86024 Regulatory Assessment Toolkit Regulatory Assessment Toolkit A Practical Methodology for Assessing Regulation on Trade and Investment in Services Martín Molinuevo Sebastián Sáez © 2014 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 17 16 15 14 This work is a product of the staff of The World Bank with external contributions. Note that The World Bank does not necessarily own each component of the content included in the work. The World Bank therefore does not warrant that the use of the content contained in the work will not infringe on the rights of third parties. The risk of claims resulting from such infringement rests solely with you. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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Regulatory Assessment Toolkit: A Practical Methodology for Assessing Regulation on Trade and Investment in Services. Washington, DC: World Bank. doi: 10.1596/978-1-4648-0057-3. License: Creative Commons Attribution CC BY 3.0 Translations—If you create a translation of this work, please add the following disclaimer along with the attribution: This translation was not created by The World Bank and should not be considered an official World Bank translation. The World Bank shall not be liable for any content or error in this translation. All queries on rights and licenses should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. ISBN (paper): 978-1-4648-0057-3 ISBN (electronic): 978-1-4648-0058-0 DOI: 10.1596/978-1-4648-0057-3 Cover design: GSD, World Bank. Library of Congress Cataloging-in-Publication Data has been requested. Contents Foreword ix Acknowledgments xi About the Authors xiii Abbreviations xv Overview 1 What Is Trade in Services and How Is It Regulated? 1 Why Is Trade in Services Important for Developing Countries? 2 What Is a Regulatory Assessment of Services Trade and Investment (RASTI)? 3 Notes 9 References 10 Policy Framework for Regulating Trade and Investment in Services 11 Objectives 11 Economic Rationales for Regulation 12 Noneconomic Rationales for Regulation 16 Challenges to and Principles of Regulation 18 Conclusion 21 Notes 22 References 22 Module 1 Mapping Regulations and Evaluating Governance 23 Objectives 23 Mapping Laws and Regulations Affecting Services Trade and Investment 23 Assessing the Governance Framework 28 Conclusion 34 References 34 Module 2 Assessing the Impact of Services Regulations: A Review of Empirical Methods 35 Objectives 35 Direct Methods 36 Indirect Methods 49 Prospective Analyses: CGE Models 51 Annex 2A 52 Conclusion 52 Notes 56 References 56 Module 3 Identifying Alternatives in Regulatory Strategies and Measures 59 Objectives 59 Regulatory Strategies 60 Making Regulation Less Burdensome 66 v vi Contents Meeting Political Economy Challenges 72 Conclusion and Policy Implications 74 Notes 75 References 75 Appendix A: Professional Services 77 Objectives 77 Shortages and Skills Mismatches in the Market for Professionals 77 Distortions in the Market for Professional Services 78 Policy Challenges 80 Implications for Policy Action 85 Conclusion 87 Note 87 References 87 Appendix B: Information Technology–Enabled Services 89 Objectives 89 Technological Change and the Growth of the Sector 89 Determinants of Success 90 Barriers to Trade 94 Assessment of Telecommunications Regulations 95 Conclusion 96 Note 96 References 96 Appendix C: Financial Services 97 Objectives 97 Who Regulates Financial Services? 97 How Is the Financial Sector Regulated? 98 Conclusion 102 References 102 Glossary 105 Boxes O.1 What Are Services? 2 PF.1 Regulatory Solutions to Information Problems in Selected Markets 15 PF.2 Regulation for “Public Interest” under International Trade Agreements 17 PF.3 Institutional Limitations Affecting Regulator Capacity in Developing Countries 19 PF.4 Good Regulatory Principles: Excerpts from the APEC–OECD Integrated Checklist on Regulatory Reform 20 PF.5 Regulatory Failures in Infrastructure Services in Selected Countries 21 1.1 Barriers to Trade in Services in Cambodia 30 1.2 Policy-Making Benefits of Effective Intragovernmental Coordination 31 2.1 Principal Component Analysis of the Electricity Sector 40 3.1 Regulatory Impact Analysis 60 3.2 Using “Yardstick” Competition in Monopolistic Markets 70 3.3 Adopting Alternative Regulatory Strategies in the Retail Distribution Sector 72 3.4 Political Economy Analysis at the Country Level 73 3.5 Political Economy Analysis at the Sectoral Level 74 A.1 Key Developments Affecting the Regulatory Environment for the Accounting Sector 82 A.2 The World Bank’s Professional Services Knowledge Platform for Eastern and Southern Africa 86 C.1 Assessment of Compliance with Individual Core Principles 99 Contents vii Figures O.1 Horizontal, Sectoral, and Service-Level Analysis of a Regulatory Assessment of Services Trade and Investment (RASTI) 5 O.2 Three Steps of a Regulatory Assessment of Services Trade and Investment (RASTI) 7 1.1 Module 1 of a Regulatory Assessment of Services Trade and Investment 24 1.2 Information Flow for Policy on and Regulation of Trade and Investment in Services 32 B2.1.1 Identification of Clusters of Countries through Principal Component Analysis of Regulations in the Energy Sector 41 2.1 Regulatory Indexes for Engineering Services in Selected Economies 47 2.2 Tariff Equivalents and Regulatory Indexes in Engineering Services in Selected Economies 48 3.1 Degrees of Intervention of Mandatory Regulation 61 A.1 Determining Whether Education and Migration Policies Contribute to Skill Shortages and Mismatches in Professional Services 79 A.2 Determining Whether Trade Barriers, Domestic Regulation, and Migration Policies Contribute to Skill Shortages and Mismatches in Professional Services 81 A.3 Regulatory Models for Legal Services 83 B.1 World Production of Information Technology (IT) Services, 2000–12 90 C.1 Exports of Total Services and Financial Services, 1986–2011 98 C.2 World Bank Services Trade Restrictiveness Index, by Region, 2008 102 Tables O.1 Advantages and Disadvantages of Selected Regulatory Strategies 9 PF.1 Key Regulatory Issues and Modes of Supply in Selected Services Sectors 12 PF.2 Policy Goals and Approaches to Ensuring Competition in Services by Regulating Monopolies 13 PF.3 Examples of Regulatory Interventions for Dealing with Market Failures 14 PF.4 Noneconomic Regulatory Objectives and Common Interventions 16 1.1 Measures Affecting Trade and Investment in Services in Kingdom of Uqbar 25 1.2 Parameters for Evaluating Services Regulation 26 1.3 Measures Affecting Trade and Investment in Services, by Stage of Supply 27 1.4 Sample Questions for Collecting Information for a Regulatory Mapping 29 1.5 Sample Questions for Mapping the Governance Framework 33 2.1 Sources of Information on Regulatory Measures Affecting Trade and Investment in Services 37 2.2 Scoring Regulations in the Banking Sector 38 2.3 Assessing Banking Regulations Based on a Two-Dimensional Taxonomy 39 2.4 Assessing Regulations in the Telecommunications, Engineering, and Banking Sectors Based on the Mode of Supply 39 B2.1.1 Identification of Factors through Principal Component Analysis of Regulations in the Energy Sector 40 2.5 Regulatory Indexes for Engineering Services in Selected Countries, by Mode of Supply 44 2.6 Taxonomy for Classifying Regulations of Engineering Services 45 2.7 Scores and Weights Used in Nguyen-Hong’s Study of Regulation of Engineering Services 45 2.8 Weighted Average Markups in Manufacturing and Services Sectors in Selected Economies, 1981–2004 51 2A.1 Selected Studies Estimating the Impact of Regulation on Services Trade Using Direct Methods 52 2A.2 Selected Studies Estimating Impact of Regulation on Services Trade Using the Gravity Approach 55 2A.3 Selected Studies Estimating Impact of Regulation on Services Trade Using the Markups Approach 56 3.1 Regulatory Strategies: Trends and Weaknesses 65 3.2 Modifications to Common Regulatory Measures to Decrease Their Restrictiveness 67 B.1 Internationally Traded Information Technology–Enabled Services 90 B.2 Frameworks for Assessing Locations for Information Technology–Enabled Services 92 B.3 Illustrative Cost Structure for Information Technology (IT) and Business Processing Outsourcing (BPO) Services 93 C.1 Trade-Related Regulatory Assessment of Financial Services 98 Foreword In recent years, services tradability has increased. Services that previously required the physical proximity between the consumer and the producer can now be delivered across borders. As technology opens new channels for international trade in services, laws and regulations become more and more relevant in supporting this economic activity and setting the conditions for its success. Domestic regulations, such as limitations on foreign participation, monopoly rights, and laws that limit the temporary movement of people, directly affect the provision of services. Economic reforms that have privatized and deregulated industries over the last two decades have allowed for the greater participation of private providers, both national and foreign, in services such as telecommunications, finance, and trans- port. Other services, such as professional ones, which have traditionally been supplied by the private sector, are increas- ingly being exposed to international competition, expanding the variety and quality of services offered. But countries’ legal and regulatory frameworks have not kept pace with these vast market (and policy) transformations. Now is an opportune time for countries to modernize their regulatory regimes and reap the economic and social benefits of increasing trade in services. Most administrations, especially in developing and least developed countries, face a number of constraints in adopt- ing this agenda of modernization. First, reviewing a regulatory framework is a time- and resource-consuming task that requires highly technical knowledge. Second, most developing countries have limited skills and human resources to put in place new, independent, regulatory agencies, and at the same time maintain capacity to define broad policies in ministries that are often sector based. Finally, assessing the impact of existing regulations and designing suitable alternatives requires a careful balance between technical feasibility, trade impact, and policy goals. Achieving this balance is challenging for countries at all levels of development. The question is not whether to regulate, but how to do so in a way that maximizes policy objectives and economic benefits. Not only can a well-designed regulatory framework for services trade help prevent market failures and achieve legitimate policy goals, it can also promote access to low-cost and high-quality services to benefit the poor, increase com- petitiveness, and foster growth. Moreover, with rapidly changing technology—in particular, information and commu- nication technology innovations—there is an ongoing need to reassess the existing regulatory environment to take full advantage of the new opportunities opened by services trade, to diversify the economy, and to participate in global value chains. Services trade costs are still significant, despite technology and reforms. Regulations that affect trade—including those that aim to achieve legitimate policy objectives such as safety, health, and consumer protection—can also create unneces- sary barriers to trade, reducing welfare and potential growth opportunities. By some estimates, the trade costs caused by regulatory measures can be two to three times higher in services than for trade in goods. One objective of this toolkit is to help countries mitigate these costs. The toolkit is designed to assist policy makers, reg- ulators, and experts in assessing their countries’ regulatory environments. It proposes a three-step approach to the reform of services regulations. The first step is to map all regulations that affect a wide range of activities; this might include, for example, cataloguing the laws and regulations that affect investment, labor, and migration. The focus is not only on formal regulations but also on the administrative practices that determine how the regulations are applied. Many countries have state-of-the-art regulations on the books, but allow wide discretion in their application. This creates uncertainty, instabil- ity, and regulatory risks. In other cases, the institutional setting is weak, which undermines enforcement. In that situation, the regulations and their administration might be adequate, but the capacity to enforce those regulations may not exist. ix x Foreword Because this is a de facto barrier to trade, the methodology includes an assessment of countries’ regulatory institutional settings. The toolkit’s second step helps policy makers understand how significant their country’s services regulations are and the impacts of those regulations on the economy and business environment. While acknowledging the constraints of often- inadequate data, the toolkit reviews the empirical literature on the impact of services regulations. This analysis helps users provide information on prices and costs, levels of competition, and market structure. It also enables them to benchmark their countries’ service performance. Quantifying the benefits and costs of maintaining or implementing services regula- tions is crucial to well-informed decision making and reform. The ultimate goal of the regulatory assessment is to encourage countries to adopt better regulations. The third and final step of the toolkit helps countries identify alternatives to the existing regulations. Using the information gathered and the analysis performed, the toolkit steers users—without being prescriptive—toward viable regulatory alternatives that reduce unnecessary restrictions to services trade. It does so by considering the policy goals of the existing measures, the impact they have on the domestic services sector and foreign services suppliers, and the institutional and market context in which the measures operate. Because the regulatory alternatives are largely context-specific, the toolkit discusses options adopted by other countries, including the adoption of internationally recognized best regulatory practices. Policy makers, regula- tors, and experts should be mindful of a country’s capacities when assessing which regulatory options are viable. Assessing the services trade regulatory environment can be burdensome. The toolkit acknowledges the information- and time-intensive nature of applying the proposed methodology. In order to partially overcome this hurdle, the meth- odology can be used in a modular way. The user can focus on specific, priority issues by mapping related regulations, assessing their impact, or assessing possible regulatory alternatives. The careful balance between policy goal and economic impact, and the strong focus on a data- and information-driven approach make this toolkit a valuable contribution to the modern regulation of services trade. Its guidance can help policy makers design regulatory frameworks that support competitiveness and shared growth and help their economies harvest the gains from international trade in services. Jeffrey D. Lewis Director Economic Policy, Debt, and Trade Poverty Reduction and Economic Management Network The World Bank Acknowledgments The Regulatory Assessment Toolkit is the result of the work undertaken at the World Bank’s International Trade Unit, Poverty Reduction and Economic Management Network of the World Bank (PRMTR). The toolkit was prepared by Sebastián Sáez (Task Team Leader) and Martín Molinuevo, with contributions from Carolina Lennon (module 2) and Ben Shepherd (module 3). Appendix A on professional services is based on the work carried out by Nora Dihel. The team is particularly indebted to Nora Dihel whose constant support and intellectual generosity was invaluable. Appendix B on information technology– enabled services is based on input provided by Michael Engman and Randeep Sudan, and appendix C on trade in financial services benefited from input from Pierre Sauvé. The team would like to thank other colleagues who contributed their input and expertise in the development of this toolkit, including Ian Gillson, Charles Kunaka, Mariem Malouche, José Guilherme Reis, Daniel Reyes, and Daria Taglioni. Carolina Lennon and Ben Shepherd provided extensive and useful comments that improved the toolkit. The team is also indebted to Verena Fritz for her guidance and references on the political economy of reforms. The authors would like to thank the peer reviewers for their valuable input, including Nora Dihel (Africa PREM, WB), Massimo Geloso-Grosso (OECD), and Martin Roy (WTO). The team also benefited from discussions with Hoe Lim and Aaditya Mattoo, and from inputs from Gonzalo Varela. The team acknowledges the support of Julian Clarke, Frederico Gil Sander, and Ekaterine Vashakmadze in the partial implementation of pilot assessments. Additionally, thanks to the many others who provided comments and input during the concept and final review meet- ings and throughout the development process, including to the participants at the internal workshop at the International Trade Unit. We are grateful to Shienny S. Lie and Marinella Yadao for their assistance on administrative issues, and to Amir Fouad who supported the publication process. We also thank Susan Graham, Stephen McGroarty, and Andres Meneses of the World Bank’s Publishing and Knowledge Division in the External and Corporate Relations Vice Presidency for the valu- able advice and guidance during the publication. Finally, the toolkit benefited from the professional editorial work of Barbara Karni. This toolkit was prepared under the direction of Mona Haddad (Sector Manager), Bernard Hoekman (former Director), and Jeff Lewis (Director) of the International Trade Unit. xi About the Authors Martín Molinuevo is an expert in international economic law with a specialty in trade and investment. He is currently a consultant at the International Trade Unit of the World Bank, where he assists governments of developing countries on trade policy and trade-related regulatory matters and investment. His areas of expertise include World Trade Organization (WTO) Law, international trade and investment agreements, and services trade policies. He has worked for several inter- national organizations, including the WTO, the United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP), the Inter-American Development Bank, and the World Trade Institute. He holds a PhD in international economic law with honors from the University of Bern, a master’s degree from the University of Bologna, and a law degree from the University of Buenos Aires. He is the author of the book Protecting Investment in Services: Investor-State Arbitra- tion versus WTO Dispute Settlement t (2012), and has published numerous articles and reports on trade policy. Sebastian Saez is a Senior Trade Economist in the International Trade Unit of the Poverty Reduction and Economic Management Network at the World Bank. He has extensive experience in trade policies. He served as advisor to Chile’s Minister of Finance (1990–94) and was involved in the Uruguay Round negotiations of the General Agreement on Tariffs and Trade (GATT). Subsequently, he was Deputy Permanent Representative of Chile to the World Trade Organization, coordinator of the Free Trade Agreement of the Americas negotiations, and participated in talks with the European Union, the Republic of Korea, and the United States. Prior to joining the World Bank he worked at the International Trade and Integration Division of the United Nations Economic Commission for Latin America and the Caribbean (UNECLAC). He has published numerous articles and books on international economic relations and trade policies. xiii Abbreviations APEC Asia-Pacific Economic Cooperation BPO business processing outsourcing CGE computable general equilibrium CIF cost insurance freight FDI foreign direct investment FOB freight on board GATS General Agreement on Trade in Services GTAP Global Trade Analysis Project IAASB International Auditing and Assurance Standards Board ICAO International Civil Aviation Organization ICT information and communications technology IFRS International Financial Reporting Standards IT information technology ITES information technology–enabled services ITU International Telecommunications Union OECD Organisation for Economic Co-operation and Development PCA principal component analysis PEZA Philippine Economic Zone Authority PMR product market regulation RASTI Regulatory Assessment of Services Trade and Investment RIA regulatory impact assessment ROSC Reports on the Observance of Standards and Codes SOX Sarbanes-Oxley Act STRI Services Trade Restrictiveness Index UNCTAD United Nations Conference on Trade and Development VoIP Voice over Internet Protocol WTO World Trade Organization Terms explained in the glossary at the back of the book are bolded the first time they are used in the text. xv Overview What Is Trade in Services and How Is It • Mode 2, consumption abroad, which occurs when con- Regulated? sumers (for example, tourists, students, or patients) travel across borders to consume services There is no commonly agreed-on definition of “trade • Mode 3, commercial presence, in which the producer of in services”; government officials and experts tend to a service establishes a local presence (for example, a sub- rely on the ordinary meaning of the term. International sidiary) in the country where the consumer is located trade in services is likely to encompass any international • Mode 4, temporary movement of labor, in which the transaction beyond merchandise trade and, arguably, producer (for example, a mining engineer) travels intellectual property rights. across borders to provide a service The services sector includes a diverse array of sectors, such as telecommunications, banking, and business pro- cessing outsourcing (box O.1). It is a crucial part of any Unlike trade in goods, which is traditionally governed trade strategy, both as a source of export diversification by border measures that regulate the entry of foreign and as a key component of a country’s competitiveness. merchandise, international trade in services is governed Over the last two decades, trade in services expanded entirely by domestic regulation.1 Services are typically sub- rapidly to reach more than a fifth of global trade flows. ject to a variety of regulations that govern access and oper- The participation of developing countries in world services ations in the sector, for both domestic and foreign firms. exports increased from 11 percent in 1990 to 20 percent Many services sectors, especially sectors with signifi- in 2011 (World Development Indicators). Technological cant network characteristics (such as telecommunications changes are bringing about new services and new ways to and transport services), are characterized by imperfect trade them, making services a relevant option for export and asymmetric information, lack of competition, and diversification. natural barriers to entry. Regulations are necessary to The trade costs of services are two to three times as provide safeguards in sectors where market failures or high (in ad valorem terms) as the trade costs of goods externalities are prevalent and to ensure that noneco- (Miroudot, Sauvage, and Shepherd 2010). The trade nomic policy objectives are met. It is often difficult to costs of goods fell about 15 percent over the last decade, differentiate between legitimate policy objectives and pro- whereas the trade costs of services remained relatively tectionist measures that introduce market distortions and stable. Governments can reduce these costs by adopting inefficiency. The key question is how to identify the best less-restrictive regulations, strengthening governance, and regulatory approach for services while reaching legitimate establishing the right incentives to adopt new technolo- policy objectives. gies that would facilitate trade in services (see Francois and Regulations often fail to respect the basic principles Hoekman 2010; Goswami and others 2012). of transparency and nondiscrimination—by imposing Trade in services takes place through four modes of restrictions on foreign ownership, market access, and the supply: operation of services providers, for example. Regulatory measures can be discriminatory or nondiscriminatory; • Mode 1, cross-border trade, which is analogous to they can affect entry and market access or the operation goods trade and involves producing services in one of the business. They can be considered trade restrictions country to be consumed in another. Examples include when other regulatory alternatives exist that are equally activities such as distance education, call centers, and effective in achieving the desired policy objective but less telemedicine. restrictive of trade in services. 1 2 Regulatory Assessment Toolkit Box O.1. What Are Services? The Services Sectoral Classification List of the World Trade Organization (WTO)—known as W120—lists 154 services, divided into 12 categories. WTO rules apply to all services, including services that are not listed. The major sectors on the list include the following: 1. Business services 7. Financial services a. Professional services a. All insurance and insurance-related services b. Computer and related services b. Banking and other financial services (excluding c. Research and development services insurance) d. Real estate services e. Rental/leasing services without operators 8. Health-related and social services a. Hospital services 2. Communication services b. Other human health services a. Postal services c. Social services b. Courier services c. Telecommunication services 9. Tourism and travel-related services d. Audiovisual services a. Hotels and restaurants (including catering) b. Travel agencies and tour operators services 3. Construction and related engineering services c. Tourist guides services a. General construction work for buildings b. General construction work for civil engineering 10. Recreational, cultural, and sporting services c. Installation and assembly work a. Entertainment services (including theater, live bands, d. Building completion and finishing work and circus services) b. News agency services 4. Distribution services c. Libraries, archives, museums, and other cultural a. Commission agents’ services services b. Wholesale trade services d. Sporting and other recreational services c. Retailing services d. Franchising 11. Transport services a. Maritime transport services 5. Educational services b. Internal waterways transport a. Primary education services c. Air transport services b. Secondary education services d. Space transport c. Higher education services e. Rail transport services d. Adult education f. Road transport services g. Pipeline transport 6. Environmental services h. Services auxiliary to all modes of transport a. Sewage services b. Refuse disposal services 12. Other services not included elsewhere c. Sanitation and similar services The W120 list is based on the United Nations’ Central Product Classification (CPC). The CPC offers greater disaggregation for a total of more than 5,000 services, classified at the six-digit level, as well as a brief summary of what is covered in each service. Source: WTO 1991. Regulatory quality depends not only on the regulation- are key to developing countries’ connectivity to the global making process but also on regulatory institutions. In economy because they are inputs in the production of developing countries, especially least developed countries, many goods and services (Cattaneo and others 2010). these institutions are typically weak. Reform proposals Reducing trade costs for services trade increases produc- may be unrealistic if they do not include an assessment tivity because openness in services helps attract foreign of whether a country should also reform, strengthen, or investment and strengthens competition between foreign create the regulatory institutions responsible for issu- and domestic providers. One would expect this competi- ing and enforcing laws and regulations. It is necessary to tive dynamic to deliver better and more reliable provision address both regulations and the framework in which they of existing services, new varieties of services, and competi- are designed, adopted, and applied. tive pricing in the services sector (Duggan, Rahardja, and Varela 2013). Openness in services matters crucially for labor Why Is Trade in Services Important for productivity and total factor productivity (TFP) growth Developing Countries? because input services facilitate transactions through space Services have a direct impact on developing countries’ (information and communications technologies and logis- competitiveness. Low-cost, high-quality, reliable services tics services) or time (financial services) (Hoekman and Overview 3 Mattoo 2009; Francois and Hoekman 2010). The quality of sectors because of the complex web of transactions with logistics services can influence firms’ decisions on where to the rest of the economy. Lejour and Verheijden (2004) find locate, which suppliers to buy from, and which consumer that regulatory barriers to services trade in a country and markets to enter. Efficient logistics systems are therefore its trading partners, as measured by the OECD’s Product a critical determinant of a country’s connectivity to the Market Regulation (PMR) Indicators, negatively affect world and an important tool for development (Kunaka, trade within the European Union. Kox and Lejour (2005) Mustra, and Sáez 2013). find that heterogeneity in regulatory opacity significantly Given the deep linkages the services sector has with reduces bilateral service exports. the rest of the economy, efficiency in services is closely linked to efficiency in other sectors. For a panel of coun- What Is a Regulatory Assessment of Services tries in the Organisation for Economic Co-operation Trade and Investment (RASTI)? and Development (OECD), Francois and Woerz (2008) find that increased import penetration of services has a A Regulatory Assessment of Services Trade and Invest- positive effect on the skill and technology mix of exports, ment (RASTI) can help policy makers assess regulations although countries with greater openness in producer consistently, streamline the regulatory framework in services sectors witnessed greater improvement in export services to improve efficiency, and set up a process for performance for skill- and technology-intensive indus- introducing new regulations. It complements a similar tries. Their results suggest that protecting intermediate toolkit developed for regulations governing nontariff services sectors places manufacturing sectors (especially measures, which has been successfully implemented in high-wage sectors) at a competitive disadvantage. In sum, development policy loans granted by the World Bank and there is strong evidence that the openness of the services in policy dialogue across regions (Cadot, Malouche, and sector is potentially beneficial in the evolution of effi- Sáez 2012). ciency in the most technology-intensive manufacturing Regulatory assessments in services are information industries. intensive and require exhaustive field work. Trade in ser- Other evidence at the firm level reinforces the significant vices is affected by domestic regulations, which may have positive correlation between the performance of services differentiated impacts depending on the sector, the regula- sectors and manufacturing productivity. Arnold, Mattoo, tion’s relevance for a mode of supply, and the importance and Narciso (2008) find a significant positive relationship of the modes of supply for the sector. In the retail sector, between firm productivity and the performance of the ser- for example, commercial presence is the main mode of vices sector. Their finding confirms that inadequate access supply; specific measures, such as zoning regulations or to essential producer services hurts African firms by under- restrictions on land ownership, may be important deter- mining their productivity. minants for access and operations. A RASTI of the sector A vital element of India’s rapid economic growth since would thus have to consider measures that affect commer- the early 1990s has been the improved performance of its cial presence as well as measures affecting cross-border manufacturing sector. According to Arnold and others trade that may affect that mode of supply. (2012), policy reforms in the services sectors played a major This toolkit is structured as follows: role in the transformation of the manufacturing sector in India, allowing greater foreign and domestic competition • A Policy framework provides the basic concepts and with greatly improved regulation. defines the analytical approach to conducting a RASTI. Van der Marel (2012) finds that the main determi- • Module 1 reviews the goals and challenges of regula- nants of comparative advantage in services are skills, tion and the main regulatory instruments that apply to institutions, and regulatory and governance frameworks. services markets. Services trade is associated with increased levels of trust • Module 2 discusses the quantitative literature on the on the part of importers. Behind-the-border measures impact of services regulation. Evaluating the economic (that is, internal laws and regulations not necessarily impact of services regulation is a key step toward related to foreign trade) have a higher impact on services developing economically sound services policies and than on goods. assessing how economic and noneconomic policy Amin and Mattoo (2006) find that countries with better objectives support (or fail to support) the development institutions have larger and more dynamic services sec- of an efficient services market. tors. They suggest that regulatory and contract-enforcing • Module 3 presents regulatory alternatives to regula- institutions play a key role in the development of services tory approaches, instruments, or institutions to achieve 4 Regulatory Assessment Toolkit policy objectives and regulate effectively the service regulatory framework can identify and eliminate unnec- markets. The outcome of implementing alternatives is essary hurdles. to remove unwarranted restrictions to services trade and investment in order to create a regulatory frame- Supporting Trade Negotiations work that facilitates the development and expansion of Countries engaged in international trade negotiations can services trade while ensuring the fulfillment of social use a RASTI to identify potential inconsistencies with inter- and development goals. national disciplines that may affect the negotiation process • The appendixes provide analysis and methodological or compliance with the agreed commitments. A RASTI can guidance on conducting a RASTI of selected services also help identify regulations that serve legitimate policy sectors (professionals and professional services, infor- objectives and should not be affected by international trade mation technology–enabled services, and financial agreements. services). A detailed mapping of the regulatory framework gives trade negotiators an accurate picture of the sectors and measures that require attention. It can, for instance, Objectives of the Regulatory Assessment inform trade negotiators of sensitive sectors and measures This toolkit can help policy makers evaluate whether the that may conflict with a proposed agreement and provide regulatory framework is promoting the development of a comprehensive view of the services markets necessary to an efficient domestic services market and whether services define the negotiating strategy. Once the agreement enters regulation is addressing market failures and achieving into force, a RASTI can help regulators implement the public interest goals in an appropriate manner. The per- agreement by identifying inconsistent laws and regulations formance of the RASTI can be tailored to serve different or sectors that may need to be reregulated in accordance purposes, depending on the circumstances and the needs with new international obligations. of the authorities. Assessing Regulatory Performance Filling Information Gaps Analysis of the governance framework assesses regulatory A first objective of a RASTI is to fill information gaps institutions’ ability to develop a regulatory framework on the regulatory framework for services trade. Many that stimulates the services sector while achieving countries, especially countries in the process of economic policy goals. It also identifies administrative practices reform, have only recently embarked on the regulation of that impair the services sector, such as excessively bur- the services sector. In some cases, economic opening has densome registration requirements, nontransparent predated regulatory reform, posing serious sequencing allocation mechanisms, and weak regulation monitoring problems and adding to the challenge of regulating the and enforcement procedures. domestic and international services market. A horizon- tal RASTI provides comprehensive information on the Promoting Better Regulatory Practices features of the regulatory framework for all services indus- The goal of a RASTI is to promote better regulatory tries, highlighting institutional weaknesses and regulatory practices and governance. Achieving this goal can help deficiencies that impair services trade and the development developing countries expand their services sector, which of an enabling services sector. would both increase economic competitiveness and export diversification and promote services exports. Supporting Regulatory Reform Using a RASTI for a horizontal or sectoral analysis— Identifying laws and regulations that restrict services including a quantitative analysis and assessment of trade and investment is a key first step in the process of alternative regulations—can contribute to the incor- regulatory reform (Sáez 2010). Where the required data poration of concepts and means of more complex are available, a quantitative analysis presents additional regulatory impact analysis (RIA) procedures. A full RIA information on how regulatory restrictions affect the ser- may be adopted later, once sufficient capacity has been vices sectors. This information can identify the measures developed. and sectors that are most restrictive. Policy makers can then consider regulatory alternatives that can promote a Levels of Analysis better regulatory framework for services trade. A RASTI can be conducted as part of a broader policy to attract Analysis of the entire regulatory framework on services foreign investment, as the streamlining of the services trade would be a colossal endeavor. A RASTI is therefore Overview 5 best performed in modules at different levels of regula- supply a service and the way in which services are pro- tion. A horizontal assessment sheds light on the general vided. But the ways in which laws and regulations are policies that affect trade in services, as well as on the main developed, administered, and implemented can be as big laws and regulations affecting some key services sector. an obstacle to services trade as the rules themselves. A A sectoral analysis focuses on a specific sector, such as RASTI therefore takes into account the main institutional professional services, tourism, or financial services. A aspects and regulatory procedures of services regulatory RASTI can also conducted on a specific service, such bodies (governance). as accounting, road transport services, or insurance. The assessment must also analyze the effect of the All RASTIs need to consider both regulation and the regulatory framework on all modes of services supply. governance framework. Laws and regulation are the main Figure O.1 summarizes the levels of analysis and provides barriers to services trade; they affect both the ability to examples of regulations at the horizontal level. Figure O.1. Horizontal, Sectoral, and Service-Level Analysis of a Regulatory Assessment of Services Trade and Investment (RASTI) GOVERNANCE Institutional capacity Regulatory procedures Independence Internal coordination Human resources Transparency Financial resources Consultations HORIZONTAL REGULATION Categories Mode 1 (M1) Mode 2 (M2) Mode 3 (M3) Mode 4 (M4) HORIZONTAL • Transfer of • Transfer of • FDI foreign • Migration LEVEL funds funds ownership • Employment Access • Local presence • Licensing • Recognition of • Reciprocity • Nationality foreign requirements qualifications t • Reciprocity • Reciprocity • Competition • Subsidies • Employment Operation • Boards of directors • Transfer of capital Financial services Telecom Transport and logistics Professional services Governance Governance Governance Governance r Institutional Regulatory r Institutional Regulatory Institutional Regulatory r r Institutional Regulatory SECTORAL capacity procedures capacity procedures capacity procedures capacity procedures LEVEL Sectoral Sectoral Sectoral Sectoral regulation regulation regulation regulation M1 M2 M3 M4 M1 M2 M3 M4 M1 M2 M3 M4 M1 M2 M3 M4 Service-specific Service-specific Service-specific Service-specific regulation regulation regulation regulation SERVICE Air transport Value added Engineering Accounting LEVEL Broadband insurance transport Trucking Banking Medical Mobile Other Legal Land Life Note: FDI = foreign direct investment; M1 = cross-border trade; M2 = consumption abroad; M3 = commercial presence; and M4 = presence of natural persons to provide services. 6 Regulatory Assessment Toolkit Coverage of the Assessment affect powerful interests and a wide range of stakehold- ers. Therefore, the entity responsible for coordination The ultimate purpose of the regulatory assessment will must be relatively high up the political echelon. It must determine its coverage. For instance, a RASTI performed be capable of conducting an assessment and monitor- as background for trade negotiations will typically be ing progress of the works performed by various parties broad, covering laws, regulations, and institutions that and instructing other entities on how to improve imple- govern a wide range of services. This horizontal assessment mentation. could be complemented by sectoral or service-level assess- 2. A strong political entity must be supported by a strong ments in the most sensitive areas. A similar approach could secretariat. Both must have good technical capabilities be used when designing a national strategy for trade and and adequate resources, including sufficient staff to exe- investment in services. In contrast, if the goal is to improve cute the secretariat’s mandate. Where the government’s conditions in a specific sector, a sectoral or service-level capacity is weak, it may make sense to allow an interna- analysis would be appropriate. tional organization, donor, or other expert to perform Regardless of the level of analysis, the main aspects of the assessment, under the guidance and oversight of the the assessment are identical. They include identifying a coordination entity. This secretariat would be respon- comprehensive set of laws and regulations that restrict ser- sible for, among other things, overseeing the regulatory vices trade and investment and examining the institutions assessment. that regulate them. 3. Coordination should include relevant stakeholders who A RASTI also covers the institutional setting and may be interested in the results of the regulatory assess- institutional arrangements for reform, because the way ments and recommendations or affected by proposed governments administer and implement the laws and reform. regulations may affect trade. Processing licensing appli- cations in an untimely fashion or enforcing measures selectively can hurt trade in services, for example, as can Modules the lack of institutional capacity and resources to enforce regulations. The toolkit proposes that the RASTI be conducted in three steps, or modules (figure O.2): Coordination of the Assessment • Module 1: Map horizontal and sectoral regulations, and Services span a large number of sectors, some of them assess the regulatory process and institutional arrange- connected. Services play many roles—supporting other ments. economic activities, with logistics and transportation, and • Module 2: Where possible, provide a quantitative assess- spurring development policies, through education, health, ment of the impact of regulations on performance and and social protection, for example. Unlike in manufactur- market structure, including prices, quality, and access. ing, agriculture, or mining, no single entity is responsible • Module 3: Recommend alternative regulations and for services oversight. Given the wide range of services, institutional arrangements. how can countries conduct a regulatory assessment aimed at reforming the sector? If reform affects only one sector, the ministry or other Module 1: Mapping Regulations and Assessing the public entity responsible for policies and regulations should Regulatory Process lead the process, including consultations with stakeholders. Measures affecting the services sectors can be enshrined in If the reform process affects a wide range of service activi- general laws and regulations or specific ministerial mea- ties, coordination across public entities, including minis- sures governing a specific services sector. Three levels of tries and regulatory agencies, and stakeholders is required. regulation can be distinguished: Determining which public entity is best suited to coordinate reform depends on the country context: different countries • The horizontal level includes measures affecting all ser- will find different solutions. Certain key conditions must be vices industries, such as restrictions on the transfer of met, however, including the following: funds, limitations on the movement of people, caps on foreign equity participation, and legislation granting 1. The entity coordinating policy must be politically preferential treatment to some minorities. strong. The political economy of services reforms is • The sectoral level encompasses broader regula- complex, involving politically sensitive issues that tion governing certain services. Laws on tourism Overview 7 Figure O.2. Three Steps of a Regulatory Assessment of Services Trade and Investment (RASTI) Module 1 • Map regulations Identify horizontal regulations affecting a wide range of sectors Identify specific regulations affecting a sector, subsector, or activity • Assess the governance framework Assess institutional capacity Evaluate the regulation-making process (transparency, necessity, and nondiscrimination) in light of international best practices Module 2 • Assess the impact of regulations on market structure, prices, quality, and access Module 3 • Assess alternative regulations • Propose new institutional arrangements, if any • Assess feasibility of alternative regulations and institutional arrangements or telecommunications or a general framework on liberalization or reform and gives an indication of poten- professional services correspond to this level. tial winners and losers from reforms, as well as possible • The service level covers measures that regulate mitigation or transitional arrangements. specifi c activities. This level of regulation is com- Policy makers need to be aware of two limitations of a mon in professional services, where each service RASTI. First, some aspects of the regulatory process cannot is normally governed by a specific body, such as a be measured, because basic data are often lacking. Second, national bar for legal services or an accounting asso- resource limitations mean that policy makers must decide ciation. Service-specific regulation can also stem from which dimensions to assess—the quality of the regulatory general laws. Laws on cultural heritage protection, process, the standard of performance represented by the for instance, restrict trade in audiovisual services or implementation and enforcement of the regulations, or entertainment services by setting limits on foreign the performance of regulation. Some of these aspects, such films or productions. as regulatory quality or enforcement capacity, are hard to quantify. Policy makers should consider the impact of reg- The mapping identifies measures that affect trade in ulations on both their direct objectives and broader policy services at each regulatory level. It evaluates their practical objectives (Baldwin 2012). effects on services by examining the following: Quantitative tools help policy makers prioritize. By quantifying the impact of regulations, a RASTI can • Restrictions on access to and operation in a market help guide regulatory reform. It can identify groups of • Quantitative and qualitative measures, which may or interests that may oppose or favor particular policy may not be discriminatory in intention or effect directions, allowing public opinion and alliances to • Laws and regulations as well as restrictions imposed by be formed to overcome political resistance to reform. informal administrative practices Quantification may also contribute to a reform’s design. By identifying the worst inefficiencies, a RASTI can help In addition, aspects of governance and regulation are policy makers focus reforms on areas that may have the considered at each level of analysis. These considerations biggest impact. are particularly relevant at the horizontal level, where Collecting data on regulatory information is a chal- the institutional and legal linkages are broader and more lenge. Moreover, that information must be complemented complex and affect more industries. by data on actual trade and investment in services, ideally disaggregated at least at the sectoral level. In many devel- Module 2: Assessing the Impact of Regulations oping countries, such data may not be available. Where The quantitative analysis is the most challenging step of data are not available, quantitative analysis cannot be con- a RASTI. It provides prices and costs, levels of competi- ducted. The lack of sufficient data does not render a regu- tion, and market structure while outlining benchmarks latory assessment impracticable, however. If necessary, the of performance. It estimates the expected benefits of assessment can omit this module. 