Liberalization of Trade in Services: The Bolkenstein-Directive

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Liberalization of Trade in Services

The Bolkestein-Directive

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Historical Background2. Trade in Services3. Bolkestein-Directive4. Theoretical Analyses5. Conclusion6. References

Exam paper written by Eigner Franz

International Trade, SS06, August 2006

Universit catholique de Louvain


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International Trade: Bolkestein-Directive Eigner Franz, SS06

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1. Historical Background

After the Second World War, industrial countries agreed with each other on the idea that

economic cooperation would be the basis for peace and an instrument to promote economic

growth and development worldwide. The GATT (General Agreement on Tariffs and Trade)

was established to diminish trade barriers as tariffs and non-tariff barriers. The main concept

used to decrease barriers was the so called unconditional most favoured nation principle.

This means that conditions applied to the most favoured trading nation (i.e. the one with the

least restrictions) must apply to all trading nations.1

However, only manufactured/industrial

goods were included in these agreements and not services, which were thought to be hardly

tradable. A start has been made at the 8th round of the GATT, in Uruguay from 1986 to 1994

which extended the multilateral trading system to services, ending in setting up GATS, which

entered into force in 1995. The GATS based roughly on the same concept as the old GATT,

but for services instead of manufactured goods. However up to now there is only a small

progress in liberalization of services.

European countries themselves forced economic integration further after 45 by harmonising

standards for producers and by restricting duties on imports and exports of (manufactured)

goods between the member countries of the EU. In 1979 economic integration was further

promoted by the Cassis-de-Dijon-decision, which said that each product, which was produced

in a member country of the EU on the basis of its laws, has to be accepted by all other

member countries, also when the product doesnt fulfil domestic laws. However up to now a

single market, which means freedom of movement of all four factors of production (goods,

services, capital and labour) was only partly achieved. One further step towards a single

market is the liberalization of the service sector, which was tackled since the middle of the

90s. The last attempt concerning this was the controversial suggestion of a new directive onservices in the internal market by the former EU Commissioner Frits Bolkestein in 2004.

1www.wwlia.org/General-Agreement-on-Tariffs-and-Trade.htm, 11.08.2006


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2. Trade in services

What are services?2

A service is a good which can not be touched (like banking services, tourism services or

telecommunications), whereas a good is a tangible object (clothing, food, vehicles)

Aspects of trade in services:3

Trade in services represents not more than 20 percent of total trade up to now, but it is the

largest sector of economic production in the EU (70%) and of employment and represents

therefore an important source of employment and employment creation. Furthermore

services are typically labour intensive and can not be replaced so easily by machines, opposed

to labour in the industrial or farming sector.

Trade in services is a much more difficult concept than trade in goods. In the GATS 4 modes

of supply can be distinguished:4

o Mode 1: Cross-border trade: trade that takes place from the territory of one countryinto another, for instance e-banking. Here only services crosses the

border, not persons which is similar to normal trade with goods

o Mode 2: Consumption abroad: consumption of services in another country e.g.tourism

o Mode 3: Commercial presence: establishment of a firm from one country in theterritory of another, i.e. bank, communications, hotel group

o Mode 4: Movement of natural persons: the ability for nationals to work overseas fora temporary period. (consultancy firm, hospital, construction company)

Most important one is Mode 3 for the GATS agreements. Most of the trades in servicesrequire the presence of provider and consumer in the same place.

Why is trade in services more restricted than trade in (manufactured) goods?5

For a long time services have not been seen as tradable objects, more as domestic activities

being non-tradable for legal and institutional reasons. For instance the rail transport and

telecommunications have been viewed as classical domains of government ownership and

2 DFID: Background briefing: Services and Developing Countries3 Services: GATS. objectives, coverage and disciplines; and Wikipedia (GATS) on 11.08.20064 DFID: Background briefing: Services and Developing Countries5

