade occurs between similar countries New theories of trade rely on increasing returns to scale and the love of variety –North-North trade in banking and transport services –Agglomeration of film-making and software

Mode 1: Shared interest in cross- border trade in business services Regional distribution of business services exports, Average growth rates of business services exports,

The comparative advantage of several developing countries is shifting towards a range of business services Change in RCA =236%

But most developing countries are not participating The exports of 70 small and poor countries have stagnated, and their share of world services trade has halved.

Fragmentation of goods

Fragmentation of Services Hospital service fragments –Call Centre for customer service, etc. –Medical transcription services –Payroll management –Web hosting services / application service providers (ASPs)

Many services tend to be skill intensive Source: Amin and Mattoo (2006).

Services are more institutionally dependent Source: Amin and Mattoo (2006).

Human capital matters: Evidence across Indian states Source: Amin and Mattoo (2006).

Institutions matter: Evidence across Indian states Source: Amin and Mattoo (2006).

II. What are the barriers to trade and how big are the gains from eliminating them?

Trade Barriers in Services Tariffs are relatively uncommon. Why? Quotas are pervasive –Limits on the number of foreign firms; limits on percent foreign ownership in banking, insurance, etc. –Foreign providers completely shut out in some sectors (transport within a country) –Foreign exchange restrictions can limit consumption abroad (tourism, education) –Limits on movement of foreign personnel –Local content requirements in broadcasting

Trade Barriers (2) Discriminatory measures –Preferential taxes and subsidies –Preferential procurement –Preferential access to essential facilities Non-discriminatory measures –Qualification and licensing requirements –Qualification and licensing procedures –Technical regulations

Barriers to Services Trade and Investment (Preliminary results of survey of 56 countries, 2007)

Restrictiveness of services policy: by sector and income group

Restrictiveness of services policy: by sector and region, 2007

Successful reform in services is associated with more rapid growth Source: Mattoo, Rathindran and Subramanian (2001)

In recent years, India has radically reformed its services sectors

Which benefited the performance of downstream manufacturing industries New study based on panel data for 10,000 Indian firms for the period finds that banking, telecommunications and transport reforms all have significant positive effects on the productivity of manufacturing firms Source: Arnold, Javorcik, Lipscomb and Mattoo (2008).

Services policy affects not just the size but also the pattern of trade in goods…

Note: Data in million US$ Source: Walmsley and Winters (2002)

Growing role of implicit impediments Two examples: Non-portability of insurance: impedes trade in health services Qualification requirements impede trade in professional, and hence education services

Imperfect portability of insurance inhibits trade in health care A range of health care services are tradable. But existing health insurance plans explicitly or implicitly discriminate against treatment abroad. Consumer choices would not be distorted if reimbursement were independent of the location of the provider and based on the full costs of treatment including travel costs. An international price comparison of 15 low-risk, highly tradable procedures reveals potentially big savings.

The US could save over $1.4 billion annually even if only one in ten US patients chooses to undergo treatment abroad. Source: Mattoo and Rathindran (2005)

Obtaining a License to Practice In the US, professional licensing is generally the responsibility of state boards. The steps involved in getting a license are: 1. The verification of educational qualifications, training and experience to establish eligibility to take the professional examination 2. The remedying of any gaps in education, training and experience before taking (all or part of) the examination, with the remedial steps to be taken in large part in the United States. 3. Passing the professional examination(s), held entirely or in significant part in the US 4. The fulfillment of additional requirements, such as experience or local residency, in order to obtain a professional license

The excessive regulatory burden The fundamental regulatory problem is non- recognition of qualifications, training and experience From this problem stem: –Costly and time-consuming evaluation of prior qualifications –Costly and time-consuming examinations –Requirements to repeat education and training and acquire additional experience – often only in US locations, by obtaining US visas

Foreign professionals pay a large regulatory tax in order to practice in the US – not accounting for necessary requirements Source: Mattoo and Mishra (2006)

III. What are the elements of successful reform of services trade policy?

III. The elements of successful reform a. Emphasis on competition b. Effective domestic regulation c. Appropriate sequencing

Partial reform: the persistence of barriers to entry Initially domestic monopoly Foreign firm enters and each gets half the market Price falls: P M to P D. Gain in CS: P M ACBP D Loss in Profit: AP M P D GDE Net social gain ABC - GBED

The pattern of reform in basic telecommunications

Sequences matter Source: World Bank/ITU Telecommunications Policy Database & Fink, Mattoo, Rathindran (2001), forthcoming.

Effective regulation (i) To remedy informational problems (e.g. in financial and professional services) (ii) To remedy market power (e.g. in transport and energy services) (iii) To achieve social objectives (e.g. universal access in transport, telecom, financial and health services).

Poor competitive position of public sector banks: NPAs Gross NPAs of SCBs as of March 2002 (% of total lending)

Regulation to protect consumer interests

A key challenge: harnessing trade and investment liberalization to advance social goals Conflicts between efficiency and equity could arise as, e.g.: essential services are liberalized services exports increase standards gravitate towards international levels What are the most efficient instruments to attain social goals in different areas?

Openness has not always improved access, e.g. in Zambia in financial services Banking was liberalized before establishing a proper regulatory framework.  : Ten new bank licenses issued  : Nine bank failures, causing estimated losses equivalent to 7 percent of GDP. Foreign banks today account for over two thirds of total assets, loans and deposits.  But credit to the private sector is only 8 per cent of GDP - lower than in 1990 and in most other Sub- Saharan African countries.  Only 5,000 people hold 90 percent of loans. Source: Mattoo and Payton (2007)

What are the efficient instruments for widened access? Command vs price interventions vs fiscal Trade-offs between regulation and access Synergies between sectors Informed by: State of technology Political economic context Institutional development

The long term consequences of flawed sequencing Economic In banking, allowing new entry without creating a mechanism to sift the sound institutions from the dubious led to disruptions that have had a durable effect on financial development. Liberalizing markets for agricultural output before the development of markets for services inputs like transport, had a durable effect on agricultural development. Political The failure to ensure that the benefits of liberalization are widely shared by implementing policies to widen access has made reform undesirable and unsustainable

Example: successful infant industry protection or costly coercion in agricultural distribution? Trends in Imports of Select Food Products from South Africa to Zambia Source: UN Comtrade data; data obtained from the Central Statistical Office in Lusaka. Note: The first Shoprite store in Zambia was opened in October 1995.

IV. What do international trade negotiations offer?

Three potential benefits Deeper liberalization through reciprocal exchange of concessions Credibility through binding commitments Regulatory cooperation

The Political Economy of Reform and International Engagement Four examples: Telecommunications Banking Accounting Transport

Potential Costs of Trade Agreements Service trade agreements can be much more complex and intrusive into domestic policy than were agreements on goods trade Trade agreement requires trade-offs between policy flexibility, domestic sovereignty and market access for foreign service providers Governments need to ensure that they retain enough policy flexibility to address market failures and internal income distribution objectives