8 Regulatory Assessment Toolkit Module 2 reviews and explains tools that can help policy Hoekman (1995) and the Australian Productivity Com- makers quantify the effect of regulations. Quantifying the mission, the Services Trade Restrictions Database contains benefits and the costs of maintaining or implementing information on discriminatory policies that affect regulations is a valuable part of a well-informed decision- international trade in services in 103 countries. The data, making process and reform. Module 2 classifies quanti- collected in 2007 and 2008, cover 79 developing countries tative tools according to three taxonomies: whether they and 24 countries from the OECD, broadly representing all employ direct or indirect methods for measuring the regions and income groups. Through surveys, the data- impact of regulation, whether they focus on sectoral or base collected information on 19 services in the financial economy-wide outcomes, and whether they use a retro- services (banking and insurance), telecommunications, spective or prospective approach. retail, transportation, and professional services (legal and The link between services regulation and services out- accounting) sectors. come is more straightforward in studies employing direct The broad scope of the data allows the creation of a methods. The viability and reliability of studies using Services Trade Restrictiveness Index (STRI) for each ser- direct methods depend on the quality and availability vice and mode of supply. The STRI enables users to eas- of the data (that is, whether countries periodically col- ily compare levels of restrictiveness across countries, lect and update data on policy measures in the services regions, and sectors. This ambitious global exercise sector). provides a first approximation to policies in services. Retrospective analyses quantify the impact of service It provides extensive data, facilitates comparative analy- restrictions using econometric estimations and informa- sis of services policies, and makes information on poli- tion about past episodes of liberalization and deregulation. cies publicly available (Borchert, Gootiiz, and Mattoo Prospective analyses try to project the impact of further 2012).2 liberalization of services trade, usually based on estima- A RASTI provides in-depth understanding of cur- tions of tariff equivalents. rent services regulation, the regulatory environment, Module 2 focuses on retrospective methods, which are and existing regulatory capacity in a specific country or carried out through econometric analyses, and sectoral services sector. It proposes (a) collecting information studies. The analysis is complemented by detailed descrip- through intensive field work on laws and regulations on tions of the data requirements for applying these quantita- services and the governance framework and (b) help- tive techniques; the source of the data; and, if the data are ing countries identify alternative means to regulate ser- not available, suggested methods for collecting them, such vices trade. This detailed analysis of regulations and their as using firms’ surveys and standard questionnaires. application generates a more precise picture of countries’ regulatory conditions. A RASTI helps identify alternative measures for reform, including from a political economy Module 3: Identifying Alternative Regulations and point of view. It thus builds on the STRI’s foundations Institutional Arrangements by revealing how domestic regulations are implemented. Module 3 is based on the findings of the regulatory It provides country-specific regulatory advice based on mapping (module 1) and, where available, the quanti- qualitative and, where possible, quantitative analysis. It tative impact assessment of services trade (module 2). can also complement the STRI by potentially including It describes options available to policy makers wishing additional sectors, subsectors, and activities and by cov- to reform services regulations, identifying the pros and ering a broader set of measures (discriminatory and non- cons, the requirements, and the means of implementing discriminatory) and countries in a manner comparable each alternative (table O.1). A RASTI helps policy mak- with the STRI database. It can help update and enhance ers identify which strategies are suitable for a particular the information provided by the global database for the country and services sector depending on the desired analyzed country. policy goals. Regulatory Impact Analyses A regulatory impact analysis (RIA) is a systematic appraisal Linkages with Other Initiatives of how legislation affects certain categories of stakeholders, Trade Restrictiveness Indexes economic sectors, or the natural environment. It is used In 2012, the World Bank made public a comprehensive to scrutinize proposed laws and regulations and examine database on restrictions to trade and investment in ser- the effects of current regulatory measures (Radaelli and vices. Building on methodologies originally proposed by de Francesco 2010). Overview 9 Table O.1. Advantages and Disadvantages of Selected Regulatory Strategies Regulatory strategy Main characteristic Main advantages Main disadvantages Direct action by State is responsible for providing Ensures a particular level of investment Government failure can be as big a the state services for consumers or facilities in goods or services with a strong problem as market failure for businesses public good component Command and Regulation usually involves imposition Bans particular types of conduct, Regulated businesses can capture control of binding standards and their ensuring relatively certain and process; enforcement by legal sanctions immediate effect introduces rigidity into the system; may create barrier to entry; difficult and costly to enforce Incentive-based Uses taxes or subsidies to encourage Reduces the danger of regulatory Requires information to set tax or regimes services providers to act in capture; subsidy at correct level accordance with the public interest encourages firms to limit harmful conduct as much as possible Competition law Can ensure level of competition in Can be applied across the board to Flexibility may create uncertainty individual markets that results in multiple sectors, thus creating supply at socially optimal levels economies of scale in regulation; does not unduly intrude into firms’ private decision-making processes Franchising Replaces competition within the Effective regulatory tool for activities Requires high level of governance (concessions) market with competition for the that display strong natural capacity market monopoly characteristics; includes payment of a license fee or negotiation of a minimum subsidy, which can have fiscal benefits for the government Disclosure Requires firms to make public Relatively light-handed government Costs of disclosing and processing regulation information regarding the strategy; information may be significant; quantity, quality, and price of their once information is publicly available, must be combined with additional outputs, as well as in some cases consumers can make informed measures the processes followed during choices that conform to their production individual levels of risk perception and tolerance Self-regulation Group of firms or individuals Less intrusive than other state-based Provides incentive to use standards of determines its own membership mechanisms conduct or licensing requirements and behavior as barriers to entry A RASTI is a one-time analysis of the regulations affect- movement of factors, including foreign direct investment ing services trade. It has a narrower scope than an RIA, as and temporary labor mobility. Barriers to trade in services it is limited to the regulation of trade in services. It seeks involve domestic policy and regulations that affect foreign to identify the set of policies and measures that affect trade firms, and trade in services can take various forms other in services regardless of the policy area from which they than cross-border trade. A regulatory assessment is a natu- emanate. It goes further than an RIA in that it also evalu- ral complement to a service competitiveness analysis. ates the governance framework related to services trade regulation. Notes 1. This study defines domestic regulation broadly to include both Services Competitiveness Analysis discriminatory and nondiscriminatory regulations. Under the General Policy makers increasingly recognize the unexploited Agreement on Trade in Services (GATS), domestic regulations refer only potential of services trade. More governments want to nondiscriminatory regulations. Other regulations that affect trade in services are considered either market access restrictions or discrimina- to improve their understanding of the size, scope, and tory (national treatment) regulations (Mattoo, Stern, and Zanini 2007). potential of services exports and of the obstacles that Following Black (2001), as quoted by Baldwin, Cave, and Lodge (2010), need to be removed to unlock the competitiveness of the regulations means “the intentional use of authority to affect behavior of domestic services sector. Analysis of the determinants of a different party according to set standards, involving instruments of information-gathering and behaviour modification.” competitiveness in trade in services is more complex than 2. The OECD is developing a similar restrictiveness index covering it is for goods, because it involves analysis of international more services sectors for its members and some observer countries. 10 Regulatory Assessment Toolkit References Francois, Joseph, and Julia Woerz. 2008. “Producer Services, Manufacturing Linkages, and Trade.” Journal of Industry, Competition Amin, Mohammad, and Aaditya Mattoo. 2006. “Do Institutions Matter and Trade e 8: 199–229. More for Services?” Policy Research Working Paper 4032, World Goswami, Arti Grover, Poonam Gupta, Aaditya Mattoo, and Sebastián Bank, Washington, DC. Sáez. 2012. “Service Exports: Are the Drivers Different for Developing Arnold, Jens M., Beata S. Javorcik, Molly Lipscomb, and Aaditya Mattoo. Countries?” In Exporting Services: A Developing Country Perspective, 2012. “Services Reform and Manufacturing Performance: Evidence ed. Arti Grover Goswami, Aaditya Mattoo, and Sebastián Sáez, 1–24. from India.” Policy Research Working Paper 5948, World Bank, Washington, DC: World Bank. Washington, DC. Hoekman, Bernard. 1995. “Tentative First Steps: An Assessment of the Arnold, Jens, Aaditya Mattoo, and Gaia Narciso. 2008. “Services Inputs Uruguay Round Agreement on Services.” Policy Research Working and Firm Productivity in Sub-Saharan Africa: Evidence from Firm- Paper 1455, World Bank, Washington, DC. Level Data.” Journal of African Economies 17 (4): 578–99. Hoekman, Bernard, and Aaditya Mattoo. 2008. “Services Trade and Australian Productivity Commission. Database. Measures of Restrictions Growth.” In Opening Markets for Trade in Services, edited by Juan on Trade in Services. http://www.pc.gov.au/research/memorandum Marchetii and Martin Roy, 21–58, Cambridge, UK: Cambridge /servicesrestriction. University Press. Baldwin, Robert, Martin Cave, and Martin Lodge, eds. 2010. The Oxford Kox, Henk, and Arjan Lejour. 2005. “Regulatory Heterogeneity as Handbook of Regulation. Oxford: Oxford University Press. Obstacle for International Services Trade.” CPB Discussion Paper 49, ———. 2012. Understanding Regulation: Theory, Strategy and Practice. CPB Netherlands Bureau for Economic Policy Analysis, The Hague, Oxford: Oxford University Press. the Netherlands. Black, Julia. 2001. “Decentring Regulation: Understanding the Role Kunaka, Charles, Monica Alina Antoci, and Sebastián Sáez. 2013. “Trade of Regulation and Self-Regulation in a ‘Post-Regulatory’ World.” Dimensions of Logistics Services: A Proposal for Trade Agreements.” Current Legal Problems 54: 103–47. Journal of World Trade e 47(4): 925–50. Borchert, Ingo, Batshur Gootiiz, and Aaditya Mattoo. 2012. “Policy Lejour, Arjan, and Jan-Willem de Paiva Verheijden. 2004. “Services Trade Barriers to International Trade in Services: Evidence from a New within Canada and the European Union: What Do They Have in Database.” Policy Research Working Paper 6109, World Bank, Common?” CPB Discussion Paper 42, CPB Netherlands Bureau for Washington, DC. Economic Policy Analysis, The Hague, the Netherlands. Cadot, Olivier, Mariem Malouche, and Sebastián Sáez. 2012. Streamlining Marconini, Mario, and Pierre Sauvé. 2010. “Negotiating Trade in Non-Tariff Measures: A Toolkit for Policy Makers. Washington, DC: Services: A Practical Guide for Developing Countries.” In Trade in World Bank. Services Negotiations: A Guide for Developing Countries, ed. Sebastián Cattaneo, Olivier, Michael Engman, Sebastián Sáez, and Robert M. Sáez, 19–86. Washington, DC: World Bank. Stern. 2010. “Assessing the Potential of Services Trade in Developing Mattoo, Aaditya, Robert M. Stern, and Gianni Zanini, eds. 2007. Countries: An Overview.” In International Trade in Services: New A Handbook of International Trade in Services. Oxford: Oxford Trends and Opportunities for Developing Countries, ed. Olivier University Press. Cattaneo, Michael Engman, Sebastián Sáez, and Robert M. Stern, Miroudot, Sébastien, Jehan Sauvage, and Ben Shepherd. 2010. “Measuring 1–28. Washington, DC: World Bank. the Cost of International Trade in Services.” MPRA Paper 27655, Duggan, Victor, Sjamsu Rahardja, and Gonzalo Varela. 2013. “Service University Library of Munich, Munich. Sector Reform and Manufacturing Productivity: Evidence from Radaelli, Claudio M., and Fabrizio de Francesco. 2010. “Regulatory Indonesia.” Policy Research Working Paper 6349, World Bank, Impact Assessment.” In The Oxford Handbook of Regulation, ed. Washington, DC. Robert Baldwin, Martin Cave, and Martin Lodge, 279–300. Oxford: Findlay, Christopher, and Tony Warren, eds. 2000. Impediments to Oxford University Press. Trade in Services: Measurement and Policy Implications. London: Sáez, Sebastián, ed. 2010. Trade in Services Negotiations: A Guide for Routledge. Developing Countries. Washington, DC: World Bank. Francois, Joseph, and Bernard Hoekman. 2010. “Services Trade and van der Marel, Erik. 2012. “Trade in Services and TFP: The Role of e 48 (3): 642–92. Policy.” Journal of Economic Literature Regulation.” World Economy y 35 (11): 1530–58. Francois, Joseph, Miriam Manchin, and Patrick Tomberger. 2013. WTO (World Trade Organization). 1991. “Services Sectoral Classification “Services Linkages and the Value Added Content of Trade.” Policy List.” WTO Document MTN.GNS/W/120, Note by the Secretariat, Research Working Paper 6432, World Bank, Washington, DC. Geneva. Policy Framework for Regulating Trade and Investment in Services Objectives • Striving for universal access in essential services (for example, health and education) The policy framework reviews the main rationales for regulat- ing services. It identifies the objectives of regulation, provides examples of measures adopted to achieve particular regula- Regulatory objectives come in all shapes and sizes; they tory objectives, and discusses the main challenges developing can be related to social issues, economic development, countries face in regulating trade and investment in services. improvements in health, and protection of the environ- Upon completing this section, readers will be able to: ment. By and large, however, the objectives of economic regulation fall into two broad categories: addressing mar- • Identify the economic rationales for regulation and how ket failures and serving the public interest. These two they apply to trade and investment in services categories provide a valuable framework for assessing a • Identify the noneconomic goals of regulating trade and regulation’s effectiveness. investment in services Regulators may choose among several instruments to • Evaluate the regulatory goals pursued by various regula- encourage individuals to behave in ways that yield socially tory measures and determine whether regulatory failure desirable outcomes. Regulation can ban or mandate a may prevent the goals from being met behavior outright (for example, prohibiting an establish- • Assess the governance framework for services based on ment from operating in certain areas), or it can set desir- principles of good regulatory practices able goals and let the concerned actors determine how best to achieve them (for example, requiring shops in resi- An assessment of laws and regulations must take into dential areas to limit noise). The state may also provide a account the policy goals that inspire them and their impact service (such as public health or public security) in ways on trade in services. Understanding the objectives of ser- private individuals would not. The various regulatory vices regulation is therefore a central component of any options afford more or less freedom to agents to operate in regulatory assessment. The regulatory objectives of policy the market. This level of freedom determines the economic areas outside the services sector must also be kept in mind, impact of regulation. because these laws and regulations often affect trade in ser- The choice of regulatory instrument is also important vices. Migration law, for example, regulates the movement because different instruments require different levels of of individual services providers. capacity and resources to develop, implement, and moni- The underlying economic and social rationale for regu- tor. The economic, regulatory, and institutional context lation of services sectors rests on three pillars (Mattoo and will condition which instrument is most appropriate for Sauvé 2003): achieving the desired regulatory goals. It is useful to put on • Preventing monopolies in network-based services (for the table alternative regulatory strategies and instruments example, telecommunications, transportation, and specific to a country’s needs. Table PF.1 outlines some key energy) regulatory issues in selected services sectors. • Addressing externalities and asymmetric information In a perfect world, in which all consumers knew every in knowledge- and intermediation-based services (for detail about the services they wished to purchase and sup- example, financial and professional services) pliers competed with one another, regulatory intervention 11 12 Regulatory Assessment Toolkit Table PF.1. Key Regulatory Issues and Modes of Supply in Selected Services Sectors Type of service Key regulatory issues Modes of supply Business • Human capital and skills; telecommunications infrastructure • Cross-border, commercial presence, and presence of • Institutions that affect contract enforcement natural persons • Labor mobility and foreign direct investment regulations; outward policies • Trading partners’ policies Financial • Prudential regulations and regulations affecting board members • Cross-border, consumption and management abroad, commercial presence, • Electronic infrastructure and regulations on personal data protection and temporary movement of and transfer labor • Innovation of new products, access to payment system • Effect on social security through links to health insurance and pension assets management • Regulations that limit scope of services (for example firewalls between banking, securities, and insurance) Professional • Nationality and residency requirements that limit access to market • Presence of natural persons was traditional mode of delivery, • Labor laws and regulations affecting professionals but cross-border profes- • Differential treatment of applications from foreign and domestic sional services are increasingly suppliers, including criteria relating to education, experience, becoming a substitute or examinations, and ethics; competence of applicants; and the need complement to this mode for in-country experience examinations Telecommunications • Electronic (virtual) delivery of services, especially on a cross-border basis • Cross-border and commercial presence • Terms, conditions, quality, and reliability of physical infrastructure, absence of which limits electronic delivery of services • Barriers to new entrants by incumbents and other limitations to competition Transportation • Intensive use of physical infrastructure • Cross-border and commercial presence • Customs and border management • Regulations dealing with international cargo and passengers, sabotage, and nondiscriminatory access to and use of basic infrastructure • Regulations on drivers, pilots, and crew Travel • Physical infrastructure and natural endowments • Consumption abroad and commercial presence • Customs and border management (for example, entry requirements) • Other services, such as transportation and health and security standards would not be necessary. Consumers could choose the environmental services). Market failures also limit con- best possible service at the price they were willing to pay, sumer options and raise prices. Regulatory oversight and welfare gains would be optimal. Unfortunately, such helps prevent market failure. Pareto-efficient conditions are not in place in many ser- vices markets. Regulation is therefore necessary to bring Preventing Monopolies or Reducing Their Impact about optimal results. Economic theory assumes that consumers have options in the quality and price of the goods they buy. No or too little Economic Rationales for Regulation competition allows monopolists to extract “rent” from Many services markets are prone to market failures, higher prices, restrict supplies, and prevent the market primarily as a result of monopolies , externalities , from delivering the best outcomes. As a result, consum- and information and coordination deficits. Left unat- ers lose, and economic welfare is reduced. Competition is tended, market failures lead to a loss of social welfare, hence central to a market economy. driving the market to produce too much of some A monopoly y can restrict supply and keep prices unduly services (high- risk financial assets) and too little of high. Oligopolies (markets dominated by a few sellers) can others (telecommunications services in isolated areas, produce similar effects, through price-fixing g or collusion. Policy Framework for Regulating Trade and Investment in Services 13 Both setups have negative dynamic effects on the economy, Although the goal of regulation is to ensure competitive reducing the incentive to innovate and thus lowering long- prices, in practice, prices in natural monopolies are higher term growth prospects. than in more competitive environments. To address problems caused by monopolies and oli- A second reason for regulating natural monopolies is gopolies, regulators focus on competition policy. This that the government may wish to promote a sector in which regulatory tool aims at correcting the negative impact of some state-owned enterprises and private companies have anticompetitive practices, including price-fixing, cross- natural monopoly characteristics (Krajewski 2003). In this subsidization of goods or services, predatory pricing, and case, regulation attempts to establish a legal monopoly collusion. Competition rules are particularly relevant in while preventing monopolist abuses. This situation exists services sectors such as transport and distribution, in which in public services, including telecommunications, energy economies of scale are large, favoring the development of distribution, and transport (Sidorenko and Findlay 2003). large suppliers that may engage in anticompetitive prac- Regulation of monopolies commonly includes obliga- tices. In some industries, such as network industries with tions on universal access. Universal access seeks to ensure high fixed costs, market structures with limited competi- that services are offered throughout society, not just in tion emerge. Industries such as public utilities (water and profitable areas. These obligations are particularly impor- electricity) and telecommunications entail such immense tant to essential services that are often provided by natural sunk investments that costs are lowest when only one firm or legal monopolies, such as water distribution, sewerage, is responsible for setting up the network (Baldwin, Cave, other environmental services, and telecommunications. and Lodge 2012; Ogus 1994). This situation is referred to as a “natural” monopoly. Natural monopolies also exist Internalizing Externalities in sectors—including railroad transport, telecommunica- tions, energy distribution, and water and sanitation—that Another form of market failure is third-party effects, or require network infrastructure. Table PF.2 provides exam- externalities. Production of some goods and services ples of regulatory measures used to promote competition imposes costs on parties other than the producer that are in services. not reflected in the price paid by users. Because purchasers Regulation of natural monopolies is necessary for two pay less than the social cost of the product, they consume main reasons (Krajewski 2003). The first is that natural more of the good or service than is socially optimal (Ogus monopolies charge monopolistic prices, reducing social 1994). Table PF.3 provides examples of regulatory inter- welfare. Because competition is not possible in these mar- ventions relating to externalities in services sectors. kets, the regulatory goal is to control the consequences Pollution is a traditional example. Left unregulated, of monopolization. Regulating prices often creates ten- producers would not internalize the costs they impose on sion, however, because the monopolist needs high prices third parties. Regulatory intervention introduces mecha- to recoup its initial network investment. Moreover, gov- nisms that mandate or encourage the producer to inter- ernments have imperfect information on incumbents’ nalize those costs—by, for instance, requiring firms to cost structures, making it difficult for them to set prices. use filters or adopt less-polluting technologies or forcing Table PF.2. Policy Goals and Approaches to Ensuring Competition in Services by Regulating Monopolies Regulatory measures Type of Main services sectors monopoly Policy instrument Policy goal Market access Operations affected Market power Competition law Maintaining and Prior approval of Standards: prohibition • Air transport restoring a mergers and of collusion, cross- • Retail distribution competitive acquisitions subsidization, market price-fixing, predatory • Road transport pricing, and other • Telecommunications anticompetitive practices Natural Regulation Preventing abuse Mitigating Standards: price • Rail transport of monopolistic entry barriers controls, mandatory • Sanitation position (compulsory cross-subsidization licensing) (universal access • Telecommunications requirements) 14 Regulatory Assessment Toolkit Table PF.3. Examples of Regulatory Interventions for Dealing with Market Failures Type of regulatory intervention Type of market failure Market access Operation Sectors affected and measures Externalities Direct provision of services by the state National and internal security services Firefighting Central banking Education Entry control: licensing Construction of infrastructure (public concessions) Entry control: geographical Distribution services (retail stores, gas stations) restrictions Behavior control: standards Air transport: noise limitations (target) Road transport: limits on emissions Behavior control: standards (specification) Economic incentives: subsidies Research and development: tax benefits and direct incentives Information Entry control: prior approval Financial services: assessment of technical and deficits (licensing) financial capacity during licensing procedures Entry control: prior approval Professional services: certification (title) (certification) requirements Information requirements: Sporting and recreational services: risk information disclosure Coordination Behavior control: standards Telecommunications services: technological problems (specifications) standards Self-regulation Road transport services: cargo standards polluters to compensate communities for the costs they Pure or partial public goods require regulation because impose on them (“polluter pays” policies). of two problems. One is that the difference between private Externalities in the services sector abound. They include and social costs and benefits can result in underproduc- environmental damage by maritime transport, traffic con- tion. The second is the free-rider problem: the difficulty gestion and possible effects on housing markets by large of excluding others from enjoying a good once it is pro- retail outlets, interference by telecommunications equip- duced means that people who do not pay for the good ment, and market instability by expansion of certain finan- (free riders) can still consume it, removing the incentive to cial services. Regulatory intervention attempts to prevent produce it. Regulation helps ensure that public goods are or remedy these problems based on market conditions and produced in socially optimal quantities. the risks posed by each sector. Encouraging Technology Transfer Promoting Public Goods Foreign investment can generate positive spillovers (exter- Not all externalities result in negative effects on third nalities) in production technology for other firms in the parties: externalities can also be positive. Public goods sector, particularly by upgrading technology and devel- exist when one party’s consumption of a good does not oping workforce capacities.1 Developing countries often affect the consumption of other parties and the supplier support technology transfer by multinationals to increase of the good cannot exclude nonpaying parties from these positive externalities. consuming it. The price of a public good does not reflect Technology transfer also influences services policies. the benefits enjoyed by nonpaying consumers (Krajewski For example, requiring that a foreign investor enter a joint 2003). venture or similar arrangement with a local firm might Although few services are pure public goods, many have help ensure that the foreign investment results in spillovers strong public good characteristics. Education, for instance, for local firms. The next section discusses whether restric- promotes knowledge that is beneficial not only to the tions on the legal form are the most efficient way of achiev- person being educated but also to society at large. ing this goal. Policy Framework for Regulating Trade and Investment in Services 15 Dealing with Information Asymmetries may not be able to evaluate or compare the quality of ser- vice in other sectors. What information should, say, archi- Economic theory assumes that actors have perfect informa- tects be required to disclose to vouch for their competency tion when buying and selling. This is not the case for many and quality? markets, leading to inefficient outcomes and choices. In an Regulation can address some of these consumer pro- unregulated market, information is often underprovided tection issues through licensing. In most countries, only (in much the same way as a public good) (Stiglitz 2010; providers who meet certain standards of education and Ogus 1994). Regulation can help ensure that consumers training are authorized to practice law or medicine. Most have access to “optimal” levels of information about the countries require commercial drivers to pass licensing price and quality of all goods and services. (For examples procedures. of regulatory interventions relating to information asym- Information asymmetries provide a strong economic metries in services sectors, see table PF.3.) rationale for requiring licenses in some services. Policy Disclosure requirements may demand that suppliers makers need to determine what the appropriate licensing reveal information about their product, including produc- requirements are (in order to prevent them from becom- tion processes, use of certain inputs, and potential risks. ing unnecessarily restrictive). Licensing requirements Disclosure requirements abound in the regulation of food may include holding a degree or certification from certain and chemical products. They exist in services sectors, too, schools or institutions, demonstrating certain technical especially to address potential liability issues (examples capacity, having experience, or passing an examination. include regulation of the securities market and adventure For example, aspiring lawyers in New York State must first tourism). Box PF.1 describes regulatory solutions to infor- demonstrate that they have completed a period of study mation problems in four markets. at a U.S. or foreign law school and then pass an exam to In many services sectors, mandatory disclosure is not demonstrate competency. In selecting the requirements for sufficient because the information is too technical for con- licensing, policy makers should seek to reduce information sumers to understand and assess. Consumers cannot fully asymmetries in a way that is economically efficient. assess a bank’s financial position, for example, and they Box PF.1. Regulatory Solutions to Information Problems in Selected Markets In many sectors, it is difficult for consumers to know how much they are actually paying for a service. Governments sometimes regulate practices in order to make prices more transparent. Loans Most loan contracts contain pages of fine print, and many of the items in the contract may not be readily understood by individuals or small businesses. Individual borrowers typically focus on the loan rate, paying little or no attention to commissions, service fees, and penalties for late payments. Government intervention to make the true costs of a loan clearer can help consumers find better loans. One policy response would be to demand price transparency for key terms by requiring lenders to provide a one-page “loan contract fact sheet” to all borrowers that contains information on the loan rate (expressed in a standardized form, such as the annual percentage rate); com- missions; fees and surcharges; penalties for default; penalties for late payment; and any other costs. Foreign Exchange Tourists changing money often look only at the exchange rate. But service fees and commissions can significantly add to the cost of the transaction. Consumers often see these charges only after they exchange their money, when they receive a printout of the effective cost. Requiring foreign exchange dealers to indicate the true cost beforehand would allow consumers to get the best effec- tive rate. Automobile Insurance Cost is only one factor in assessing the value of an insurance policy. There is also an important quality dimension to automobile insurance: consumers need to know how likely and quickly the company is to pay claims. This dimension is opaque unless the insured has access to additional information: consumers who buy based only on price could be in for a shock when they find that the company drags its heels when processing claims. Requiring insurance companies to reveal their average rejection rates for claims and average length of time to resolve claims could help consumers to make better decisions. Funerals Lack of transparent price information practices in the funeral industry motivated the U.S. Federal Trade Commission to require all funeral homes in the United States to provide itemized estimates of the costs of a funeral before it is held. Source: Based on OECD 2011. 16 Regulatory Assessment Toolkit Addressing Coordination Problems of noneconomic regulatory objectives and examples of related measures in the services sector while box PF.2 dis- High transaction costs may justify regulating certain cusses how these objectives are addressed in international markets. Private law provides mechanisms to reduce trans- agreements. action costs, mainly through contracts, corporate law, and tort law (Ogus 1994), but in some situations, regulatory intervention may be less expensive than private coordina- Achieving Distributional Justice tion. The classic example is regulation of road traffic: the market would not provide an efficient solution for deter- A true market economy can lead to efficient outcomes, mining which side of the road people drive on. A much but it does not necessarily produce socially just outcomes. more efficient solution is for the regulator to require drivers Governments can use regulatory tools to promote not only to drive on a particular side of the road, thereby eliminat- the well-being of the market but also the market dynamics ing the coordination problem. In the services sector, a that produce equitable outcomes. regulatory response to coordination problems concerns Distributional justice policies encompass several ele- the setting of technical standards, such as the selection of ments. The basic approach involves redistributing wealth appropriate technology for digital television broadcasting. and income usually through fiscal policies, direct payments (Table PF.3 provides examples of regulatory interventions or social benefits, compulsory social security systems, or relating to coordination problems.) national health and pension schemes. These policies go well beyond regulation to the direct supply of certain ser- vices, such as education, health care, and pensions. Noneconomic Rationales for Regulation In services regulation, governments strive toward dis- Correction of market failures motivates most market tributional justice by ensuring consumer rights and setting regulation, but governments also regulate to achieve minimum conditions for services that, left unregulated, noneconomic goals. Ogus (1994) identifies three main would not be accessible to consumers with little bargain- noneconomic grounds for regulation: distributional jus- ing power. Distributional considerations often impose tice, community values, and individual well-being (or universal service requirements on monopolistic suppliers, “paternalism”).2 Table PF.4 below provides an overview for example. Distributional justice considerations may also Table PF.4. Noneconomic Regulatory Objectives and Common Interventions Types of regulatory intervention Goal Market access Operation Sectors affected and measures Achieve Direct provision of services by the state Financial services (national pension scheme) distributional Public services: health (publicly funded justice hospitals) Behavioral control: standards (performance: Public services (telecom, water distribution, universal services requirement) and price energy distribution) control Behavioral control: standards (specifications): All services sectors limitations on private contracting Consumer protection measures Behavioral control: price control Leasing of real estate Reflect community Entry control: Entertainment services (bars, nightclubs, values prohibitions, casinos) licensing Economic incentives: subsidies Cultural services (libraries, theaters) Behavioral control: standards (specification): Screen and stage quotas national treatment requirements Support individual Information requirements Distribution services: disclosure of risks in well-being tobacco and alcohol products Economic incentives: specific taxes Distribution services: additional taxes for tobacco and alcohol products Information requirements and behavioral Entertainment services: rating of films and control: standards (specification) video games Policy Framework for Regulating Trade and Investment in Services 17 Box PF.2. Regulation for “Public Interest” under International Trade Agreements International agreements on trade and investment in services strive to promote reciprocal liberalization of services. These agree- ments, which include obligations on market access and national treatment in a broad swath of sectors, call for the removal of restrictions to trade in services. However, measures that pursue legitimate policy objectives, including the correction of market failures and noneconomic goals, trump liberalization obligations—under certain conditions. Such agreements do not force countries to forfeit their ability to regulate services sectors or introduce measures to pursue public policy goals, even if such measures restrict trade and investment in services. The General Agreement on Trade in Services (GATS) provides a standard example of a “general exceptions” provision, which has been replicated in multiple bilateral, plurilateral, and regional agreements. GATS Articles XIV and XIV bis provide that members of the World Trade Organization (WTO) remain free to maintain or introduce such measures necessary to protect public morals or maintain public order; protect human, animal, or plant life or health; or protect their essential security interest. The appendix on trade in financial services entitles members to take measures for prudential reasons, including for the protection of investors, depositors, policyholders, or persons to whom a fiduciary duty is owed by a financial services supplier or to ensure the integrity and stability of the financial system, regardless of other GATS provisions. These provisions embody the legitimate public interest considerations that justify restrictions to international trade in services even in sectors subject to liberalization obligations. They go beyond the “traditional” exceptions adopted in the General Agree- ment on Tariffs and Trade (GATT). The language of these exceptions is purposely broad. As a result, WTO dispute settlement bodies have been able to confer a high degree of deference to national authorities in determining what policy objectives can be covered. The United States, for instance, argued successfully that restrictions on online (and cross-border) gambling, maintained to prevent minors from gambling, are covered by such provisions. In the context of trade in goods, governments have argued in favor of certain restrictions to benefit health goals (for example, restrictions on beef with hormones or products with asbestos) or environ- mental objectives (such as limitations on gasoline additives or imported tuna and shrimp caught in ways that harm other species). It is not sufficient for governments to invoke the public interest of a measure to exclude it from international trade obligations— if it were, international agreements would be little more than fancy declarations of intent. Instead, if any WTO member challenges a measure as a restriction to services trade, a country has to show that such measures are “necessary” to achieve public interest goals, that they are not arbitrary or discriminatory, and that they are not disguised restrictions on trade in services. In addition, trade restrictions must be proportionate to the interests pursued. Decision makers must consider and evaluate possibly less restrictive alternatives when introducing measures and adopt, to the extent possible, the measure least disruptive to trade and investment in services. (For more detail, see Cottier, Delimatsis, and Diebold 2008.) result in differential pricing for public services, particularly Policy makers may choose to reflect community val- essential services such as gas and electricity distribution. ues and regulate in a manner that preserves certain goods Often, distributive measures do not transfer resources and services that embody them. These values are usually to a disadvantaged group directly. Instead, they deal with promoted through subsidies, but regulatory measures can coordination or collective action problems faced by large also be used. Some of these measures—such as quotas for groups (Sunstein 1990). In these cases, regulation may audiovisual and broadcasting services and local employ- set out certain conditions for contracts between parties ment requirements—affect international trade in services. with unequal bargaining power. Labor laws, for instance, may define minimum wages and benefits and maximum Supporting Individual Well-Being employment hours or rental contracts (Baldwin, Cave, and Lodge 2010). Public policies can at times restrict some individual liberties in the benefit of that very same person. Typical regulatory measures to support individual well-being Reflecting Community Values include the obligation to wear a seat belt or helmet. The market and prices reflect consumers’ personal The support of individual well-being may also lead to preferences for products and services. But people’s regulations on trade in services. Many countries ban community preferences may differ from their personal minors from purchasing certain goods and services (such preferences (Krajewski 2003). People who are not frequent as alcohol and tobacco, movies, or gambling) and limit visitors of, say, public libraries, museums, or national parks the sale of other goods (requiring prescriptions for some may still consider them worth maintaining; people who do medications, for example). These regulations translate into not attend or even listen to the opera might be upset to learn specific restrictions on retail services. In a similar manner, that La Scala or the Unter den Linden Staatsoper were to regulations may limit some financial companies to trade close. From a market perspective, individual unwillingness to to licensed agents only, since individual consumers may pay would suggest that there is no demand for such supply, not be familiar with the system or understand the risks thus driving it to extinction. involved in some complex financial products. 18 Regulatory Assessment Toolkit Challenges to and Principles of Regulation telecommunications or energy distribution, are particu- larly vulnerable. Government intervention is necessary to prevent market Regulators often try to disguise regulatory capture, failure and to support the public good. It can help create claiming that measures that actually benefit special inter- an efficient services market, increase distributional justice, ests serve the public good. This type of declaration not and promote social values (Stiglitz 2010). only hides the benefits received by the small group, it also But government intervention can also have the oppo- bestows greater legitimacy to the laws and regulations. For site effects. Laws and regulations can curtail competition, instance, a rule requiring domestic recertification of, say, increasing the welfare of selected providers at the expense medical doctors might not gain wide public support if the of consumers. Regulation can introduce unnecessary and stated purpose were to protect domestic doctors. If, how- burdensome procedures on business, raising costs, dis- ever, the measure is portrayed as ensuring quality against couraging innovation, and weakening the country’s com- an influx of poorly trained foreign professionals, it is more petitiveness. Nontransparent regulatory mechanisms may likely to garner support. deter new suppliers from entering the market, limiting the options of consumers and reducing social welfare. Bounded Rationality and Institutional Capacity Like market agents, regulators lack perfect information. Regulatory Failure Because knowledge is costly and incomplete and insti- Regulatory failure occurs when regulation is motivated by tutional capacity inherently limited, regulation rarely illegitimate rationales or its outcomes are welfare reducing. completely achieves its intended effect. Furthermore, Like market failure, it reduces social welfare and creates information deficits can lead to capture, because the infor- distortions that hurt society at large. The challenge for reg- mation needed by the regulator is normally controlled by ulators is to prevent or correct market failures and pursue the private sector, which can use it to its advantage. the public interest while avoiding regulatory failure. Institutional capacity affects the ability to plan, develop, Identifying why regulatory failure has occurred is and implement regulation efficiently. Estache and Lewis a central step in improving the regulatory framework, (2009) identify four broad types of limitations of regula- as policy makers can use the analysis to develop rem- tion in developing countries: capacity, accountability, edies. For instance, they can address cases of regulatory commitment, and fiscal efficiency (box PF.3). “capture”—the taking over of decision-making processes Assessing the regulation of monopolies in developing by the sector subject to regulation—by setting up firewalls countries, Laffont (2005) points to aspects that often result between the regulatory agency and providers, strength- in institutional limitations: ening mandatory information requirements, increasing transparency in the regulatory procedures, or promot- • The high cost of public funds ing the involvement of more stakeholders in a regulatory • Insufficient capacity to monitor compliance with consultation process. These measures may also improve regulation institutional capacity. • Institutional hierarchies • Corruption Capture • Lack of long-term commitment Regulatory capture is a common cause of regulatory fail- • Weak rule of law ure. Groups may use pressure, influence, or bribery to • Financial constraints protect their interests and subvert the regulators’ objec- tives. One way to prevent capture is to align the interests of Because trade in services encompasses a broad range regulatory bodies with desired policy objectives (Baldwin, of heavily regulated industries, it is particularly sensi- Cave, and Lodge 2012). tive to regulatory capacity and information asymmetries. Capture is most frequent in the regulation of services Furthermore, many services sectors, such as telecom- industries dominated by monopolies or oligopolies, espe- munications and finance, can experience radical changes cially when one of the suppliers is or was a state-owned with technological developments. As these changes cre- enterprise. Other groups that may benefit from close links ate opportunities or new services or expansion of services to the policy-making levels of government, such as law- through new modes of supply, there is an increased risk of yers, may also benefit from capture. Regulators of indus- regulatory failure linked to the lack of adequate informa- tries typically dominated by a few big companies, such as tion in the regulatory decision-making process. Policy Framework for Regulating Trade and Investment in Services 19 Box PF.3. Institutional Limitations Affecting Regulator Capacity in Developing Countries Institutional problems often constrain the ability of regulators in developed countries. It is in developing countries, however, that these problems are most acute. Limited Regulatory Capacity Regulators generally lack resources, usually because government revenues are low, sometimes because funds are withheld to under- mine the agency. The lack of resources prevents regulators from employing skilled staff—an already difficult task in countries with few highly educated professionals and inadequate civil service pay scales. A weak auditing system and inexperienced judiciary place further limits on implementation. Limited Accountability Institutions in developing countries are often less accountable than their counterparts in the developed world. Where accountability is lax, collusion between the government and various interest groups, including regulated firms, is more likely to occur. Indeed, in least developed countries, there is abundant evidence of corruption in both the privatization process and regulation. Limited Commitment The institutional framework in many developing countries makes it impossible to rely on contracts. In Latin America, for example, between 1985 and 2000, more than 40 percent of concessions (excluding the telecommunications sector) were renegotiated, most of them at the request of governments. Fear of future renegotiation is a serious impediment to attracting private sector participa- tion. The private sector’s inability to rely on contracts is particularly damaging in least developed countries, where uncertainties about cost, demand, and macroeconomic stability are significant. Limited Fiscal Efficiency When consumers have a limited ability to pay for services, public institutions are unable to collect adequate revenue to allow them to subsidize them. In infrastructure, this limitation is apparent in the slow progress state-owned enterprises have made in increasing access to networks. The scale of network expansion required to widen access to services and the inability of many citizens to pay tariffs at a level that will ensure cost recovery mean that private or public enterprises are unlikely to be financially autonomous, but the poorest countries’ limited fiscal efficiency means their governments cannot provide high levels of subsidies. Source: Estache and Lewis 2009; see also Eberhard 2007. Principles of Good Regulation 4. Regulation should not be unduly prescriptive; prefer- ably, it should be specified in relation to performance Evaluation of regulation should be done on a case-by-case or outcomes. It should be flexible enough to allow busi- basis and account not only for a measure’s intended pur- nesses some freedom to find the best way to comply pose but also for the context in which it is conceived and and to allow the regulation to adapt to changed circum- implemented. Certain general principles of good regula- stances. tion should guide the process. 5. Regulation should be accessible, transparent, and International organizations and countries including the accountable. The public should be able to readily find Australia, New Zealand, and the United Kingdom have out what regulations they must comply with, and the launched government-wide initiatives to promote bet- regulations must be reasonably easy to understand and ter regulatory practices. The principles of good regulation fairly and consistently administered and enforced. enunciated by the Council of Australian Governments and 6. Regulation must be clear, concise, and communicated endorsed by the government in 1998 include the following effectively. (Coghlan 2003): 7. Regulation should be mindful of the compliance bur- den imposed, proportionate to the problem being 1. Regulation must yield a net benefit to the community, addressed, and set at a level that lessens compliance not just to a particular group or sector. costs while still achieving the set objective. 