Trade in Services and Liberalization · 2017. 4. 21. · Trade in Services and Liberalization...

World BankInstitute

Trade in Services and

Liberalization

Presentation Script

Module 01An Introduction to International Trade in Services Outline and Objectives

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Trade in Services and Liberalization

Module 01: An Introduction to International Trade in Services - Outline and Objectives Presentation Script

Overview

In this module we will study how services trade differs from goods trade, the sector’s relevance to economic growth and international trade, and the different channels through which services are typically traded.

At the end of the module, you should be able to:

• First, understand the specific characteristics and global patterns of trade in services and compare them to trade in goods

• Second, describe the central role played by services in international trade and growth, and

• Third, distinguish between the different modes of international supply of services

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What are Services?

Before we proceed further, it will be useful to get a more precise idea of what we are talking about.

Services have often been described as:

• “something you can buy and sell but cannot drop on your foot”

• or: “an economic activity that adds value either directly to another economic unit or to a good belonging to another economic unit”.

Services Value Added as Percentage of Total GDP

Services pervade our lives, from the transport of goods and people, to financial intermediation, communications, hotels and healthcare, to name just a few.

No sector of the world economy has grown as fast as services. In this graph, the dotted line shows us that the value added generated by services grew from about 53% of the global Gross Domestic Product in 1970 to 70% of the global GDP by 2008.

As households and firms increasingly source out the services they once provided for themselves, the services or “tertiary” sector has dramatically increased its share of economic output and employment.

Technological changes, such as IT based innovation in distribution, the rise of the Internet, and the hub and spoke model for transport have contributed to the increased tradability and gains in efficiency in the services sector.

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Income per Capita and Share of Services in Economy

The services sector is generally more developed in high income developed countries than developing ones.

This graph, using information from the World Bank Open Data webpage, shows that the share of the services sector to a country’s Gross Domestic Product – GDP ‐‐ increases with its level of economic development, as measured by GDP per capita along the horizontal axis. For the high income countries, in the top right corner, services play a central economic role, often over two‐thirds of the economic activity, that is a key to their development process.

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Services as a Channel for Growth

Efficient services not only confer a direct benefit to consumers, but also help to shape a country’s overall economic performance. An effective services sector facilitates economic transactions through space, particularly for communication and transport services, as well as over time, thanks to financial and insurance services.

A well‐regulated financial sector leads to a better allocation of capital and better risk sharing throughout an economy. It also contributes to a more efficient transformation of savings to investment. For their part, telecommunications generate economy‐wide benefits as a vital intermediate input to the production of firms and government services. Similarly, transport services contribute to a more efficient distribution of goods within a country.

Services are not only important direct inputs into the production of goods and services, but also are essential determinants of the productivity of production factors. Much like financial services matter for the efficient use of capital, higher education and health services are essential for research and development and overall productivity of the labor force. Telecommunications are also crucial to the dissemination and diffusion of knowledge.

These considerations confirm the intuition of the previous slide. Developing economies should have a strong interest in improving their services sector in order to initiate and sustain economic growth across other aspects of their economies.

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Trade in Services: Do Standard Concepts Apply?

Unlike goods, we cannot drop services on our foot. Services are neither tangible nor storable.

As such, they usually require simultaneous production and consumption, which in turns requires proximity ‐‐ either in time or space ‐‐ between the consumer and the producer. This implies that services are often traded internationally differently than goods. Frequently, the producer or the consumer has to physically move for the international transaction to take place, which is not the case for goods.

Therefore, the conventional view of trade, in which only the product crosses an international frontier, is insufficient to explain a whole range of services trade.

Growth in World Exports of Goods and Services Compared

Services have not only grown as a share of domestic economies, as we earlier saw, but also as a share of world trade. Statistics from the World Trade Organization reproduced in this slide indicate that the growth rate of services exports has outpaced that of goods exports, to grow 10‐fold over the past three decades.

Moreover, the services trade volume reported in this graph accounts only for services that are directly traded. This volume would double if it also included input content to the production of traded goods.

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Developing Countries Remain Small Services Exporter on Average

Trade in services has been especially important to low and lower middle income countries. They have seen their share of world services exports increase from 14 per cent in 1985–89 to nearly 37 per cent in 2006 to 2009.

However, developing countries remain very small players internationally: on average, any developing country accounts for only a 0.08% share of the world’s services exports.

Furthermore, for all regions outside the OECD except South Asia and India, the average country share of world trade in services is lower than the corresponding average share of world’s trade in goods. This suggests that rich economies’ trade is specialized more towards services than their developing country counterparts.

