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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, 1990-2005
Average growth rates of business services exports, 1995-2005
Regional Distribution of Business Services Exports
223 7 9
256
79
4 11 8
380
86
10 17 12
530
171
3523 23
0
100
200
300
400
500
600
East Asia & Pacif ic South Asia Latin America & Caribbean Middle East & Africa OECDs
(in b
illio
n of
US
dolla
r)
1990 1995 2000 2005
906
Average Growth Rate of Business Service Exports for Selected Countries during 1995-2005
9.3
9.4
9.7
9.8
10.6
10.6
10.9
10.9
11.5
11.9
12.2
12.2
12.3
13.6
14.4
14.7
15.1
16.6
25.4
31.6
0 5 10 15 20 25 30 35
United States
Norway
Sweden
Mauritius
Malaysia
Morocco
New Zealand
Nigeria
Jamaica
United Kingdom
Spain
Finland
Malta
Israel
Argentina
Romania
Brazil
China
India
Ireland
(%)
The comparative advantage of several developing countries is shifting towards a range of business
services Brazil's RCA for Services Exports in Selected Categories
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
RC
A in
de
x
Other business services
Travel
Transportation
Change in RCA=236%
0
1
2
3
4
5
Other B usiness
Travel
Transportation
Others
Change in R CA=327%
India's R CA for Services Exports in Selected Categories
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
Skiil to labor ratios (%)
05
1015202530354045
Source: Amin and Mattoo (2006).
Services are more institutionally dependent
Gini coefficient (%)
0
5
10
15
20
25
30
35
40
Source: Amin and Mattoo (2006).
Human capital matters: Evidence across Indian states
Services output and Education: averages over 1980-00
OR
AP
BH
HY KNKR
TN
UPWB
GJ
MPRJ
PJ
MH
0
1000
2000
3000
4000
5000
6000
0 0.001 0.002 0.003 0.004 0.005
Tertiary educated per cpaita
Ser
vic
es
ou
tpu
t p
er c
ap
ita
Source: Amin and Mattoo (2006).
Institutions matter: Evidence across Indian states
T&D Loss and Services per capita: averages over 1980-00
BH
OR
TN
WB
PJ
KN
UP
MP
KR
GJ
AP
HY
RJ
MH
R2 = 0.45
0
1000
2000
3000
4000
5000
6000
10 15 20 25 30
T&D Losses (%)
Se
rvic
es
pe
r c
ap
ita
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)
Argentina
AustraliaAustriaBelgium
Brazil
CambodiaCanada
Chile
China
ColombiaCzech_republic
Denmark
Ecuador
Egypt
Fin land
France
GermanyGhana Greece
Hungary
India
Indonesia
Ireland
Italy
Japan
Jordan
KenyaKorea_Rep
Lithuania
Malaysia
Mexico
Mongolia
Morocco
Netherlands
New_zealand
Nigeria
Pakistan
Peru
Philippines
Poland
Portugal
Russia
Saudi_Arabia
Senegal
South_Africa
Spain
Sri_Lanka
Sweden
Tanzania
Thailand
Trinidad
Tunisia
Ukraine
United_KingdomUnited_States
Venezuela
10
20
30
40
50
60
Re
stri
ctiv
en
ess
of S
erv
ices P
olic
ies
0 10 20 30 40Per Capita GDP(thousand)
rest_ind Fitted values
GDP per capita,PPP (constant 2005 international $)
Source: Gootiiz, Mattoo
Restrictiveness of services policy: by sector and income group
Restrictiveness index: by income group
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
Lowincome
Low ermiddle
UpperMiddle
Highincome
Fin. Serv
Telecom
Retail
Transport
Professional
Restrictiveness of services policy: by sector and region, 2007
Regions: sectoral indices
0.0010.0020.0030.0040.0050.0060.0070.0080.0090.00
SAR EAP MENA LAC AFR ECA OECD
Fin. Services
Telecom
Retail
Transport
Professional
Successful reform in services is associated with more rapid growth
Linear prediction
1 8.5
-.024
.059
ITA NZL
SLV
PAN
PRT
FIN
ISL
ARG
CHE
ESP
BEL NLD
NOR USA CAN SGP
EGY
FRA
SWE
GRC
GUY
AUS
GBR
AUT
CYP JAM
BOL
DNK
MLT
MWI
CRI
ZAF TUR
MOZ
KEN
IND
MAR
VEN
MEX PHL
NIC CHL
URY KOR PER
MYS
ECU
AGO
THA
HND
COL
TUN LKA
BRA
IDN
DOM
Composite services liberalization index
Growth rate (adjusted for other factors)
Source: Mattoo, Rathindran and Subramanian (2001)
In recent years, India has radically reformed its services sectors
Newly created index of services reform
0
0.5
1
1.5
2
2.5
3
3.5
4
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Banking Insurance Telecom Transport
Newly created index of services reform
0
0.5
1
1.5
2
2.5
3
3.5
4
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Banking Insurance Telecom Transport
0
5
10
15
20
25
30
35
40 Growth Rate (CAGR)
36%
20%
FDI in Services*
FDI in Non-services
India: FDI in services sector is growing faster than in non-services . . .