2. Regulation must be set to the minimum level neces- 8. Regulation must be enforceable and embody the mini- sary to achieve the objectives and to avoid unnecessary mum incentives needed for reasonable compliance. restrictions. It should be targeted at the problem. Adequate resources must be provided for monitoring 3. Regulation should be integrated and consistent with and to ensure reasonable compliance. other laws, agreements, and international obligations. Any restrictions on competition should be retained only The Organisation for Economic Co-operation and if they provide a net benefit to the community and gov- Development (OECD) has long been promoting dis- ernment objectives cannot be achieved by other means. cussions on common principles of good regulatory 20 Regulatory Assessment Toolkit practices. Box PF.4 reproduces the key points of the Regulatory bodies must also be independent from the Asia-Pacific Economic Cooperation (APEC)–OECD influence of the firms they govern. Although fluid con- Integrated Checklist on Regulatory Reform of 2005.3 tact between government and the private sector results in Baldwin, Cave, and Lodge (2010) describe regulatory more effective regulatory solutions, adequate firewalls are principles as responding to the following key questions:4 needed to help ensure that regulatory bodies can regulate for public interest and not be captured by their regulatees. • Is there an appropriate scheme of accountability? Certain procedural steps in the regulatory decision- • Are procedures fair, accessible, and open? making process may enhance accountability. They include • Is the regulator acting with sufficient expertise? offering adequate reasoning for decisions, disclosing infor- • Is the action of the regime efficient? mation on the procedures leading to decisions, and incor- porating public hearings or other mechanisms for public Accountability participation into the decision making (Baldwin, Cave, Regulators can usually perform their technical duties bet- and Lodge 2010). ter if their agency benefits from a degree of independence from the political branches. The flip side of independence, Due Process however, is that regulators often have vague mandates and Whether regulation is deemed legitimate by the general are seen as lacking popular legitimacy. Agencies may over- public often depends on fair, accessible, and open regu- come this legitimacy deficit by being accountable to, and latory procedures. Regulators should thus pay attention controlled by, other government institutions that enjoy to equality, fairness, consistency of treatment, and pub- greater legitimacy, particularly institutions that have been lic participation, including by consumers and relevant democratically elected. services providers (Baldwin, Cave, and Lodge 2010). Box PF.4. Good Regulatory Principles: Excerpts from the APEC–OECD Integrated Checklist on Regulatory Reform Regulatory reform refers to changes that improve regulatory quality to enhance the economic performance, cost-effectiveness, or legal quality of regulations and related government formalities. A. Horizontal Dimension A1. To what extent is there an integrated policy for regulatory reform that sets out principles dealing with regulatory, competition and market openness policies? A5. To what extent has regulatory reform, including policies dealing with regulatory quality, competition and market openness been encouraged and coordinated at all levels of government (for example, federal, state, local, supranational)? A6. Are the policies, laws, regulations, practices, procedures and decision making transparent, consistent, comprehensible and accessible to users both inside and outside government and to domestic as well as foreign parties? And is effectiveness regularly assessed? A8. To what extent are there effective interministerial mechanisms for managing and coordinating regulatory reform and integrat- ing competition and market openness considerations into regulatory management systems? B. Regulatory Policy B2. Are the legal basis and the economic and social impacts of drafts of new regulations reviewed? What performance measure- ments are being envisaged for reviewing the economic and social impacts of new regulations? B4. To what extent are rules, regulatory institutions and the regulatory management process itself transparent, clear and predict- able to users both inside and outside the government? B5. Are there effective public consultation mechanisms and procedures, including prior notification open to regulated parties and other stakeholders, nongovernmental organizations, the private sector, advisory bodies, accreditation bodies, standards- development organizations and other governments? B8. To what extent have measures been taken to assure compliance with and enforcement of regulations? C. Competition Policy C9. To what extent does the competition law apply broadly to all activities in the economy, including both goods and services, as well as to both public and private activities, except for those excluded? C12. In the absence of a competition law, to what extent is there an effective framework or mechanism for deterring and addressing private anticompetitive conduct? D. Market Openness Policies D2. To what extent does the government promote approaches to regulation and its implementation that are trade friendly and avoid unnecessary burdens on economic actors? D8. To what extent are measures implemented in the countries accepted as being equivalent to domestic measures? Source: OECD 2005. Policy Framework for Regulating Trade and Investment in Services 21 Government-wide standard rules governing the regulatory imposes the lowest possible (additional) costs on the ser- process can enhance due process. Following such rules- vices providers while achieving its desired policy goal. on-rules can limit the regulator’s discretion and promote Efficient regulation also entails proportionality between transparency and accountability. the desired policy goals and the regulatory requirements. The regulatory principles adopted in the United Kingdom, Expertise for instance, require that policy solutions be proportion- Regulatory functions, particularly in the complex, dynamic ate to the perceived problem or risk, justify the imposed services sector, require expert knowledge. Technical profi- compliance costs, and not create unnecessary burdens ciency is not only a necessity for tackling the sector’s problems (BIS 2011). and assessing alternatives, it is also a source of legitimacy for the regulator (Baldwin, Cave, and Lodge 2010). Regulation in Practice Efficiency and Proportionality The principles of good regulation are not always observed, An important source of legitimacy is the belief that a regu- as box PF.5 indicates. lation is aimed at achieving efficiency (Baldwin, Cave, and Lodge 2010). An efficiency goal is particularly relevant Conclusion when adopting regulation to prevent or correct market failure. Government regulation is a powerful instrument for pre- Efficiency considerations can also play a role in venting or correcting market failures and attaining social regulation for noneconomic goals. An efficient regulation goals. It is particularly important in the services sector, seeks to achieve public interest goals and avoid introduc- because information asymmetries and limited competi- ing unnecessary burdens in the market. The ideal result tion often cause market failures and because the sector Box PF.5. Regulatory Failures in Infrastructure Services in Selected Countries Argentina A 1996 review of Argentina’s gas sector revealed investor concerns about the transparency and predictability of the National Gas Regulatory Authority. In one case, the agency did not permit wholesale prices charged to distribution companies to be passed on to consumers. In addition, it used its authority over transportation and distribution activities to regulate field prices, changing the rules of the game after they were deregulated as part of privatization. The agency did not provide coherent or predictable principles for determining acceptable gas prices. It also reportedly imposed capricious penalties for violations of gas quality standards. Latvia In 1999, Latvia’s Telecommunications Rate Council approved large increases in telephone rates. The sector ministry called the increases unfair and annulled the council’s decision, a move not clearly allowed by the law. The Ministry of Justice evaluated the legality of the annulment and declared it legal. Its decision was backed by Latvia’s parliament, which argued that the council had failed to safeguard the interests of consumers. The government then removed the original members and announced that a new council would be formed. Romania In Romania, responsibilities for overseeing telecommunications prices were splintered among the National Agency for Communications and Informatics, the Office of Competition, the Cabinet, and the Competition Council. Unclear guidelines for determining which prices should be regulated produced anomalies, such as the lack of regulation of interconnections not involving Rom Telecom, the dominant carrier. In addition, regulators were not required to justify their policies, and they could not request cost information from services providers. As a result pricing decisions were uncoordinated, and inconsistencies—such as differ- ent prices for local services, interconnections between Rom Telecom and mobile carriers, and interconnections between mobile carriers—were not explained. Ukraine Ukraine’s National Electricity Regulatory Commission, established in 1994, was one of the first independent regulators in a transi- tion economy. In 1997, its specialists included about 70 percent engineers, 20 percent economists, and 10 percent lawyers. All but one of the economists had graduated from a Soviet university between 1965 and 1981. The commission had no specialists in regu- latory economics, and Ukraine offered no training in energy regulation. Moreover, key employees left the electricity commission to join private companies regulated by it—increasing pro-industry bias and the potential for capture. Source: World Bank 2004. 22 Regulatory Assessment Toolkit plays a vital social role by providing critical services in key References sectors, such as health, education, communication, and Baldwin, Robert, Martin Cave, and Martin Lodge, eds. 2010. The Oxford finance. Handbook of Regulation. Oxford: Oxford University Press. Regulation can also become a tool of protectionism and ———. 2012. Understanding Regulation: Theory, Strategy and Practice. Oxford: Oxford University Press. a safeguard of local interest groups. Through inadequate BIS (Department for Business, Innovation, and Skills). 2011. Principles of planning and weak administration, it can introduce distor- Economic Regulation. London: BIS. https://www.gov.uk/government tions. There is a high risk of regulatory failure related to / uploads/system/uploads/attachment_data/file/31623/11-795 -principles-for-economic-regulation.pdf. capture when regulation is adopted for noneconomic pur- Coghlan, Paul. 2003. “The Principles of Good Regulation.” In Regulation poses, because these objectives often garner political and and Market Access, ed. Alexandra Sidorenko and Christopher Findlay, public support even if there is no analytical or empirical 17–39. Canberra: Asian Pacific Press and Australian National justification for their adoption. If the government lacks the University. Cottier, Thomas, Panagiotis Delimatsis, and Nicolas Diebold. 2008. means to regulate effectively, regulation may create market “Article XIV GATS.” In WTO: Trade in Services, ed. Rüdiger distortions and welfare losses even when legitimately intro- Wolfrum, Peter-Tobias Stoll, and Clemens Feinäugle, 287–328. duced to correct market failures. Leiden: Martinus Nijhoff. Eberhard, Anton. 2007. Infrastructure Regulation in Developing Countries: To overcome these regulatory failures, policy makers must An Exploration of Hybrid and Transitional Models. Washington, DC: establish a process for adopting and enforcing regulation that Public-Private Infrastructure Advisory Facility (PPIAF). reflects the main principles of good governance. Public con- Estache, Antonia, and Liam Wren Lewis. 2009. “Toward a Theory of Regulation for Developing Countries.” Journal of Economic Literature sultations and other procedures that increase transparency 47 (3): 729–70. enhance the regulators’ accountability. They also inform reg- Feintuck, Mike. 2004. “The Public Interest” in Regulation. Oxford: Oxford ulated entities of the relevant regulatory process, safeguard- University Press. ing against regulatory capture. Adequate expert advice and Krajewski, Markus. 2003. National Regulation and Trade Liberalization in Services. The Hague: Kluwer Law International. interagency coordination mechanisms increase efficiency Laffont, Jean-Jacques. 2005. Regulation and Development. Cambridge: and enhance analytical support for regulation, reducing the Cambridge University Press. scope for failures related to bounded rationality. Mattoo, Aaditya, and Pierre Sauvé. 2003. “Domestic Regulation and Trade in Services: Key Issues.” In Domestic Regulation and Service Trade Liberalization, ed. Aaditya Mattoo and Pierre Sauvé, 1–7. Washington, DC: World Bank. Notes OECD (Organisation for Economic Co-operation and Development). 2005. APEC–OECD Integrated Checklist on Regulatory Reform. Paris: OECD. 1. Production technology comprises all means by which a firm pro- ———. 2011. Competition Assessment Toolkit. Vol. 2: Guidance. Paris: duces its services, including methods, management competence, and OECD. organizational structures. Ogus, Anthony I. 1994. Regulation: Legal Form and Economic Theory. 2. Prosser (2010) distinguishes three noneconomic rationales for Oxford: Hart Publishing. regulation: protection of human rights, promotion of social solidarity, and Prosser, Tony. 2010. The Regulatory Enterprise: Government, Regulation, resolution of problems. Sunstein (1990) offers six motivations: redistribu- and Legitimacy. Oxford: Oxford University Press. tion, collective desires and aspirations, diverse experiences and preference Sidorenko, Alexandra, and Christopher Findlay. 2003. “Domestic formation, social subordination, endogenous preferences, and irreversibil- Regulatory Reform and Trade Liberalization.” In Regulation and ity (regarding the environment and human and nonhuman life). Feintuck Market Access, ed. Alexandra Sidorenko and Christopher Findlay, (2004) does not propose categories, focusing instead on the specific content 1–16. Canberra: Asian Pacific Press and Australian National of “public interest” in different regulatory instruments and sectors. Stiglitz University. (2010) adds “market irrationality” as another source of policy concern. Stiglitz, Joseph. 2010. “Government Failure vs. Market Failure: Principles 3. See also the OECD Recommendation of the Council on Improving of Regulation.” In Government and Markets: Toward a New Theory of the Quality of Government Regulation of 1995, the 2005 Guiding Principles Regulation, ed. Edward Balleisien and David Moss, 13–51. Cambridge: for Regulatory Quality and Performance, and the OECD Recommendation Cambridge University Press. of the Council on Regulatory Policy and Governance of 2012. Sunstein, Cass. 1990. “The Function of Regulatory Statutes.” In After the 4. Baldwin, Cave, and Lodge (2010) include a fifth principle, which Rights Revolution: Reconceiving the Regulatory State. Cambridge, MA: they call “legislative mandate.” There is no doubt that the regulator’s Harvard University Press. mandate, particularly when it comes from a democratically elected Veljanovski, Cento. 2010. “Economic Approaches to Regulation.” In The institution, is an important source of legitimacy. Whether such man- Oxford Handbook of Regulation, ed. Robert Baldwin, Martin Cave, and date amounts to a principle is less clear, as suggested by the fact that Martin Lodge, 17–38. Oxford: Oxford University Press. regulatory handbooks and guidelines do not usually include a similar World Bank. 2004. Reforming Infrastructure: Privatization, Regulation, principle. and Competition. Washington, DC: World Bank. MODULE 1 Mapping Regulations and Evaluating Governance Objectives requires an adequate institutional setting capable of assess- ing the challenges posed by the services sector. Regulators This module explains how to map the laws and regula- must evaluate the impact of regulation on services and tions affecting services as well as the governance framework other economic sectors and identify and implement viable for adopting and implementing those laws and regulations. regulatory decisions. These procedures require the coop- Upon completing it, readers will be able to: eration of various entities from the government and the private sector. • Identify the parameters of regulatory measures relevant for a regulatory assessment • Map the regulatory restrictions that affect services trade Mapping Laws and Regulations Affecting and investment by identifying their parameters and the Services Trade and Investment sectors and modes they affect • Assess whether a law or regulation constitutes a restriction In principle, a regulatory mapping should include all levels to trade and investment in services and identify the cat- of regulation and institutions that affect services trade. Full egory of restrictions into which it falls analysis of all services sectors at all levels of regulation is • Assess the governance framework for adopting and imple- rarely efficient or practical, however. It is therefore recom- menting laws and regulations mended that the mapping focuses mainly on a horizontal, • Distinguish between formal limitations to trade and sectoral, or services level, depending on the information investment in services and restrictions originating in needed. administrative practices Relevant laws and regulation include all measures affect- ing the access of services suppliers to the market or the The first module of a Regulatory Assessment of Services conditions under which they may operate. In many cases, Trade and Investment (RASTI) involves two main steps however, restrictions stem from administrative practices (figure 1.1). The first is a comprehensive review—or that are not spelled out in formal instruments. Assessment “mapping”—of all laws and regulations affecting trade of the governance framework can identify such practices and investment in services. These measures include not and propose ways to avoid them. only laws and regulations governing a particular sec- Mapping laws and regulations identifies how they affect tor but also measures that affect a wide range of sectors services sectors and contribute to achieving policy goals. (“horizontal” measures). Regulations on tourism, for Policy makers must consider various parameters when example, obviously affect services providers in the sec- assessing how regulation affects trade in services and whether tor. But so, too, do other laws and regulations, such as more trade- and investment-friendly alternatives are avail- regulations on buying and selling foreign currency, laws able. These parameters include the purpose of the measure, on entry and stay of foreigners, and procedures related to the modes of supply, the level of regulation, the nature the establishment of firms. of the measure, the stage the measure governs, the origin The second step of a regulatory mapping is the assess- of the measure, the type of impact, and whether the mea- ment of the governance framework. Governance deter- sure discriminates against foreign providers. This informa- mines the way rules affecting services are prepared, tion should be summarized in a table, as table 1.1 does for an adopted, and applied. The regulation-making process imaginary country. 23 24 Module 1: Mapping Regulations and Evaluating Governance Figure 1.1. Module 1 of a Regulatory Assessment of Services Trade and Investment MODULE 1 Module 1 • Map laws and regulations affecting services trade and investment Identify horizontal regulations affecting a wide range of sectors Identify specific regulations affecting a sector, subsector, or activity • Assess the governance framework Assess institutional capacity Evaluate the regulation-making process (transparency, necessity, and nondiscrimination) in light of international best practices The mapping should also identify desirable laws and restrictions on a mode of services supply include the regulations that are not in place. In many sectors, regula- following: tion is necessary to prevent or correct market failures and create an efficient services market. Lack of regulation may • Cross-border trade: measures on transfer of funds, result in anticompetitive behaviors or translate into inef- restrictions on access to foreign currency ficient de facto measures. • Consumption abroad: exit visas for nationals, restric- tions on access to foreign currency • Commercial presence: limitations on land owner- Parameters ship, restrictions on establishment of juridical persons, The regulatory mapping should take into account all and domestic employment requirements for foreign parameters relevant to identifying regulatory measures and companies assessing their impact (table 1.2). These parameters help • Presence of individual services suppliers: visa require- policy makers evaluate possible alternatives. ments for foreigners, limitations on periods of stay Sectoral Scope Stage of Supply Affected Three levels of regulation of services can be distinguished: Some regulations limit the entry of services suppliers to the market. They include licensing and registration • Horizontal laws and regulations include measures requirements. Other measures establish conditions that affecting all services industries, such as restrictions affect business operation. They include taxes, employ- on the transfer of funds, limitations on the move- ment conditions, information requirements, and price ment of people, caps on foreign equity participation, regulation. and legislation granting preferential treatment to some Legitimate policy objectives may justify both types minorities. of measures. Licensing may be required to ensure that • Sectoral measures cover regulations that govern a providers are able to supply a service and have sufficient particular industry, such as tourism or telecommu- capital to operate in the industry and cover any damages nications, or that create a framework for professional caused by hazardous activities. Measures regarding opera- services. tions may be necessary to provide information about key • Service-specific regulations refer to measures that regu- industries, limit the price effects of the lack of competi- late specific activities, such as the practice of law, medi- tion in natural monopolies, and ensure competition in cine, or accounting. network industries. Measures affecting market access tend to restrict trade Mode of Supply and investment more than measures affecting operations, “Modal” regulation (regulation that affects cross-border because they limit the entry of new market actors, favoring trade, the movement of people, or the establishment of existing providers and limiting competition, which usually foreign companies) is usually related to policy objec- raises prices. Measures affecting operations may increase tives other than the regulation of trade in services. costs, causing prices to rise, but in general they favor a Examples of horizontal measures not directly aimed at more competitive market (module 2 offers more detail on regulating international trade, but that imply horizontal the economic implications of measures on market access Table 1.1. Measures Affecting Trade and Investment in Services in Kingdom of Uqbar Policy goal Market failure Noneconomic Sectors Mode of Nature of addressed by policy achieved Possible Measure covered supply Stage affected measure Origin Impact restriction by restriction alternative Access to and use of land Horizontal Modes 3 Entry/market Qualitative Legal Nondiscriminatory Protection of of indigenous people are and 4 access minorities restricted Subsidies and state support Horizontal All modes Operation Qualitative Legal Discriminatory Support of are granted only to Uqbar nationals nationals Acquisition of Uqbarian Horizontal Mode 3 Entry/market Qualitative Legal Discriminatory Maintenance businesses of Uq$5 million or access (economic (law or foreign of national more by foreigners is subject needs test) investment) security to review by National Board of Investment Only individuals residing in Horizontal/ Modes 1 Market access/ Qualitative Legal (law De facto Prevention Require additional Uqbar and enterprises with distribution and 3 operation on export discriminatory of crime information head offices in Uqbar can services and import (contraband) from foreign apply for import permits permits) companies Accountants must have been Accounting All modes Market access Qualitative Legal (law on De facto Information Require all continuously domiciled in accountants) discriminatory asymmetry accountants Uqbar for at least three years to pass and have at least one year examination of accounting experience in Uqbar Foreign lawyers are not allowed Legal services Modes 2 Market access Qualitative Regulatory Discriminatory Information Protection of Allow registration to become members of the and 4 (Uqbar asymmetry domestic for international national bar national bar providers law only directive) Sanitary regulations are Tourism Mode 3 Operation Qualitative Practice (Ministry Discriminatory selectively enforced of Tourism) Licenses to foreign banks are Banking Mode 3 Market access Quantitative Practice (Central Discriminatory Protection of Provide subsidies limited Bank) small domestic to small financial banks institutions Note: FDI = foreign direct investment; Mode 1 = cross-border trade; Mode 2 = consumption abroad; Mode 3 = commercial presence; and Mode 4 = presence of natural persons to provide services. 25 26 Module 1: Mapping Regulations and Evaluating Governance Table 1.2. Parameters for Evaluating Services Regulation The impact of laws, regulations, and administra- MODULE 1 Parameter Options tive measures on foreign suppliers is another important Sectoral scope of the • Horizontal parameter in the regulatory mapping exercise. Regulations measure • Sectoral may affect foreign and domestic services suppliers alike, or • Service they may discriminate against foreign suppliers. The cor- Mode of supply affected • Mode 1 (cross-border trade) rection of market failures and the achievement of noneco- • Mode 2 (consumption abroad) nomic goals rarely require discriminatory measures. • Mode 3 (establishment) The most clearly discriminatory measures set different • Mode 4 (presence of individual services supplier) requirements for foreign and domestic providers. This type Stage of supply affected • Access/establishment of open, de jure discriminatory measure is evident from a • Operation superficial review of laws and regulations. For many coun- Nature of measures • Quantitative tries, this type of discriminatory measures appears in the • Qualitative schedules of commitments or lists of reservations to agree- Origin of measures • Legal or regulatory instrument ments in trade in services. An example of a de jure discrimi- • Administrative practice natory measure is access to certain subsidies and government Impact of measures • Formally discriminatory contracts, which tend to be limited to domestic suppliers. • De facto discriminatory • Discriminatory application Laws and regulations may contain nondiscriminatory • Nondiscriminatory wording but have different implications for nationals and Policy goals • Address market failure foreign services providers in practice. Residency require- ° Monopoly ments for managers and directors are typical de facto dis- ° Public goods criminatory measures. Language requirements can also be ° Externalities discriminatory. ° Asymmetric information The impact of these measures needs to be assessed on a ° Coordination problems case-by-case basis to determine whether they address legit- • Achieve noneconomic goal imate concerns or serve only to limit trade in services. For ° Distributional justice ° Regulatory failure example, language proficiency may help ensure the qual- ° Public interest ity of services provided by health care professionals, thus the requirement. In contrast, such a requirement may not be necessary for other professionals, such as engineers and and operations). Where restrictions on services are neces- computer technicians. sary to achieve public policy goals, it is thus preferable that The services market may be distorted by measures that they focus on the operations stage. are nondiscriminatory in their terms and intent but are applied only to certain services suppliers. Sanitary regula- Nature of Measures tions and controls, for example, may be applied only to Laws and regulations can restrict the number of suppli- foreign-owned hotels; foreign suppliers may be required ers (quantitative) or impose obligations on market actors to abide by harsher competition rules than are domestic (qualitative) (table 1.3). providers. These practices not only protect domestic pro- viders from outside competition, they also affect the gen- Origin and Impact of Measures eral governance and regulatory framework. Both laws and regulations and the ways in which those laws and regulations are applied (or not applied) can restrict Policy Goals trade and investment in services. Administrative practices Identifying and recording the policy goals of a regulation help that restrict the sector include the following: officials assess whether the regulations contribute to stated objectives. Mapping the regulatory framework pinpoints the • Failure to grant licenses or permits main regulatory obstacles to trade in services and illuminates • Failure to publicly disclose requirements the context. It helps policy makers determine whether alter- • Ambiguous/unclear requirements natives could help achieve the same objective while introduc- • Imposition of unofficial fees ing fewer restrictions on trade and investment in services. • Inconsistent/unpredictable application of regulation The purpose of a policy is often difficult to identify. It • Discriminatory application of regulation may be stated in the preamble of a law or regulation. • Deficient monitoring and enforcement procedures Whenever possible, such goals should be taken into account. Mapping Laws and Regulations Affecting Services Trade and Investment 27 Table 1.3. Measures Affecting Trade and Investment in Services, by Stage of Supply MODULE 1 Stage of supply affected Quantitative Qualitative Market access/establishment • Establishment of monopoly • Licensing, based on qualifications, education, • Numerical restrictions experience, technical capacity • Zoning/geographical restrictions • Nationality/residency requirements for services providers • Foreign equity ceilings • Track record requirements • Economic needs tests • Requirement to belong to association (syndication • Authorization/permit requirements (subject requirements) to unspecified requirements) • Approval of mergers and acquisitions • Restrictions on form of establishment • Prohibition of certain services • Minimum capital requirements Operations • Numerical restrictions on • Nationality/residency requirements of managers ° Transactions and directors ° Operations/output • Restrictions on land ownership ° Employees • Discriminatory taxation ° Repatriation of funds • Discriminatory access to subsidies ° Duration of license/divestment • Knowledge transfer requirements ° Hours of operation • Advertising restrictions • Screen and stage quotas • Rules on anticompetitive behavior • Performance requirements • Restrictions on distribution channels • Restrictions on pricing • Restrictions on transfer of funds • Restrictions on type of shares foreigners can own • Performance requirements • Need for import permit • Discriminatory access to government contracts These statements are usually general, however; they rarely Methodology offer details about individual measures or restrictions. Field A comprehensive review of the laws and regulations work often sheds additional light on regulatory goals, at affecting trade in services requires extensive field work. times suggesting motivations that differ substantially from Evaluators must also review documents. Examples of laws those stated in the actual regulation. or regulations that should normally be examined include To a large extent, the nature of a regulatory measure the following: indicates its motivation. Certification requirements, for instance, generally aim at overcoming information asym- • Laws on foreign investment set out the general require- metries. Price caps on monopolistic suppliers are usually ments foreign suppliers must meet to do business in a intended to prevent abuse of a dominant position. country. Such laws usually feature the main horizon- In other cases, the objective may be less clear. tal conditions for market access and guidelines on the Geographical restrictions on the construction of large conditions of operation. discount stores, for instance, may be based on the need • Laws on commercial enterprises set forth the procedural to limit vehicular traffic in certain areas, or they may be a conditions for establishment of firms and the types response to pressure from domestic retailers who wish to of juridical persons that may be admitted, including avoid competition. Discriminatory licensing is often used branches and representation agencies of foreign sup- to protect domestic providers. pliers. Regulations implementing the law should clarify The issuing process of the regulation can also reveal pol- the principles and procedures governing the issuance of icy objectives. A transparent and participatory process can operating licenses. help officials assess whether regulations are necessary and • Regimes on international transfers of funds set out how stakeholders are affected. The assessment of the gov- the conditions for movement of funds across borders. ernance framework can thus help uncover the goals behind Measures on the transfer of funds may affect all modes of certain trade restrictions, especially when the assessment supply, including the ability to make cross-border pay- focuses on a specific sector. ments, invest and repatriate funds, or receive payments. 28 Module 1: Mapping Regulations and Evaluating Governance • Land laws establish the conditions for access to real The recording should include specific reference to the MODULE 1 estate, including for juridical persons and foreigners. parameters identified in table 1.2. Explicitly setting out • Laws governing access to foreign currency may limit these parameters helps evaluators assess the impact of a trade in services by introducing barriers to international measure and analyze it based on the General Agreement on payments and the transfer of funds. Trade in Services (GATS) and other international free trade • The legal and regulatory framework on migration affect agreements. Although trade agreements do not always fea- the provision of services through the movement of nat- ture disciplines with identical scope, trade officials can eas- ural persons and the establishment of a company. ily associate the parameters with the relevant obligations of most trade and investment agreements. Box 1.1 provides Other horizontal regimes relevant to the regulatory examples of the types of restrictions to trade a horizontal mapping include the following: regulatory mapping identifies. Where possible, it is also important to link the regu- • Access to courts and dispute resolutions, including latory measure with a particular type of restriction. national and international commercial arbitration Table 1.3 identifies 36 types of regulatory restrictions plus • Government procurement regimes establishing the 7 administrative practices that impinge on services trade condition under which foreign services suppliers may and investment. To keep the task manageable, evaluators access government contracts and concessions should record measures that appear to restrict trade and • Subsidies regimes investment in services, ignoring measures that do not. • Competition policies Categorizing the measures is also necessary, in order • Performance requirements to be able to conduct a quantitative analysis later (see International trade and investment agreements identify module 2) or to compare the measures with existing general laws that affect services trade. Further information restrictiveness indexes. The quantitative record will allow can be found in the protocols of accession of countries that officials to compare regulatory policies across sectors. It recently joined the World Trade Organization (WTO). This provides the background data required in module 2, in information generally relates only to formal laws, however; which the impact of restrictions is estimated. The RASTI it says little about secondary regulations or the conditions website (http://www.worldbank.org/trade/RASTI) under which such measures are applied. Such sources provides a sample form for recording and eventually should therefore be used as initial guidance that is comple- quantifying the regulatory restrictions. mented with reviews of laws and regulations on the ground. Regulatory information can also be obtained from public Assessing the Governance Framework databases of laws and regulatory measures. The World Bank’s Investing across Borders and Services Trade Restrictions Many barriers to trade and investment in services stem databases, the Product Market Regulation Database of the from opaque and discretionary administration of laws and Organisation of Economic Co-operation and Development regulations rather than from outright restrictions. The (OECD), and the WTO’s Integrated Trade Intelligence assessment of the governance framework aims to iden- Portal provide basic information on restrictions to trade and tify shortcomings in the regulatory process and institu- investment across the board as well as on selected sectors. tional setting that may undermine the functioning of the These initiatives have also developed indexes on restrictive- services market. This section describes two aspects of the ness, which facilitate comparison across countries (see the governance framework relevant to a regulatory assessment list of references at the end of this module). and offers methodological guidelines for developing and These sources can help officials gain a broad idea of the implementing regulation. regulatory framework, but an accurate and comprehensive regulatory mapping can result only from research in the Institutional Setting field. The main sources normally come from discussions with government officials from regulatory agencies and A weak regulatory environment may arise from an inad- domestic and foreign services providers. These interviews equate institutional setting. In such a setting, the gov- should be informed by background research and should ernment bodies charged with regulating services lack a lead to further, more detailed fact-finding and checking. mandate to regulate, the ability to resist pressures from Table 1.4 provides excerpts from the World Bank question- other government bodies or private interests, and adequate naires that can be used in interviews. The full questionnaires resources to understand and evaluate the complexity of a can be found at http://www.worldbank.org/trade/RASTI. market and the impact of regulation. Assessing the Governance Framework 29 Table 1.4. Sample Questions for Collecting Information for a Regulatory Mapping MODULE 1 Measure Sample questions Legal and regulatory measures Market access and establishment General • Is private ownership of services companies allowed? • Are any sectors monopolies or served by exclusive providers? • Does the state own all or part of such monopolies? Land ownership • Are there restrictions on private ownership of land? • Are there restrictions on ownership of land by foreign individuals and companies that are not applied to nationals? If so, can foreigners lease land? For how long? Economic needs test • Is private investment subject to an economic needs tests? • Do economic needs tests apply to all private investments or only to foreign investments? Is the restriction set out in a law or regulation, or is it the result of usual practice? • What are the requirements of the economic needs test? Are they spelled out in a legal instrument? Operations Regulatory restrictions • Are there restrictions on advertising? If so, do the same rules apply to foreign and domestic providers? • Does a performance requirement apply to services providers? If so, are the requirements the same for foreign and domestic services providers? Measures regarding • Are there quotas for foreign employees? movement of people • Are there economic needs tests on the employment of foreign personnel? • Are labor certification tests required for intracorporate transferees or professionals? • Has the country concluded and implemented mutual recognition agreements with other countries? Administrative practices Transparency and • How accessible are laws and regulations to the public? application of measures • How are laws and regulations made publicly available? • Do licensing and authorization procedures correspond to the publicly available rules? • Are there unofficial fees in licensing procedures? • How strong is the monitoring and enforcement of regulations? • Are enforcement and monitoring procedures applied evenhandedly? Ideally, a comprehensive regulatory mapping would Mandate analyze all agencies that enact laws or regulations that affect An adequate mandate provides the government body with trade in services—that is, virtually all agencies. Depending the ability to seek information from other agencies and on the scope of the intended mapping, a more efficient regulated entities, initiate the lawmaking process where approach focuses on government bodies directly involved necessary, pass regulation, monitor the services market and with the measure. services providers, and enforce compliance with regulation. A horizontal assessment should map ministries In sectors that require significant technical expertise, and agencies with broad regulatory mandates that span all such as financial services, telecommunications, or energy sectors of the economy. They include bodies that regulate distribution, the regulator needs independence from industry and commerce, handle trade policy and diplo- policy-making bodies to regulate the market. This indepen- macy, and regulate investment and the establishment dence is particularly important when the government also of juridical persons. Not every aspect of each govern- provides the service (through a state-owned enterprise or ment body needs to be analyzed. The focus should be equity participation in a private company). Requisites for on departments that are closely linked to the regulation, regulatory independence include the following (Wu 2008): administration, and monitoring of market regulation. A sectoral analysis should focus on bodies with regulatory • An independent leader mandates over the relevant services sector. In some cases, • Exclusive licensing authority the mapping may include bodies outside the formal execu- • Independent funding tive branch structure, such as central banks for the regula- • Private sector regulatees tion of financial services; independent agencies that regulate • Minimal staff crossover between industry and regulator sectors such as telecommunications and energy sectors; and • Consumer offices private regulatory bodies, such as professional associations. • Universal system offices 30 Module 1: Mapping Regulations and Evaluating Governance MODULE 1 Box 1.1. Barriers to Trade in Services in Cambodia Cambodia has experienced extraordinary economic growth in recent years and become one of Asia’s most open economies. This impressive growth has been driven largely by a boom in services trade, led by a rapid expansion in tourism. Despite this boom, the services sector remains relatively small. Because its main services industry is export oriented, Cambodia has a high level of services exports but a low level of domestic services relative to GDP. There is therefore still considerable scope to develop the services sector, both domestically and for export. To maintain growth momentum in the sector, Cambodia needs to move beyond the pillars of tourism and textiles, diversify- ing into exports of more sophisticated high value-added modern services. To make this transition successfully, Cambodia needs to address several major challenges. Weak governance and regulation represent main hurdles to the development of an efficient services sector. Lack of transparency in the transport sector is leading to significantly higher transport costs, by creating an environment in which informal payments are ubiquitous. In the tourism sector, establishing a more developed regulatory environment, setting up adequate safety and quality standards, and ensuring equitable legal enforcement would help create a better environment for the expansion of more high-end tourism services, reversing the current emphasis on low-end backpacker tourism. In professional services, deficiencies in the regula- tory framework appear to run counter to Cambodia’s WTO commitments. Better infrastructure, particularly in broadband telecommunications, is required for the expansion of Cambodia’s services trade. Although mobile telephony has expanded rapidly, broadband communications are available only in a few locations, and the cost is prohibitive for most of the population. As a result, Cambodia has the lowest broadband connectivity in the region after the Republic of the Union of Myanmar. The reason for this disappointing expansion of broadband is that Cambodia has a deficient institutional and regulatory framework in the telecommunications sector—one that is not conducive to attracting foreign direct investment. Con- sequently, telecommunications services have grown at a meager 3 percent a year in the past seven years, compared with 18 percent for tourism. Cambodia’s regulatory framework on telecommunications is patchy, opaque, and inconsistent, with many administra- tive decisions not made public. The Ministry of Posts and Telecommunications acts as the policy maker as well as the regulator and the supervisory authority in the sector. Therefore, developing an enabling environment through policies and regulations that promote investment and market entry—including the passage of a law on telecommunications in line with internationally accepted principles of telecom regulation and Cambodia’s WTO commitments—remains a key priority Among other issues, new regulations should clarify the legal framework for providers, institutionalize a system for spectrum allocation, and establish an independent regulator to monitor the system. In addition to sector-specific initiatives, the authorities should consider three horizontal measures: • Ensure that the official legal gazette/journal publishes all laws, subdecrees, prakas, and ministerial directives affecting trade and investment in services. The gazette should be published weekly in both electronic and hard-copy form after allowing for early dissemination of drafts and consultation with the private sector. • Establish annual ministry-specific regulatory programs that outline issues to be tackled through regulation and the desired objec- tives of the proposed regulations. Public disclosure of the regulatory program (through the gazette) would allow other ministries and regulatory agencies, as well as the private sector, to issue comments and feedback on planned regulations. • Adopt policy guidelines that set out procedures to be followed in the law- and regulation-making process. These guidelines should be aligned with principles of good regulation, including transparency, public consultations, interagency coordination, and regulatory efficiency. Source: World Bank 2012a, 2012b. • Public notice and comment during decision making of services. The assessment of the institutional setting must • Rules against gifts take these limitations into account. • Rules against conflicts of interest In general, the resources of regular government agencies • Rules on postemployment (ministries and other bodies that report to the executive) should come from the regular government budget (which, This does not mean that such a regulatory structure ideally, has been approved by the legislature). Allowing may be feasible for all countries. Particularly in small low- policy-making entities, such as the ministry of tourism, income countries, the optimal institutional setting may to generate revenue (through the collection of fees for require adopting some of these principles in institutional approval of licenses for hotels and restaurants, for exam- structures that are not necessarily independent. ple) creates incentives that can cause it to deviate from its goal of regulating the market. Revenue from fees and other Capacity and Resources services should instead feed the regular budget, which To regulate efficiently, regulators need solid expertise. should be distributed based on needs and policy objectives. Many countries, especially small and developing econo- Independent regulatory agencies may collect part of their mies, may not have access to the technical expertise funding from the services providers under their author- necessary to tackle the most complex regulatory issues ity, which helps shield the agency from pressures from Assessing the Governance Framework 31 other sectors of the government (Brown and others 2006). Except in rare circumstances, the more open the infor- MODULE 1 Adequate transparency and checks should be in place to mation flow between the concerned regulatory agency and limit possible abuses of such authority. third parties, the better and more legitimate is the result- Ideally, regulators would conduct a regulatory impact ing regulation. Adequate information flow should include assessment for a proposed regulation, based on the eco- coordination with other government agencies and consul- nomic and social costs of current and prospective regula- tations with stakeholders and the general public. tion. Many countries lack both the data and the skills to do so, however. However, a number of small developing Interagency Coordination economies have incorporated key concepts of a regulatory Coordination with other ministries and agencies ensures impact assessment in their procedures without engaging in that regulation reflects broader public policy objectives the more demanding and data-intensive steps of the assess- and that regulation by one regulator does not obstruct the ment (World Bank 2009). goals of another. For instance, opening the road transport market to suppliers from neighboring countries requires the regulator—typically, an agency from the ministry of Regulatory Procedures transport—to coordinate with the environmental protec- Regulatory procedures that ensure transparency, adequate tion agency and with regulatory agencies from neighboring coordination with other government bodies, and consul- countries. Regulation from other bodies may affect transport tations with the private sector can strengthen capacity. services by introducing unnecessarily burdensome restric- Indeed, a well-designed and coordinated regulatory pro- g for truck drivers. tions, such as restrictions on licensing cess that ensures the smooth and transparent flow of infor- Most administrations—including many low-income mation may help overcome resource limitations in small countries at the bottom of governance rankings— economies, especially low-income countries. engage in internal coordination. However, coordination The mapping of the regulatory procedures identifies procedures often remain informal and lack transparency, deficiencies that affect the preparation, adoption, and leaving officials plenty of room to enact regulation with lit- application of current regulations. Understanding the pro- tle input from other agencies and no effective policy coor- cedures regulatory bodies follow in developing and imple- dination. To avoid such a situation, all regulatory agencies menting helps policy makers improve the quality of the should adopt standard government-wide coordination regulation and avoid or modify administrative practices procedures. Box 1.2 describes some of the policy-making that may introduce de facto barriers to trade in services. benefits of effective intragovernmental coordination. Officials can assess the governance framework based on Many countries have adopted a “law on laws” or similar internationally recognized good regulatory practices. instrument that outlines the steps in the regulation-making Box 1.2. Policy-Making Benefits of Effective Intragovernmental Coordination Given the regulatory intensity of many services activities and the range of sectors involved, coordination across government agen- cies is critical. Promoting an effective process of intragovernmental coordination is likely to generate positive policy-making exter- nalities, including the following: • Crafting unified government positions. Coordination is essential to develop negotiating positions based on complete assessment of key national priorities and to ensure that negotiators are informed of the full range of factors influencing the domestic services market. • Generating information based on measures affecting trade in services. Policy makers need accurate information on the domestic regu- latory environment affecting trade in services. Trading partners require this information during trade negotiations. Creating and updating a central inventory or focal point (such as a database) of regulatory measures can help meet such transparency obligations. • Identifying and analyzing the effects of measures on achieving economic or social policy objectives. Governments at all levels need to periodically review the effectiveness of domestic policies and regulations in achieving economic and social policy objectives. Doing so may involve analyzing the trade or investment effects of regulatory measures. • Avoiding duplicating consultations with other agencies and domestic stakeholders. Given the multitude of subsectors and measures arising from services trade, officials must achieve a balance between engaging intragovernmental partners on issues of mutual concern and avoiding inundating key departments and agencies with too much information or requests for input. Good regular lines of communication between individuals can assist in quickly addressing issues without creating unnecessary processes. • Contributing to an ongoing assessment of the impact of liberalizing services trade. In most countries, data for impact analysis are the responsibility of the national statistical agency. However, collecting such data is challenging for several reasons. Recourse to anecdotal information can be useful. Sources: Adapted from Marconini and Sauvé 2009; OECD 2002. 