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Summary

So far we have seen that:

• The service sector comprises almost half of the GDP in developing countries and 70 percent of GDP in OECD countries.

• It makes up a quarter of total world cross‐border trade and has been growing at a faster rate than goods trade for the past three decades.

Illustrating the importance of trade in services, services trade has been more resilient than goods trade during the global financial crisis, both in rich and poor countries. Also, more than half of foreign direct investment flows each year come in the form of services.

Mode of Supply 1: Cross – Border Trade

Before moving forward with our understanding of services trade, we must first get a more thorough look at how services are supplied internationally. As we now know, services can be traded differently than goods are, and you have perhaps already heard about the four different modes of international supply of services. Understanding each of these four different modes of supply matters, as they each have varying economic, political, and legal significance.

The four different modes of international supply of services are commonly referred as mode 1 to mode 4 of supply. Their definition and numbering comes from the World Trade Organization’s General Agreement on Trade in Services.

Let’s start by considering here the 1st mode of supply: “cross‐border trade”.

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As with goods, the international supply occurs through the shipping of the service from Home to Abroad. Note that the services must cross an international border, depicted by the brick wall in this slide.

A user abroad receives the service at home through his telecommunications or postal infrastructure. Such supplies may include consultancy or market research reports, tele‐medical advice, distance training, or architectural drawings.

Mode of Supply 2: Consumption Abroad

The next diagram illustrates mode 2, also called “consumption abroad”.

In this instance, consumers move abroad to consume the services. Foreign nationals travel from abroad as tourists, as students, or as patients (the move being represented

by the dotted line) to consume the respective services (the service provision, the red arrow, taking place at home). Here, take note that the consumer of the service travels across an international boundary. This differs from Mode 1, where the service moves.

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Mode of Supply 3: Commercial Presence

The third mode of supply is called “commercial presence”.

The service is provided abroad through a locally‐established affiliate, subsidiary, or representative office of a home‐owned and – controlled company. This requires prior establishment abroad (represented by the dotted arrow on the graph). This is common with banks, hotel groups, and construction companies who provide services abroad to consumers abroad. This differs from mode 1 and mode 2 because, in this case, the service provider moves across the international boundary.

Note that this involves foreign direct investment (hence the addition of a dollar symbol on the graph) and generally also requires the movement of individuals. The provision of service takes place abroad.

Mode of Supply 4: Temporary Movement of Natural Persons

Finally, mode 4 of supply is called the “temporary movement of natural persons”.

A foreign national provides a service abroad as an independent supplier (such as a consultant or a health worker) or an employee of a service supplier (such as a consultancy firm, a hospital, or a construction company). For this to occur the foreign national travels abroad.

It is important to note that the movement of the home person is temporary, unlike the case of more permanent migration.

To review, take a minute to remind yourself how each mode of supply differs. In other words, what has to cross the border in each instance?

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Differences between Modes of Supply

Mode 1 requires that the service crosses the border from the country of supply to the country of consumption. Mode 2 requires that the consumer moves from home to the market of the service provider, and mode 3 requires that the service provider set up an establishment in the market of the consumer. Finally, mode 4 requires that the person who provides a service travel to the consumer in order to provide it.

Global Importance of Different Modes of Services Exports

Until recently one had only a vague idea of the relative importance of each mode of provision of services in international trade. Recent work by Professor Joseph Francois has shed some light on the issue, showing that mode 1 (cross border trade) and mode 3 (commercial presence) are the main channels of this type of trade.

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Interestingly, mode 4, which garners much political interest in many developing countries, represents only a small share of global trade.

Of course, these data differences may also reflect the extent of trade barriers with particular modes of supply.

We also can see that the increase in trade in each mode since 1997 has been sizable, but not at the same rate across each mode. Cross border trade has increased the most which may reflect the impact of the telecommunication revolution during that timeframe.

Modes of Supply as Substitutes

An important consideration when thinking about the different modes of supply in services is the question of how these different modes of supply interrelate.

The various modes of supply, mode 1, 2, 3 and 4, can indeed become substitutes to each other in some services sectors.

For example, a home customer could buy an electronic insurance contract abroad so that the service is exported cross‐border (mode 1) by internet. Alternatively, the foreign insurance company could set up a physical local branch office to serve new customers there, such that the home clients would deal with a nearby office (mode 3).

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Once the foreign insurer has been established at home, it could also send agents from its headquarters in order to settle claims abroad. In other words, the insurer could rely on temporary movements of natural persons (mode 4). Alternatively, home personnel could assess the claims remotely (mode 1).