The development impact of trade liberalization under GATS


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A company can provide services to consumer in another member state on the basis

of the laws of its country of establishment. As a result it facilitates the free

movement of service providers on a temporary basis to encourage cross-border

competition, to encourage individuals or companies to test other markets without

first having to establish. A popular example: a polish plumber could work in France

under Polish labour laws

o Mutual assistanceMutual assistance between member states to strengthen economic integration. For

instance it is planned that service providers will be able to obtain information and

complete administrative formalities through single points of contact in any member

state.10

Benefits according to the European Commission:11

The European commission claims that these reforms help to boost economic growth and

sustainable jobs. Furthermore cross-border competition would bring down prices and

improve quality and choice for consumers. The reforms would remove pointless red tape

and improve cooperation between national authorities in different member states to protect

and inform consumers and would replace the current wasteful duplication of national

regulations and controls.

Critics:12

The directive was criticized mainly by unions, environmentalists and left winged politicians.

They claim that a forced (cross-border) competition between all member states means

offering companies the best conditions to the debit of the consumers, which will make high

pressure on social security, product quality and environmental standards. The country of

origin principle implies that high-cost (un)qualified workers (French plumbers) would have

to compete with low-cost unqualified workers (polish plumbers), who can be engaged under

less strict laws of the country of origin. This competition will lead to decreasing wages in

more regulated, higher income-countries, for instance France and Germany and end in a

system of social dumping. What is more, the directive allows service providers from a given

member state to work in another country, but still being controlled (concerning product

quality, environmental laws ) by the country of origin. Critics say incentives therefore are

10 as above11 as above12

Attac. Die EU-Dienstleistungsrichtlinie der Bolkestein-Hammer


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small because the performances of these companies have a positive influence on the balance

of trade of the country of origin. They in general claim for a stepwise adaptation of social,

environmental and quality standards on a high level between the member states.

Revised proposal of the European commission:13

On account of the annoyance of large parts of the population in Western Europe, the

commission was forced to make some compromises in order to find an acceptable solution,

which could also pass the European Parliament. These changes strongly weakened the

directive by excluding branches like health care services, audiovisual services, social services

relating to social housing, child care, public transport and public education. The new proposal

confirms again, that the directive is limited to facilitating and simplifying the development of

services activities at EU level in those areas which are already open to competition and it

would not affect the freedom of the member states to define what they consider to be public

services. The country of origin principle was formally deleted and substituted by a more

vague law, called freedom to provide services. Labour law provisions like minimum wages

are not affected by the Directive anymore. Furthermore service providers have to be

controlled by the country of establishment, not by the country of origin anymore.

After the council found a common position about the new directive in the end of July, the next

stage will be the second reading in autumn in the European Parliament with the aim of

adopting a final text during the Finish Presidency in the second half of 2006.

4. Theoretical analyses

These analyses make use of simple theories of International Trade to explain distributive and

welfare effects of the service directive by changes in relative prices and terms of trade.We first assume that 2 kinds of goods exist which differ in their factor intensity.

Sophisticated industrial goods, which are expected to be intensive in skilled labour and

which are traded before the reform (and afterwards) and unsophisticated goods, these are

services, which are expected to be intensive in unskilled labour and are not traded before the

reform. The high-skilled labour abundant West (richer countries) is expected to have an

advantage in the production of industrial goods on account of its higher relative endowments,

whereas the low-skilled abundant East (poorer countries) is expected to have an advantage in

13FAQ on the Commission's amended proposal for a Services


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the production of services. We assume that technology differences in producing services

between the trading partners dont exist. As a consequence trade in services is not motivated

by technology differences, but by differences in factor endowments between West and East.

The effects of trade under these circumstances are captured by the Heckscher-Ohlin model. It

says that competition due to economic integration will lead tofactor price equalization, which

means that in an open economy relative factor prices (unskilled labour to skilled labour) will

converge. We can imagine trade in services as a substitute for trade in factors. Countries

(West) will export goods that are intensive in the factors, with which they are abundantly

supplied and in doing so they export indirectly their abundant production factor (skilled

labour) itself. On account of factor price equalization the return to the scarce factor (unskilled

labour) in an economy will fall, whereas the return to the abundant factor will increase.