32 Module 1: Mapping Regulations and Evaluating Governance Figure 1.2. Information Flow for Policy on and decision-making process also lends greater legitimacy MODULE 1 Regulation of Trade and Investment in Services to the measures, fostering compliance and facilitating implementation. Regulatory agency Policy goals In low-income countries, consultations help build Regulatory status quo regulatory capacity, as government officials engage in Regulatory plan substantive exchanges with knowledgeable industry representatives. Such exchanges are particularly important for rapidly expanding sectors, because the private sector Trade ministry Trade ministry is often better equipped than the state to attract domes- Compliance and coordination Trade policy with trade policy and Trade negotiation objectives tic and international expertise, especially in developing international agreements and strategy countries. A number of principles should guide consultations with stakeholders (Better Regulation Office 2009): Regulatory agency Proposed regulation • Continuity. Consultation should be continuous and start early in the policy development process. • Targeting. Consultation should attempt to capture the diversity of stakeholders affected by the proposed changes. procedure and the information that must be disclosed at • Timeliness. Consultation should start when policy each stage. Such steps often include giving public notice objectives and options are identified. Throughout the of the intention to regulate; identifying the agencies that process, stakeholders should be given sufficient time to should be informed of the intended regulation; sharing a provide considered responses. proposed draft with other agencies; announcing the pro- • Accessibility. Officials should inform stakeholder groups posed rule in order to receive public comments; and pub- of consultations and proposals through a range of meth- lishing an approved regulation before its entry into force. ods. Agencies should consult jointly with other agencies Standardized and transparent procedures improve to reduce the burden on stakeholders. the flow of information among agencies, thus increasing • Transparency. Policy agencies need to clearly explain cooperation and enhancing knowledge in the regulatory the objectives of the consultation process and the reg- process. Excessive formal requirements on the exchange ulation policy framework. They should provide feed- of information may tax an administration’s capacity, espe- back on how they have considered the responses. cially in small and low-income economies. • Consistency and flexibility. Arrangements should be For an effective trade policy, information should flow consistent but flexible enough to suit the proposal’s back and forth between the trade ministry and the regula- circumstances. tory agency (figure 1.2). The regulatory agencies should first • Evaluation and review. Policy agencies should evaluate provide the trade ministry with a clear picture of the regu- consultation processes to make them more effective. latory status quo on their specific sector, including current laws and regulations, policy goals, and the regulatory plan. As with interagency coordination, procedures for con- The trade ministry should then articulate a services policy, sultation should be standard and mandatory for all gov- including guidelines on potential international obligations, ernment agencies. Ideally, they should specify the details to as part of a broader national trade policy. The policy can be be shared at each stage. enacted through the adoption of necessary changes in the A document should reflect stakeholders’ comments and regulation under the orbit of each relevant body. The trade explain how the proposal was modified to take account of ministry and other relevant ministries should have access their views. If the proposal was not modified, the regulation to proposed new regulations at conception and at the draft should explain why dissenting views were not reflected. stage to assess the impact on trade and its compliance with international trade agreements. Methodology Consultations with Private Stakeholders Mapping the institutional setting and the regulatory To ensure that its decisions are well informed, the regu- procedures is an information-intensive exercise. Most lator should set up an effective consultation mechanism low-income countries lack an institutional blueprint that with private stakeholders. Involving stakeholders in the clearly sets out goals, mandates, and competencies of Assessing the Governance Framework 33 government institutions. Moreover, institutional frame- tackle across-the-board issues, such as the registration and MODULE 1 works are constantly evolving as policies and practice approval of investment, the movement and stay of natu- advance and political preferences change. Many devel- ral persons, and the transfer of funds, as well as agencies oped economies have complex institutional settings, charged with regulatory coordination and oversight. with overlapping mandates based on geographical or A questionnaire to guide the collection of informa- thematic areas, often deliberately in an attempt to pro- tion on the mandate of institutions, their financial and mote regulatory competition. human capacity, and the procedures that govern the Unearthing the facts and figures of the governance regulatory process is available at the World Bank web- framework requires extensive field work. The objective of site (http://www.worldbank.org/trade/RASTI). Table 1.5 the mapping exercise will determine the desired level of provides some excerpts from the questionnaire. For detail and precision of the information sought. In a hori- additional guidance, see OECD (1995, 2005, 2012) and zontal mapping, the focus is on regulatory agencies that World Bank (2010). Table 1.5. Sample Questions for Mapping the Governance Framework Issue Sample questions Institutional setting Mandate • Has the agency the mandate and necessary authority to set tariffs for regulated entities; establish, modify, and monitor market and service quality rules; and investigate, adjudicate, and mediate on consumer complaints? • Does the institutional framework provide clear guidelines for the mandates and functions of each governmental unit/agency? Human resources • What is the staffing of the agency relative to its mandate? • What is the salary difference between agency employees and their counterparts in the private sector? • How long do professionals stay at the agency? Financial resources • Is the agency’s budget sufficient to carry out its regular operations? What percentage of the regulatory agency’s budget comes from the regular government budget? What percent comes from payments by regulated entities (for example, license fees) or consumers (for example, specific fees or taxes)? Regulatory procedures General regulatory • Is there a law or regulation that governs the regulatory process as a whole? procedures • Does each governmental unit/agency establish regulatory procedures? • Is a “map” of the regulatory process publicly available? Standards and regulatory • Are agencies required to consider international standards during the regulatory process? impact assessment • How are alternatives to regulation assessed? Are agencies required to formally state the alternatives considered in the proposal for regulation? Interagency coordination • Are other governmental units and agencies required to participate in the regulatory process? • What information is included in notifications to other agencies? Public notification • Are agencies required to make their regulatory activity public? • When does the agency make information public? • How does it do so? Stakeholder consultations • Are there formal public consultation mechanisms and procedures, including prior notification to regulated parties and other stakeholders? • Does the agency officially address the submissions received from stakeholders in the regulatory process? Additional questions for the trade ministry Implementation of trade • Are there specific formal mechanisms in the regulatory decision-making process to promote compliance agreements with international trade agreements? • Is there a specific government unit or agency charged with ensuring compliance with and implementation of international trade commitments? • How do agencies ensure nondiscrimination in the regulatory process? Additional questions for independent regulatory agencies Institutional context • How was the agency created? • Are appointments subject to approval by the legislature or one of its bodies? • Is approval from another institution required? • Did appointees who served less than a full term leave voluntarily or involuntarily? 34 Module 1: Mapping Regulations and Evaluating Governance A number of documents can assist in gathering infor- The main benefit of field work lies not in providing MODULE 1 mation. Where available, a law on laws or similar decree detailed information on law and regulations, however, but can inform about the decision-making and regulatory pro- in providing insight into the policies and market conditions cesses. Laws and regulations creating independent agencies on services in the country. These insights reveal the environ- provide the mandate of the agency, interagency coordi- ment in which services regulations must be implemented. nation, and stakeholder consultation. Information from Only based on a regulatory mapping that takes account of these formal instruments should be compared with and the country’s social and economic background can analysts complemented by actual regulatory practices as part of the offer specific guidance on regulatory practices that allow a assessment of the regulatory setting. country to reap the benefits from services trade and invest- Interviews with government officials and stakehold- ment while achieving other desired policy objectives. ers play a central role in the mapping of the institutional framework, because detailed information on the institu- References tional setting is not usually publicly available in developing countries. APEC–OECD (Asia-Pacific Economic Cooperation and Organisation for Economic Co-operation and Development). 2005. Integrated Policy makers can use the regulatory mapping to Checklist on Regulatory Reform. Paris: APEC–OECD Co-operative evaluate the institutional setting and procedures based Initiative on Regulatory Reform. on principles of good regulatory practices, including Australian Government. 2010. Best Practice Regulation Handbook. Canberra: Commonwealth of Australia. transparency, internal and public consultations, and Better Regulation Office. 2009. Guide to Better Regulation. Department of effi ciency. Internationally recognized guidelines such Premier and Cabinet, New South Wales, Australia. as those developed by the OECD Guiding Principles for Brown, Ashley, Jon Stern, Bernard Tenenbaum, and Defne Gencer. 2006. Handbook for Evaluating Infrastructure Regulatory Systems. Regulatory Quality and Performance (OECD 2005) or the Washington, DC: World Bank. APEC C–OECD Integrated Checklist on Regulatory Reform Investing across Borders (database). World Bank, Washington, DC. (APEC–OECD 2005) and government manuals on http://iab.worldbank.org/. domestic regulation (such as New Zealand’s Best Practice Marconini, Mario, and Pierre Sauvé. 2009. Negotiating Trade in Services: A Practical Guide for Developing Countries. Washington, DC: World Guidelines [State Services Commission 2004] and Bank. Australia’s Best Practice Regulation Handbook [2010]) OECD (Organisation for Economic Co-operation and Development). can serve as benchmarks. 1995. Recommendation of the Council on Improving the Quality of Regulation. Paris: OECD. ———. 2002. Managing the Request-Offer Process. Paris: OECD. ———. 2005. OECD Guiding Principles for Regulatory Quality and Conclusion Performance. Paris: OECD. ———. 2012. Recommendation of the Council on Regulatory Policy and Mapping of the regulatory framework on trade and invest- Governance. Paris: OECD. ment in services entails identifying the laws and regulations OECD Product Market Regulation Database. Organisation for Economic Co-operation and Development, Paris. http://www.oecd.org that affect services and assessing the governance frame- /economy/pmr. work. Documents and websites provided in this module State Services Commission. 2004. Best Practice Guidelines for Departments may provide relevant material for the mapping. However, Responsible for Regulatory Processes with Significant Commercial Implications. Ministry of Economic Development, State Services obtaining detailed regulatory information requires field Commission, Wellington, New Zealand. work in the country concerned. Substantive discussions World Bank. 2009. Making It Work: “RIA Light” for Developing Countries. with a wide range of government officials, representa- Investment Climate Advisory Services, Washington, DC. tives of the private sector, academics, and other domestic ———. 2010. Regulatory Quality and Competition Policy. Investment Climate Advisory Services, Washington, DC. experts are essential to understanding how policies work in ———. 2012a. Cambodia Services Trade Performance and Regulatory practice. Information garnered from field work may com- Framework Assessment. Washington, DC: World Bank. plement or contradict the information indicated by formal ———. 2012b. “Trade Development: Helping Cambodia to Become a Sophisticated Services Exporter.” Policy Note, Washington, DC. laws and regulations. Indeed, it often indicates that for- World Bank Services Trade Restrictiveness Index (STRI). Washington, mal measures that appear restrictive are not so in practice, DC. http://iresearch.worldbank.org/servicetrade/home.htm. because they are not applied or because easy ways around WTO Integrated Trade Intelligence Portal. World Trade Organization, Geneva. https://www.wto.org/english/res_e/statis_e/itip_e.htm. them exist. Conversely, opaque administrative practices Wu, Irene. 2008. “Who Regulates Phones, Television, and the Internet? may make legal regimes that look open to services trade What Makes a Communications Regulator Independent and Why It and investment restrictive in practice. Matters.” Perspectives on Politics 6 (4): 769–83. MODULE 2 Assessing the Impact of Services Regulations: A Review of Empirical Methods Objectives is particularly important in countries that do not have mechanisms such as regulatory impact analyses (RIAs) in This module reviews the main empirical methods for assessing place (see box 3.1 in module 3). the impact of regulations on the provision of services. Upon Many developing countries lack the resources or completing it, readers will be able to: capacity to use highly sophisticated methodologies with- • Gather information on restrictions out hiring external experts. For this reason, this module • Score, classify, and construct regulatory indexes does not describe in detail computable general equilibrium • Estimate tariff equivalents of regulatory measures (CGE) models. Therefore, an economy-wide assessment of • Estimate the level of restrictiveness when direct measures welfare is outside the scope of this review. The approaches of regulation are not available described do provide options for estimating tariff equiva- • Use econometric models to estimate the level of lents, which are crucial inputs for assessing welfare gains restrictiveness and losses using CGE models. Quantitative methods can be classified according to A quantitative assessment calculates the costs and ben- three not mutually exclusive taxonomies: whether they efits of maintaining or implementing regulations.1 It is a employ direct or indirect measures, whether they focus on critical component of a well-informed decision-making sectoral or economy-wide outcomes, and whether they use process and reform. Quantifying the impact of regulation a retrospective or a prospective approach. Direct methods can help policy makers choose the most efficient regulatory use information on service restrictions and policy in mix. It can help them both prioritize and design reforms. econometric analyses to assess the impact of restrictions on This module offers practical guidance on sources of certain outcomes. Indirect methods are used when direct statistical data and methods that can be used in quantifi- information on restrictions is not available. In these cases, cation exercises. Statistics on services trade and regulation analysts estimate or infer the level of openness, restrictive- are generally limited, especially in developing countries, ness, or contestability of a market by comparing it with sometimes making quantitative analysis impracticable. a particular benchmark (normally a country that has no Quantitative assessment should therefore be considered an restrictions or is relatively open). The main limitations of optional step that can complement the qualitative assess- indirect methods are that the resulting estimates may cap- ment described in module 1. ture more than trade barriers and that it is usually diffi- Even where statistics are available, there is no perfect cult to link these estimates to a specific policy measure. For way to conduct a quantitative assessment; every aspect these reasons, this approach is less suitable to guide policy of the process involves trade-offs. Impact estimations decisions than the direct approach. should therefore be interpreted as indications of orders of Retrospective analyses quantify the impact of services magnitude rather than precise estimates of impact. restrictions using econometric estimations and informa- With these caveats in mind, countries should attempt tion about past episodes of liberalization and deregulation. to undertake some degree of quantitative analysis when Prospective analyses try to project the impact of a further conducting a regulatory assessment. Such an assessment liberalization of services trade (for example, by means of 35 36 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods CGE models). They usually rely on estimations of tariff • Using the results from the impact estimations to equivalents provided by retrospective analyses. construct price, cost, or productivity impact measures This module focuses on retrospective methods carried as a proxy for tariff equivalents. out through econometric analyses and on sectoral studies. It also presents two indirect methods, gravity equations Policy makers can use information gathered from direct and estimated markups across sectors and countries, and methods as an input for calculating tariff equivalents for briefly examines CGE modeling. a set of out-of-the-sample countries or assessing welfare gains and losses using CGE modeling. Direct Methods Step 1: Gathering Information on Restrictions Many studies based on direct methods assess the impact of service regulation on a sector-by-sector basis. Researchers Step 1 involves collecting information on both domestic first gather information on restrictions and policies in a and foreign regulations. Ideally, domestic information is sector. They then use econometric models to estimate the obtained by conducting horizontal and sectoral regulatory impact of restrictions and policies on industry-specific mappings (as described in module 1). Analysts should also measures of performance, such as prices, costs, profits, gather information on measurable indicators of the goals and quantities. An advantage of this method is that the regulations seek to achieve and related implementation impact on performance can be directly linked to a particu- and enforcement costs. lar policy. To obtain information on regulations for a larger In the 2000s, the Australian Productivity Commission number of economies, some researchers rely on trade pol- and the Australian National University conducted one of icy information. They collect data on countries’ commit- the most comprehensive studies of services sector regulation ments under the frameworks of multilateral services trade MODULE 2 across industries and countries.2 They collected informa- negotiations at the World Trade Organization (WTO) tion on restrictions in the banking (McGuire and Schuele (that is, the General Agreement on Trade in Services 2000; Kalirajan and others 2000); telecommunications [GATS]) and preferential trade agreements. Secondary (Warren 2000); maritime transport (Kang 2000; McGuire, information can also be useful. It includes information Schuele, and Smith 2000); wholesale and retail distribution gathered by international organizations (primarily the (Kalirajan 2000); education (Kemp 2000); and professional OECD, the WTO, the World Bank, the United Nations services (Nguyen-Hong 2000) sectors in selected economies (UN) Conference on Trade and Development [UNCTAD], in Europe, Asia, and North and South America.3 and the International Telecommunication Union [ITU]); The Organisation for Economic Co-operation and by intergovernmental associations, such as APEC; and by Development (OECD) has mapped services regulation and governmental agencies such as the Office of the U.S. Trade assessed the impact of restrictions in the electricity (Steiner Representative. Country surveys and sector-specific ques- 2001), telecommunications (Boylaud and Nicoletti 2001), tionnaires can also provide information. Table 2.1 identi- and air passenger transport (Gönenç and Nicoletti 2001) fies some good sources of services policy information. sectors. Findlay (2011) summarizes a set of studies on the Using trade policy measures from countries’ commit- impact of policy and structural reforms in telecommuni- ments and negotiating offers (also referred to as schedules) cations, energy, and transport in Asia-Pacific Economic under the GATS has both advantages and disadvantages.4 Cooperation (APEC) economies. An advantage is the extensive country coverage: all 159 Direct methods typically involve some or all of the WTO members have provided information on commit- following steps: ments and negotiating offers. In addition, under the GATS framework, countries make commitments by services sec- • Gathering information on restrictions affecting the pro- tor and mode of supply, allowing policy makers to con- vision of services in a particular sector struct indicators by sector, country, and mode of supply • Translating qualitative information into quantitative and to compare trade liberalization across countries. measures, classifying regulations, and constructing a A disadvantage relates to the “ positive listing ” regulatory index approach. In a positive list, countries list or mention only • Estimating the impact of regulations on the provision the sectors they want to liberalize (none, for no limitations, of services (price, cost, price-cost margin, quantity, or in GATS terminology). If a country does not list a sector, productivity) while controlling for other factors that it has not made a commitment to liberalize that sector (in may affect performance GATS terminology, the sector is unbound). Researchers Direct Methods 37 Table 2.1. Sources of Information on Regulatory Measures Affecting Trade and Investment in Services Institution/type of information Source or example World Trade Organization (WTO) Services trade regulations (joint with the World Bank) http://i-tip.wto.org/services/ General Agreement on Trade in Services (GATS) schedules http://tsdb.wto.org/default.aspx Database on GATS schedules, GATS proposals, and service regional Roy (2011); http://www.wto.org/english/tratop_e/serv_e trade agreements /dataset_e/dataset_e.htm GATS negotiating offers Regional trade agreements http://rtais.wto.org/UI/PublicMaintainRTAHome.aspx Trade policy reviews http://www.wto.org/english/tratop_e/tpr_e/tpr_e.htm Air services agreements http://www.wto.org/asap/index.html Background documents produced by the WTO Secretariat, for S/C/W/270/ on air transport instance World Bank Services Trade Restrictions Database and Services Trade http://iresearch.worldbank.org/servicestrade/ Restrictiveness Index (STRI), which cover five key sectors: financial Borchert, Gootiiz, and Mattoo (2012) services (banking and insurance), telecommunications, retail distribution, transportation, and professional services Regulation and supervision of banks database http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTRESEA RCH/0,,contentMDK:20345037~pagePK:64214825~piPK:64214 943~theSitePK:469382,00.html Organisation for Economic Co-operation and Development (OECD) Product Market Regulation (PMR) survey http://www.oecd.org/document/1/0,3746,en_2649_37443_2367 297_1_1_1_37443,00.html MODULE 2 U.S. Trade Representative (USTR) National Trade Estimate (NTE) Report on Foreign Trade Barriers http://www.ustr.gov/about-us/press-office/reports-and -publications/2013/NTE-FTB Asia-Pacific Economic Cooperation (APEC) Individual Action Plans http://www.apec-iap.org/ typically assume that trade is restricted in unlisted sectors, regulations against foreign services suppliers but also to but these sectors may be fully liberalized (see Gootiiz and nondiscriminatory regulations—regulations that apply Mattoo 2009). equally to domestic and foreign providers. Consequently, When using GATS as a source of information on ser- in addition to trade policy information, the Productivity vice regulations, officials should also consider three other Commission collected information on nondiscriminatory limitations: service regulations. This information is valuable, but relying on differ- • GATS schedules of commitments do not necessarily ent sources of information can undermine comparability reflect current regulatory regimes. across countries. Documentation of services regulation • Air transport regulations lie largely outside multilateral tends to be greater for developed than for developing coun- negotiations.5 tries. This difference could lead to the erroneous belief that • Some barriers to trade in services, including barriers countries for which data are available have more restrictive associated with domestic regulations, are not explicitly regimes. listed in the GATS schedules. Country surveys and sector-specific questionnaires can provide data on restrictions that are comparable across Australia’s Productivity Commission noted the last countries. The OECD Product Market Regulation (PMR) limitation in the studies it reviewed. It recognized that Indicators are examples. The PMR data come mainly because of its reliance on different modes of supply, trade from surveys of member countries (the OECD Regulatory in services is subject to a wide set of behind-the-border Indicators Questionnaire). They are thereby highly com- measures. Services are subject not only to discriminatory parable across countries. The 1998, 2003, and 2008 PMRs 38 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods cover several nonmanufacturing sectors as well as network Table 2.2. Scoring Regulations in the Banking Sector industries such as energy (electricity and gas); transport Type of restriction Score Regulation (air, rail, and road transport); communications (post Restrictions on duration of 1.00 No temporary entry and telecommunications); retail trade; and professional stay of executives, senior of executives, managers, and specialists senior managers, or services. specialists allowed The World Bank has compiled the Services Trade 0.75 Entry allowed for stays Restrictions Database (Borchert, Gootiiz, and Mattoo up to 30 days 2012). It contains information on an unprecedented 0.50 Entry allowed for stays up to 60 days range of countries and sectors: 103 countries; 5 services 0.25 Entry allowed for stays sectors (financial services, telecommunications, retail dis- up to 90 days tribution, transportation, and professional services); and 0 Entry allowed for stays 18 subsectors. The database classifies services regulations up to 120 days based on their mode of supply. Restrictions on foreign 1.00 Foreign ownership not equity permitted The World Bank’s Services Trade Restrictiveness Index 0.99–0.01 Inversely related to (STRI) includes information from country surveys con- maximum share of ducted between 2008 and 2010 on 79 developing countries. foreign ownership It indicates whether services policies discriminate against allowed foreign services providers. It does not include informa- 0 No restrictions on foreign ownership tion on domestic services regulations that apply equally to domestic and foreign suppliers. Countries can benefit from previous studies and from A note of caution is warranted concerning the scoring the efforts of international organizations such as the OECD process: when adding scores, analysts must consider the MODULE 2 and the World Bank. Particularly useful are the Regulatory interaction between regulations. In some cases, a policy Assessment of Services Trade and Investment (RASTI) measure may be sufficient to completely close the market questionnaires (available at http://www.worldbank.org to foreign suppliers. In such a context, other regulations— /trade/RASTI) and the questionnaire used to construct the on, for instance, the operation of foreign firms—will World Bank’s Services Trade Restrictions Database (http:// have no additional impact on the market under analysis. iresearch.worldbank.org/servicestrade/). Treating restrictions as additive would therefore be flawed. Based on the mapping conducted in module 1, analysts When regulations are logically linked, analysts should take should also gather information on measurable indicators this information into account and try to incorporate it into of the goals of services regulation as well as on implemen- the scoring system. tation and enforcement costs. Classifying Regulations Depending on the study’s purpose, regulations can be Step 2: Scoring, Classifying, and Constructing Regulatory classified according to predefined taxonomies. One common Indexes classification is shown in table 2.3, which classifies regula- Step 2 consists of creating quantitative measures (that is, tions based on (a) their impact on the establishment of a translating qualitative information into scores); classifying business and its ongoing operations and (b) whether they regulations; and constructing regulatory indexes. discriminate against foreign providers. Kalirajan (2000) and Nguyen-Hong (2000) use this type of classification. Scoring Regulations Once restrictions on entry and establishment are Once regulations have been identified, their stringency separated from those on ongoing operations, the results must be translated into quantitative measures, typically by can be used as inputs in a CGE model. In such models, a system of scores. Table 2.2 shows scores for two banking restrictions affecting the entry of service suppliers can sector measures. The first measure relates to the duration be modeled as restrictions on the movement of capital, of stay of foreign executives, senior managers, and special- and restrictions on ongoing operations can be modeled as ists. In this example, the scores range from 0 to 1; the more affecting output. stringent a regulation, the higher the score. The second Crozet, Milet, and Mirza (2011) use a slightly different measure relates to restrictions on foreign ownership. In type of classification, distinguishing restrictions affecting this case, a country’s score is inversely related to the foreign fixed costs (which may be associated with restrictions on ownership share allowed. entry) from restrictions affecting variable costs (which may Direct Methods 39 affect ongoing operations). Jensen, Rutherford, and Tarr (Mode 3). Officials could also use this type of classifica- (2008) distinguish between discriminatory and nondis- tion to understand how different modes of supply affect criminatory policy measures. Their CGE model of the performance variables. Tanzanian economy finds that the largest gains derive from In some cases, rather than rely on a predefined clas- liberalization of nondiscriminatory regulatory barriers. sification, it may be preferable to develop a classification Dihel and Shepherd (2007); Bottini, Marouani, and system based on data analysis. One type of such analysis is Munro (2011); and Borchert, Gootiiz, and Mattoo (2012) principal component analysis (box 2.1). classify regulations based on mode of supply (table 2.4). This classification can help policy officials analyze inter- Constructing Regulatory Indexes dependencies between modes of supply. For instance, Many regulations affect the provision of services, making restricting cross-border trade (Mode 1) could increase comparison of the contestability of markets across or decrease the effect of restricting commercial presence countries difficult. Studies normally deal with this prob- lem by constructing regulatory indexes that summarize in Table 2.3. Assessing Banking Regulations Based on a Two- Dimensional Taxonomy a single indicator a set of policies affecting the provision of services. Once the methodology is applied to several coun- Impact on entry/ Impact on ongoing tries, the market contestability of a service category can be establishment operations Nondiscriminatory Number of banking Banks are restricted compared across economies. licenses is in the manner in An important issue is determining how regulations can restricted. which they can be grouped or added in a single indicator. What weights raise funds. should be assigned to individual regulations? The simplest Discriminatory Number of foreign Foreign banks are banking licenses restricted in the method is to give restrictions equal weights (that is, sim- is restricted. manner in which ply averaging the regulation scores). This method has been MODULE 2 they can raise used to construct regulatory indexes based on GATS com- funds. mitments and offers (see, for example, Hoekman 1996, Source: Adapted from McGuire 2003. Eschenbach and Hoekman 2006, and Roy 2011). Table 2.4. Assessing Regulations in the Telecommunications, Engineering, and Banking Sectors Based on the Mode of Supply Mode Telecommunications Engineering Banking 1: Cross-border trade Restrictions on leased lines or private Restrictions on provision of cross- Limits on cross-border provision networks, third-party resale and border engineering services or of deposits by foreign banks Internet telephony (VoIP), and local presence requirement to connections of leased lines and provide the service private networks to the public switched telecommunications network (PSTN) 2: Consumption Restrictions on provision of call-back Restrictions on the purchase of Restrictions on the purchase of abroad services engineering services abroad financial services by country’s by country’s residents living residents abroad abroad 3: Commercial Restrictions on foreign equity, joint Limits on ownership of Restrictions on provision of presence venture arrangements, issuance of engineering firms by nonbanking services, such new licenses, screening and approval nonprofessionals; restriction as insurance and securities for new entry on form of establishment services (for example, incorporation prohibited or permitted) 4: Movement of natural Limits on duration of stay of executives, Burdensome requirements Limits on duration of stay of persons senior managers, or specialists; or procedures for licensing executives, senior managers, restrictions on nationality of and accreditation of foreign or specialists; restrictions on members of company’s board professionals nationality of members of of directors; and restrictions on Imposition of economic needs company’s board of directors; issuance of working permits and visas tests for granting of work and restrictions on issuance subject to, for instance, professional permits of working permits and visas qualifications subject to, for instance, professional qualifications Source: Adapted from Dihel and Shepherd 2007. 40 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods Another common method is to use a priori judg- A third alternative is to use statistical techniques, such as ments about the relative economic importance of differ- factor analysis, in particular principal component analysis, ent restrictions. Kalirajan (2000), for example, considers to derive weights based on data characteristics. (Figure B2.1.1 commercial presence the most important mode of supply provides an example applied to the energy sector.) in distribution services and assigns restrictions affecting Finally, econometric analysis can be used to estimate foreign investments heavier weights. the relative impact of regulations on a variable of service Box 2.1. Principal Component Analysis of the Electricity Sector Principal component analysis (PCA) is a statistical technique that summarizes information from a large set of variables into a reduced number of new variables referred to as factors or latent variables. These latent variables can be used not only to classify regulations but also to group them and to construct summary indicators such as regulatory indexes. Using the latent variables, analysts can plot countries visually, to show how countries are clustered. Steiner (2001) provides an example of PCA applied to services regulations (see also Nicoletti, Scarpetta, and Boylaud 2000; Gönenç and Nicoletti 2001; Boylaud and Nicoletti 2001; Barth, Caprio, and Levine 2004; Fontagné and Mitaritonna 2009; and Bottini, Marouani, and Munro 2008). She assesses the impact of liberalization and privatization on efficiency and price in the elec- tricity industry. As a first step, she collected information on energy regulations for 19 OECD countries over a 10-year time period. She then clustered the 13 original regulatory variables (the rows in table B2.1.1) into 3 factors or latent variables (the columns in table B2.1.1). The factors are linear combinations of the original variables and are therefore correlated with them. Thus, although the method does not provide an explicit economic interpretation of the factors, they can be interpreted by their correlation with the origi- nal variables, in this case the 13 original regulatory variables. The first factor in the table is highly correlated with the first eight regulatory variables, which are related to the degree of liberalization of the energy market. Accordingly, Steiner renamed factor 1 “liberalization.” Factor 2 was correlated mainly with regulations related to the degree of privatization of the market (rows 9–11). MODULE 2 Steiner therefore relabeled it “privatization.” Subsequently, countries can be rescored and plotted using the liberalization and privatization variables, as shown in figure B2.1.1. The liberalization and privatization variables can be thought of as regulatory indexes, as they combine different regulations in a single indicator that can be used to produce countries’ rankings. Once the countries are plotted, clusters of countries can be identified. Steiner identifies five groups. One is formed by a single country, the United Kingdom (GBR), which scores high on both liberalization and privatization. At the opposite end, in the bottom left-hand corner of figure B2.1.1, is a large cluster of economies with low scores on both liberalization and privatization. In order to conduct a PCA, the regulatory variables should be correlated. If regulations correlate, then they carry similar informa- tion, and the PCA is capable of summarizing the information into a reduced number of variables. Sometimes it proves difficult to give an interpretation to the factors in economic terms. This problem might prevent researchers from implementing this approach. The factors are by construction orthogonal (that is, the correlation between factors equals 0). Therefore, it could prove useful to include them rather than the original regulatory variables in the econometric analysis, in order to avoid multicollinearity (the correlation of two or more variables) in step 3 (described in the next section). Table B2.1.1. Identification of Factors through Principal Component Analysis of Regulations in the Energy Sector Factor 1: Factor 2: Factor 3: Regulation Liberalization Privatization Ancillary regulation 1. Liberalization 0.928 0.052 –0.083 2. Time to liberalization 0.744 –0.166 0.114 3. Third-party access 0.827 0.122 0.152 4. Unbundling of generation and transmission 0.909 0.120 0.121 5. Vertical integration 0.759 0.093 0.38 6. Interaction of integration and ownership 0.615 0.526 0.369 7. Wholesale pool 0.932 0.104 –0.081 8. Choice threshold –0.711 –0.259 0.497 9. Privatization 0.023 0.930 –0.157 10. Private ownership 0.126 0.900 0.011 11. Time to privatization 0.093 0.836 0.197 12. Price regulation 0.207 –0.254 0.369 13. State preference for renewable technology 0.003 0.233 0.817 Source: Steiner 2001. (continued on next page) Direct Methods 41 Box 2.1. (continued) Figure B2.1.1. Identification of Clusters of Countries through Principal Component Analysis of Regulations in the Energy Sector Electricity supply industry, 1986–96 3.5 GBR 2.5 Degree of liberalization NOR 1.5 0.5 SWE FIN DEU NLD DNK AUS ESP ITA T PRT BEL JPN –0.5 F CAN FRA USA –1.5 –1.5 –1.0 –0.5 0 0.5 1.0 1.5 2.0 2.5 Degree of privatization MODULE 2 Source: Steiner 2001. performance, and the resulting coefficient estimates can be In practice, the lack of in-sample variation of some used to construct regulatory indicators. regulations and the presence of multicollinearity among All of these methods suffer from limitations; the choice them frequently prevent researchers from conducting of method will depend on the study’s purpose. On the one econometric analysis. hand, using averages is simple, transparent, and objective. On the other hand, assigning equal weight to regulations fails Step 3: Estimating the Impact of Regulation to account for the varying economic importance of individ- ual restrictions. Therefore, it is not very informative about Step 3 consists of estimating the impact of regulation on the level of restrictiveness of different regulatory regimes. measures of economic performance while controlling for Using a priori judgments—based on expert or industry other factors that might affect the variables. opinions, for example—might better analyze the restric- tiveness of the regulatory regime. But these judgments are Measures of Economic Performance contentious and subjective. Because trade barriers in services typically operate behind PCA weights are strictly data based; regulations with the border, studies usually quantify the barriers’ effects on higher in-sample variation receive heavier weights in this behind-the-border measures of performance (Dee 2011; see method. The PCA is thus objective but not very informa- annex table 2A.1). Except for studies on the international tive about the level of restrictiveness. Another limitation of transport sector, most studies rely on behind-the-border PCA is that weights are not stable. Indeed, they are likely to measures of economic performance (dependent variable). change with the data sample. Thus, applying them to differ- (Measures of economic performance in the transport sec- ent country and year samples is likely to be inappropriate.6 tor relate mainly to trade rather than behind-the-border Different weighting methodologies may result in measures. For instance, fares and the number of interna- different indicator values, which could affect country tional flights are used as dependent variables in studies on rankings. Therefore, it is important to test the sensitivity of air transport services.) the regulatory indexes and the resulting country rankings Many studies investigate how service regulations affect to different weighting techniques. the ability of service suppliers to set prices above mar- In theory, using econometric analysis results in an ginal costs (that is, monopolistic prices) by using markups objective indicator that is meaningful in economic terms. as a measure of service performance. Several studies use 42 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods price-cost margins to assess the effects of service regulations between barriers that actually restrict trade (that is, bind- on professional services, telecommunications, distribution, ing restrictions) from those that do not because they are and insurance and net interest margins for the banking redundant (Whalley 2004). Second, the use of regulatory sector. Studies of the energy and the telecommunications indexes may overlook the different impacts regulations industries have investigated the impact of regulation on have on performance variables and the fact that different domestic prices; studies on telecommunications have ana- regulations may cancel out each other’s effects.9 Third, this lyzed the impact of regulation on the number of telephone approach does not allow analysts to investigate the poten- lines and mobile subscribers per inhabitant (penetration tial interdependence of regulations—that is, whether other rate). regulations augment or diminish the effect of a particular regulation. Cost-Creating versus Rent-Creating Regulations In their estimation models, Fink, Mattoo, and The empirical literature recognizes the need to distinguish Rathindran (2003) investigate the impact of privatization cost-creating from rent-creating regulations. The first type and competition on labor productivity and the number prevents firms from operating efficiently, pushing up vari- of telephone main lines per inhabitant. They find that able costs. The second type protects existing firms from privatization and competition independently lead to sig- competition, allowing them to set monopolistic prices and nificant improvements in performance and that they are capture rents. This distinction is important because restric- complementary—that is, larger gains accrue when both are tions have different impacts on welfare depending on their present. type. If services restrictions are cost creating, removing Given the limitations of using individual regulations them may yield greater welfare gains than if they are rent and regulatory indexes, analysts often seek an inter- creating (Francois and Hoekman 2010). Imposition of mediate solution, namely, subindicators. To construct a rent-creating restriction may have only a redistributive subindicators, analysts can use a regulatory taxonomy or MODULE 2 effect (that is, it transfers rent from the government to the factor analysis. private sector or from domestic to foreign firms). In con- trast, imposition of a cost-creating restriction creates inef- Control Variables and Panel Data ficiencies, thus affecting the optimal allocation of resources To ensure that the impact of service regulation on the and reducing production to below optimal levels. performance variable is not the result of omitted vari- To identify whether restrictions are cost creating or rent ables, analysts must collect data on nonregulatory restric- creating, analysts need data on prices (or markups) and tions that may also affect the service performance. The costs.7 Because these data are not readily available (except set of control variables is sector specific. It may involve for the banking sector), many studies rely on price-cost collecting information on private sector practices, such margins. They interpret regulations as rent creating when as buyer-supplier networks in distribution services and regulations increase price-cost margins and as cost creating existing agreements in maritime services; variables of when they reduce them. This approach may underestimate market structure; and firm-specific variables, such as the real impact of regulations. For instance, a regulation size. could be cost creating but services suppliers could increase Alternatively, depending on the level of data disaggrega- prices and pass on to consumers the higher costs gener- tion, analysts can use panel data techniques, such as fixed ated by the new regulation. Under such circumstances, the effects, to control for sector characteristics. This technique econometric estimation would not identify any regulatory is possible when firm-level data for a number of countries, impact.8 bilateral data, or data for several years are available. Many studies use firm-level data; bilateral data are frequently Individual Restrictions versus a Regulatory Index used for transport services. In contrast, few studies use data Lack of data often limits empirical work on services. with time variation, mainly because regulatory data were Coverage of countries and years is spotty, leaving too little inconsistently collected over time, making it difficult to data for estimation models. Moreover, the lack of in-sample control for country characteristics to investigate whether variation of some regulations and the presence of multicol- the sequencing of policies played a role.10 For instance, linearity frequently prevent researchers from including reg- using data that expanded from 1985 to 1999, Fink, Mattoo, ulations separately in the same estimation model. and Rathindran (2003) find that the sequence of reform Using a regulatory index can be a good alternative. matters. Their results indicate that mainline penetration Regulatory indexes have important limitations, however. tends to be lower when competition is introduced after, First, this approach does not allow users to differentiate rather than at the same time, as privatization. Direct Methods 43 Regulations with Legitimate Objectives In the banking sector, regulators may restrict bank Some regulations guarantee a market’s contestability while activities in order to prevent conflicts of interest and risky addressing environmental, equity, and other social objec- behavior that could lead to a crisis. They typically try to do tives. Indeed, as Doove and others (2001) note, “In many so by restricting banks’ involvement in activities such as service industries, the relevant question is not whether to securities, insurance, and real estate investment.11 Whether regulate, but rather what type of regulation is the most such restrictions are effective is not clear: Barth, Caprio, and appropriate, and at what level.” Levine (2004) find no clear relationship between nonper- The absence of regulation can have an adverse effect on forming loans and restrictions on bank activities. Instead, the economy, but too much regulation can reduce welfare they find that restricting the scope of bank activities has as well. In a study of maritime transport services, Clark, a negative impact on bank development and increases the Dollar, and Micco (2004) find that some level of regulation incidence of banking crises. Their results suggest that some positively affects port efficiency but excessive regulation policy measures that seem to have legitimate objectives reverses these gains. may not bring about desired outcomes, thus highlighting Ideally, the regulatory assessment should focus not only the need for conducting cost-benefit analyses and a regula- on the costs but also on the benefits of the imposition of tory assessment. regulations. It should identify whether regulations have brought about desired outcomes in environmental, equity, Step 4: Constructing Tariff Equivalents and social objectives. Most studies investigate associated costs—whether RASTI can use impact assessments of service regulations regulations increase firms’ rents (price-cost margins), (step 3) to construct tariff equivalents.12 A tariff equiva- production costs, and prices or reduce efficiency and the lent (also known as an ad valorem equivalent) is the tar- supply of services in a market. Most studies include all iff that would yield the same effect as a nontariff barrier. MODULE 2 regulations—whether they pursue legitimate objectives or Tariff equivalents are used as inputs in assessing the impact not—in the construction of regulatory indexes and econo- of regulation on welfare through a CGE model. metric estimations. This approach fails to yield a complete The tariff equivalents in the studies reviewed in this picture of the costs and benefits of regulation. Only when module capture the impact of full liberalization of the ser- policy makers have information on the trade-offs involved vices sectors on costs/prices. They are obtained by com- in regulation can they identify whether regulations are paring the service costs/prices that would have existed in more burdensome than necessary and whether other regu- the absence of the regulatory restrictions with actual costs/ lations may be equally effective but less costly. prices given the restrictions.13 Most studies recognize this limitation. Gönenç and This approach raises the problem of determining an Nicoletti (2001, 186), who study airfares to assess the appropriate benchmark. As Doove and others (2001) point impact of regulation on the air passenger sector, point out out, using a fully unregulated world as a benchmark fails that “while price outcomes are studied in detail, limita- to recognize that some regulations may have legitimate tions on available data made it impossible to consider the objectives. Using econometric estimations, they use as a implications of liberalization for service quality and con- benchmark the regulatory regime that brings about the sumer convenience.” By the same token, by focusing on best estimated economic outcome, which in practice does fares, the authors disregard benefits from regulations, such not necessarily relate to the most liberalized regime. as reductions in noise, pollution, and accidents. Another problem—and probably the major criticism Among the studies applying direct methods listed in of constructing tariff equivalents from price and cost annex table 2A.1, only Barth, Caprio, and Levine (2004) impacts—lies in its economic underpinning. As Deardorff adopt a cost-benefit approach. Using the World Bank’s and Stern (2008) describe, there is only one case in which the database on bank regulation and supervision, they assess price change resulting from a restriction equals the import the impact of regulations and supervisory practices in the tariff that brings about the same economic effect (that is, banking sector in 107 countries. They analyze the impact in which price changes equal the tariff equivalent measure). of a regulatory regime not only on the costs regulations This scenario is a world in which markets are highly com- may impose (by, for example, increasing banks’ interest petitive: a world without market failures, in which prod- margins and the number of nonperforming loans) but ucts are perfect substitutes, and in which no country is big also on the potential benefits of the regulatory framework enough to have an impact on world prices. These conditions (such as improving banking system stability and bank are not met in the services sector, where market failures are development). frequent and the level of product differentiation is high. 44 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods In the absence of perfect competition, the price change Step 1: Gathering Information on Restrictions resulting from an imposed restriction is typically smaller than Nguyen-Hong (2000) and Dihel and Shepherd (2007) its tariff equivalent. Therefore, constructing tariff equivalents rely on secondary sources for information on the engi- from price and cost impacts tends to underestimate the level neering sector. Nguyen-Hong gathers information on 17 of restriction, resulting in conservative measures of barriers categories of regulations using the OECD Inventory of and gains from liberalization in CGE models. Measures Affecting Trade in Professional Services (OECD Some studies apply estimates from previous econo- 1996), APEC Individual Action Plans, and WTO Trade metric analyses to countries not included in the estima- Policy Reviews. Dihel and Shepherd draw on OECD proj- tion sample to estimate tariff equivalents. This technique ects on trade in services in transition economies carried is useful when countries have resource constraints. out by the Trade Directorate, data from the Organization Analysts must still collect information on regulations, of American States, National Trade Estimates from score regulations, and construct regulatory indexes for the the Report on Foreign Trade Barriers of the U.S. Trade out-of-the-sample country. Once analysts construct regu- Representative, GATS schedules, and product market latory indexes, they can estimate tariff equivalents by using regulation. coefficients from previous cross-country analyses without conducting another econometric estimation (as shown in Step 2: Scoring, Classifying, and Constructing the next section). Regulatory Indexes Doove and others (2001) use OECD results to project tax With the information on the 17 categories of regulations, equivalents for non–OECD countries. Dee (2005) calculates both research teams classify regulations and estimate their tariff equivalents for several services categories in Vietnam, quantitative effect using a system of scores. Dihel and based mainly on research by the Productivity Commission Shepherd (2007) classify regulations by mode of supply and Australian National University. Researchers have MODULE 2 (table 2.5). Nguyen-Hong (2000) uses the classification drawn on the work of the Productivity Commission to cal- shown in table 2.6. The 17 categories of regulations are first culate tariff equivalents for out-of-the-sample countries in classified based on whether they apply equally to domes- Armenia (Jensen and Tarr 2011); Kazakhstan (Jensen