This example shows that different modes of supply can achieve relatively similar outcomes as a claim is assessed in each case.

Medical services are another example. A specialized surgical team could come from abroad to perform surgery in the home country; alternatively the home patient could go abroad to receive that same treatment. Again, what are the different modes of supply entailed here?

Modes of Supply as Substitutes

If you thought mode 4 for the surgical team relocating and mode 2 for the traveling patient, you are correct.

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Modes of Supply as Complements

We just saw examples of modes of supply as substitutes. However, modes of supply may also be complementary to each other.

For example, if a firm chooses to have a physical presence in a foreign market, then it may be best served by personnel who are allowed to move from the home to its foreign offices.

From a policy perspective, the implication is that a restriction on any of these three modes can be detrimental to the cost or quality of the overall service provision, even if the other modes of supply are liberalized.

Services are also complementary with goods trade. For example, the export of goods requires transportation and insurance services. It may also require the establishment of distribution networks, facilities to deal with repairs or with training of customers in the use of products. Hence in some cases the potential gains from goods trade cannot be fully realized without a similar liberalization of service trade.

Conversely, the liberalization of goods trade, such as in computers, may well be a condition for realizing the benefits of services trade.

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What Drives Trade in Services?

To conclude this module, we briefly examine the main motors of trade in services.

Whether for goods or for services, the two predominant explanations for trade between countries consist of either:

• the existence of comparative advantage (which draws upon fundamental differences in factors of production between countries), or

• by gains from economies of scale in one firm or location (which explains trade between similar countries).

Trade in services in the following examples arises from comparative advantage:

• call centers in India provide customer services for US firms;

• nannies from the Philippines move to Canada temporarily to provide childcare services; and

• Europeans travel to Peru for a week in the jungle as part of an eco‐tourism package.

First recall that in each of these examples, trade takes place via a different mode: the call center services are sent across a border by telephone; the nannies travel to a foreign country to provide their services; and the eco‐tourism consumers engage in consumption abroad.

Each example has, however, something in common. Trade is driven by differences between the home and abroad countries. Trade in both child care and in call centers services are driven by differences in labor costs across countries. Consider too that the Amazon has unique attributes that are not available to be consumed at home by the European tourists.

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Trade between Similar Countries

While differences between countries are one of the major explanations for trade, particularly between countries with very different income levels, they cannot account for all trade. Much of the world’s trade occurs between high‐income countries, and there is also a growing trade between developing countries. This suggests that similarities between countries need not deter trade. In fact much of the trade between similar countries is in similar products. For example, Canadian engineers work on projects in the U.S., and U.S. engineers work on projects in Canada. One way to think about how trade can emerge between similar countries is to consider the following example. Think of two equally bright and talented students starting university at the same time. At this point their productive capacities may seem indistinguishable, until one chooses to study medicine and the other chooses to study engineering.

Ten years later, they will have very different skills which they can trade with each other in the labor market. The doctor can sell her medical services and the engineer can sell her engineering services. First, the students enjoy gains from specialization but these are not due to an initial comparative advantage. Second, students cannot afford to learn both medicine and engineering because this would be prohibitively costly in their time and their tuition fees. It makes the most sense for each to specialize in different fields and to then exchange those respective services.

Third, because the fixed cost of investing in education is an up‐front investment, there is an element of lock‐in once the investments in education have been made. It is then very costly to switch fields. History matters, and decisions made in the past (including past government policies) have a large influence on current patterns of trade and apparent comparative advantages in services.

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More generally, imperfect competitions – markets where barriers to entry and exit are high and where the number of suppliers is potentially limited – feature prominently in services sectors. This has, as we will see, important implications for the understanding of services trade liberalization.

Parting Thoughts

This concludes our first module.

We have seen that services are an indispensable ingredient of economic growth, comprising almost half of GDP in developing countries and 70 percent of GDP in OECD countries. The pervasiveness of services in fast growing economies renders essential the efficient supply of services. International trade in services is one way to benefit from access to efficient services from suppliers abroad and to take advantage of new export opportunities. However trade in services is vastly different from goods. The uniqueness of services requires policy makers to take into account new dimensions:

• There are four modes of international supply of services: cross‐border trade, consumption abroad, establishment abroad and temporary movement of natural persons

• Modes of supply can take place concurrently, so interaction among the different modes of supply matter, depending on whether substitution or complementarily among the modes occurs. The interaction between services and goods trade also matters.

We will now turn to the measures and effects of policies to restrict some or all modes of supply in a few important services sectors.

Trade in Services and Liberalization · 2017. 4. 21. · Trade in Services and Liberalization...

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