(1992/93 values are indexed to 1; Unit: US$)
1992
/93
1993
/94
1994
/95
1995
/96
1996
/97
1997
/98
1998
/99
1999
/00
2000
/01
2001
/02
0
5
10
15
20
25
30
35
40 Growth Rate (CAGR)
36%
20%
FDI in Services*
FDI in Non-services
India: FDI in services sector is growing faster than in non-services . . .
(1992/93 values are indexed to 1; Unit: US$)
1992
/93
1993
/94
1994
/95
1995
/96
1996
/97
1997
/98
1998
/99
1999
/00
2000
/01
2001
/02
Which benefited the performance of downstream manufacturing industries
Gains in Annual TFP Growth After Services Reform
0
1
2
3
4
industries withlimited
dependence on banking
industries with high
dependence on banking
industries with limited
dependence on telecomms
industries with high
dependence on telecomms
Percent Gains in Annual TFP Growth After Services Reform
0
1
2
3
4
industries withlimited
dependence on banking
industries with high
dependence on banking
industries with limited
dependence on telecomms
industries with high
dependence on telecomms
Percent
New study based on panel data for 10,000 Indian firms for the 1990-2005 period finds that
banking, telecommunications and transport reforms all have significant positive effects on the productivity of manufacturing firms
Source: Arnold, Javorcik, Lipscomb and Mattoo (2008).
High Cost of Telecommunications Penalizes Trade, Especially in
Differentiated Goods
0.640.78
1.80
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2.00
homogeneous reference differentiated
Note: The chart is based on 1999 data and uses the Rauch classification of goods.
Services policy affects not just the size but also the pattern of trade in goods…
Welfare Gains from a 3% Increase in Developed Countrues' Temporary Labor
Quota
0
10,000
20,00030,000
40,000
50,000
60,00070,000
80,000
90,000
Developed Rest of the world
Unskilled Labor Skilled Labor
Note: Data in million US$
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 $1.4 billion annually even if only one in ten US patients chooses to
undergo treatment abroad.
Procedure US inpatient
price ($)
US inpatient volume
US outpatient price ($)
Estimated US outpatient
volume
Foreign price including travel cost ($)
Savings if 10% of US patients undergo surgery abroad instead of in the US ($)
Knee surgery 10,335 399,139 4,142 60,000 1,236 380,604,366 Shoulder Arthroplasty 5,940 23,300 7,931 N/a 2,204 8,704,809 TURP 4,127 111,936 3,303 88,064 2,385 27,581,317 Tubal Ligation 5,663 78,771 3,442 621,229 1,248 171,065,574 Hernia Repair 4,753 40,553 3,450 759,447 1,608 152,655,706 Skin lesion excision 6,240 21,257 1,696 1,588,884 812 151,952,860 Adult Tonsillectomy 3,398 17,251 1,931 102,749 1,010 13,588,218 Hysterectomy 5,783 640,565 5,420 N/a 1,869 250,704,845 Haemorrhoidectomy 4,945 12,787 2,081 137,213 781 23,160,663 Rhinoplasty 5,050 7,265 3,417 N/a 1,906 2,284,315 Bunionectomy 6,046 3,139 2,392 41,507 1,487 5,186,290 Cataract extraction 3,595 2,215 2,325 1,430,785 1,133 171,078,116 Varicose vein surgery 7,065 1,957 2,373 148,043 1,393 15,618,521 Glaucoma procedures 3,882 - 2,292 75,838 1,017 9,670,440 Tympanoplasty 4,993 754 3,347 149,246 1,261 31,408,685
Total savings 1,415,264,725
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
P rofession
Number of Indian professionals coming to the US annually (average for the 1995-2000
period)
Visa, examination and licensing fees
paid per professional
Average income foregone per
professional due to differential requirements
Total Income/ fees paid or lost by Indian professionals due to
regulations (US$ in million)(A) (B) ( C) (D)
Physicians and Surgeons 1092 $4,640 $100,000 114
Civil and Mechanical Engineers 683 $2,270 $60,000 43
Accountants 518 $5,600 $30,000 18
Architects 350 $3,030 $25,000 10
Total for all professionals 10234 614-768$60,000-$75,000
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
O Q M
J
P M
P D
H
P
B G
C
A F
E D
Q D
M R
M C
Q
D
F o r e i g n e n t r y i n t o a m o n o p o l i s t i c m a r k e t
Q C
Initially domestic monopoly
Foreign firm enters and each gets half the market
Price falls: PM to PD.