and tic and foreign services providers and whether they treat Tarr 2007); Kenya (Balistreri, Rutherford, and Tarr 2009); foreigners in a discriminatory way. They are then classified the Russian Federation (Jensen and others 2004); and based on whether they affect entry of new services provid- Tanzania (Jensen and others 2008). Whether the econo- ers or the operations of service providers that have already metric sample in the previous analysis is representative entered the market. enough to be applied to the out-of-the-sample countries is Nguyen-Hong and Dihel and Shepherd employ a similar the main concern of this approach. system of scores. Table 2.7 shows the scores Nguyen-Hong applied to the 17 regulations. Steps 1–4 Applied to the Engineering Sector Two studies construct tax equivalents using the coefficient Table 2.5. Regulatory Indexes for Engineering Services in estimates obtained in their econometric estimations. Selected Countries, by Mode of Supply Nguyen-Hong (2000) constructs regulatory indexes for Country Aggregate Mode 1 Mode 2 Mode 3 Mode 4 accounting, architecture, engineering, and law in Asia Malaysia 2.01 1.07 1.28 2.72 0.53 Pacific, Europe, and the Americas, examining 34 economies China 1.71 2.15 0 1.64 1.53 for the first three subsectors and 29 for legal services. He Indonesia 1.57 2.15 2.57 0.96 1.6 also conducts an impact analysis for engineering using Brazil 1.42 2.15 2.57 1.01 1.21 firm-level accounting data for 20 economies. Thailand 1.39 2.15 0 1.73 0.72 Dihel and Shepherd (2007) construct regulatory indexes Chile 1.04 2.15 2.57 0.16 1.56 for banking, insurance, telecommunications (fixed and Philippines 0.73 2.15 2.57 0.1 1.59 mobile), engineering, and distribution services for selected Singapore 0.56 2.15 0 0.1 0.88 countries in Africa, Asia, Central and Eastern Europe, Argentina 0.51 0 0 0.1 0.65 Latin America, and the Middle East. Their country cover- Russian 0.46 1.07 0 0.1 0.82 Federation age ranges from 10 to 29, depending on the data available. They conduct impact assessments for each sector under Source: Adapted from Dihel and Shepherd 2007. Note: Scores range from 0 to 1; the more restrictive a regulation, the higher analysis. For engineering services, they estimate the impact the score. Mode 1 = cross-border trade; Mode 2 = consumption abroad; of service regulations in 10 economies. Mode 3 = commercial presence; Mode 4 = presence of natural persons. Direct Methods 45 Table 2.6. Taxonomy for Classifying Regulations of Engineering Services Impact on entry/establishment Impact on operations Nondiscriminatory • Form of establishment • Activities reserved by law to the profession • Investment and ownership by nonprofessional investors • Multidisciplinary practices • Licensing and accreditation of domestic professionals • Advertising, marketing, and solicitation (scores additive) • Fee setting Discriminatory • Foreign partnership/association/joint venture • Licensing requirements on management • Investment and ownership by foreign professionals • Other restrictions (scores additive) • Nationality/citizenship requirements • Movement of people (temporary) • Residency and local presence • Quotas/economic tests on the number of foreign professionals and firms • Licensing and accreditation of foreign professionals • Movement of people (permanent) Source: Adapted from Nguyen-Hong 2000. Table 2.7. Scores and Weights Used in Nguyen-Hong’s Study of Regulation of Engineering Services Restriction category Score Weight Apply to domestic providers? Barriers to establishment Form of establishment 0.08 Yes Prohibition on incorporation 1.0 No Some form of incorporation permitted 0.5 No No restrictions 0 No MODULE 2 Foreign partnership/association/joint venture 0.08 No Prohibition on partnership/association/joint venture with foreign professionals 1.0 No Partnership/joint venture with foreign professionals required 0.5 No No restrictions 0 No Investment and ownership by foreign professionals 0.05 No Investment and ownership by nonprofessional investors 0.05 Yes Nationality/citizenship requirements 0.135 No Nationality required to qualify, become member of professional body, 1.0 No or practice Nationality required to obtain professional title, but practice is relatively free 0.25 No No restrictions 0 No Residency and local presence 0.135 No Permanent or prior residency (more than 12 months) required 1.0 No Less than 12 months prior residency 0.75 No Prior residency required for local training 0.5 No Domicile or representative office only 0.25 No No restrictions 0 No Quotas/economic tests on the number of foreign professionals and firms 0.1 No Quotas/economic needs tests 1 No Some restrictions apply 0.5 No No restrictions 0 No Licensing and accreditation of foreign professionals 0.1 No Local retraining required for full license 1.0 No Local examination required in all cases 0.75 No Case-by-case assessment of foreign qualification/license 0.5 No Aptitude tests 0.25 No Foreign license/qualifications sufficient to practice 0 No Licensing and accreditation of domestic professionals (scores additive) Yes Compulsory membership of domestic professionals (scores additive) Professional examination requirements 0.25 No (continued on next page) 46 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods Table 2.7. Scores and Weights Used in Nguyen-Hong’s Study of Regulation of Engineering Services (continued) Restriction category Score Weight Apply to domestic providers? Practical experience requirements 0.25 No Higher education requirements 0.25 No Movement of people (permanent) 0.02 No No entry of executives, senior managers, or specialists 1.0 No Executives, specialists, or senior managers can stay a period of up to 1 year 0.8 No Executives, specialists, or senior managers can stay a period of up to 2 years 0.6 No Executives, specialists, or senior managers can stay a period of up to 3 years 0.4 No Executives, specialists, or senior managers can stay a period of up to 4 years 0.2 No Executives, specialists, or senior managers can stay a period of 5 or more years 0 No No Barriers to ongoing operations No Activities reserved by law to the profession 0.05 Yes 4 core activities and over 1.0 No 3 core activities 0.75 No 2 core activities 0.5 No 1 core activity 0.25 No None 0 No Multidisciplinary practices 0.05 Yes Prohibition on partnership with other professionals 1.0 No Majority partnership required 0.5 No No restrictions 0 No MODULE 2 Advertising, marketing, and solicitation 0.05 Yes Advertising, marketing, and solicitation restricted 1.0 No Some form of advertising, marketing, or solicitation allowed 0.5 No No restrictions 0 No Fee setting 0.05 Yes Mandatory minimum or maximum fees 1.0 No Restrictions for some groups or activities 0.5 No No restrictions 0 No Licensing requirements on management 0.02 No All directors/managers or at least a majority of them must be nationals or 1.0 No residents At least one director/manager must be a national or resident 0.75 No Directors and managers must be locally licensed 0.5 No Directors and managers must be domiciled 0.25 No No restrictions 0 No Other restrictions (scores additive) 0.02 No Restrictions on hiring professionals 0.33 No Restrictions on the use of firm’s international names 0.33 No Government procurement: restrictions toward foreigners 0.33 No No restrictions 0 No Movement of people (temporary) 0.01 No No temporary entry of executives, senior managers, or specialists 1.0 No Temporary entry of executives, senior managers, or specialists up to 30 days 0.75 No Temporary entry of executives, senior managers, or specialists up to 60 days 0.5 No Temporary entry of executives, senior managers, or specialists up to 90 days 0.25 No Temporary entry of executives, senior managers, or specialists over 90 days 0 No Source: Adapted from Nguyen-Hong 2000. Direct Methods 47 For each category of regulations, the scores range from services market (a proxy for market structure at the indus- 0 to 1; the more stringent a regulation in a country, the try level) and some firm-level characteristics, such as size higher the score. Score is inversely related to maximum and market share. equity participation permitted in a professional firm. For Both teams conducted cross-sectional analysis in which example, maximum ownership of 49 percent receives a score they compare regulatory impact across countries but not of 0.51. Both research teams compile the scores of individual over time. Both used a version of the following simplified regulations into regulatory indexes (figure 2.1). For each model: country, they construct a global indicator and subindica- ∑α X tors based on the taxonomy chosen. The two studies employ ln(PCM ij ) = b 0 + b1RI i + k i different weighting methods. Nguyen-Hong uses a subjec- k =1... K tive set of weights, in which heavier weights are given to cat- egories considered to have greater impact on services trade and activity. He assigns the heaviest weight to regulations + ∑δ X f =1... F f ij + μij (2.1) on the nationality and residency of professionals. To avoid subjectivity in allocating weights to restrictions, Dihel and where the price-cost margin (PCM Mij) charged by engi- Shepherd (2007) apply principal component analysis (PCA). neering firm j in country i is explained by the country’s They construct indicators using the first factor of the PCA. Regulatory Index (RI Ii) and a set of control variables (X), of which K variables are industry specific (Xi) and F are firm Step 3: Constructing Econometric Models specific (Xij). In both studies, the dependent variable (the Both research teams collected accounting data on the price-cost margin) is calculated as a firm’s earnings before price-cost margins of engineering firms to use as a interest and taxes plus accounting depreciation, all divided dependent variable in their econometric model. They used by revenues. Regarding the regulatory index, the authors MODULE 2 information on industry- and firm-specific characteristics include the subindicators as explanatory variables (hence, as control variables (that is, to isolate the effect of service Dihel and Shepherd estimate the regulatory impacts by regulations on firms’ profits from other factors influencing mode of supply, and Nguyen-Hong estimates the regu- firms’ price-cost margins). Some of the control variables latory impacts using the two-way classification). In the they used included the concentration of the engineering model, μij is an error term and b 0, b 1, αk, and δf are the Figure 2.1. Regulatory Indexes for Engineering Services in Selected Economies 0.45 2.5 0.40 Dihel and Shepherd scale 0.35 2.0 Nguyen-Hong scale 0.30 1.5 0.25 0.20 1.0 0.15 0.10 0.5 0.05 0 0 Afr ds d S nd Ne Aust om Ko Koingapand Gr ates Au key mb dia w Jap ly Sp sia Po any Ind Bra e Un Ze an Sw rgen ina F um rm ia Tu ico on zil n d K inl k ing and A Ch . n e xe In ca SA a, R e ilip nd Ita n ain Swnada Ge ys e era ina Ca ines Meugal So erl ralia Ph tzerla na Fed Ch ia S ail rg R, ep ite F mar c De ranc ng re or Ma Chil tio e str uth an ee i Th ou ed e ti ite ala x d r lgi a t p rt l Be h i t Ne Lu an Un ssi Ru ng Ho Dihel and Shepherd Nguyen-Hong Sources: Nguyen-Hong 2000; Dihel and Shepherd 2007. 48 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods coefficients to be estimated. In step 4, the coefficient on the tariff equivalents are used, countries’ rankings must be the regulatory index (b 1) is used to estimate countries’ tariff same, as in Dihel and Shepherd (2007). However, the mag- equivalents. nitude is different. For instance, among the 10 countries in their analysis, Malaysia has the most restrictive regime, Step 4: Assessing Impact on Price, Cost, and Productivity with a regulatory index of 2. Using this information and Using the estimation model in equation 2.1, the authors equation 2.2, Dihel and Shepherd estimate Malaysia’s tariff estimate tariff equivalents using the following equation: equivalent to be 3.72 percent. Although the principle is always the same, the formula ⎡ PCM ij − PCM 0 j ⎤ for calculating the tariff equivalent depends on the form Tariff equivalent i ≅ 100 ⎢ ⎥ ⎣ PCM 0 j ⎦ of equation 2.1. Nguyen-Hong (2000) does not include the dependent variable in its log form but instead uses the ≅ 100 [ e b1RIi − 1] (2.2) price-cost margin directly. In this case, the tariff equivalent will depend not only on b 1 but also on the price and cost of In this equation, the tariff equivalent is calculated as engineering services in each country. Countries’ rankings the difference, in percentage terms, between what the from tariff equivalents and regulatory indexes may there- price-cost margin of a firm would be in the absence of reg- fore differ. ulatory restrictions (PCM Mij), M0j) and what it actually is (PCM Figure 2.2 compares the tariff equivalents and regula- given the level of restrictions in the country where the firm tory indexes obtained in Nguyen-Hong. In most cases, operates. All other things held constant, the tariff equiv- the two measures are similar. Austria, which has the most alent can be estimated for each country by using the last restrictive regime, has a regulatory index of 0.4 and an terms in equation 2.2—that is, by using the coefficient on estimated tariff equivalent of 14.5 percent. At the other the regulatory index b 1 and the actual level of a country’s extreme, Belgium, which has the least restrictive regime, MODULE 2 regulatory index Ii . x RI has a regulatory indicator of 0.02 and an estimated tariff The tariff equivalent is proportional to a country’s reg- equivalent of 0.5 percent. The tariff equivalents indicate ulatory index (although the relationship is not linear): a that further liberalization of engineering services would country with a higher regulatory index has a higher tariff reduce prices by 0.5 percent in Belgium and 14.5 percent equivalent. Therefore, whenever regulatory indexes or in Austria. Figure 2.2. Tariff Equivalents and Regulatory Indexes in Engineering Services in Selected Economies 0.45 16 0.40 14 Tariff equivalent scale (%) 0.35 Regulatory index scale 12 0.30 10 0.25 8 0.20 6 0.15 4 0.10 0.05 2 0 0 M ria M ico do ia er a y d in Sw tes Ja n Ko S an n SA gap a So , C re N hA a he ica d str s ng ia Fi m Fr rk Be ce m en d ite Au nd an G esi ng in ad ut hin e pa In lays Ki al ite Spa a R o D an do iu an st ed et fr a ex m rla m n lg St Au nl a C Un Un ng Ho T Tariff equivalent r index Regulatory Source: Adapted from Nguyen-Hong 2000. Indirect Methods 49 The results from the estimation model in Nguyen-Hong then compare them with those of a benchmark economy. show that services regulation has a positive impact on The result is indicative of trade barriers. In addition to engineering firms’ profits (that is, price-cost margins). As allowing policy makers to compare trade barriers across there is no plausible explanation of why regulations would countries and sectors, this approach allows them to esti- decrease firms’ costs, the increase in profits is interpreted mate tariff equivalents that can be used as inputs in CGE as the result of an increase in the price of engineering ser- models. (Annex table 2A.2 identifies some studies employ- vices. For this reason, the estimated tariff equivalents in ing this approach.) Nguyen-Hong are referred to as the price impact of regula- As shown in equation 2.3, the gravity equation is a log- tory regimes. linear specification, in which trade (M) between exporting country i and importing country j is positively influenced by the size of each country and negatively affected by the Indirect Methods distance between countries:14 Some studies employ indirect methods to estimate bar- riers to trade and investment in services. Researchers use ln M ij = b 0 + b1 ln GDPi + b 2 ln GDPj these methods when they do not have information on restrictions. They estimate or infer the level of openness, − b 3 ln Dist ij + ∑α X k k ij + ε ij (2.3) restrictiveness, or contestability of a market by comparing countries with a benchmark. This approach is less suitable Unlike in merchandise trade, distance in services does than direct measures as a guide to policy decisions, because not reflect transport costs (except for transport services). the measures may capture more than trade barriers and In this sector, the distance variable reflects transaction because it is difficult to link indirect estimates to a spe- costs between exporting and importing countries. Gravity cific policy measure. It is necessary, however, where direct equations also include an array of variables and dummy MODULE 2 information is unavailable. variables reflecting other determinants of transaction The simplest indirect method is the price gap, which costs, such as trade policy, a common language, and past compares product prices in countries that are similar colonial ties. except for their level of restrictions. The price differences Once equation 2.3 is estimated for a set of exporting and are assumed to reflect the countries’ differences in trade importing countries, a tariff equivalent can be estimated, barriers. The price gap method has been widely used to as follows: estimate ad valorem equivalents of nontariff measures in agriculture, where prices are associated with rela- j ⎞ ⎛ Ma ⎛ M benchmark a ⎞ −σ ln(tariff equivalent j) = ln ⎜ p ⎟ − ln ⎜ p ⎟ tively homogeneous products (see, for instance, Cadot, ⎝ Mj ⎠ ⎝ M benchmark ⎠ Malouche, and Saez 2012). It has been deemed inappro- priate for services because of sector characteristics such  benchmark j −ε =ε (2.4) as the high level of product differentiation and the inci- dence of monopolistic behavior, which imply that price The tariff equivalent for importing country j is differences across countries may not reflect barriers to obtained by using the simple average of the actual trade but rather monopolistic pricing or product differen- (M aj) and predicted (M pj) import values and the simple tiation such as service quality (see, for instance Dee 2005; average of the predicted and actual import values for a Deardorff and Stern 2008; McGuire 2008; and Francois benchmark country obtained from the econometric esti- and Hoekman 2010). mation (equation 2.3). In equation 2.4, tariff equivalents Other indirect methods involve estimating trade costs are obtained by using the average of the residuals (ε) through discrepancies between actual and predicted trade associated with the imports of country j and those of the flows by means of gravity equations and comparing esti- benchmark country. Typically, the country with the larg- mated markups across countries and sectors. Both meth- est difference between actual and predicted import val- ods are examined in the sections that follow. ues is selected as the benchmark. To transform the measure of restriction (expressed as the difference in imports) to a price measure, it is Gravity Approach necessary to make an additional assumption about the Gravity equations estimate import flows between pairs elasticity of substitution (σ). The elasticity of substitu- of countries. After estimating them, analysts compare tion describes the level of product differentiation in an each country’s actual and predicted import flows and industry.15 50 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods The gravity approach allows analysts to estimate trade be written not only in terms of products but also in terms barriers for a large number of countries and to avoid the of production costs and thus prices. Following an analo- demanding task of collecting information on services gous explanation, Solow’s dual residual can be defined as regulations. Fontagné, Guillin, and Mitaritonna (2011) the increase in marginal cost unexplained by increases in use it to estimate tariff equivalents for 65 countries and factor prices (wages, the cost of capital, the cost of inter- 9 services sectors. However, the resulting tariff equiva- mediate products).17 lents are sensitive to the elasticity of substitution and to In a world with perfectly competitive markets, the the specification of the estimated gravity equation. Tariff primal and dual residuals should be highly correlated. In equivalents may be artificially high because of omitted practice, they are not. variables; they may reflect not only trade barriers but also Roeger finds that the difference between residuals is some aspects of market structure (such as, for instance, a explained when the assumption of perfect competition is dominant player that limits new competitors).16 relaxed and firms can charge prices that exceed unit costs. This method is hampered by the poor quality and He shows that by subtracting Solow’s dual residual (SRP) limited availability of trade data on services. Estimating from Solow’s primal residual (SR), the markups charged in a gravity model requires data that are broken down by sector j in the country i can be estimated as follows: trading partners, which are scarce. There is no worldwide collection of data broken down geographically for any of SRtij − SRPtij = b 0 + b1 ( ytij − ktij ) + ε t , the four modes of supply (coverage is better for Modes 1 and 2, for which data are collected in balance of pay- pij − c ij where b1 = (2.5) ments statistics). Given this lack of data, some studies rely pij on reconstructed data and apply this approach only to where y is nominal growth in production, k is growth in cross-border trade in services (Mode 1). MODULE 2 the cost of capital, ε is the error term, and the b s are the Most studies find that some Asian economies coefficients to be estimated. Of particular interest is b 1, (including Indonesia, the Philippines, and Taiwan, China) which is the Lerner index x ([price – cost]/price), from are relatively open for most sectors and that the level of which the estimations of markups can be obtained. The protection of services trade is not systematically related dependent variable, SR – SRP, can be constructed by using to the level of development. These findings contrast with information on the expenditure of individual factors of analyses based on direct methods, which usually find that production. developed economies have less-restrictive services mar- To estimate markups, analysts use data from national kets than developing countries and that Asian economies accounts statistics for countries such as the United States do not rank among the most open economies. Borchert, and Austria; the STAN (Structural Analysis) database for Gootiiz, and Mattoo (2012), for example, find that some OECD economies; the EU KLEMS database for mem- Asian countries have some of the most restrictive policies bers of the European Union; and firm-level financial data in the world. from the Amadeus database on a set of European coun- tries. Annex table 2A.3 lists some studies employing this Estimated Markups approach. Some studies assess market contestability by estimating Results suggest that firms often charge markups and and comparing markups across sectors and countries. that they are higher in the services sector than in the They follow the seminal paper by Roeger (1995), which manufacturing sector. Using data for 1981–2004 from proposes estimating markups by comparing the residu- the EU KLEMS database, Christopoulou and Vermeulen als obtained from countries’ sectoral production func- (2008) estimate markups (as the price to unit cost ratio) tions with those from their cost functions. In particular, for a set of European countries. They find that for all sec- he compares the primal with the dual Solow residuals. tors in all countries, markup ratios generally exceed 1, Solow’s primal residual refers to the part of the increase implying that prices are usually higher than marginal in the volume of production that cannot be explained costs (table 2.8). For all countries in the sample, markups by increases in the factors of production such as capi- are higher in the services sector than in other sectors. The tal, intermediate products, and labor. This unexplained authors argue that the higher markups in services reflect growth, or residual, is normally associated with techno- the fact that services are difficult to trade internationally logical progress or total factor productivity (TFP) growth. and are subject to regulations and entry barriers that may All production functions have a dual function, as they can reduce competition and generate rents. Prospective Analyses: CGE Models 51 Table 2.8. Weighted Average Markups in Manufacturing Prospective Analyses: CGE Models and Services Sectors in Selected Economies, 1981–2004 Prospective analyses studies employ partial equilibrium Manufacturing and Country construction Services All and CGE models to estimate the impacts of future trade Austria 1.20 1.45 1.31 liberalization (see Francois and Hoekman 2010 for a Belgium 1.14 1.29 1.22 review of CGE modeling and Dihel 2003 for CGE studies). Euro Area 1.18 1.56 1.37 They assess the impact of deregulation not only on the Finland 1.22 1.39 1.28 services category and country under study but also on France 1.15 1.26 1.21 other sectors of the economy and the rest of the world. Germany 1.16 1.54 1.33 Prospective analyses typically simulate the welfare gains Italy 1.23 1.87 1.61 and losses for consumers, producers, and the government, Netherlands 1.13 1.31 1.22 thus revealing the economy-wide impact of services trade Spain 1.18 1.37 1.26 liberalization. United States 1.28 1.36 1.32 Most research has focused on trade in goods rather than Source: Adapted from Christopoulou and Vermeulen 2008. services, partly because of the lack of comprehensive data Note: Country average markups are constructed from sectoral estimates using sectoral gross output in the year 2000 as sector weights. on both trade and barriers to trade in services. Estimates of services barriers in CGE modeling are based on tar- iff equivalents obtained from studies based on direct and Comparing markups across countries and sectors can indirect methods. yield information about the contestability of markets and Unlike models of trade in goods, CGEs of services therefore help identify which markets and sectors are rela- must account for different modes of supply; focusing tively competitive. It cannot identify whether a higher level only on cross-border trade in services would leave out MODULE 2 of competition in a market reflects policy or other factors, important sources of gains. Konan and Maskus (2006) such as market structure, the level of technology, and pri- model both cross-border trade and foreign direct invest- vate practices. ment (FDI) in services in Tunisia. They find that the Høj and others (2007), Badinger and Breuss (2005), most important component of welfare gains comes and Badinger (2007) try to identify the extent to which from the removal of barriers to FDI in services sec- policy can explain estimated markups. Høj and others tors. Moreover, services are highly heterogeneous, and use the OECD–STAN database to estimate markups for services categories play different roles in the economy. 17 countries and 18 industries, including 6 services sectors. Decisions about their production functions and their Using econometric estimations, they regress the markups link to other sectors in the economy may affect the final on the indicators of OECD product market regulation. result. This finding is consistent with other studies that They find that countries with more restrictive product show that liberalization of trade services, in particular market regulations tend to have higher markups, especially barriers that affect FDI, yields welfare gains that are sev- for nonmanufacturing sectors. eral times larger than the gains from liberalizing goods Badinger and Breuss (2005) and Badinger (2007) trade (Tarr 2012). carry out a similar analysis. They investigate the extent to By and large, the literature shows that liberalization of which new member countries’ accession to the European services trade can generate overall welfare gains, which Union influenced the level of competition in their econo- tend to be higher for developing countries, partly because mies. Using information on 46 industries for the period of the relatively high level of restrictions on services in 1978–2001, Badinger and Breuss investigate the effect of these economies. However, the reliability of results from Austria’s accession to the European Union (in 1995) on CGE modeling depends on whether different modes of the country’s estimated markups. Badinger focuses on the supply are implicitly included, on the assumptions on the participation of 10 EU members in the EU Single Market economic functions for the different service categories, program. He finds that countries’ participation in the and on the accuracy of estimated services barriers, which Single Market increased competition in the manufactur- depends on the availability of tariff equivalent measures ing sector, where markups declined. In contrast, in most from direct and indirect methods. Improvement in the services, markups increased, a trend that, according to collection of data on services regulations and the sophis- the author, may reflect the slow progress in services lib- tication of these methods is therefore crucial for obtaining eralization under the framework of the EU Single Market accurate estimations of the economy-wide impact of ser- program. vices trade liberalization. 52 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods Conclusion in the regulatory framework over time, allowing them to investigate how the sequencing of regulations may This module describes several methods and provides prac- affect outcomes. More detailed information can allow tical guidance on how countries can quantify the impact of policy makers to investigate whether the effectiveness regulatory frameworks in the services sector. It focuses on of individual regulations hinges on other regulations in the impact of regulations on the provision, price, and cost place. Given these benefits, governments should try to of services. establish mechanisms for systematically and periodically The module reviews direct methods and two indirect inventorying regulations and outcomes in the services methods. It helps analysts identify which type of assess- sector. ment they can carry out given their data and resource Previous studies have confronted difficulties in iden- constraints. tifying whether regulations have brought about the Even countries with limited data and resources can desired environmental, equity, and social outcomes. In undertake some parts of a quantitative assessment. All addition, none of the studies reviewed in this module countries can estimate the impact of the regulatory frame- included the costs associated with enforcing regulations work based on the results of a previous study (that is, (compliance costs, such as administrative burdens and conduct an out-of-the-sample estimation). These efforts paperwork that firms incur to comply with regulations, can provide policy makers with estimates of the impact of and enforcement costs incurred by governments and regulations on the provision, cost, and price of services. In regulatory agencies as part of inspections and audits). addition, countries can use an out-of-the-sample approach A well-conducted mapping of the regulatory frame- to estimate tariff equivalents, which can then be used in work can improve the quantitative analysis presented CGE models to investigate the economy-wide impact of here. Measurable objectives of regulations and imple- service regulations on welfare. mentation and enforcement costs can be identified and MODULE 2 More detailed information on both the regulatory included in the quantitative analysis. Coordination framework and sector performance allows countries among governmental bodies, rather than strong techni- to achieve more accurate quantitative assessments. By cal skill, is crucial for this task. mapping regulation, governments can record changes Annex 2A Table 2A.1. Selected Studies Estimating the Impact of Regulation on Services Trade Using Direct Methods Sector Study Coverage Dependent variablea Data source Professional services Legal services Nguyen-Hong (2000) Regulatory index for 29 economies Accounting services Regulatory index for 34 economies Architectural Regulatory index for services 34 economies Engineering services Dihel and Shepherd Regulatory index for Price-cost margin Disclosure’s Worldscope (2007) 34 economies, Database (firms’ accounting econometric model data) for 84 companies in 20 economies 10 economies Price-cost margin Datastream Telecommunicationsb Fixed telephone Borchert and others About 100 countries Market concentration TeleGeography’s GlobalComms services (2012) (Herfindahl index), database and International penetration rates Telecommunication Union (ITU) Lee, Ure, and Lee (2011) 21 Asia-Pacific Penetration rates ITU Economic Cooperation economies (continued on next page) Annex 2A 53 Table 2A.1. (continued) Sector Study Coverage Dependent variablea Data source Bottini, Marouani, and Arab Republic of Egypt, Price-cost margin Datastream Munro (2011) Jordan, and Morocco Fontagné and 11 developing Price-cost margin Dihel and Shepherd (2007) Mitaritonna (2009) economies Dihel and Shepherd 24 countries Price-cost margin Datastream (2007) Fink, Mattoo, and 86 developing Penetration rates, ITU and World Bank Rathindran (2003) countries productivity (mainlines per employee) Doove and others (2001) 47 countries Price ITU, OECD: Communications Outlook, and OECD: Telecommunications database Boylaud and Nicoletti 24 OECD members Price, labor productivity, OECD: Communications (2001) quality Outlook, and OECD: Telecommunications database Mobile services Borchert and others About 100 countries Market concentration TeleGeography’s GlobalComms (2012) (Herfindahl index), database and ITU penetration rates Lee, Ure, and Lee (2011) 21 APEC economies Penetration rates ITU Bottini, Marouani, and Egypt, Arab Rep., Price-cost margin Datastream Munro (2011) Jordan, and Morocco Fontagné and 11 developing Price-cost margin Dihel and Shepherd (2007) Mitaritonna (2009) economies MODULE 2 Dihel and Shepherd 24 countries Price-cost margin Datastream (2007) Doove and others (2001) 47 countries Price ITU, OECD: Communications Outlook, and OECD: Telecommunications database Boylaud and Nicoletti 24 OECD member Price, productivity OECD: Communications (2001) economies Outlook and OECD: Telecommunications database Broadband Lee, Ure, and Lee (2011) 21 APEC economies Penetration rates ITU Distribution services Fontagné and 11 developing Price-cost margin Dihel and Shepherd (2007) Mitaritonna (2009) economies Dihel and Shepherd 19 countries Price-cost margin Datastream (2007) Kalirajan (2000) 38 countries from Price-cost margin Disclosure’s Worldscope the Asia-Pacific, Database European, and American regions Financial services Bankingc Bottini, Marouani, and Egypt, Arab Rep., Net interest margin Datastream Munro (2011) Jordan, Lebanon, and Morocco Dihel and Shepherd 29 countries Net interest margin Datastream and Banker’s (2007) Almanac Barth, Caprio, and Levine 107 countries Bank development, Net interest margin and (2004) net interest margin, overhead cost variables from overhead costs, Beck and others (2001). For nonperforming loans, bank development data, probability of banking they update Levine, Loayza, crisis and Beck (2000); for data on crises, they use Caprio and Klingebiel (1999). Data on nonperforming loans come from their own survey. (continued on next page) 54 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods Table 2A.1. Selected Studies Estimating the Impact of Regulation on Services Trade Using Direct Methods (continued) Sector Study Coverage Dependent variablea Data source Financial services (cont.) Insurance Dihel and Shepherd 25 countries Price-cost margin Datastream (2007) Transport Air Borchert and others About 100 countries Number of international Air Transport Intelligence’s (ATI) (2012) flights, total seat Flightglobal database capacity, number of flights per airline versus number of airlines servicing a market (intensive versus extensive margin) Sourdin (2011) APEC economies Trading cost: (CIF – FOB)/ Import data collected by customs FOB of imported goods agencies of four importing economies (Australia, Brazil, Chile, United States) at the six-digit level of aggregation of the Harmonized System Micco and Serebrisky United States and its Trading cost (cost of all U.S. Imports of Merchandise (2006) trading partners freight, insurance, and Database from U.S. other charges excluding Department of Commerce U.S. import duties per unit of weight) Doove and others (2001) 35 countries Price (business, economy, International Civil Aviation and discount airfare) Organization (ICAO) MODULE 2 Gönenç and Nicoletti 27 OECD countries, Efficiency: load factor Online air ticket reservation (2001) for a set of 102 air and distance from systems and ICAO routes connecting 14 production efficiency international airports frontier Price: business, economy, and discount airfares Maritime Sourdin (2011) APEC economies Trading cost: (CIF – FOB)/ Import data collected by customs FOB of imported goods agencies of four importing economies (Australia, Brazil, Chile, United States) at the six-digit level of aggregation of the Harmonized System Clark, Dollar, and Micco United States and its Port efficiency (various Waterborne Trade Database (2004) trading partners measures), trading compiled by the U.S. cost (cost of all freight, Department of Transportation insurance, and other charges excluding U.S. import duties per unit of weight) Fink, Mattoo, and United States and 59 Trading cost (cost of all Waterborne Trade Database Rathindran (2002) U.S. trading partners freight, insurance, and compiled by the U.S. other charges excluding Department of Transportation U.S. import duties per unit of weight) Energy Electricity Dee (2011) APEC economies Price: industrial electricity Electricity information and prices energy prices and taxes from Efficiency: utilization rate, the International Energy calculated as gross Agency (IEA) production (GWh)/ net capacity (MWe), and deviation of reserve margin from optimal, calculated as abs[(capacity – peak)/ peak – 0.15] (continued on next page) Annex 2A 55 Table 2A.1. (continued) Sector Study Coverage Dependent variablea Data source Doove and others (2001) 50 economies Industrial electricity prices Electricity information and energy prices and taxes from the IEA Steiner (2001) 19 OECD countries Price: industrial electricity Electricity information and prices, ratio of industrial energy prices and taxes from to residential electricity the IEA prices Efficiency: utilization rate, reserve plant margins Gas Dee (2011) APEC economies Price: industrial gas prices Electricity information and Efficiency: utilization energy prices and taxes from rate, calculated as gas the IEA consumption (million m3)/pipeline length (kms) Note: CIF = Cost, insurance, and freight; FOB = free on board. a. The price-cost margin is typically measured using firms’ accounting data and calculated as earnings before interest and taxes plus accounting deprecia- tion all divided by revenues. b. Depending on the telecommunications category, penetration rates are the number of telephone main lines, the number of mobile phone subscribers, or the number of fixed broadband subscribers, all of them expressed as per 100 inhabitants. c. The net interest margin employed in the banking sector is typically measured as banks’ interest income (interest earned minus interest paid on borrowed funds) divided by total interest-earning assets (any asset, such as a loan, that generates interest income). MODULE 2 Table 2A.2. Selected Studies Estimating Impact of Regulation on Services Trade Using the Gravity Approach Year(s) of Study data Coverage Sectors Data source Park (2002) 1997 52 economies 7 sectors: construction, transport, Global Trade Analysis trade, communication, financial, Project (GTAP) version business, and other services (including 5 database, bilateral education, health, and administration) data Francois, Meijl, and 1997 16 groups, including not 2 sectors: business services GTAP version 5 database, van Tongeren only regions such as (including business, financial, and using importing (2003, 2005) EU and South America communication) and other private and country totals but also such individual public services countries as France, Germany, India, and China Walsh (2006) 1999–2001 49 economies All services OECD statistics on international trade in services, bilateral data Fontagné, Guillin, 2004 65 economies 9 sectors: construction; communication; GTAP version 7.4 and Mitaritonna trade; finance; other services database, bilateral data (2011) (education, health, defense, and public administration); business; transport; water transport; and insurance 2002–06 OECD countries and Total services (aggregated), transport, OECD statistics on partners communication, and construction international trade in services, bilateral data Guillin (2013) 2005 63 economies 11 sectors: transportation; other business Eurostat international services; travel; communication; trade in services construction; insurance; financial database, bilateral data services; royalties and license fees; computer and information services; personal, cultural, and recreational services; and government services 56 Module 2: Assessing the Impact of Services Regulations: A Review of Empirical Methods Table 2A.3. Selected Studies Estimating Impact of Regulation on Services Trade Using the Markups Approach Study Years of data Coverage Sectors Data source Roeger (1995) 1953–84 United States 24 manufacturing sectors U.S. National Income and Product Accounts (NIPA) and Bureau of Economic Analysis (BEA) Badinger and Breuss 1978–2001 Austria 46 sectors (two-digit NACE Statistics Austria (2005) Rev. 1.1), including 19 services sectors; markups were estimated for 7 industry groups Badinger (2007) 1981–99 10 European Union (EU) 18 sectors, including 6 STAN (Structural Analysis) member states (Austria, services sectors; and 3 database of the OECD Belgium, Finland, France, groups (manufacturing, Germany, Italy, the construction, and Netherlands, Spain, Sweden, services) and the United Kingdom) Høj and others (2007) 1975–2002 17 countries 18 sectors, including 6 STAN database of the OECD services sectors Christopoulou and 1981–2004 8 Euro Area countries and the 50 sectors EU KLEMS (2007 release) Vermeulen (2008) United States Bottini and Molnár 1993–2006 20 European OECD countries 28 services sectors Amadeus database (2010) Molnár (2010) 1995–2005 Slovenia 37 sectors, including 17 Amadeus database services sectors MODULE 2 Notes 13. When the impact of service regulations is evaluated by quantity (that is, the number of services provided), price elasticity measures are 1. The authors would like to thank Daniel Reyes and David Tarr for needed to transform the quantity impact into a price impact. their valuable comments and suggestions on an early draft of this module. 14. Gross domestic product (GDP) is usually used as the proxy 2. The Australian Productivity Commission is the research and advi- for size, and distance between countries’ capital cities is used for dis- sory body on economic, social, and environmental issues of the Australian tance. Increasingly, country fixed effects have been used to capture government. country-specific characteristics such as GDP, remoteness, and price 3. Part of this work can be found in Findlay and Warren (2000); the indexes. rest can be found on the website of the Productivity Commission (http:// 15. This elasticity refers to the elasticity of substitution between www.pc.gov.au/research/memorandum/servicesrestriction). different varieties of products in a particular industry. Trade mod- 4. Hoekman (1996), Langhammer (2005), Eschenbach and Hoekman els with intraindustry trade and imperfect competition, such as new (2006), Gootiiz and Mattoo (2009), and Roy (2011) document GATS economic geography models, typically employ a constant elasticity of commitments and proposals. substitution. 5. GATS coverage of air transport excludes traffic rights and is lim- 16. Although the elasticity of substitution has an impact on the magni- ited to three ancillary services: aircraft repair and maintenance services, tude of the tariff equivalents, it does not affect countries’ ranking. selling and marketing of air transport services, and computer reservation 17. In perfect competition, at equilibrium, changes in product prices system services. equal changes in marginal costs. Solow’s dual residual refers to the part of 6. This limitation recently motivated the change of the weighting the change in product prices that cannot be explained by the changes in method in the construction of the Product Market Regulation (PMR) the price of production factors. Indicators of the OECD (Wölfl et al. 2009). 7. For instance, Barth, Caprio, and Levine (2004) find that restric- tions on entry are positively associated with overhead costs in the banking References sector; they find no significant link between entry restrictions and net interest margins. Amadeus (database), Bureau van Dijk, London, http://amadeus.bvdinfo 8. See Kalirajan (2000) for the logic behind using price-cost margins .com. to distinguish between cost-creating and rent-creating restrictions. Badinger, Harald. 2007. “Has the EU’s Single Market Programme 9. When equal weights are assigned, the regulatory impacts are Fostered Competition? Testing for a Decrease in Mark-Up Ratios assumed to be the same across regulations. When researchers want to in EU Industries.” Oxford Bulletin of Economics and Statistics 69 (4): assess the impact of regulations on cost-price margins, they may use a reg- 497–519. ulatory index including both cost-creating and rent-creating restrictions. Badinger, Harald, and Fritz Breuss. 2005. “Has Austria’s Accession to the 10. Among the few studies using data with time variation are Boylaud EU Triggered an Increase in Competition? A Sectoral Markup Study.” and Nicoletti (2001); Steiner (2001); Fink, Mattoo, and Neagu (2002); Empirica 32: 145–80. and Micco and Serebrisky (2006). Balistreri, Edward J., Thomas F. Rutherford, and David G. Tarr. 2009. 11. Banks’ involvement in real estate activities could lead them to “Modeling Services Liberalization: The Case of Kenya.” Economic extend mortgages to people with a high risk of defaulting. Modelling 26 (3): 668–79. 12. Some studies that construct tariff equivalents are Nguyen-Hong Barth, James R., Gerard Caprio, Jr., and Ross Levine. 2004. “Bank (2000); Dee (2005); Bottini and Marouani (2009); Dihel and Shepherd Regulation and Supervision: What Works Best?” Journal of Financial (2007); and Fontagné and Mitaritonna (2009). Intermediation 13 (2): 205–48. References 57 Beck, Thorsten, Asli Demirgüç-Kunt, and Ross Levine. 2001. “The Air Passenger Transport and Electricity Supply.” Productivity Financial Structure Database.” In Financial Structure and Economic Commission, Canberra, Australia. http://128.118.178.162/eps/othr Growth: A Cross-Country Comparison of Banks, Markets, and /papers/0110/0110004.pdf. Development, ed. Asli Demirgüç-Kunt and Ross Levine, 17–80. Eschenbach, Felix, and Bernard Hoekman. 2006. “Services Policies Cambridge, MA: MIT Press. in Transition Economies: On the EU and WTO as Commitment Borchert, Ingo, Batshur Gootiiz, Arti Grover, and Aaditya Mattoo. 2012. 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Nicoletti, Giuseppe, Stefano Scarpetta, and Olivier Boylaud. 2000. Kalirajan, Kaleeswaran, Greg McGuire, Duc Nguyen-Hong, and Michael “Summary Indicators of Product Market Regulation with an Extension Schuele. 2000. “The Price Impact of Restrictions on Banking to Employment Protection Legislation.” Economics Department Services.” In Impediments to Trade in Services: Measurement and Policy Working Paper, Organisation for Economic Co-operation and Implications, ed. Christopher Findlay and Tony Warren, 215–30. Development, Paris. London: Routledge. OECD (Organisation for Economic Co-operation and Development). Kang, Jong-Soon. 2000. “Price Impact of Restrictions on Maritime 1996. Inventory of Measures Affecting Trade in Professional Services. Transport Services.” In Impediments to Trade in Services: Measurement Paris: OECD. and Policy Implications, ed. Christopher Findlay and Tony Warren, Park, Soon-Chan. 2002. “Measuring Tariff Equivalents in Cross-Border 189–200. London: Routledge. 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World Bank, in the Doha Round: Evidence of a Not-Yet-Perfect Customs Union.” Washington, DC. http://iresearch.worldbank.org/servicestrade/. JCMS: Journal of Common Market Studies 43 (2): 311–25. Sourdin, Patricia. 2011. “Quantifying the Impacts of Structural Reforms Lee, Roy C., John Ure, and Hsin C. Lee. 2011. “Quantifying the Impacts on International Transport Margins.” In The Impacts and Benefits of Structural Reforms in Telecommunications Markets in APEC of Structural Reforms in Transport, Energy and Telecommunications Economies.” In The Impacts and Benefits of Structural Reforms in Sectors, ed. Christopher Findlay, 66–87. Singapore: Asia-Pacific MODULE 2 Transport, Energy and Telecommunications Sectors, ed. Christopher Economic Cooperation. Findlay, 179–208. Singapore: Asia-Pacific Economic Cooperation. STAN (database), OECD, Paris, http://www.oecd.org/industry/ind Levine, Ross, Norman Loayza, and Thorsten Beck. 2000. “Financial /stanstructuralanalysisdatabase.htm. Intermediation and Growth: Causality and Causes.” Journal of Steiner, Faye. 2001. “Regulation, Industry Structure and Performance Monetary Economics 46: 31–77. in the Electricity Supply Industry.” OECD Economic Studies 32: McGuire, Greg. 2003. “Methodologies for Measuring Restrictions on 143–82. Trade in Services.” In Quantifying the Benefits of Liberalising Trade in Tarr, David. 2012 “Putting Services and Foreign Direct Investment with Services, 33–62. Paris: OECD Publishing. Endogenous Productivity Effects in Computable General Equilibrium ———. 2008. “Measuring and Modelling Restrictions on Trade in Models.” Policy Research Working Paper, World Bank, Washington, Services: A Case of Asia-Pacific Economic Cooperation Economies.” DC. MARKHUB Working Paper 13, United Nations Economic and Social Walsh, Keith. 2006. “Trade in Services: Does Gravity Hold? A Gravity Commission for Asia and the Pacific, Bangkok. Model Approach to Estimating Barriers to Services Trade.” McGuire, Greg, and Michael Schuele. 2000. “Restrictiveness of Discussion Paper, Institute for International Integration Studies, International Trade in Banking Services.” In Impediments to Trade Dublin. in Services: Measurement and Policy Implications, ed. Christopher Warren, Tony. 2000. “The Impact on Output of Impediments Findlay and Tony Warren, 201–14. London: Routledge. to Trade and Investment in Telecommunications Services.” McGuire, Greg, Michael Schuele, and Tina Smith. 2000. “Restrictiveness In Impediments to Trade in Services: Measurement and Policy of International Trade in Maritime Services.” In Impediments to Trade Implications, ed. Christopher Findlay and Tony Warren, 93–108. in Services: Measurement and Policy Implications, ed. Christopher London: Routledge. Findlay and Tony Warren, 184–200. London: Routledge. Whalley, John. 2004. “Assessing the Benefits to Developing Countries of Micco, Alejandro, and Tomas Serebrisky. 2006. “Competition Regimes Liberalisation in Services Trade.” World Economy 27 (8): 1223–53. and Air Transport Costs: The Effects of Open Skies Agreements.” Wölfl, A., I. Wanner, T. Kozluk, and G. Nicoletti. 2009. “Ten years of Journal of International Economics 70 (1): 25–51. product market reform in OECD countries: Insights from a revised Molnár, Margit. 