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

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. Source: WTO Exports of goods and services

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 Transport cost incidence Nominal tariff 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. 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 Credibility and stability of policy

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

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?