In the West owners of unskilled labour, the service providers will suffer from real wage

losses after trade, if compensatory transfers are not feasible. The loss in real wages is large, if

labour mobility is more restricted, because then workers can not relocate to other occupations.

The real wage loss however may be softened by complete liberalization, which leads to

smaller prices for other imported services and has therefore positive income effects for skilled

and unskilled workers. In theory, the loss of real wages for the unskilled would be more than

compensated according to the Standard Trade Model under the assumption of free and

costless labour mobility within a country - by more efficient factor allocation. As a

consequence total welfare of the West would increase, further forced by beneficial effects of

increasing returns to scale, which are not captured by the Standard Trade Model.

However the terms-of-trade effect favours the East and therefore increases its welfare,

because the newly traded goods (services) can be exported at higher relative prices. After

factor price equalization in the East service providers will profit from trade on account of

higher relative factor prices in form of higher real wages whereas producers of industrial

goods have to face a loss in real wages.

The service directive (especially the Freedom of Establishment principle) can be interpreted

as an instrument towiden the range of goods that are tradable in a country, such as plumbing

services rather than an instrument to reduce tariffs. This will lead to more competition in

production of the same good, which is assumed to force a more efficient allocation of factor

endowments. However under the context of the fact that labour markets in the West are more

regulated than the labour markets in the East and on account of negative terms of trade effects

for the West, it could be that wage losses of the unskilled in the West can not be compensated


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by higher efficiency, whereas welfare of the East should benefit from an integrated service

market, especially when its assumed that its labour market is less regulated.

5. Conclusion

The results of the theoretical analyses in this paper give us some explanations for the negative

reaction of Western Europe countries like France and Netherlands towards the reform, fearing

social dumping opposed to Eastern Europe, where even Hungarys socialist minister of

European affairs, Etele Barth claims that the freezing of the service directive is unfair.14

Most economists support the new Directive, pointing to the benefits of more efficiency in

factor allocation, which could be used to help losers from trade on account of negativedistributive effects afterwards. Furthermore in general economists tend to represent the large,

but unorganized group of expected trade winners, because those who are expected to lose

from trade are generally much better organized and have no problems to make pressure on

politicians. Thus economists often act as a counterweight against this bias in political process.

Furthermore they claim that each change in a nations economy, for instance technological

progress or discovery of new resources has an impact on the distribution of wealth. However

according to them, too strict regulations which aim at softening the speed of such changes

would slow down economic progress.

6. References

Trade in Services:www.wto.org/english/tratop_e/serv_e/gsliber_e.docWTO: The development impact of trade liberalization under GATS. June 99. Last access: 11.08.2006

www.dfid.gov.uk/pubs/files/tradebrief-services.pdfDFID: background briefing: Services and Developing CountriesDepartment for International Development. March 2003. Last access: 11.08.2006

www.wto.org/english/tratop_e/serv_e/gatsqa_e.htm Last updated: 04.10.2005SERVICES: GATS. The General Agreement on Trade in Services (GATS): objectives, coverage and disciplines.

Bolkestein-Directive:http://ec.europa.eu/internal_market/services/index_en.htmEuropean Commission: Internal Market for services. Last access: 11.08.2006

www.delcyp.cec.eu.int/en/qa/MEMO-06-154_EN.pdf

14www.euractiv.com/en/agenda2004/freezing-eu-services-directive-fair-hungarian-minister/article-136602


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Frequently Asked Questions (FAQs) on the Commission's amended proposal for a Services Directive.Brussels, 4. April 2006.

http://idei.fr/doc/wp/2005/making_sense.pdfInstitut d'Economie Industrielle (IDEI): Analyses: Making sense of Bolkestein-Bashing. 27. Mai 2005

www.attac.de/bolkesteinAttac. Die EU-Dienstleistungsrichtlinie der Bolkestein-Hammer. Last access: 11.08.2006

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Liberalization of Trade in Services: The Bolkenstein-Directive