2010. “Measuring Competition in Slovenian PMR indicator.” OECD Economics Department Working Paper 695, Industries: Estimation of Mark-Ups.” Economics Department OECD, Paris. MODULE 3 Identifying Alternatives in Regulatory Strategies and measures Objectives their economic impacts. The second section considers alternative regulatory strategies. A third section advises on This module provides an overview of regulatory strategies and how to take into account the political economy challenges alternatives to regulation that can be adopted in the services in the assessment. The last section summarizes the main sector. Upon completing it, readers will be able to: policy implications. • Identify key strategies for regulating the services sector and Regulating services sectors effectively in a way that distorts evaluate the costs and benefits associated with each trade as little as possible is complex.1 To do so, countries need • Identify the factors that favor some strategies over others a policy-making framework that allows them to consider the • Link regulatory strategies to the broader institutional impact of regulatory measures on trade in services. framework needed to ensure efficient and effective One principle that is critical to making regula- regulation, and appreciate the limitations of this approach tion as unrestrictive of trade in services as possible is in developing countries proportionality y—the notion that the trade-restrictive effect of regulation should not be out of proportion to the Trade costs are high in services sectors—perhaps twice desired policy objective. In addition, regulation should the level observed for goods trade (Miroudot, Sauvage, be targeted at addressing the specific risks and problems and Shepherd 2010). Costs are high partly because many identified as requiring government action (World Bank countries have in place a raft of policies that restrict trade in 2010a). Ideally, a regulatory intervention should be based services. Sometimes these measures are protectionist in on an analysis showing that the benefits outweigh the intent, explicitly designed to reserve a market for domestic costs and that the benefit-cost ratio is maximized by the incumbents and insulate them from foreign competition. instrument chosen.2 To determine whether the proposed Often, however, measures that restrict services trade do so regulatory intervention maximizes achievement of a social inadvertently, in the pursuit of other social objectives. goal and minimizes the costs to trade and investment in This module examines some common regulatory services, analysts need to conduct an economy-wide review strategies that can restrict trade in services, analyzes their (that is, a general rather than partial equilibrium analy- possible justification, and proposes alternative strategies sis), because a regulation may be optimal from the point of that can achieve the same goals at lower economic cost. view of a sector but not the economy as a whole. The perspective is one of regulatory cost-benefit analysis. Regulatory impact analysis (RIA) offers a mechanism The objective of economic analysis should be to identify for comparing the cost-benefit ratios of different regula- social goals and find the most efficient way possible of tory measures (box 3.1). achieving them. Of course, the first-best solution will not RIAs require well-designed regulation-making pro- always be achievable in developing countries, particularly cedures with fluid interagency coordination. They also where governance institutions and regulatory oversight are require strong quantitative skills and ample reliable data. weak. It is therefore important to keep alternative strate- Although some developing countries have implemented gies as simple as possible. some elements of RIAs (World Bank 2010b), most lack the The module is organized as follows. The next sec- institutional arrangements and resources to do so. tion discusses common restrictions on services trade, To overcome these challenges, low-income coun- focusing on their identification and the classification of tries, with the assistance of donors and international 59 60 Module 3: Identifying Alternatives in Regulatory Strategies and Measures airports, but operation of the facilities is then put out to Box 3.1. Regulatory Impact Analysis competitive tender (see the later section on franchising). This approach ensures a particular level of investment in Regulatory impact analysis (RIA) is a key tool for improv- ing the efficiency, transparency, and accountability of goods or services but avoids the inefficiencies of govern- regulatory decision making (OECD 2008). The contribu- ments as service providers. It sets prices and ensures the tion of RIA to regulatory decision making rests on the sys- supply of a particular quality and quantity of services. tematic assessment of the impacts of a regulatory measure and adherence to the principles of accountability, trans- One of the main disadvantages of the direct inter- parency, and consistency. RIAs usually focus on the qual- vention strategy is that government failure can be just ity of the regulation-making process, assessing the likely impacts of new regulations in quantitative and qualitative as much of a problem as market failure. As discussed in terms. module 1, governments may be unduly influenced by private lobbies seeking to benefit from a new investment or may lack private incentives to reduce costs. In addi- organizations, can focus on adopting basic principles such tion, direct intervention can lead to the stalling of tech- as transparency and accountability (World Bank 2010a). nology at a particular level, as the private sector has no They can develop in-country capacity in the area of regu- incentive to innovate once the state has intervened in the latory reform, including through South-South knowledge market in a decisive way. For these reasons, developed exchange. They can use cost-benefit analyses undertaken in countries have tended to avoid direct intervention in other countries as a basis for their own work. This approach recent decades. Instead, countries tend to opt for more is a second-best solution, because a general equilibrium market-based approaches, which generally yield a higher cost-benefit analysis depends on country-specific factors. benefit-cost ratio. The remainder of this section discusses Nevertheless, some information on the costs and ben- regulatory strategies that can be combined with a minimal efits of different regulatory options is better than none. degree of direct action to help achieve overarching social International institutions can act as intermediaries in this goals. process by collecting and disseminating national experi- ences. They can also learn from experience elsewhere. Command and Control Regulation Even without the benefit of rigorous cost-benefit analysis of the type advocated here, many countries—including Regulation by command and control usually involves the low-income ones—have reformed services sectors in imposition of binding standards by the state. These stan- ways that have dramatically improved performance. Their dards are enforced by legal sanctions: civil, criminal, or experience has given rise to rules of thumb that can guide administrative penalties for noncompliance. low-income country policy makers in their regulatory Command and control covers a wide range of regula- reform efforts. The last section of this module offers some tory stances, including rule-making and enforcement examples of these guidelines. and licensing arrangements, under which operators must acquire a permit to be allowed to engage in a particular activity. Command and control regulation can extend Regulatory Strategies beyond standards and rules designed to preserve the qual- ity of a service or its manner of delivery to include the This section reviews the main strategies for regulation.3 allocation of resources, prices charged to consumers, and The next section examines alternatives to them. profits earned by service providers. Ogus (2004) provides a typology of standard-setting within the context of the command and control strat- Provision of Services by the State egy, differentiating each type of regulatory measure by MODULE 3 The most interventionist regulatory strategy is direct the degree of intervention involved (figure 3.1). At the intervention by the state. Under this strategy, it is the low intervention end of the spectrum, information stan- state itself that provides the services. This is always the dards require firms to disclose certain types of informa- case, for example, with services provided by security tion to the public so that consumers can make informed forces. Some states also provide some services related decisions (this approach overlaps with disclosure regu- to some specific assets, such as distribution of energy or lation, which is discussed later as a separate regulatory administration of ports and airports. In a less interven- strategy). The midrange of intervention takes the form tionist variant of this model, the government is respon- of behavioral control over market participants. The high- sible for initial investment in infrastructure like ports or est level of intervention is prior approval, or licensing, Regulatory Strategies 61 Figure 3.1. Degrees of Intervention of Mandatory Regulation ARKET MARKE A OPERATION ACCESS mpetition law Competit Prior approval Qualifications Behavioral control standards Information requirements req Quotas Specification Performance T Target + Degree of intervention – Source: Adapted from Ogus 2004. which is usually subject to stringent training or capacity are the most technical rules issued by the regulator; they requirements. may set out a series of specifications providing detailed Ogus (2004) distinguishes three types of behavioral guidance for the industry to achieve an outcome for control standards, based on their level of intervention in which a single performance standard may suffice. They firm decision making: are less costly than performance standards to formulate and easy to monitor and enforce. Specifications may • Target standards prescribe no specific conduct by the point, for instance, to the type of tires or the number of supplier but hold them liable for certain harmful con- airbags that should be put in a car. In the services sec- sequences arising from their output. This type of regu- tor, specification standards are most commonly found lation is advantageous for suppliers, because it allows in construction (an example is the prohibition on using them to choose how to avoid the harmful consequences. asbestos) and telecommunications (an example is the Target standards are generally appealing because they requirement that certain equipment be used). are not costly to formulate—the desired goal can be easily translated into a rule. They are effective, how- Unlike developed countries, which have shifted toward ever, only when the damage can be easily associated market-based approaches in recent decades, developing to a specific actor. Target standards are most valuable countries rely heavily (sometimes exclusively) on com- where the damage that needs to be avoided is a collec- mand and control regulation. There are both advantages tive damage—such as pollution—for which no individ- and disadvantages of command and control from a devel- ual is likely to demand compensation. Although these opment point of view. Advantages include the ability to standards are frequently associated with production prohibit particular types of conduct with the force of law, of goods and extractive industries, they also apply to which means that the effect is relatively certain and imme- services industries that may cause such risks. diate. Command and control regulation is also politically • Performance standards require that certain conditions popular, because it gives the appearance of taking a strong of quality be met at the point of supply but leave the stand against a particular social ill and using the law to supplier free to decide how to meet those conditions. protect the public from undesired outcomes or unscrupu- MODULE 3 They focus on controlling certain outputs, such as gas lous operators. emissions and noise levels affecting transport services. There are also problems with command and control They are more costly to formulate than target standards, regulation. Because of its strong legal authority, regulatory because they require familiarity with the industry. They failures are particularly severe when embodied in manda- can be firm specific, but they are easily monitored. tory regulatory standards. For example, the fact that the • Specification standards compel suppliers to follow a cer- regulator needs information from regulated firms to put tain process or production method—requiring the use properly designed standards in place means that it requires of certain equipment, for instance, or prescribing certain a close relationship with business, leaving it particularly specifications for infrastructure. These design standards susceptible to regulatory capture. 62 Module 3: Identifying Alternatives in Regulatory Strategies and Measures A second potential problem with command and regulatory capture, although in most cases it substan- control regulation is that it may introduce rigidity into tially reduces it. the system. Setting standards, especially specification or Second, incentive-based regulation encourages firms performance standards, necessarily limits the capacity to limit harmful conduct as much as possible. By contrast, of business to adapt to changes in demand and technol- command and control regimes require only that the harm- ogy that may make different production methods desir- ful conduct be limited to the point set out in the standard. able. The need to go through a lengthy, legalistic process One of the main disadvantages of incentive-based to change the standards means there can be a significant regulation is that a great deal of information is still required lag between the identification of a potential innovation to set the tax or subsidy at the correct level. It is first neces- and its implementation in the form of new or different sary to estimate the relationship between the cost and the products. production of the harmful consequence it is intended to Related to both problems is the potential for com- limit. There is thus considerable scope for trial and error mand and control standards to operate as barriers to entry. in setting the appropriate level of tax or subsidy. Such an Adopting a standard based on the practices of incumbent approach has two negative consequences. The first is that operators can discourage entry by new competitors, which it creates uncertainty for business, which may limit invest- would have to adapt their business models to meet the ment, including foreign direct investment. The second is standard. that if the initial tax or subsidy rate is set at a level that still Another difficulty with command and control as results in substantial production of harmful consequences, a regulatory strategy is that it can be difficult and irreparable damage may be done. For example, if taxes for costly to enforce. Operators need to be inspected to environmental purposes are too low, they do not act as an assess compliance. Enforcement of legal penalties for adequate disincentive to pollute, thus failing to prevent the noncompliance—especially with target standards—may environmental harm. require recourse to the courts, which adds substantial For developing countries, there are two main costs and uncertainty. disadvantages to using taxes and subsidies as regulatory tools. In the case of subsidies, it is necessary for the govern- ment to mobilize the necessary funds through its general Incentive-Based Regimes budget. Doing so may be impossible given the competing The essence of regulation based on economic incentives is uses (including social necessities such as health and edu- the use of taxes or subsidies to encourage service providers cation spending) and the low level of government rev- to act in accordance with the public interest. Rather than enue. Regulatory taxes can be difficult to administer in setting down “pass or fail” standards, incentive-based countries with limited fiscal capacity. For these reasons, regulation uses charges and credits to bring private and the economic incentives approach may be more applicable social costs into line, helping create an outcome that to middle-income countries—particularly upper-middle- preserves market outcomes but achieves important pub- income countries with relatively strong administrative lic interest goals. This approach has a long history in capacities—than to low-income countries. the economic analysis of regulation: Pigovian taxes— taxes applied to market activities that generate nega- Market-Harnessing Controls tive externalities, such as “polluter pays” policies—were proposed in the early 20th century. Other regulatory approaches rely on market mechanisms Incentive-based regulation has certain advantages over to encourage private operators to conform to social goals, command and control. First, the danger of regulatory rather than on mandatory regulation. They include com- capture is greatly reduced, because economic incentives petition law, franchising, regulation by contract, and MODULE 3 operate in a mechanical and transparent way once they establishing tradable permits. are created. Whereas command and control regulation requires an ongoing close relationship between the reg- Competition Law ulator and the regulated industry, economic incentives One of the goals of market-oriented regulation is to can operate effectively with greater distance between the promote competition and ensure that it is harnessed in two. Oversight of the regulated industry and verification the public interest. General provisions of competition law of the base used to calculate tax liabilities or subsidies can be used as part of a more general regulatory frame- are still needed, however. Incentive-based regulation work or even in place of specific regulatory provisions. does not, therefore, completely eliminate the risk of Competition law is often used in the telecommunications, Regulatory Strategies 63 energy, and water sectors to ensure that incumbent net- of quantity, quality, and price. Franchising is perhaps work operators, which enjoy monopolies, allow access most appropriate for middle-income countries, especially to their networks on reasonable terms. These laws create upper-middle-income countries, with relatively well- competitive pressure at the level of the supply of services to developed governance structures. Alternative approaches individual consumers. may need to be adopted in low-income countries. One advantage of using competition law as a regulatory strategy is that it can be applied across the board (to multi- Regulation by Contract ple sectors), thus creating economies of scale in regulation. In addition to their role as regulators, governments are also The lack of industry specificity also reduces the likelihood substantial purchasers of goods and services from private of regulatory capture and the corresponding possibility suppliers. Government procurement therefore provides a that regulations become barriers to entry. lever to achieve regulatory objectives. Flexibility is both an advantage and a disadvantage of A government can agree to purchase services from competition law as a regulatory strategy. On the one hand, a provider on condition that it conform to certain firms value flexibility, as it leaves them free to exploit their conditions, such as the quality and quantity of services, the competitive advantages within the framework of a given payment of minimum wages, or the employment of a cer- set of rules. Unlike command and control strategies, com- tain percentage of local workers. Contracts for the acquisi- petition law does not unduly intrude into firms’ private tion of goods or services can be used as an indirect way of decision-making processes. On the other hand, flexibility achieving regulatory objectives, by including appropriate leads to uncertainty. The courts play a major role in devel- conditions in the procurement agreement. Although the oping and interpreting competition law, and businesses regulatory aspect is generally secondary to the acquisition may be unclear as to whether a particular conduct is in of goods or services, the fact that any agent dealing with the violation or not. government is required to behave in certain ways means that these kinds of agreements can nonetheless count as Franchising regulatory tools, especially in sectors where the govern- Some activities display natural monopoly attributes. ment is a significant purchaser. Traditionally, command and control techniques regu- late these kinds of monopolies. An alternative approach Tradable Permits that gives greater scope to market-based mechanisms is Tradable permits have received considerable atten- franchising: the replacement of competition within the tion in environmental protection. Under this approach, market with competition for the market. Under a fran- providers whose activities produce a social nuisance— chising, or concession, scheme, firms bid for a license to such as carbon dioxide emissions—must acquire a permit be the exclusive service provider for a particular activity to continue those activities. By issuing a fixed number of within a geographical region, usually for a limited time. permits, the government caps the total amount of harm- An auction mechanism can be used to encourage firms ful activity. Once they acquire these permits, firms are to compete on quantity, quality, and price. If properly free to trade them. The market for permits gives firms an instituted, this system incentivizes firms to bid based on incentive to engage in abatement activities while limiting assumptions of efficient operation. If the successful bid- the overall harm inflicted. der can subsequently be held to the terms of the bid, the net operator behaves in many ways as if it were in a com- Rights and Liabilities petitive environment, even though it is granted a monop- oly right. An additional advantage is that franchising A precursor to the idea of tradable permits is the grant- often includes the payment of a license fee, or negotiation ing of rights and liabilities to particular parties in order to MODULE 3 of a minimum subsidy, which can have fiscal benefits for encourage socially desirable behavior. Civil law generally the government. allows neighbors the right to take action against polluting The main disadvantage of franchising for develop- businesses, which in some circumstances can be liable for ing countries is that it requires a high level of governance any harm caused to neighboring properties. In this case, capacity, including a clear and strong legal framework. the right to pollute is not tradable, but the right to a clean If high license fees are involved, the potential for cor- environment gives rise to a liability to compensate suffer- ruption is significant and can result not only in a loss of ers for harm caused. government revenue but also in granting of licenses to The main disadvantage of this regulatory strategy service providers that do not offer the best combination is that rights and liabilities are subject to considerable 64 Module 3: Identifying Alternatives in Regulatory Strategies and Measures uncertainty, because they must generally be enforced up a market for the sale of particular types of securities through the courts. Moreover, because the costs of win- and prohibiting sales outside an organized market limits ning damages are relatively high, there is an incentive for the types of securities individuals can purchase. This parties to agree to a negotiated settlement at less than the approach can be seen as an extension of the kinds of prohi- full value of the damage. bitions used in command and control regulation in which The rights and liabilities strategy also interacts in the intervention takes place at an earlier stage, by mak- troubling ways with insurance. The ability for harm-causing ing certain types of transactions or behaviors impossible, businesses to insure themselves against subsequent law- rather than imposing sanctions after they do occur. This suits blunts the incentive to reduce the conduct in ques- type of regulation can be used to ensure that a sufficient tion, because insurance spreads the losses widely across the degree of competition and consumer satisfaction exists community rather than imposing them solely on the pro- within particular markets. ducer of the harmful activity. Nudging is also designed to steer behavior while preserving freedom of choice for consumers, albeit in a curtailed way. Nudging involves creating an architec- Disclosure Regulation ture for choice that favors a particular decision. (The Where information asymmetry is a significant problem in requirement to tick a box in order not to become an free markets, a relatively light-handed government strat- organ donor is a typical example of regulatory nudging.) egy is to require firms to make public information regard- Although nudging represents a promising and relatively ing the quantity, quality, and price of their outputs and light regulatory strategy in some areas, it is unlikely to in some cases the processes followed during production. be applicable across the board, especially in areas where The idea is that once the information is publicly available, economic incentives are strong or decisions are made individual consumers can make an informed choice that collectively. conforms to their levels of risk perception and tolerance, which differ from one person to another. Self-Regulation One major disadvantage of disclosure regulation is that the costs of disclosing and processing the informa- Under self-regulation, a group of firms or individuals sets tion may be significant. Moreover, in some cases, the risks standards for membership and behavior. Self-regulation associated with certain types of business conduct may has been very important in the professions, such as law be so great that information disclosure is inadequate. In and medicine, although many countries have moved to a these cases, command and control regulation—such as mixed approach involving command and control strate- prohibition—may be required. In medical services, for gies as well. example, it is generally regarded as insufficient to require One main advantage of self-regulation is that it practitioners to reveal their training to potential patients. involves the people with the most expertise—the Instead, states set minimal levels of qualifications so that regulatees—in the process of developing, promulgat- unqualified practitioners cannot do irreparable harm to ing, and enforcing standards of conduct. Of course, this patients. advantage is also a potential disadvantage, because the Because of these types of problems, information regulator has an incentive to use standards of conduct disclosure is often not a sufficient regulatory strategy on or licensing requirements as barriers to entry, thereby its own; it must usually be combined with additional mea- choking off competition, increasing prices, and limiting sures, such as some level of command and control regula- variety in the market. These strategies also need a well- tion, to be effective. Information disclosure requirements developed and sophisticated private sector with adequate may be sufficient alone when the risks of substantial harm competition to ensure regulatory quality and lack of MODULE 3 resulting from substandard conduct are low, the cost of anticompetitive arrangements. It is generally necessary processing the information is low, and consumers can to combine self-regulation with enforcement of competi- accurately assess risks. tion law to ensure that incumbents do not use it to erect barriers to entry. Design Solutions and “Nudging” Comparison of Regulatory Strategies Another form of regulation is for the government to set up a framework for private transactions so that particular Table 3.1 highlights the strengths and weaknesses of forms of harm simply cannot occur. For example, setting selected regulatory strategies. Regulatory Strategies 65 Table 3.1. Regulatory Strategies: Trends and Weaknesses Strategy Strengths Weaknesses Example 1. Direct • Can separate infrastructure provision • Involves costly funding State-owned intervention from operation • Requires heavy public sector involvement transport • Ensures acceptable level of provision services • May hamper market-driven innovation • Allows state to plan long-term investment 2. Command and • Has force of law; use of penalties • Intrudes on management decisions Safety regulation control indicates forceful stance of authorities • Prone to capture in transport • Sets minimum acceptable levels of sector • Involves complex rules, which tend to multiply behavior • Is inflexible • Screens entry • Imposes severe informational requirements • Protects social interests • Is expensive to administer and enforce • Requires strong institutional capacity • Can disguise restrictions to trade and limitations to competition • Imposes high compliance costs for firms • May inhibit innovation 3. Incentives • Limits regulator discretion • Requires rules Tax breaks for • Costs little to apply • Provides inadequate response to problems arising research and from irrational or careless behavior development • Involves limited intervention in management • Requires predicting outcome from given • Includes incentives to reduce harm to incentive, which is difficult zero, not just to standard • Is mechanical, so inflexible • Creates economic pressure to behave • Involves regulatory lag acceptably • Fails to prohibit offenses • Costs state revenue 4. Market- • Response is driven by firms, not • No regulatory body addresses technical or harnessing bureaucracy commercial problems in the industry controls Competition • Can be applied across industries • Increases uncertainty and transaction costs Retail distribution policy • Creates economies of scale in • Requires strong competition authority services regulation • Depends on courts, which move slowly • Involves low level of intervention • Develops principles only as policy is put into • Grants firms flexibility practice Concessions • Enforcement is low cost to public • Applies only to specific services Administration • Involves low level of restriction • Creates tension between specification and of ports and • Respects managerial freedom responsiveness/innovation airports • Allows competition for market as • Uncertainties impose cost on consumers substitute for competition in market • Requires multiple bidders • Response is from firms rather than • Nontransparent bidding procedures leave room government bodies’ preferences for corruption • Terms of franchise need to be enforced Contracts • Combines control with provision of • May confuse regulatory and service provision Street-cleaning services roles services • Sanctions through economic incentive • Is limited to selected services or nonrenewal • Lacks transparency and accountability • Easier to operate than licensing and concessions MODULE 3 5. Information • Level of intervention is low • Requires high degree of understanding by Mandatory disclosure • Leaves market decisions to consumers consumers disclosure • Is appropriate only in low-risk sectors of terms in • Reduces danger of regulatory capture insurance • Economic incentives (for example, low price) prevail over information (risk) • Involves potentially high costs of disclosure • Requires monitoring of information quality and fraud (continued on next page) 66 Module 3: Identifying Alternatives in Regulatory Strategies and Measures Table 3.1. Regulatory Strategies: Trends and Weaknesses (continued) Strategy Strengths Weaknesses Example 6. Design and • Imposes low cost • May not work where decision processes are Consent to organ Nudge • Combines influence with freedom of complex or are influenced by other incentives donation choice (for example, prices) • Lacks transparency and accountability • Is suitable only in low-risk sectors 7. Rights and • Decision remains with agents • May not prevent undesired effects Tort law, liabilities • Low degree of state intervention • Enforcing individual rights may be too costly individual rights • Imposes low cost on state • Legal uncertainties reduce enforcement • Insurance may temper deterrent effects Source: Baldwin, Cave, and Lodge 2012. Making Regulation Less Burdensome are also common. In Algeria, for example, only citizens can practice domestic law.4 Some countries also restrict This section examines examples of alternatives to spe- cross-border trade in professional services. Brazil prohib- cific regulatory approaches that are particularly restric- its the cross-border supply of accounting, auditing, and tive to services trade. The first part looks at ways in which legal services, presumably because it is difficult to control regulations can be made less burdensome while retaining the activities and competence of professionals not located the same overall strategy. The second part looks at changes within the national jurisdiction. The establishment of a in strategy. It discusses the relative costs and benefits of commercial presence is also heavily restricted in profes- different approaches in particular sectors. The presenta- sional services, with some countries, such as Argentina, tion is general. A box at the end of the section makes the prohibiting equity participation by nonnationals. discussion concrete by applying the concepts to the retail Regulators can reduce the burdens imposed on business distribution sector. by licensing by requiring domestic licensing only for activi- ties for which there is a public interest in doing so. In legal Decreasing the Burden of Command and Control services, for example, requiring domestic law practitioners Regulation to be citizens may make sense; extending the regulation to experts in international law may not. In accounting, it is pos- Regulatory reform does not always involve a change in reg- sible to separate out activities that require tight regulation ulatory strategy. In many cases, reform can take the form on public interest grounds, such as the provision of statu- of changes to a strategy’s structure and implementation tory audits, from those where the rationale for consumer (table 3.2). protection is weaker, such as routine back-office services. Limiting licensing or nationality requirements to particular Reducing the Scope of Entry Restrictions activities where the consumer protection rationale is stron- Licensing regimes in some sectors are an example of gest is preferable to a blanket prohibition on the provision command and control regulation. Although this kind of of services by foreign accounting professionals. The case for regulation sometimes comes with high costs, it is difficult licensing is substantially weaker for business-to-business to imagine successful regulation of sectors like professional services than it is for services that affect individual consum- services, telecommunications, or retail banking without ers directly, as businesses are presumed to be familiar with some form of licensing in place. The rationale is different the commercial activities they perform. in each case and is sector specific. In cases where domestic licensing of foreign MODULE 3 In professional services, the main rationale for licens- professionals is desirable from an economic efficiency ing is primarily consumer protection. From a trade policy standpoint, policy makers need to set education and train- standpoint, the key issue is whether foreign-licensed pro- ing requirements. One possibility is to require that foreign fessionals should be authorized to practice domestically. lawyers comply with the same education requirements as The most restrictive approach to licensing is to require domestic lawyers—the practice in Chile. An alternative is foreign professionals to satisfy the same educational to recognize some foreign educational qualifications on a requirements as domestic professionals. Chile takes this unilateral basis but submit all professionals—foreign and approach with respect to lawyers, subject to reciprocity or domestic—to a knowledge-based examination process, as mutual recognition agreements. Nationality requirements some states in the United States do. Making Regulation Less Burdensome 67 Table 3.2. Modifications to Common Regulatory Measures to Decrease Their Restrictiveness Regulatory measure Rationale Problems/considerations Modification of approach Granting of Natural monopoly exists or Natural monopoly must be • Carefully allocate monopoly right by exclusive right state wants to ensure a carefully defined. (In what limiting its scope and duration, auctioning large strategic investment or part of the market does it it, and repeating the auction periodically. meet specific socioeconomic exist? Is it durable or likely to • Break up monopoly and encourage political objectives, such as be eliminated over time by competition in areas not characterized universal access to services. technology or other changes?) by natural monopoly (such as electricity Regulating monopoly generation and distribution); focus is difficult. Is the cost of regulation on core natural monopoly (such regulating greater than the as electricity transmission). hoped-for gain? • Consider more direct ways to help target groups, sectors, and regions. Licensing and State seeks to address market Licenses can be manipulated • Explore scope to decrease anticompetitive permitting failure or achieve other public to restrict entry, following impacts. interest objectives, such lobbying from incumbents; • Review licensing and permitting to ensure as equity or better use of encourage corruption; and that benefits of regulation exceed costs. environmental resources. be difficult and costly to • Consider alternatives, such as reliance administer. on other regulations, fiscal instruments, information campaigns, market-based instruments, product liability laws, or quasi-regulation (such as industry codes of conduct). Limiting State seeks to favor local or small Policies are generally protectionist • Carefully consider policy merits of favoring government businesses in order to promote and impose high cost on particular groups. procurement domestic enterprise/import suppliers. Other means of • If warranted, consider subsidies, vouchers, to services substitution. favoring particular groups are or targeted removal of unwarranted from domestic likely to be more effective and impediments (regulatory or otherwise) to suppliers transparent. participation. Raising the cost States seeks to protect Entry costs rise as a result of • Assess extent of consumer problems/ of entry or exit consumers. increased product testing potential harms and size of benefits caused requirements, need for greater by interventions. financial capacity (including • Keep requirements to a minimum. insurance) requirements, and • Consider consumer education as an so on. Policies disadvantage alternative. new entrants, protecting incumbents and reducing innovation and dynamism in the market. Many provisions yield relatively limited consumer benefits. Restricting flow Often a tool of regional policy, Artificially reduces size of market. • Consider other regional policy tools, of goods, in which state attempts Significant efficiency costs are including provision of subsidies, targeted services, to enhance viability of often created by excluding investments by government, and enhanced capital, or regional economies, increase potentially larger and more infrastructure. labor across employment, and so on. efficient groups of alternative borders suppliers. Invites retaliatory action from other governments, creating a negative-sum game. Controls on Maximum prices often a Defeats market disciplines, • Use general competition law to deal with prices of corollary of entry restrictions. protecting inefficient producers. predatory pricing, which is in any case rare. goods or Minimum prices sometimes Consumers pay higher prices. • Where entry restrictions lead to monopoly services a response to concerns over Even maximum prices may tend power, remove the restrictions. MODULE 3 predatory pricing, where price to increase average prices by • Seek alternatives, as there are virtually no competition has been fierce. serving as a price signal. cases in which regulation of prices is a first-best solution. Restrictions on State seeks to prevent false/ Limits consumer information and • Rely on general competition law to prevent advertising misleading advertising or makes markets less efficient. false and misleading advertising. discourage overconsumption Usually ineffective in limiting where it can result in negative consumption, choice, or entry. impacts on consumers. (continued on next page) 68 Module 3: Identifying Alternatives in Regulatory Strategies and Measures Table 3.2. Modifications to Common Regulatory Measures to Decrease Their Restrictiveness (continued) Regulatory measure Rationale Problems/considerations Modification of approach Setting product State may set standards above Limits consumer choice, especially • Competition laws allow for cooperation standards at levels informed consumers ability to choose low-price/ in setting standards if not used to unduly high levels would choose to reduce low-quality options. Likely limit competition; emphasis should be on political risks or provide a to be a problem for poorer performance versus technical standards. level of protection considered consumers. desirable at the political or broader community level. Source: World Bank 2010b, adapted from OECD 2007. Regulation could also be modified in the transport barriers to entry, thus moderating prices and increasing sector. Licensing of operators and imposition of load limits variety for consumers. are probably justifiable on economic grounds—although 4. Use recognition arrangements wherever possible . load limits could at least partly be replaced with a load- Recognition can be either unilateral or mutual (recip- based tax to cover the negative externalities imposed by rocal or plurilateral). In many cases, the bulk of the large loads, such as road damage. Differences in licens- economic gains from recognition can be obtained ing requirements and load limits across countries impose through a unilateral process, which has the advantage additional costs on cross-border transport, however, of being politically and administratively more straight- because of the need to unload and reload merchandise at forward than engaging in the international negotia- the border and change drivers. Countries can reduce trans- tions necessary for mutual recognition. Recognition can port costs by harmonizing regulations or accepting each take the form of either complete recognition of foreign other’s requirements (mutual recognition). Smaller coun- licenses and standards or partial recognition (such as rec- tries, which may not be able to negotiate such deals, may ognition of foreign educational achievements even if an consider unilaterally recognizing their neighbors’ require- additional domestic licensing requirement is imposed). ments, particularly when they are part of a regional hub. Recognition may not be appropriate in all cases, but in sectors such as transport and some subsectors within Creating an Appropriate Licensing Regime professional services, it can facilitate international trade An economically efficient licensing regime should have the by reducing the cost burdens facing businesses. following characteristics (Ogus 2004): 5. Keep administrative costs to a minimum. Although administrative costs are necessary to ensure the func- 1. Be independent of the operators being licensed. The fact tioning of the licensing regime, paperwork and eviden- that professionals have traditionally been responsible tiary requirements should not intrude into other areas for their own licensing has often led to anticompetitive of the license seeker’s business or practices. Reducing conduct through the erection of barriers to entry. The the cost burden facing potential licensees should be a close relationship between financial regulators and reg- priority for licensing regimes, as it encourages entry and ulated financial firms has been brought into question in thus decreases prices and provides greater variety for light of the global financial crisis of 2008–09. consumers. 2. Be transparent. Licenses should be granted according 6. Strictly define the licensed activities, and limit them to to preestablished criteria. When discretion is used, the activities for which there is a strong economic case for regulator should explain its decision. Licenses should licensing. Within a sector, it is increasingly possible to MODULE 3 not be granted or refused based on the license giver’s divide activities into activities that require licensing and perceptions. activities that do not. 3. Discriminate between foreign and domestic operators and between incumbents and potential entrants as Shifting Regulatory Strategies little as possible. Nondiscrimination helps ensure that market disciplines, not institutional preferences, play a In many services sectors, there is scope to employ fundamental role in determining the success or failure incentive-based regimes, such as taxes and subsidies, in of individual service providers. By ensuring as little place of command and control regulation. This section discrimination as possible, the regulator can reduce discusses some examples. Making Regulation Less Burdensome 69 Shifting to Incentive-Based Regimes such conditions and policies are the source of the problem. Regulators can consider shifting to incentive-based But at least on a short-term basis and a relatively small regimes in a variety of areas. For example, one horizon- scale, payroll tax credits—an incentive-based regulatory tal regulation encountered in some developing countries strategy—could replace command and control methods is a restriction on repatriation of profits by foreign-owned such as local content requirements. The advantage of the firms. In Malawi, for instance, central bank approval is tax approach is that it is less distortionary with respect to required before earnings can be repatriated. The objectives firms’ hiring decisions. It is also transparent and not sub- of this measure are likely twofold: to ration scarce foreign ject to evasion or manipulation. Moreover, far from dis- exchange and to ensure that foreign firms pay all relevant couraging FDI, tax credits are likely to encourage it by taxes and charges within the jurisdiction. However, this reducing the effective cost of local labor. command and control approach—in which the central In addition to horizontal measures, there are also bank has broad discretion—creates considerable uncer- sector-specific policies in which at least a partial transition tainty for foreign firms, which may discourage them from from command and control to incentive-based regulation entering the market, thereby limiting competition. Such could be made. Road transport is one example. Most coun- measures can also have the perverse effect of discouraging tries impose command and control standards governing inflows of foreign direct investment (FDI) and thus exacer- maximum loads that can be carried by trucks. Such an bating shortages of foreign exchange. approach is appropriate from a road safety point of view. If regulation in this area is necessary on economic But an alternative justification for this type of regulation grounds, it may be preferable to use an incentive-based is that heavier loads impose greater externalities in the approach, such as taxation of repatriated earnings. Such form of more damage to roads. There is therefore a case taxation can be imposed on a withholding basis, to ensure to be made for retaining standards-based measures as an that foreign companies pay the appropriate taxes and absolute maximum but imposing taxes corresponding to charges in the domestic jurisdiction and are thus not load weights as well. Such an approach would have the afforded a competitive advantage over local firms. The advantage of internalizing the externalities caused by heavy tax rate should not be prohibitive or it will have the same loads and thus promoting economic efficiency. This kind effect of discouraging FDI as a command and control of tax measure is transparent and relatively straightforward approach. If properly implemented, a tax-based approach to administer, at least in countries with well-developed is preferable to administrative discretion on grounds of networks of weigh stations or traders who demonstrate transparency and nondiscrimination. Although it still dis- a high level of compliance in declarations. It is probably criminates against foreign companies, it does so less than more applicable to middle-income than low-income coun- other approaches. tries, where regulation probably needs to remain primarily Another area in which it is possible to make the transition command and control based. from command and control regulation to incentive-based regulation is local content requirements. In services, these Shifting to Market-Harnessing Regulation regulations require foreign firms to employ a minimum In some situations, market-harnessing controls, such as proportion of locals. In some cases, these requirements competition policy and franchising, can help ensure that are applied horizontally (that is, to all sectors). In others, market disciplines play the largest possible role in regula- they are applied on a sectoral basis. Bolivia, for instance, tion. Where appropriate, changing regulatory strategies in requires that 85 percent of the employees of foreign-owned this way can yield significant economic gains. banks be locals. The public policy objective of such mea- Telecommunications and energy were both traditionally sures is to promote local employment. regulated as natural monopolies under a command and con- In many countries, employment is taxed through pay- trol strategy. This approach may have been appropriate in MODULE 3 roll deductions. It is therefore possible to encourage local the past; advances in technology have made it less so today. employment by providing payroll tax credits. There is no Technological change has highlighted the possibility of economic justification for applying such measures only in using competition as a regulatory tool in at least some parts the case of foreign-owned enterprises. It would make sense of these sectors. In both cases, two crucial issues emerge: to apply them across the board if labor market conditions network access and the separation of natural monopoly are such that some degree of intervention is warranted. activities from activities where competition is possible. Of course, such measures cannot deal with structural As technology has improved, it has become increas- unemployment linked to macroeconomic conditions and ingly possible to identify particular activities in sectors policies; alternative measures would need to be adopted if such as telecommunications and energy that have natural 70 Module 3: Identifying Alternatives in Regulatory Strategies and Measures monopoly characteristics, rather than assuming that entire Even this may not be sufficient in very small markets, sectors are natural monopolies. In telecommunications, however. In such cases, where franchises are unlikely to for instance, network development is often considered a prove attractive to foreign or domestic investors, regu- natural monopoly, at least for some parts of the fixed line lators may need to stick with a command and control network. In energy, generation is a (local) natural monop- strategy, perhaps backed up by the use of competition law oly. In both cases, market-harnessing mechanisms can rep- (box 3.2). It is important to avoid a situation in which resent an effective transition from command and control foreign investment is opened up in a highly selective way— regulation. One option is to adopt a franchising approach, perhaps with one developed country partner—effectively in which firms compete for, rather than within, the market. killing off competition for the franchise and resulting in a By taking competitive bids for a time-limited monopoly, case where monopoly profits may be repatriated overseas regulators can encourage firms to adopt pricing models with only limited efficiency gains. It is therefore important that approach competitive levels. for developing country governments to get the sequencing Several considerations are relevant in assessing the of reforms right. relative costs and benefits of franchising versus com- A second market-harnessing control that is impor- mand and control regulation (Baldwin, Cave, and Lodge tant in sectors such as energy and telecommunications is 2012). On the positive side, franchising results in a rela- competition law, particularly market access regimes. When tively market-friendly regulatory stance. Enforcement generation or network creation is separated from distribu- involves low costs to the public, and managers are left free tion or use, only generation or network creation need to to respond to changes in market conditions, rather than be regulated as natural monopolies; distribution and use being hamstrung by possibly outdated bureaucratic stan- can be regulated on a competitive basis, provided that all dards. On the negative side, it is important to be realis- operators have nondiscriminatory access to the network. tic about the possibility for effective competition for the Use of competition law can be problematic in devel- market, particularly in developing countries. Franchising oping countries. Some middle-income countries have is most effective when it attracts a large number of sophis- adopted competition laws and are enforcing them with ticated bidders. For developing countries, which often lack increasing vigor. In contrast, most low-income coun- capacity and financial resources, it is necessary to relax tries lack the human resources and financial capacity to foreign investment laws in a nondiscriminatory way before do so. A further drawback of using competition law as a franchising out activities such as energy generation or tele- regulatory strategy is that the law usually lays down broad communications network construction, in order to ensure principles that need to be elaborated by the courts to pro- the maximum possible level of competition for the market. duce detailed regulatory policies. This process can take Box 3.2. Using “Yardstick” Competition in Monopolistic Markets A form of competition that could help reduce the burden on regulators is yardstick competition. Under this approach, regulators assess the performance of an infrastructure service provider (for example, prices and coverage) by comparing it with a provider in another place (such as a neighboring country) and adjusting regulations. Although this approach does not create competition in the market, it can have similar effects on incentives for infrastructure providers. Competition among “monopolists” can reduce the need for sectoral regulation in sectors such as petroleum and electricity distribution. For example, the transport of petroleum by pipeline between two points may well be a natural monopoly. Producers at a particular location, however, may not require regulatory protection if they have alternative customers to that pipeline (for example, local buyers or customers elsewhere who can be reached through other means of transport). Similarly, customers at a particular point on a pipeline that is a monopoly may not require regulatory protection if they have alternative sources of petroleum, such as local producers or shipment by water or a pipeline from another origin. Similar conditions hold for some natural MODULE 3 gas pipelines. In Argentina, pipelines from two different gas-producing areas—Gas Atacama (a joint venture of Chile’s Endesa and the U.S. firm CMS Energy) and Norandino (Belgium’s Tractebel)—are just beginning to compete to bring natural gas across the Andes Mountains to northern Chile. Similarly, even if the long-distance transmission of electricity between the generation facility and the consuming enterprise or municipality is a natural monopoly, generators at a particular location may not require regulatory protection if they are served by different long-distance transmission lines serving different sets of customers. Customers at a particular location may not require regulatory protection if they are served by different long-distance transmission lines carrying power from different generators. Municipal and large industrial users are currently enjoying such competition from different generation facilities in Argentina, Brazil, Chile, and Peru. Source: World Bank 2002. Making Regulation Less Burdensome 71 years and is subject to considerable uncertainty, particu- regulation depends on the courts’ interpretations of statu- larly where judicial capacity is low. tory instruments, which may lead to circumvention by The combination of franchising and competition law regulated firms. does not usually remove the need for a sectoral regulator. It is Disclosure regulation presents an attractive alternative. possible to outline criteria that such a regulator should have. It is already being implemented to varying degrees in finan- According to the World Trade Organization’s Reference cial markets around the world, where firms are required to Paper on Telecommunications Services, sectoral regulators disclose to investors a wide range of factors that may affect should be independent of incumbent operators, promote the choice to invest. competition and network access, be transparent, and ensure One area that does not appear to have been addressed nondiscrimination between domestic and foreign firms and is retail banking. Many countries prohibit or limit between incumbents and potential entrants. cross-border retail banking transactions (Mode 1 trade). Many developing countries—except the smallest and Even countries that are liberal on Mode 1, such as the very poorest—could benefit from using franchising as United States and the United Kingdom, prohibit advertis- a regulatory strategy in such sectors as telecommuni- ing by foreign retail banks, thereby limiting the market to cations and energy; it is probably only relatively high- a small number of well-informed investors. A more liberal capacity middle-income countries that can effectively approach would be to allow transactions and advertising use competition law to promote network access. Small, by foreign-licensed retail banks, subject to full disclosure low-income countries may therefore need to continue to that they do not hold a banking license in the domestic rely on command and control strategies, at least to some jurisdiction, that they are not subject to the same capital extent, in regulating these sectors. Command and control adequacy requirements or other supervisory measures is not a “one size fits all” strategy, however; it is subject as domestic banks, and that deposits are not guaranteed to many interpretations and combinations of measures. by domestic deposit insurance mechanisms. Although a Countries that retain a significant role for command and detailed cost-benefit analysis of this approach is needed to control regulation should ensure that it erects as few barri- ensure that it would not result in significant investment in ers to entry as possible and reduces to a minimum the cost unsafe products by ill-informed consumers, it could be a burdens facing operators. more liberal regulatory strategy for retail banking services Another sector in which alternative regulatory strategy that would help promote trade. can be applied is transport. The construction and opera- Greater use of disclosure regulation could also be ben- tion of some port and airport facilities display natural eficial in professional services. It is desirable to limit the monopoly characteristics and could therefore be regulated scope of domestic licensing to a relatively narrow range in appropriate cases via a franchising strategy. Ancillary of activities, such as advice on domestic law in the case of operations—such as cargo handling—do not display such legal services or the signing of statutory accounts in the characteristics; they can be regulated through a competi- case of accounting and auditing. To ensure that consumers tive model, using competition law as appropriate. do not mistakenly use unlicensed professionals, disclosure regulation could require professionals with foreign licenses Shifting to Disclosure Regulation whose practice is limited to foreign and international law The financial and professional services sectors could poten- or back-office accounting functions to identify themselves tially benefit from increased use of disclosure regulation. as such. Requiring foreign professionals to use titles such as As there are important consumer protection rationales for “foreign lawyer” or “foreign accountant” would highlight regulation in both sectors, the provision of information to the public that the professionals in question followed an could enable consumers to choose services that fit their alternative procedure to gain access to the domestic market preferences and risk profiles. and are different from domestically licensed professionals MODULE 3 In finance, a command and control approach to regula- in the range of services they can legally offer. The com- tion prohibits certain types of instruments or transactions bination of limiting command and control regulation based on their perceived risks. For instance, retail banks and increasing disclosure regulation would result in an and insurance companies were traditionally allowed to increase in trade in professional services, at the same time invest only in a certain range of tightly regulated instru- ensuring that consumers remain protected from unscru- ments. Although there is clearly a case for retaining a pulous operators. command and control approach to issues such as capital Alternative regulatory strategies could also be applied adequacy, the broader use of command and control is in the retail distribution sector. Box 3.3 discusses some not without problems. For instance, the effectiveness of options. 