Gain in CS: PMACBPD
Loss in Profit: APMPD GDE
Net social gain ABC - GBED
The pattern of reform in basic telecommunications
P r o p o r t i o n o f c o u n t r i e s w i t h p r i v a t i z e d i n c u m b e n t p h o n e o p e r a t o r s ( b y r e g i o n )
0 . 0 0
0 . 2 0
0 . 4 0
0 . 6 0
0 . 8 0
1 . 0 0
1 9 8 5 1 9 9 0 1 9 9 5 1 9 9 9
A s i a
A f r i c a
L a t i n A m e r i c a
P r o p o r t i o n o f c o u n t r i e s w i t h c o m p e t i t i o n i n l o c a l s e r v i c e s ( b y r e g i o n )
0 . 0 0
0 . 2 0
0 . 4 0
0 . 6 0
0 . 8 0
1 . 0 0
1 9 9 0 1 9 9 5 1 9 9 9
A s i a
A f r i c a
L a t i n A m e r i c a
P r o p o r t i o n o f c o u n t r i e s w i t h a n i n d e p e n d e n t r e g u l a t o r ( b y r e g i o n )
0 . 0 00 . 1 00 . 2 00 . 3 00 . 4 00 . 5 00 . 6 00 . 7 00 . 8 00 . 9 01 . 0 0
1 9 8 5 1 9 9 0 1 9 9 5 1 9 9 9
A s i a
A f r i c a
L a t i n A m e r i c a
S o u r c e : W o r l d B a n k / I . T . U . T e l e c o m P o l i c y D a t a b a s e , a n d F i n k , M a t t o o , R a t h i n d r a n ( 2 0 0 1 ) , f o r t h c o m i n g .
2a. The power of competition
1.a. Mainlines
7.30%
13.80%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
privatized privatized+competition
1.b. Productivity
13.80%
31%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
privatized privatized+competition
The sequence of telecom reform in selected countries
Country 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Malaysia Privatization Competition Regulation India Privatization Competition Regulation Argentina Privatization Competition Regulation Brazil Privatization Competition Regulation El Salvador Privatization Competition Regulation Nigeria Privatization Competition Regulation South Africa Privatization Competition Regulation Uganda Privatization Competition Regulation
Source: World Bank/ITU Telecommunications Policy Database & Fink, Mattoo, Rathindran (2001), forthcoming. Note: Competition refers to the fixed-line local services segment.
Sequences matter
Source: World Bank/ITU Telecommunications Policy Database & Fink, Mattoo, Rathindran (2001), forthcoming.
Effects of sequencing mainlines
12.40%
25.50%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
Privatization before competition
Competition before privatization
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)
15.9
14.0
12.4
11.1
13.1
10.8 10.9 11.0
6.2
4.15.1
8.9
7.67.0 6.8
5.4
Public Sector Banks Old Pvt. Sector Banks New Pvt. Sector Banks Foreign Banks
Port liberalization and Breakup of Private Carrier Agreements:
Estimated Reductions in Liner Transport Prices
8.27
20.05
0
5
10
15
20
25
Liberalization of port services Breakup of private carrieragreements
equivalent to savings of $850 million
equivalent to savings of $2,063 million
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. 1991-1994: Ten new bank licenses issued1995-2001: 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