72 Module 3: Identifying Alternatives in Regulatory Strategies and Measures Box 3.3. Adopting Alternative Regulatory Strategies in the Retail Distribution Sector Retail distribution is a regulated sector in many economies. Regulatory measures include entry restrictions and measures that affect the ongoing operations of incumbents. For 1998, 2003, and 2008, the OECD’s Product Market Regulation Indicators (PMRs) pro- vide a snapshot of the regulatory environment in up to 40 countries. Most of the data cover OECD member countries; the 2008 version also covers Brazil, China, India, Indonesia, the Russian Federation, and South Africa. Command and control, embodied in mandatory regulations, is the dominant regulatory strategy in the sector, sometimes com- bined with self-regulation. For instance, some countries require retail outlets selling food to be licensed or listed in a commercial register. This requirement is a classic licensing requirement that is consistent with a command and control approach. Unfortunately, the PMRs do not disclose the criteria used for the licensing decision—such as whether it is automatic or discretionary—so it is difficult to assess the performance of different countries on this metric. An example of (partial) self-regulation in the retail sector is the inclusion by some countries of retail associations in licensing decisions. This strategy comes with considerable potential costs, as established retailers can easily capture the licensing system and use it to erect barriers to entry. Although any licensing system needs to be based on professional knowledge of the characteristics of the sector, direct involvement of regulated entities in the licensing decision can lead to undesirable and uncompetitive outcomes. A more efficient approach would be to institute a licensing system that is independent and transparent. Another example of command and control in the retail sector is the application by some countries of specific regulations for outlets that exceed a certain surface area. If surface area is a genuine economic or social issue—because, for example, a large store leaves a deeper environmental footprint—an appropriate and more efficient regulatory strategy would be to use economic incen- tives. For instance, a tax could be applied to retail outlets based on their surface area. To the extent that large outlets cause more environmental damage than small ones, the tax would internalize the externality. Of course, the question would then arise as to why retail outlets—rather than all commercial facilities—should be subject to an additional tax. The appropriate approach would therefore be to embed the sectoral issue in a broader approach to environmental regulation of commercial facilities—preferably through a system of economic incentives. In addition to these measures affecting market entry, retail distribution also sometimes involves regulations that increase the cost of doing business for incumbents. Examples are the regulation of shop opening hours and price controls. In neither case is there an obvious economic rationale. The goals of possible rationales for price controls—limiting inflation and ensuring that basic goods are accessible to poor people—can be achieved in more efficient ways using alternative regulatory strategies. With regard to inflation, macroeconomic policy (particularly monetary policy) is a more targeted response and introduces fewer microeconomic distortions than do price controls. To ensure that poor people have access to basic goods, it is more efficient—and probably more effective—to adopt an economic incentives strategy. Consumption subsidies for people below a certain level of income can ensure that they have access to sufficient food and other basic resources without distorting the consumption choices of other members of the community. Examination of the PMRs at the country level reveals a range of approaches to these regulatory problems. Some countries, such as China, employ a relatively restrictive regulatory stance. Others, such as Brazil, have a more liberal approach, comparable to that of such developed countries as Australia. This range of experience among developing countries forms the basis for significant South- South knowledge exchange. Source: World Bank, based on OECD Product Market Regulation Database. Meeting Political Economy Challenges governance should be reformed to strengthen the reforms’ feasibility. The analysis allows policy makers to widen the Reform of services trade and investment does not take space for reform by improving and targeting an informa- place in a vacuum.5 Because of the significant interests tion and communication strategy, working more inten- involved in services, establishing and implementing reform sively with stakeholders, and building and strengthening is complex (Hoekman and Kostecki 2009). supporting coalitions. Reforms may not be politically feasible unless they take A political economy assessment includes the following into account the political economy reality in a country and steps: how it constrains economic choices. A Regulatory Assessment of Services Trade and Investment (RASTI) must therefore • Identify the problem, issue, or vulnerability (the services MODULE 3 identify the factors that influence the regulatory framework sectors and modes that will be reformed, how they will for services and assess how influential they may be in prevent- be reformed, and the winners and losers from those ing the implementation of technically sound policy options. reforms). Assessment of the political economy context should • Map existing institutional and governance arrangements, help policy makers design a sustainable reform strategy. in order to understand how supportive (or not) of The focus should be on finding feasible approaches for development concerns they are. The analysis of insti- reform and assessing whether the priorities identified in tutions is concerned with the access stakeholders have the regulatory assessment are realistic, what vulnerabilities to the institutional context, the rules of the game, the may affect the implementation of the reforms, and how distribution of resources of power/influence, and the Meeting Political Economy Challenges 73 importance of the institutional context in the results examples of appropriate questions to pose when assess- of the reforms, including how the existing configura- ing the political economy factors at the sectoral level. tion and interaction among them will be affected by the Analysis at the policy or project level is narrower in reform process. scope. It aims to address a more specific issue identified • Understand political economy drivers. This step involves during the regulatory assessment. analyzing stakeholders’ interests, leadership, priori- The political economy analysis should be based on ties, motivation, resources, capacity to influence, and evidence (that is, supported by data). Data from the capacity to build alliances and incentives; the ways in Worldwide Governance Indicators and other sources which stakeholders interact (formally and informally) may help assess a country’s capabilities to adopt reforms. with existing institutions; and the ways these interac- Sources that identify stakeholders and their interactions, tions have evolved over time at the country or sectoral as well as data that help assess stakeholders’ economic and level (World Bank 2008; Corduneanu-Huci, Hamilton, political importance and relevance beyond the economic and Masses Ferrer 2013). More important, the analysis and political dimension, such as their relative economic should determine how the proposed regulatory reforms importance and population significance, should also be will affect stakeholders. used. At the sectoral level, the data should assess the influ- ence of stakeholders and, if possible, compare it with their In line with the desired scope of the RASTI, the influence at the country level. political economy analysis may take place at the country, Corduneanu-Huci, Hamilton, and Masses Ferrer (2013) sector, or policy or project level. Country-level analysis provide guidance on what this analysis allows policy mak- is appropriate when the analysis of the political economy ers to do: seeks to assess the overall governance situation in the country (Fritz, Kaiser, and Levy 2009). Box 3.4 provides a • A political economy context identifies stakehold- set of basic questions for country-level analysis. ers and the consequences that reform could have for Sector-level analysis of the political economy context them. complements the regulatory assessment at the sectoral • It creates maps of stakeholders that can be classified level, by identifying factors that can influence the success under different groupings that might support or oppose or failure of the regulatory reform. Box 3.5 provides reform. Box 3.4. Political Economy Analysis at the Country Level Key issues to consider in a political economy analysis at the country level include the following: • How does the country compare with other countries with respect to the provision of good policies generally and in the priority areas identified? • The credibility and legitimacy of government (in relation to both elites and the broader society) are integral aspects of gover- nance. Lack of credibility and legitimacy reduces the ability of public and private actors to plan with a long-term horizon and makes it more difficult to construct a durable coalition that favors reform. Both credibility and legitimacy are underpinned by the allocation of resources and rents. Are agreements regarding rent extraction and distribution accepted by a critical mass of elite interests? Are they stable and credible—that is, are beneficiaries of rent-seeking arrangements (whether private investors, key political actors, or social groups) confident that these arrangements will continue? Is there similar confidence in the credibility of property rights? What is the basis of this confidence? • One key aspect of governance relates to the incentives of politicians to pursue policies in the broad public interest. What aspects of the political environment augment or diminish the political incentives to pursue such policies? MODULE 3 • Another key aspect of governance is the ability of the administration to carry out policies in the broad public interest predict- ably and sustainably. What limitations does bureaucratic capacity impose on the ability of politicians to promise and deliver on promises regarding policy reforms? Alternatively, what is the potential of the bureaucracy to implement priority reforms tech- nocratically and sustainably? • What are the sources of fragility in the country? What arrangements—economic and noneconomic mechanisms—seem to be essential to ensuring stability (in mediating among deeply divided social groups, for example)? What impact would the pro- posed priorities have on these mechanisms or social equilibriums? • Are the development priorities identified by the assessment the right ones given the context? What additional priorities are important to consider? Source: Adapted from Fritz, Kaiser, and Levy 2009. 74 Module 3: Identifying Alternatives in Regulatory Strategies and Measures Box 3.5. Political Economy Analysis at the Sectoral Level Key issues to consider in a political economy analysis at the sectoral level include the following: • What is the ownership structure in the sector (public and private)? • How are responsibilities distributed between the national and subnational levels? Is this distribution clear? Does it generate significant distortions? • How is the sector regulated (what are the rules and institutional structures)? Does existing regulation—including informal/ de facto rules—ensure integrity? Does it allow the sector to maintain or expand services in line with demand (and commitments to poverty alleviation)? What interests drive/maintain the current regulatory system (including its weaknesses or gaps)? • How are the sector and its components funded (user fees, taxes/general budget, earmarked taxes such as gasoline excise taxes, informal revenue generation, petty corruption from consumers, and so on)? • What is the pricing structure for consumers? Which groups benefit (from subsidies, for example)? Are benefiting groups politi- cally salient/powerful? Which consumer groups have a voice? • Is there significant petty or grand corruption in the sector? If so, why does it persist, and what are the main impacts? • What opportunities for rent-seeking and patronage are related to the sector? Who appears to benefit from rents? How is patron- age being used? • What are the legacies of the sector? What reforms were attempted or undertaken in the past? What were the results? How does this experience appear to shape current expectations of stakeholders? • What are the relevant policy processes linked to past or proposed reforms? • Are there social or ethnic factors that are relevant for sector dynamics? • What is public opinion on sector performance or proposed reforms? Does the public trust/expect that reform will bring improve- ments? • What stakeholders are (officially and unofficially) involved in discussions concerning sector reforms, and what are their interests? What veto points exist in the decision-making and implementation processes? • What, if any, stake do the government/top executive/key political factions have in the reform? • How would proposed reforms affect the existing set of interests and incentives? • What risks exist in failure or negative unintended consequences of proposed reforms? • What would a politically and institutionally feasible reform look like? Source: Adapted from Fritz, Kaiser, and Levy 2009. • It assesses the factors that determine the strength of experience suggests that it is possible to liberalize services the stakeholders’ preference and their ability to act trade and eliminate measures that create barriers to entry collectively. by foreign services providers while ensuring high levels • It provides an analysis of the institutional context in of consumer protection and achieving other important which actors’ interaction occurs, which allows policy policy objectives. makers to better understand how to navigate the insti- The perspective put forward in this module is one of tutional framework and overcome existing obstacles. regulatory proportionality. Recent decades have seen • It improves the understanding of and incorporates into a shift away from strategies such as direct action and analyses the constraints that reform faces. It helps define command and control toward competition policy and what is feasible and under what time frame. economic mechanisms. Independent review and analy- sis from an economy-wide perspective is needed to bring about this kind of change. Analysis has to take a general Conclusion and Policy Implications equilibrium perspective that includes the gains and losses This module assesses the advantages and disadvantages to consumers. Partial equilibrium analysis, which focuses of various forms of regulation in order to identify strat- primarily on the needs of producers, is likely to produce egies that are effective (achieve their objective) and regulations that are unduly restrictive and that therefore MODULE 3 efficient (do so at minimum economic cost). The two result in less competition, higher prices, and lower variety criteria most useful in assessing the costs and benefits for consumers. of regulatory strategies are whether the strategy creates Developing country policy makers can take away five entry barriers that discriminate against either all poten- rules of thumb from this module: tial entrants or foreign entrants and whether the strategy unnecessarily increases ongoing costs for market par- 1. Trade restrictions should be the exception rather than ticipants. Many countries employ regulations that are the rule as a means of promoting economic and social justified by reference to important social or economic objectives. In most cases, trade policy is not an effi- goals but impose high economic costs. Cross-country cient way of promoting social goals such as consumer References 75 protection or job creation—and it tends to harm con- economic resources used to do business. There will obvi- sumers. Because consumers of services include manu- ously need to be a case-by-case approach to such ques- facturing firms and other producers, restrictive trade tions. policy in services can reduce productivity and exports Developing countries are experimenting widely with in manufacturing. services policies. Some countries have chosen to adopt 2. Policies that target market failures are likely to be more a liberal stance regarding trade via Modes 1 and 3, efficient than indirect interventions, such as trade policy. whereas others have chosen to be more restrictive. From an economic efficiency point of view, trade policy Experience will provide guidance on the best mix of is the best policy for dealing with market failures that policies to achieve sectoral regulation that is effective in are fundamentally trade related. However, the mar- achieving economic and social objectives and economi- ket failures considered here are only incidentally trade cally efficient. related. With labor market problems, the most effi- 5. A regulatory strategy normally relies on a combination cient approach is to design appropriate interventions of approaches. Services sectors will normally not be that apply across the board, rather than constraining exempted from competition law but will be regulated the activities of a relatively small number of foreign- by specific sectoral provisions. Finding the right invested firms. combinations is context and country specific, adding 3. It may not be technically or financially feasible to imple- complexity to the assessment process. The people ment an optimal policy, particularly where it requires responsible for conducting the assessment should an economic mechanism that presupposes a high level of be mindful of the context within which alternative financial and institutional development. Trade policy regulatory options are recommended. may appear attractive as a second-best way of achieving an economic or social objective. If this is the case, the regulation should distort trade as little as possible. In Notes general, the most important objectives discussed here 1. This section draws on Dee (2006). and those that require the most government interven- 2. When the regulation in question is largely economic in nature or deals with measurable phenomena such as externalities, quantifying costs tion relate to consumer protection. The rationale for and benefits can be relatively straightforward, provided that sufficient restricting trade as a second-best consumer protec- reliable data exist. In the case of noneconomic social goals, quantification tion measure applies more strongly to cross border is much more challenging. 3. The section draws heavily on Baldwin, Cave, and Lodge (2012) and (Mode 1) trade than to commercial presence (Mode 3). Ogus (2004). As Mode 3 requires a foreign services provider to estab- 4. The rationale behind this regulation is presumably that it gives lish itself commercially in the local market, it is much clients the right of recourse against the service provider in cases of easier to subject the foreign firm to the same consumer negligence. 5. This section is based on Fritz, Kaiser, and Levy (2009) and protection requirements that domestic firms are subject Corduneanu-Huci, Hamilton, and Masses Ferrer (2013). to. That process is much more problematic for Mode 1 trade. To the extent that developing country policy mak- ers find themselves constrained to use trade policy as a References second-best policy alternative, national welfare would Baldwin, Robert, Martin Cave, and Martin Lodge. 2012. Understanding be best served by concentrating restrictive measures on Regulation: Theory, Strategy, and Practice. Oxford: Oxford University Press. Mode 1 and leaving Mode 3 as open as possible. Corduneanu-Huci, C., Alexander Hamilton, and Issel Masses Ferrer. 4. Services sector regulations should be designed to make 2013. Understanding Policy Change: How to Apply Political Economy maximum use of market mechanisms whenever possible. Concepts in Practice. Washington, DC: World Bank. Even where social objectives require the use of subsidies, Dee, Philippa. 2006. “Institutional Strategies within APEC for Improving the Microeconomic Policy Foundations of East Asia’s Economic MODULE 3 policy makers can make the process more efficient by Performance.” Working Paper, Australian National University, using an economic mechanisms strategy like an auction Canberra. http://crawford.anu.edu.au/pdf/staff/phillippa_dee to allocate them. Similarly, the priority for regulatory /concept_paper.pdf. Fritz, Verena, Kai Kaiser, and Brian Levy. 2009. Problem-Driven reform should be to introduce competition in markets Governance and Political Economy Analysis: Good Practice Framework. where it is restrained. In most cases, doing so will mean Washington, DC: World Bank dismantling entry barriers before addressing other mea- Hoekman, Bernard M., and Michel M. Kostecki. 2009. The Political Economy of the World Trading System. New York: Oxford University Press. sures that increase the costs of doing business. In mar- Miroudot, Sébastien, Jehan Sauvage, and Ben Shepherd. 2010. Measuring kets that are already relatively competitive, it may be the Cost of International Trade in Services. MPRA Paper 27655, appropriate to focus on measures that increase the real University Library of Munich. 76 Module 3: Identifying Alternatives in Regulatory Strategies and Measures OECD (Organisation for Economic Co-operation and Development). World Bank. 2002. World Development Report 2002: Building Institutions 2007. Integrating Competition Assessment into Regulatory Impact for Markets. Washington, DC: World Bank. Analysis. Paris: OECD. ———. 2008. The Political Economy of Policy Reform: Issues and ———. 2008. Introductory Handbook for Undertaking Regulatory Impact Implications for Policy Dialogue and Development Operations . Analysis (RIA). Paris: OECD. Washington, DC: World Bank. OECD Product Market Regulation Database. http://www.oecd.org/eco ———. 2010a. Making It Work: “RIA Light” for Developing Countries. /reform/indicatorsofregulatoryconditionsintheretaildistributionsector Washington, DC: World Bank. .htm. ———. 2010b. Regulatory Quality and Competition Policy. Washington, 1994. Regulation: Legal Form and Economic Theory. Oxford: Hart DC: World Bank. Publishing. Worldwide Governance Indicators (database). World Bank, Washington, Ogus, Anthony I. 2004. Regulation: Legal Form and Economic Theory. DC. http://info.worldbank.org/governance/wgi/index.asp. Reprint, Portland, OR: Hart Publishing. MODULE 3 Appendix A: Professional Services Objectives Professional services play a critical role in the functioning of modern economies and are among the fastest-growing This appendix provides background information and services sectors in many developed and developing econo- straightforward guidelines for mapping the professional mies. Accounting, for example, is a critical component in services market and regulatory framework. Upon completing the infrastructure of a market economy. In addition to gen- it, readers will be able to: erating and processing information on the financial position and profitability of operations—essential for good financial • Distinguish between the conditions affecting the markets management and accountability—accounting provides for professionals and professional services the foundation of a country’s fiscal system and plays a key • Assess the reasons for skills shortages and mismatches that role in corporate governance (Trolliet and Hegarty 2003). affect the professional services market Effective law and justice systems are key structural pillars of • Recognize regulatory failures in the professional services sustainable development and poverty reduction (Cattaneo market and Walkenhorst 2010). The engineering sector plays a vital • Classify the nature of regulatory restrictions to trade and role in the development and maintenance of a country’s investment physical infrastructure and is essential to the productivity • Identify possible regulatory alternatives, in particular and sustainability of other economic activities alternatives to formal restrictions to professional services The use of professional services is associated with higher labor productivity. In all six southern African This appendix presents the conceptual framework for countries documented in the World Bank Survey of Users of the analysis of professional services sectors and trade in Professional Services, for instance, firms that used account- professional services.1 The first two sections focus on the ing, legal, and engineering services had higher average market for professionals and professional services. They labor productivity than firms without professional services present a methodological approach for identifying the linkages (World Bank 2011b). main shortcomings affecting the market. The third section focuses on policies relevant to trade in profes- Shortages and Skills Mismatches in the sional services—namely, education, domestic regulation, Market for Professionals trade barriers, and labor mobility—and discusses their main regulatory measures, including alternatives that are A diagnostic of the market for professionals should less trade restrictive of trade. Drawing on these elements, determine whether there are sufficient numbers of them the fourth section considers policy implications, suggest- and whether they have the skills that are in demand. Such ing possible national and international actions to promote a diagnostic helps frame recommendations for more trade in professional services. The last section summarizes targeted skills formation and the reform of selected cur- the main findings on regulatory barriers to professional riculums. It should answer the following questions: services. A questionnaire on legal, accounting, and engi- neering services, available at http://www.worldbank.org • How many qualified professionals work in the country? /trade/RASTI, offers additional practical guidance for • Are there skill shortages in any professional services conducting a regulatory mapping. It draws attention to subsectors? If so, what is the magnitude of these short- pertinent issues to raise in interviews with government ages, and what are the projected skill gaps? officials and stakeholders when conducting a regulatory • Is there evidence of skills mismatches in professional mapping. services? 77 78 Regulatory Assessment Toolkit Understanding the causes of the identified outcomes • Liquidity constraints and limited access to financing requires data on the salaries and fees earned by pro- • Poor quality of secondary education, which prevents fessionals and comparable categories of workers in students from being admitted to institutions of higher particular countries and their neighbors. As scarcity may learning manifest itself by higher wages paid to certain profes- • The absence or insufficient capacity of educational sional skills, the diagnostic needs to document poten- institutions tial labor market premiums for professional skills. Such wage premiums can be based on estimates of returns Other explanations for this outcome include inappro- to tertiary education or returns to specific professional priate or absent regulations and standards that prevent degrees. the emergence of certain professionals (such as midlevel Analysts also need information on the extent to which professionals). immigration and foreign professionals are filling the Despite incentives and ability to acquire skills, national skills gap, the capacity of higher education insti- professionals may find limited incentives to practice tutions to train professionals and the cost of obtaining domestically or over a longer period of time (outcome 4 qualifications, and the extent of skilled emigration. From in figure A.1). Higher returns abroad could motivate pro- this information, it is possible to determine whether fessionals to emigrate, or higher returns in other activities there are incentives to acquire professional skills, whether (such as management tasks for professional accountants) students are able to acquire the desired degrees/skills, and could create shortages of senior-level professionals. whether there are incentives for graduates to work as pro- Sector-specific skill mismatches (outcome 5 in fessionals. Figure A.1 outlines the steps in this analysis and figure A.1) could arise because of the following factors: identifies the underlying explanatory factors for the poten- tial outcomes. • The lack of domestic specialization courses or practical One possible outcome is the absence of wage premi- training ums despite skill shortages (outcome 1 in figure A.1). In • The lack of links between professional institutions and such cases, it is necessary to identify why the market is the private sector not creating institutions for skills acquisition. Possible • The inability of professionals to access courses abroad explanations include the following: (possibly because of financial credit constraints) • Foreign professionals are to some extent bridging the Distortions in the Market for Professional skills gap Services • Labor market regulations or the monopsony y power of employers maintain wages at low levels A complementary diagnostic examines the professional • Skills are perceived as an undersupplied public good services market to determine whether, even if sufficient professionals do exist, regulatory obstacles are distorting Shortages of professionals can reflect a lack of incen- the market, leading to an inefficient allocation of profes- tives to acquire skills (outcome 2 in figure A.1). Such an sional services. Key questions to ask as part of this analysis outcome could be explained by include the following: • Lower wage premiums in professional services than in • Who are the main providers of professional services, other sectors that require tertiary education and what is their market share? • Insufficient information about the benefits of acquir- • What is the degree of concentration and the level of ing professional skills (as a result of weak or nonexistent fragmentation in the sector? links between the labor markets and professional • What is the ownership structure of the main providers? associations) • How much foreign direct investment is there in the sec- • Liquidity constraints tor, and what is the potential for more? • How transparent are the fees and tariff structures of Skill shortages and mismatches can persist despite professional service firms? incentives to acquire professional degrees (outcome 3 • How important are imports of professional services? in figure A.1) because many potential students are not • Which tasks within the selected professional services able to acquire the desired skills, for a variety of reasons, are traded cross-border, both within and outside the including: region? Figure A.1. Determining Whether Education and Migration Policies Contribute to Skill Shortages and Mismatches in Professional Services 1. Are prices for professional services high (large wage premiums)? No Yes 2. Is there an incentive to acquire professional degrees/skills? No Yes Skills are public good 3. Are students able to acquire desired professional Labor market degrees/skills? regulations (ceiling on wages) Lower premiums than in Immigration of other sectors requiring No Yes professionals tertiary education covering gaps Insufficient information Monopsony power on benefit of skill Liquidity constraints k as a professional? 4. Is there an incentive to work of employers acquisition Poor secondary Liquidity constraints education No education institution to offer degree (for No Yes example, middle level) Higher returns abroad Absence of market-relevant skills as Higher returns in other activities inadequate domestic educational Higher returns in informal sector institutions and practical training, and High risks/liabilities no access to foreign education Outcome 1 Outcome 2 Outcome 3 Outcome 4 Outcome 5 Shortage as students Economy-wide skill Skill shortages as Sector-specific, task-level skill Skill shortages get different degrees mismatches professionals go abroad, mismatches go/return to civil service/other formal sectors/rent-seeking activities 79 80 Regulatory Assessment Toolkit Information on the use of professional services by size Education Policies and sectors is needed to determine the demand for— Professional services require a skilled workforce. The quality and accessibility and quality of—professional services. of education is thus critical. Possible education-related Figure A.2 details the steps of this analysis. barriers include financial constraints, which may pre- One possible outcome is limited demand for profes- vent individuals from acquiring professional education, sional services (outcome 1 in figure A.2). The prevalence and limitations in the capacity and quality of educational of informal arrangements—such as handshake deals, oral institutions, which may prevent students from acquiring agreements, and other customs and practices—may limit market-relevant skills. demand for certain legal services. Limited monitoring of compliance with financial reporting or safety standards may curb demand for accounting and consulting engineering Domestic Regulation services. Other possible outcomes are unsatisfied demand for Professional services have traditionally been subject to professional services given skills shortages or mismatches heavy regulation. Measures, which range from qualitative or trade barriers and inadequate regulation of domestic and quantitative entry regulation to conduct regulation, and foreign professionals and firms (outcomes 2–4 in are a result of both direct governmental regulation and figure A.2). Examples of regulations that limit the incen- rules by self-regulatory bodies. Entry regulation includes tives or abilities of potential providers to enter the markets educational and professional qualification requirements, include the following: exclusive or shared exclusive rights to provide services, ownership restrictions, and restrictions on the numbers • Quantitative entry regulations, such as limits on the of providers. Conduct regulation includes regulations number of professionals in relation to the population governing business structure and multidisciplinary prac- • Qualitative entry regulations, such as professional tices, pricing, and advertising. It can be applied to domestic examinations and foreign providers. • Minimum required periods of professional experience Public interest theories claim that many of these • Compulsory membership in a professional body regulatory measures are justified to address such market • Activities reserved to specific licensed professionals failures as information asymmetries, externalities, lack of • Exclusive or shared exclusive rights to provide certain economies of scale, and equity concerns. Private inter- services est theories have been critical of many aspects of pro- • Entry restrictions on foreign providers fessional regulation, especially self-regulation, focusing on the private sector’s ability to capture the regulatory Professional services could remain unaffordable process. or be of inadequate quality because of inappropriate Public interest theories argue that qualitative regula- regulation, such as limitations on prices or business tory measures are necessary to guarantee high-quality structure, multidisciplinary practices, and advertising services and avoid adverse selection. Qualitative entry restrictions (outcomes 5 and 6 in figure A.2). The restrictions may thus be necessary. Private interest theo- export potential of professional services also needs to ries warn that qualitative regulations may be dispropor- be considered. The assessment needs to examine the tionate because of excessive entry requirements set by following factors: rent-seeking professionals and professional associations. In addition, if the profession gains a monopoly over the • Fundamentals, such as the country’s factor endowment, training organization, the education of professionals may especially of human capital, and institutional quality, be limited. especially the regulatory environment It is difficult to determine whether qualitative • Policies affecting trade, investment, and labor mobility requirements are disproportionate. Examples of qualitative • Proactive policies, such as export promotion activities requirements are restrictions on access to the profession, (Goswami and others 2012) which reflect the monopoly of professional associa- tions over training institutions, and multiple certifica- tion requirements. For instance, a country’s banking and Policy Challenges insurance laws may require that all companies use audi- A variety of factors affect the markets for professionals and tors approved by the banks or insurance institutions— professional services. Each of them needs to be examined. generally auditors affiliated with one of the “Big Four” or Figure A.2. Determining Whether Trade Barriers, Domestic Regulation, and Migration Policies Contribute to Skill Shortages and Mismatches in Professional Services 1. Is there demand for professional services Yes No 2. Resource availability: Are there (sufficient) professionals who could potentially engage in the provision of professional services? (Is there a pool of potential entrants?) No Yes 3. Market entry decision: Is there an incentive to enter the market of professional services? No Yes 4. Are professionals/firms able to enter the market for professional services? Informality and status of business regulation Public good/underconsumption No Yes Preference for alternative dispute resolution, no property rights, no Sunk costs due to: contract enforcement 5. Are incumbents able to remain in operation? Education, qualifying Legal services standards Limited: no monitoring of compliance Skill shortages with financial reporting standards Licensing No Yes Skill mismatches Accounting services Limited: no monitoring of compliance Depends on level of conduct regulation (advertising rules, fee Depends on level of entry restrictions and reserved rights applied to domestic regulations, multidisciplinary practices, business structure) applied with safety standards suppliers and foreign suppliers (trade barriers-market access) and immigration restrictions to domestic and foreign suppliers (trade barriers national treatment) Engineering services Outcome 1 Outcome 2 Outcome 3 Outcome 4 Outcome 5 Outcome 6 No demand (for certain Demand but low quality of Unsatisfied demand as no Unsatisfied demand as no Unsatisfied demand as Low quality services and/or high segments) or slowly service, and prices remain too emerging demand suppliers suppliers prices too high prices for all/certain segments high for SMEs (Skill shortage (No entry of firms/ (Concentration/ (Exit of firms) (Incumbents cater to mismatch) professionals) fragmentation) certain consumers) (Export more profitable) 81 82 Regulatory Assessment Toolkit other large companies—to prepare financial statements key regulatory developments in the accounting sector in for outside investors or other external parties to obtain a recent years. credit. These requirements may limit the access of smaller Highly skilled professionals in all sectors have exclu- suppliers to the market. Box A.1 provides examples of the sive rights to perform certain activities, such as auditing, Box A.1. Key Developments Affecting the Regulatory Environment for the Accounting Sector Reliable accounting services are essential to the implementation and enforcement of prudential requirements and other financial regulatory measures, which support stability in financial markets. For this reason, many developed countries and international orga- nizations have passed regulations or established standards to promote sound and transparent accounting practices. Reports on the Observance of Standards and Codes Initiative In 1999, the World Bank and the International Monetary Fund initiated the Reports on the Observance of Standards and Codes (ROSC) initiative, covering data dissemination; fiscal transparency; transparency in monetary and financial policies; banking supervi- sion; securities market regulation; insurance supervision, payments, and settlements; anti–money laundering and the combating of financing of terrorism; corporate governance; accounting and auditing; and insolvency and creditor rights. Objectives of the ROSC program include analyzing the comparability of national accounting and auditing standards with international standards, determin- ing the degree to which applicable accounting and auditing standards are followed, and assessing the strengths and weaknesses of the institutional framework in supporting high-quality financial reporting. The ROSC initiative also assists countries in developing and implementing action plans for improving institutional capacity, with the aim of strengthening the corporate financial reporting regime. Sarbanes-Oxley Act The Sarbanes-Oxley Act (SOX), enacted in the United States in July 2002, significantly revised the oversight and regulation of the U.S. accounting profession, most notably by strengthening corporate governance requirements and improving transparency and accountability. SOX required the U.S. Securities and Exchange Commission to implement new rules, including rules on indepen- dence, to address areas such as prohibited nonaudit services, audit partner rotation, and conflicts of interest. SOX also established the Public Company Accounting Oversight Board (PCAOB) to oversee the audit of public companies. Although SOX rules are con- sidered necessary and important, they may limit the number of accounting firms able to audit large companies. With respect to multidisciplinary practices, SOX limits possibilities for conflicts of interest, as did the 2006 Directive on Statutory Audits of the European Union. Some countries prohibit multidisciplinary practices, such as accounting and legal services. Among the potential conflicts of interests could be the obligation of lawyers to protect client interests, which may conflict with the transpar- ency requirements for accounting. Group of 20 The G-20, in its declaration of April 2009, stated that accounting standard-setters should take action by the end of 2009 to reduce the complexity of accounting standards for financial instruments; strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information; improve accounting standards for provisioning, off-balance sheet exposures, and valuation uncertainty; achieve clarity and consistency internationally in the application of valuation standards, working with supervisors; make significant progress toward a single set of high-quality global accounting standards; and, within the framework of the independent accounting standard-setting process, improve the involvement of stakeholders, including prudential regulators and emerging markets, through the constitutional review of the International Accounting Standards Board. International Financial Reporting Standards Since 2001, almost 120 countries have required or permitted the use of International Financial Reporting Standards (IFRS). They are firmly established in Australasia and Europe, Canada, South Africa, the Republic of Korea, the Russian Federation, and Turkey and are set to be adopted in other jurisdictions. The United States is reducing the differences between its Generally Accepted Account- ing Principles (GAAP) and the IFRS, with the expectation of reaching convergence in the near future. The economic and financial crisis brought additional issues to the already wide-ranging debates on the implementation of the IFRS, especially the debates related to financial reporting in a distressed economic situation. They include such challenges as measurement in illiquid markets, the procyclicality of the IFRS, provisioning aspects, and risk management and related disclosures and audit considerations. One of the most important new issues is how to ensure that the financial reporting system not only provides a fair and objective reflection of companies’ financial status and performance but also provides early warning signals that may help avert major financial disasters. The new issues are particularly challenging for countries with less developed financial markets and accounting infrastructure. International Standards on Auditing More than 100 countries are using the International Standards on Auditing (ISA), are in the process of adopting or incorporating them into national auditing standards, or are using them as a basis for preparing national auditing standards. ISA are intended for use in all audits, including audits of publicly traded companies, private businesses of all sizes, and government entities at all levels. They are issued by the International Auditing and Assurance Standards Board (IAASB), a standard-setting body operating indepen- dently under the auspices of the International Federation of Accountants (IFAC). The goals of the IAASB include setting high-quality auditing, assurance, quality control, and related services standards and facilitating the convergence of international and national standards, which should enhance the quality and uniformity of practice throughout the world and strengthen public confidence in the global auditing and assurance profession. Source: WTO 2012. Appendix A: Professional Services 83 representing clients before courts, providing advice on Public interest theories justify advertising restrictions legal matters, conducting feasibility studies, and design- by the need to protect consumers. Private interest theo- ing and planning of infrastructure. The argument in ries maintain that there is no justification for prohibiting favor of exclusive rights is that they can lead to increased advertising that is relevant, truthful, and not misleading. specialization of professionals and guarantee higher- Advertising fosters competition by informing consum- quality service. The price and allocation effects of exclu- ers about different products and allowing them to make sive rights, which act as monopolies, can be substantial, better-informed buying decisions. Advertising, especially however, especially if they are granted for standardized comparative advertising, can be a crucial competitive tool services that can be provided at a lower cost by less reg- for new firms entering a market. ulated or unregulated providers. Figure A.3 describes Professional associations justify restrictions on business three models for regulating legal services based largely structure on the grounds that professionals are more likely to on the extent of the exclusive rights granted to legal give independent advice if certain forms of intraprofessional professionals. partnerships are prohibited and that restrictions on multi- Price regulations are often introduced and supported disciplinary activities prevent potential conflicts of interest by national professional associations. But most of the that are detrimental to consumers. Private interest theories economic literature concurs that these regulatory instru- stress that these regulations are clearly anticompetitive and ments can seriously harm competition by eliminating or may prevent providers from developing new services or reducing the benefits that competitive markets provide. cost-efficient business models. For example, these regula- Most agree that less-restrictive mechanisms, such as tions might prevent lawyers and accountants from provid- better information on the services provided, should be ing integrated legal and accounting advice for tax issues. used instead. In general, restrictions on collaboration among members Figure A.3. Regulatory Models for Legal Services Regulation of legal market Model 1: Exclusive Model 2: Reserved Model 3: Regulation by professional practice activities accreditation Legal market is reserved Legal market consists of Legal market consists of entirely to suppliers some reserved activities for some regulated activities who are licensed which legal licenses must open to any providers who members of legal be obtained from local bar are accredited by an profession association and wider independent regulator. r (for example, lawyers, activities for which license Membership of legal notaries). to practice is not required. profession represents a quality standard rather than a method of accessing the market. Issues in regulating this Issues in regulating Issues in regulating market: this market: this market: Who grants access to Boundaries How is professions—the between reserved independence government, the bar,r and unreserved of legal advice the courts? areas of work guaranteed? Applicable rules of Access to Qualification conduct (for reserved work requirements example, ability (see box on left) for accreditation to be employed) r Disciplinary arrangements (disbarring) Source: Delimatsis 2010. 84 Regulatory Assessment Toolkit of the same profession seem to be less justifiable than Negative externalities can be addressed through liability restrictions on collaboration among members of different regulations, but this approach operates ex post and has professions where there is a strong need to protect the inde- limited success, because of the high costs of enforcement. pendence and liability of professionals. Ex ante quality requirements, such as standards related to Like all regulation, regulation of professional services education and training, seem preferable. Positive externali- seeks to prevent or correct market failures or achieve ties include the creation of public goods. Many professional noneconomic public interest goals. Market failures services benefit parties not involved in the transaction. common in the professional services market relate to Lawyers, for example, define and enforce property rights, asymmetric information, the presence of positive and which support innovation. negative externalities, and anticompetitive practices by dominant services providers. Regulation for noneco- Market Power nomic goals is usually based on distributional justice In certain professional services, such as accounting, leading considerations. Limited market size often hampers the firms (which are often foreign owned) control a signifi- development of some professions, which can be spurred cant share of the market, and a large gap exists between the through regulatory measures. leading firm and other firms. This type of market structure may reflect regulatory failure, such as uniform standards Asymmetric Information or licensing controls at multiple levels. In such cases, inter- Professional services require that practitioners have a high ventions may be needed to address inadequate direct or level of technical knowledge. Many knowledge-intensive indirect regulation. professional services are credence goods—goods whose quality clients may not have the knowledge to judge. Distributional Justice A possible market-based correction mechanism for Markets sometimes exclude certain actors from access this problem is the reputation premium, which allows to education or services. Therefore, governments or professionals with good reputations to charge higher prices. professional associations justify regulatory measures, such However, in many professional services, reputation (and as price regulation, to ensure access to services for low- high prices) is not enough to provide adequate information income consumers. about quality to consumers. Public interest theories assert that consumers need to be protected through professional Market Size standards such as education and qualification requirements; The small size of the domestic market may prevent the by other qualitative entry requirements, such as limiting development of a large professional services sector, certain tasks to professionals; and by advertising regulations. including the skills base necessary to support it. Local busi- Public interest theories claim that regulatory interven- ness services providers often lack the expertise to support tion is needed to address supplier-induced demand. In some manufacturing exporters. Professional services may lack cases, the services provider has an incentive to oversupply investment from foreign firms. In such cases, it is essen- quality in order to charge higher prices even if the consumer tial to identify unnecessary measures and trade barriers would be better off with a lower-quality service at a more that prevent local companies from exploiting economies of reasonable price. Such adverse selection issues are often scale and examine how regional or multilateral liberaliza- addressed by (minimum) standards or price regulation. tion (along with mutual recognition agreements) can help compensate for underdeveloped local services markets. Externalities The use of professional services may bring benefits not Explicit Trade Barriers only to users but also to third parties. For example, an accurate audit can help companies obtain credit while also Most international trade in professional services takes place helping creditors and investors make informed lending through commercial presence and the temporary presence and investment decisions. of natural persons. Restrictions on professional services However, some providers and potential users, particu- exporters thus relate to Mode 3, in General Agreement larly small enterprises, may be unaware of the private and on Trade in Services (GATS) terminology, including social benefits that the use of professional services offers. limitations on the foreign ownership of juridical persons, Intervention in many professional services markets tries to joint venture requirements, and numerical quotas on ensure that positive social externalities occur and negative the number of operating licenses available to providers of externalities are avoided. professional services. Appendix A: Professional Services 85 The supply of professional services through Mode 3 is Education reforms need to focus on the following issues: often accompanied by Mode 4 supply to provide skilled and professional services directly to projects and to • If financial constraints prevent individuals from maintain local offices. Professional services firms employ acquiring a professional education, then developing a variety of professionals, such as auditors, lawyers, engi- new and expanded means of financing higher education neers, and specialized technicians. Restrictions on Mode 4 (such as student loans schemes) must be a priority. may also arise from a country’s overall immigration policy • If weaknesses in educational systems mean that students or specific labor market conditions, including visa require- are poorly equipped to acquire professional skills, then ments, labor market tests, and residency requirements. enhancing the quality and capacity of schools (espe- The deployment of professionals for temporary assign- cially in mathematics, sciences, and technical studies) ments in export markets, separately or as a complement needs to be a priority. to foreign direct investment, is common in these sectors. • If professional education institutions suffer from capac- The movement of natural persons is a sensitive issue in ity constraints and poor quality, improving existing many countries because of illegal immigration and security institutions and encouraging the creation of new ones concerns. should be priorities. Trade in selected professional services, such as engineering consultancy services, can be provided via Entry requirements can be relaxed by narrowing the Mode 1 by using mass communications (mail, fax, scope of tasks reserved to licensed professionals. Exclusive telephone, Internet). The principal restrictions on the rights can lead to increased specialization of profession- cross-border supply of professional services are the need als and guarantee a higher quality of service. If they create to certify services by locally registered service providers monopolies, however, they can have adverse price and and the need for cross-border service providers to have a allocation effects, especially when granted for services for commercial presence in the importing country. which adequate quality can be provided at a lower cost by less regulated midlevel professionals. Migration Policy Action at the International Level The trade-migration linkage is an important part of the debate on migration reform. Trade policy officials should Policy action is called for in two main areas. The first is not neglect the immigration and labor market perspec- relaxing the explicit trade barriers applied to the move- tives when considering temporary entry or Mode 4 issues. ment of natural persons and commercial presence of pro- Policies related to visas, work permits, and treatment of fessional services. Examples of possible reforms include the foreign workers must be considered. following: • Articulating the economic and social motivations for Implications for Policy Action nationality and residency requirements Policy measures in education, trade, domestic regulation, • Developing transparent criteria and procedures for and migration must be coordinated to address skills applying any quantitative restrictions on the movement shortages and mismatches and failures in the markets for of professionals, such as economic needs tests professional services. Many policy measures can be imple- • Minimizing restrictions on the forms of establishment mented at the national level or by unilateral domestic allowed liberalization. Regional and international engagement can • Developing a transparent and consistent framework for help countries mobilize resources for and lend credibility accepting professionals with foreign qualifications to domestic reform. The reduction of explicit trade barriers needs to be complemented with the reform of immigration laws. Policy Action at the National Level The second area is the coordination of trade liberalization Reforms at the national level need to create conditions with regulatory reform and cooperation at the regional that address skills shortages and mismatches and attempt level. Ideally, trade barriers should be liberalized on a most- to facilitate the growth of professional services. Regulatory favored-nation or nonpreferential basis, because it would reforms need to focus on incremental, qualitative improve- generate the largest welfare gains. Such liberalization may ments in domestic regulation. not be technically feasible or politically acceptable, however, 86 Regulatory Assessment Toolkit especially when impediments arise from differences in enterprises can prevent smaller firms from using auditing regulatory requirements. Deeper regional integration and accounting services. A single standard may be appro- through regulatory cooperation with neighboring part- priate if there is little demand for service variety and ners that have similar regulatory preferences can usefully no anticompetitive risk from having a single standard. complement nonpreferential trade liberalization. Regional However, if the market requires variety to satisfy different integration would also enhance competition among services types of users, a single standard may not be appropriate. providers, enable those providers to exploit economies of • Removal of restrictions to the free movement of labor. scale in professional education, and produce a wider vari- Regional cooperation in removing restrictions on the ety of services. A larger regional market can attract greater free movement of labor (including visa and immigration domestic and foreign investment. Regionalization may also laws) is crucial to the provision of professional services. help regulators take advantage of scale economies in regu- The mobility of businesspeople is a key factor in the lation, particularly where national agencies face technical promotion of free and open trade. skills or capacity constraints. • Improvement of professional education. The absence of Regulatory cooperation to overcome regulatory hetero- institutions that offer specialized (postgraduate) courses geneity can be particularly useful in the following areas: (in law and engineering, for example) or the absence of institutions offering academic and professional training • Mutual recognition of professional qualifications and courses for midlevel professionals can be addressed at licensing requirements. A full-fledged mutual recognition the regional level. Where the market in a country is too agreement of professional qualifications needs to cover small to justify the creation of institutions or courses, areas such as education, examinations, experience, con- policies to facilitate access to foreign training are duct and ethics, professional development and recertifi- needed, including policies on the portability of course cation, scope of practice, and local knowledge. credits and scholarships. Specialized courses for which • Development of appropriate standards. The development a concrete need is identified can be designed and imple- of appropriate standards may be desirable at the regional mented at the regional level. Regional institutions can rather than the national level to exploit economies of exploit economies of scale and recoup the large fixed scale in regulatory expertise, prevent fragmentation of costs of establishing training programs to produce stu- the market, and limit the scope for regulatory capture. dents with the necessary specializations. Inappropriate standards can stifle demand for services. Although uniformity of standards may improve the qual- These objectives, and more broadly the integra- ity, completeness, and comparability of the reported tion of markets for professional services, can be sup- information, and international standards remain appro- ported through the adoption of regional programs for priate in specific cases, applying common international the sector. One such effort is being developed by the standards to large firms and small and medium-size World Bank in Africa (box A.2). Box A.2. The World Bank’s Professional Services Knowledge Platform for Eastern and Southern Africa The Professional Services Knowledge Platform for Eastern and Southern Africa will provide the following: • Information and analysis on the performance of a particular sector and its impact on other sectors and the wider economy, pos- sibly obtained through surveys of users and service providers • Assessment of barriers to trade and foreign investment and current regulatory policies, in the form of a trade and regulatory audit in addition to an assessment of their impact on entry and conduct in the market • Review of the necessary steps to remove explicit barriers to trade and the regulatory options for an integrated services market, including measures that can be pursued at the national level and measures that are likely to be more effective in collaboration with partner countries at the regional level. This review will be informed by analysis of the experience of other countries that have implemented reform programs in the specific sector, drawing on inputs and interactions with officials and experts from these countries. • Assessment of capacity building that will be necessary for effective implementation and monitoring of outcomes in the sector and the impact of current regulation In pursuing these outputs, the platform aims to support a process that ensures regular consultation between private and public stakeholders; effective communication between regulators, sector specialists, and relevant government ministries; and extensive dissemination of information and analysis at the national and then regional levels to increase awareness and deepen understanding of the policy issues affecting each sector. Appendix A: Professional Services 87 Conclusion References Entry restrictions are pervasive in the professional services Cattaneo, Oliver, and Peter Walkenhorst. 2010. “Does More Trade Rhyme with Better Justice?” In International Trade in Services: sector. Although some can be justified on the grounds that New Trends and Opportunities for Developing Countries, ed. Olivier consumers have limited information about the quality of Cattaneo, Michael Engman, Sebastián Sáez, and Robert Stern, 67–98. services providers, restrictions often reflect regulatory cap- Washington, DC: World Bank. Delimatsis, Pangiotis. 2010. “Transnational Private Regulation in ture by domestic constituencies. This risk is higher where Professional Services.” Tilburg Law and Economics Center (TILEC), regulation of professional services is handled by profes- Tilburg Law School, Tilburg, the Netherlands. http://ssrn.com sional associations, as is common. /abstract=2140927. Goswami, Arti Grover, Poonam Gupta, Aaditya Mattoo, and Sebastián Regulations governing the movement, stay, and Sáez. 2012. “Service Exports: Are the Drivers Different for Developing employment of foreigners are among the horizontal mea- Countries?” In Exporting Services: A Developing Country Perspective, sures most relevant to professional services. In addition to ed. Arti Grover Goswami, Aaditya Mattoo, and Sebastián Sáez, 25–80. horizontal restrictions on establishment, entry restrictions Washington, DC: World Bank. Trolliet, Claude, and John Hegarty. 2003. “Regulatory Reform and Trade include the following: Liberalization in Accountancy Services.” In Domestic Regulation and Services Trade Liberalization, ed. Aaditya Mattoo and Pierre Sauvé, • Qualitative restrictions, in particular examination and 147–66. Washington, DC: World Bank. World Bank. 2010. Reform and Regional Integration of Professional Services education requirements in East Africa: Time for Action. Washington, DC: World Bank. http:// • Exclusive and shared rights siteresources.worldbank.org/INTAFRREGTOPTRADE/Resources • Restrictions on ownership of professional services /NEWReformProfessionaServicesEACReport.pdf. ———. 2011a. Harnessing Regional Integration for Trade and Growth in firms or the use of foreign name brands for domestic Southern Africa. Washington, DC: World Bank. http://siteresources establishments .worldbank.org/INTAFRREGTOPTRADE/Resources/Harnessing • Limitations on the form of establishment: professional _Regional_Integration_Trade_Growth_SouthernAfrica.pdf. services cannot usually take the form of incorporated ———. 2011b. “Towards a Regional Integration of Professional Services in Southern Africa.” Trade Policy Note 10, World Bank, Washington, companies; enterprises can usually be established only in DC. http://siteresources.worldbank.org/INTAFRREGTOPTRADE the form of associations or limited liability companies. /Resources/10SouthernAfricaProfessionalServicesREDESIGN.pdf. • Limitations on the numbers of professionals or their WTO (World Trade Organization). 2012. “Regulatory Issues in Sectors and Modes of Supply.” Note by the Secretariat S/WPDR/W/48, geographical distribution Geneva. Note 1. This appendix draws heavily on World Bank (2010) and World Bank (2011a), under the guidance of Nora Dihel. Appendix B: Information Technology–Enabled Services Objectives storability and transmission across borders and reduc- ing the need for producers to be near consumers. 1 This appendix reviews the main determinants of trade in World exports of services related to IT grew at an aver- information technology–enabled services (ITES) and age annual rate of 16 percent between 2000 and 2012 to provides guidance on the main regulatory barriers that affect reach 6 percent of total cross-border services exports the sector. Upon completing it, readers will be able to: (figure B.1). Information technology–enabled services (ITES) • List the main ITES include services directly related to information technology, • Identify conditions for success of exports of ITES including software development, system integration, and • Assess the services sectors that support the ITES sector by web page design. They also include business services that providing infrastructure or inputs use IT to, for example, process insurance claims, perform • Evaluate regulatory measures that indirectly affect the desktop publishing, conduct audits, complete tax returns, development of ITES and transcribe medical records. Table B.1 lists ITES that • Propose regulatory changes that promote the ITES sector are commonly traded internationally. Trade in ITES still represents a small share of total This appendix describes the regulatory issues governments exports of most developing countries. Although several must address to help developing countries increase their countries are enjoying the gains from trade in ITES, participation in information technology (IT) services only a handful have developed sizable, export-oriented trade. The first section describes the growth of IT-enabled IT and ITES sectors. These countries include Brazil, services. The second section examines factors that can spur China, Costa Rica, India, the Philippines, and Uruguay. the growth of the sector. The third section identifies bar- Increasingly, companies based in developing countries riers to entry. The fourth section discusses the regulatory have been successfully competing in international mar- framework for telecommunications services, the main kets for these services, for a variety of reasons (Engman infrastructure supporting ITES. A concluding section sum- 2010): marizes the main findings. A questionnaire, available at http://www.worldbank • Essential supply-side requirements in the IT sector .org/trade/RASTI, complements this appendix. It offers match factor endowments in many developing practical guidance on identifying the common formal reg- countries. ulatory barriers to trade and investment and the existence • Widespread connectivity to international telecommuni- of an enabling governance framework. The International cation networks enables ITES entrepreneurs to compete Telecommunication Union (ITU) (2006) examines how for business independent of location. countries can implement these principles. • Companies with the necessary talent can tap into international markets and grow on the back of foreign Technological Change and the Growth of the demand; although a dynamic domestic market may Sector help, it is not a prerequisite for success. Changes in technology have increased the tradabil- ity of services in recent years. Information technology The rapidly growing ITES market consists of numerous (IT) allows the digitalization of services, facilitating subsectors and niche markets. 89 90 Regulatory Assessment Toolkit Figure B.1. World Production of Information Technology (IT) Services, 2000–12 700 7 Share of total services (%) 600 6 Index (2000 = 100) 500 5 400 4 300 3 200 2 100 1 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Share in total trade (right axis) ICT services Total services Source: UNCTAD Statistics (http://unctadstat.unctad.org). Table B.1. Internationally Traded Information Technology–Enabled Services IT services Application services Engineering services Business services Application development and Manufacturing engineering Business processing outsourcing (BPO) services maintenance • Upstream product engineering Vertical processes • Application development ° Concept design • Banking • Application development integration ° Simulation • Insurance and testing ° Design engineering • Travel • Application maintenance • Downstream product engineering • Manufacturing System integration ° Computer-aided design, • Telecommunications • Analysis manufacture, and engineering • Pharmaceuticals ° Embedded software • Design • Other ° Localization plant and process • Development engineering Horizontal processes • Integration and testing • Customer interaction and support (such as call • Package implementation Software product development centers) • Product development • Human resource management IT infrastructure services • System testing • Finance and administration • Help desks • Porting/variants • Supply chain (procurement logistics • Desktop support • Localization management) • Data center services • Maintenance and support • Mainframe support Knowledge processing outsourcing (KPO) services • Gaming • Network operations • Business and financial research • Animation Consulting • Data analytics • IT consulting • Legal process and patent research • Network consulting • Other high-end processes Source: Sudan and others 2010. Determinants of Success questions regarding the availability of human resources (Engman 2010): Successful provision of ITES depends critically on the availability and quality of human resources. Appendix A, • Are new engineering and computer science graduates on professional services, can be used to assess the pool of adequately trained? If not, where is education failing? available skills to support the development of this sector. Are curriculums up to date and in line with what the In addition, policy makers should ask the following IT services sector demands? What can be done to raise Appendix B: Information Technology–Enabled Services 91 educational standards in these fields and the relevance lower corporate tax rates; investment-friendly regulations of training? Does the government have the capacity to on profit remittances and repatriation of capital, capital enforce regulations for quality assurance? gains on assets, and other property transfers; and special • Is the local education system producing enough incentives and tax holidays (Sudan and others 2010). computer science engineers to meet demand? If not, are In countries with weak infrastructure and poor business there barriers to private provision of training services in environments, a common approach is to let private real estate the IT field? If there are barriers, do they fulfill a clear developers build software and high-tech parks near popula- policy objective? Are the barriers discriminating against tion centers with engineering colleges (Goswami, Mattoo, foreign providers of training and technical education? If and Sáez 2012). These policies usually aim to create an so, to what purpose? Is there scope to reform these rules? enabling business environment in which the private sector, • Are new graduates trained in foreign languages? Are national or foreign, has access to better infrastructure, often there rules that prohibit or discourage teaching in benefits from incentives, and enjoys a more streamlined foreign languages? If so, what are the objectives of such regulatory environment (Engman 2010). These parks pro- prohibitions, and can the same goals be reached with vide modern office facilities with a guaranteed power sup- increased flexibility? ply and Internet broadband connectivity. These nurturing • Are postgraduate courses offered in computer science clusters allow ITES companies to enjoy economies of scale and related engineering fields? If not, is there scope to in procuring input services and overcome infrastructure initiate collaboration with the private sector to finance bottlenecks. The key focus in the parks is services provision. and design such programs and help sponsor students? A streamlined interface to public authorities and ready-to- • Are there specific barriers affecting female students of use facilities are the main attractions. Some high-tech parks computer science and engineering or issues that reduce offer their export-oriented investors fiscal incentives, such as their desire to work in the industry? If so, what are they time-limited income tax holidays, duty-free importation of and how can they be removed? capital goods, and grants for training new employees. Fiscal incentives are seldom necessary to attract investment in the Governments that wish to take advantage of global oppor- IT sector. Essential incentives include full equity ownership tunities in ITES can benefit from a structured assessment for foreign investors and facilitated employment of foreign of the strengths and weaknesses of their location. nationals in supervisory and technical positions. Consulting firms have developed benchmarking frame- Inadequate Internet connectivity is one of the key supply works, locational indexes, and rating criteria for determin- constraints to trade in ITES (Sudan and others 2010). ing the e-readiness and attractiveness of different locations Many countries, in particular in Africa, are restricted from for ITES industries (Sudan and others 2010) (table B.2). the international ITES market because of expensive, unreli- Among these studies, there is broad agreement that several able, and low-capacity Internet connectivity. Policy makers key factors determine locational competitiveness: the avail- in such countries should investigate local market condi- ability of skills (including IT skills), competitive costs, the tions and assess whether low capacity and high prices may quality of public infrastructure relevant to the ITES indus- be a result of the regulatory environment or anticompeti- tries, and the overall business environment. tive behavior of local providers. If necessary, they should The existence of competitive telecommunication take action to improve competition or modify the rules and markets, especially for broadband services, and the avail- regulations that cover telecommunications and Internet ability of employee skills are the most important factors, broadband providers and by extension stimulate private according to Sudan and others (2010). The rapid growth of investment. Policy makers should also reassess local labor the industry has created a situation in which skills scarcity market policy and telecommunication policy with regard creates opportunities for countries new to the industry to to restrictions to voice communications over the Internet offer and develop strong local talent pools. (Voice over Internet Protocol [VoIP]) and night shifts to The main cost components of concern to potential mar- ensure that these policies are conducive to IT services trade. ket entrants are labor; infrastructure; facilities; and selling, The assessment should obtain answers to the following general, and administrative expenses. The most important key questions (Engman 2010): costs are wages, infrastructure, and training (table B.3). Costs affecting the establishment of services suppli- • How do local broadband connectivity, reliability, and ers in the ITES sector can be reduced through targeted prices compare with those in other countries in the policies that seek to attract investment, through reduc- region and the world? Are there any local rules and reg- tions in tariff or trade restrictions on imports and exports; ulations that hold back investment in network capacity? 92 Regulatory Assessment Toolkit Table B.2. Frameworks for Assessing Locations for Information Technology–Enabled Services (ITES) A. T. Kearney’s Global Services Hewitt’s international McKinsey’s Location Location Index Gartner’s 10 criteria benchmarking model Readiness Index Availability of people and skills Infrastructure Infrastructure Infrastructure • Remote services sector • Power • Real estate • Telecommunications experience and quality ratings • Telecommunications • Telecommunications power and network • Labor force availability • Transport • Real estate Connectivity • Education and language • Transportation Labor pool Talent • Attrition risk • Power • Quality • Availability Financial attractiveness • Quantity • Quality Talent • Compensation costs • Cost • Availability • Scalability • Infrastructure costs • Suitability • Work conditions General demographics • Tax and regulatory costs • Willingness Environment Educational system • Accessibility Business environment • Macroeconomic • Quality • Trainability • Country environment • Business environment • Number of institutions • Infrastructure • Geopolitical environment Cost • New grads in IT • Labor • Cultural exposure Clusters Cost • Infrastructure • Security of intellectual property Incumbent ITES subsector • Labor • Taxes • Real estate, infrastructure Market maturity • Telecommunications • ITES employees Political and economic environment as percentage of total services sector • Stability of government employment • Corruption • ITES as percentage of • Geopolitical risks gross domestic product • Financial stability (GDP) from services • Presence of subsector Language association Government support • Promotional support Risk profile • Institutional support • Regulatory environment • Education • Country investment • Data protection Cultural compatibility • Cultural attributes Other incentives Environment • Adaptability • Government support • Proximity • Business and living • Ease of travel environment Global and legal maturity • Accessibility Data and intellectual property • Living environment security and privacy Source: Sudan and others 2010. • Are high prices a result of lack of competition? If so, • Is the country’s connectivity dependent on a what action can the government take to liberalize the single-source cable? If so, would more points of market and increase investment? connection increase reliability and network capacity? • Are there barriers to market access for foreign provid- Could negotiations with neighboring countries help ers of Internet/telecommunications services? If so, what address some of the capacity issues? purpose do they serve? Can foreign providers provide • Are consumers prohibited from using VoIP services? If the necessary investment and source of competition to so, does the prohibition serve a useful purpose? Who improve connectivity and capacity? benefits from the restriction? Can negotiations reform • Are tariffs imposed on the importation of the physi- the current framework? cal equipment for Internet connectivity? If so, to what extent are they likely to raise prices and reduce invest- Infrastructure considerations include the availability, qual- ment in broadband infrastructure? ity, and reliability of services such as telecommunications Appendix B: Information Technology–Enabled Services 93 Table B.3. Illustrative Cost Structure for Information When assessing markets for investment, providers consider Technology (IT) and Business Processing Outsourcing (BPO) the quality of the judicial system, the legal framework for Services Percent of total costs contract enforcement, opportunities to arbitrate locally, the legal framework for intellectual property protec- IT BPO services services tion, and antitrust laws, among other factors (Sudan and Cost component firms firms others 2010; Goswami, Mattoo, and Sáez 2012). A country Wages 46 42 becomes an attractive ITES investment destination when Physical infrastructure and support 18 17 it combines a deep and well-qualified talent pool, a cost Training and productivity 9 11 advantage, good availability and quality of infrastructure, Transition and governance 7 8 and other factors that facilitate the smooth and predictable Communications 3 5 day-to-day running of a business (Sudan and others 2010). Disaster recovery and business continuity 3 5 Country risk, transparency of the law, macroeconomic sta- Resource redeployment 4 3 bility, treatment of foreign capital, and protection of data Travel 3 3 and intellectual property are also important determinants Advisory services 3 2 Exchange rate changes 3 2 of investment. Resource redundancy 1 2 Source: Sudan and others 2010. Business Parks In countries with unreliable infrastructure, service provid- (including broadband), power, and transportation and the ers can overcome this hurdle by developing IT parks that availability of suitable real estate. A competitive broadband provide modern office space, high-speed broadband links, telecommunications market is also a critical factor for reliable power supply (including backup supply), security the growth of trade in ITES: policy makers can promote services, and other infrastructure, such as banks and travel competition by ensuring that there is more than one inter- agents. These parks also address land requirements and national service provider, more than one international may be subject to special regulatory regimes that provide gateway, and multiple international cables linking the loca- for simplified procedures for, for example, applying for tion to competitive global communication networks. permits and licenses. The availability of international air- Regarding market access issues, policy makers need to ports with good flight connections near ITES locations is ask the following questions (Engman 2010): also an important factor (Sudan and others 2010). Goswami, Mattoo, and Sáez (2012) review the empirical • Are there legal restrictions to market entry through literature on service exports and estimate a gravity model to commercial presence by foreign companies? If so, assess the importance of electronic infrastructure. According what types of restrictions exist and what purpose do to their results, firms exporting services need access to high- they serve? What is their impact on foreign direct quality electronic infrastructure that does not necessarily investment? Can the policy rationale of restrictions be need to cover the general population of the exporter coun- addressed through less-trade-restrictive means? Can full try. Internet penetration among the general population in ownership of local subsidiaries be allowed in high-tech the exporter country may not significantly affect service parks for export-oriented activities? exports. Exporting firms in developing countries can own • Are foreign suppliers required to establish themselves the equipment for better-quality telecommunications or the locally through a particular legal form? If so, which ones? government can create special technology parks (as it has in Are restrictions to commercial presence compliant with the Arab Republic of Egypt, India, and the Philippines) to the country’s prospective World Trade Organization overcome the handicap of low technology penetration. (WTO) commitments? In Egypt, targeted policies have played a crucial role in • Is the local IT services sector controlled by the public sec- services exports. Although Egypt is not a top-ranked devel- tor? Do these links give rise to market distortions at home oping country with regard to the quality of its educated and hold back expansions abroad? If so, what is the stra- labor force, it has nevertheless been able to promote ITES tegic value of government retaining stakes in the sector? exports, especially within the Arab world. The govern- ment established the Information Technology Industry The empirical literature confirms that the general busi- Development Agency (ITIDA) in 2004 with a mission to ness and living environment of a country are important develop the IT sector and boost exports. It also created spe- determinants of the success of the IT services sector. cial technology parks for promoting ITES exports. 94 Regulatory Assessment Toolkit Expansion of India’s services exports in the last decades quality standards are other areas in which policy makers was driven by the large pool of skilled IT professionals can facilitate mobility. and the availability of personnel with management and Policy makers should ask the following questions when entrepreneurial skills. Establishment of software technol- assessing labor mobility (Engman 2010): ogy parks that aimed to create an enabling business envi- ronment to overcome the bottlenecks in infrastructure and • What types of restrictions affect labor migration in institutions facilitated India’s services exports. By allow- client countries? Do major export markets impose quo- ing duty-free/license-free imports of computer hardware, tas, economic needs tests, or other impediments to the these parks promoted software development. Firms in movement of project staff? technology parks were granted tax exemptions; guaranteed • Do local consulates of foreign countries provide access to high-speed satellite links; and provided with reli- expeditious, fair, and streamlined application pro- able electric power (including core computer facilities), cedures for business visas and work permits? If not, fully stocked office space, and communication facilities. what is the scope for local policy makers to approach Full foreign ownership was permitted in exchange for an these consulates to build trust and seek facilitated export obligation. Firms were allowed to repatriate capital procedures? investment, royalties, and dividends free once they paid the • What concerns do foreign consulates have, and what taxes due. can policy makers and local IT services companies do In the Philippines, active private sector participation to address them? Do the country’s IT professionals have led to the establishment of the Philippine Economic Zone a poor record in respecting work permit rules in client Authority (PEZA). In 2000, the government identified IT as countries? If so, what can policy makers do to make the one of the investment priorities sectors to be included under sector improve its record? the PEZA incentives. Firms registered with PEZA and located • Is the business visa and work permit application process in designated IT parks and IT buildings have been eligible for administered in an expeditious and cost-effective way? an income tax holiday of up to eight years, with a 5 percent How can administrative efficiency in the local applica- gross income tax rate thereafter (in lieu of all national and tion process be improved? local taxes) and duty-free importation of capital equipment, • Are there restrictions or issues related to nonrecogni- spare parts, and supplies. In addition, PEZA–registered busi- tion of qualifications for IT workers at home or in ness processing outsourcing (BPO) investors receive value major export markets? added tax (VAT) exemptions on locally purchased goods and • Can temporary movement be facilitated through bilat- services (for example, telecom, electricity, and water) and a eral, regional, or multilateral negotiations? deduction of up to 150 percent of training expenses after the end of the income tax holiday. PEZA also supports BPO by Barriers to Trade expediting permits for key personnel and offering one-stop- shop services for starting a business. Trade in ITES such as back-office services, IT mainte- nance, and software development generally benefits from open regulatory regimes. Cross-border trade in ITES relies Labor Mobility on telecommunications platforms, which make it diffi- The global delivery model that increasingly brings IT cult for regulators to monitor and therefore regulate. The services to foreign markets is based on cross-border most important barriers in this sector are thus found in supply and the temporary movement of natural persons. supply-side constraints and limitations that affect the tele- Difficulties securing business visas and work permits com infrastructure and other services sectors that serve as for project managers in foreign markets has become a input for ITES, such as accounting, legal, and financial ser- major impediment to trade in some countries. To facili- vices (Engman 2010). tate trade, policy makers should address such concerns Some constraints reflect the inherent difficulty of sup- as quantitative restrictions and prohibitions; restrictive plying services remotely; others are linked to the enabling regulation of work permit holders; and slow, opaque, and infrastructure for ITES, shortages of human capital, or burdensome consular and visa-processing services. Policy regulatory and institutional conditions. Strategies for makers can also help by supporting industry associations relieving these constraints are likely to include initiatives that disseminate information, promote the industry at that help attract private investment from local and for- home and abroad, and raise operational standards. The eign investors, reward entrepreneurship by improving the awarding of professional certificates and international business environment, and raise educational standards. Appendix B: Information Technology–Enabled Services 95 The most common barriers to the growth of ITES negotiated in 1997 (ITU 2006)—competitive safeguards, are indirect measures that restrict other services interconnection agreements, universal service obligations, activities. Typically, limitations on cross-border provi- public availability of licensing criteria, the independence of sions of professional services affect ITES that relate to regulators, and the allocation of scarce resources—should that professional activity. For example, regulation of serve as a “checklist of success” of reforms.The principles professional services may affect the scope of the develop- seek to address the following issues: ment of business processing outsourcing BPO services related to legal, auditing, and accounting services. Other • Competitive safeguards. Competitive safeguards require examples are regulations that seek to protect confidential members to adopt measures for preventing suppliers information, which may affect the free flow of the data to that alone or together represent a major supplier from be processed. These regulations may relate to insurance, engaging in or continuing anticompetitive practices. health, or finance. Such practices include engaging in anticompetitive Provision of ITES depends on countries’ electronic cross-subsidization, using information obtained from infrastructure. Countries in which competition in the tele- competitors with anticompetitive results, and not mak- communications market is not allowed and basic regula- ing available to other services suppliers on a timely tory principles are not in place or enforced generally have basis technical information about essential facilities and low-quality electronic infrastructure (often with high commercially relevant information necessary that allow costs) and low broadband penetration that impairs the them to provide services. delivery of ITES or limits the sector’s competitiveness. • Interconnection agreements. Interconnection with a major supplier must be ensured at any technically feasible point in the network and be provided on Assessment of Telecommunications nondiscriminatory terms (including technical standards Regulations and specifications). Rates and the quality of intercon- The telecommunications sector requires regulations nection should be no less favorable than provided for its to ensure entry and competition among providers. own like services, for like services of nonaffiliated ser- Regulations must enable access and use of the telecom- vice suppliers, or for its subsidiaries or other affiliates. munication infrastructure by users and providers of other In relation to transparency, the reference paper requires services that depend on this infrastructure. that the procedures applicable for interconnection to a Regulations affecting telecommunication services are major supplier be publicly available and that a major extremely complex, affecting entry, operations, and the supplier make publicly available either its interconnec- equipment necessary to access the infrastructure by such tion agreements or a reference interconnection offer. users as BPO industries. Regulatory frameworks differ Regarding possible dispute settlement, a service sup- across countries, but common elements necessary to plier requesting interconnection with a major supplier regulate the sector have been agreed upon internation- should have recourse at any time (or after a reasonable ally. Topics include the function of regulatory authority, period of time that has been made publicly known) the decision-making process, accountability, consumer to an independent domestic body to resolve disputes protection, dispute resolution, and enforcement powers regarding appropriate terms, conditions, and rates for (ITU 2012). interconnection within a reasonable period of time. According to the International Telecommunication • Universal service obligations. The reference paper Union (ITU 2012), regulatory reform should aim to create ensures the right to define the universal service obliga- a functional regulator, prepare the incumbent to face tions a member wishes to maintain and provides that competition, allocate and manage scarce resources on a such obligations will not be regarded as anticompetitive nondiscriminatory basis, expand and enhance access to per se, insofar as they are administered in a transparent, telecommunications and IT networks and services, and nondiscriminatory, and competitively neutral manner promote and protect consumer interests, including uni- and are not more burdensome than necessary for the versal access and privacy. Adopting such reforms should kind of universal service defined by the member. obviate the need for some regulation. • Public availability of licensing criteria. Where a license The regulatory assessment should focus on the basic is required, all criteria and the period of time normally issues identified at the international level as minimum required to reach a decision concerning an application regulatory requirements of any country. The six prin- for a license and the terms and conditions of individual ciples of the WTO telecommunications reference paper licenses must be public. The reasons for the denial of 96 Regulatory Assessment Toolkit a license must be made known to the applicant upon country’s overall immigration policy or specific labor mar- request. ket conditions and include visa requirements, labor mar- • Independence of regulators. To ensure an impartial role ket tests, and residency requirements. The following are of the regulatory authority, the regulatory body must examples of conditions for approving the entry of service be separate from, and not accountable to, any supplier suppliers: of basic telecommunications services. Moreover, deci- sions and procedures of regulators must be impartial • Visa requirements with respect to all market participants. An effective • Labor market needs test for foreign employees regulator must ensure credible market access, compli- • Residency requirements for intracorporate transferees ance, and enforcement of regulations. Structural and and a requirement that the foreign company employ financial independence, accountability, transparency, specific numbers of local staff and predictability are critical attributes of an effective • Authorization subject to nonavailability of locals regulator, which should have well-defined functions • Authorization subject to performance requirements and responsibilities. (employment creation, transfer of technology, level of • Allocation of scarce resources. The procedures for allocat- investment). ing and using scarce resources, including frequencies, numbers, and rights of way should be carried out in an Although the IT and business services are not heavily objective, timely, transparent, and nondiscriminatory regulated, the telecommunications platform that enables manner. them is. A regulatory mapping for the ITES sector should thus pay particular attention to the regulatory framework Conclusion for telecommunications. Specific areas that should be considered include the following: ITES is not a regulation-intensive sector. IT and busi- ness services are not usually affected by specific licensing • Allocation of resources and licensing procedures requirements but rather depend on the general regula- • Operational conditions, including the “packages” of tory framework. Mapping ITES hence requires a com- telecom services that operators are allowed to own or prehensive scan of the general regulatory framework for operate services. • Regulation of anticompetitive conduct and intercon- Because exports of ITES are usually associated with nection requirements foreign investment, the mapping should pay attention to • Universal access the conditions for establishing foreign companies. Typical restrictions affecting commercial presence in professional Note services include the following: 1. This appendix draws on Engman (2010), Sudan and others (2010), and World Bank (2011). The authors acknowledge the contributions of • Limitations on foreign equity ownership Michael Engman and Randeep Sudan. • Economic needs test for approval of foreign investment • Quotas on the number of operating licenses References • Joint venture requirements Engman, Michael. 2010. “Exporting Information Technology Services: In • Regulation of contracts by value and number through the Footsteps of India.” In International Trade in Services: New Trends an annual licensing system and Opportunities for Developing Countries, ed. Olivier Cattaneo, • Nationality or residency requirements for establish- Michael Engman, Sebastián Sáez, and Robert M. Stern, 177–218. ment of foreign companies Washington, DC: World Bank. Goswami, Arti Grover, Aaditya Mattoo, and Sebastián Sáez. 2012. • Requirements that foreign businesses hire specific ratios Service Exports: Are the Drivers Different for Developing Countries? of domestic staff to foreign staff Washington, DC: World Bank. • Reservation of some services sectors or activities for ITU (International Telecommunication Union). 2012. “Legal and Institutional Aspects of Regulation.” ICT Regulation Toolkit, Module nationals or residents 6, Geneva. http://www.ictregulationtoolkit.org. Sudan, Randeep, Seth Ayers, Philippe Dongier, Arturo Muente-Kunigami, The supply of ITES through Mode 3 (commercial pres- and Christine Zhen-Wei Qiang. 2010. The Global Opportunity in IT–Based Services: Assessing and Enhancing Country Competitiveness. ence) is often accompanied by the movement of person- Washington, DC: World Bank. nel to provide specific expertise in projects or to direct World Bank. 2011. Telecommunications Regulation Handbook, 10th anniv. local offices. Restrictions on labor movement arise from a ed. Washington, DC: World Bank. Appendix C: Financial Services Objectives partly because it is costly to assess their financial standing. A market solution is to improve the availability of infor- This appendix provides a methodology for conducting a mation to the public. regulatory assessment of financial services. It emphasizes This sector has a unique characteristic among services the relationship between market-opening and domestic sectors. When an institution faces a solvency or liquid- regulation, including the readiness of supervisory authorities ity problem, or is perceived by other economic agents to for liberalization. Upon completing this appendix, readers be fragile, it can create a crisis of confidence that affects will be able to: all institutions. This crisis is known in the literature as systemic risk or contagion. Regulations are need to pre- • Recognize the regulation that governs financial services vent contagion and ensure the integrity and stability of • Determine whether regulations fall within or outside the the financial sector as a whole while addressing the specific scope of a trade-related regulatory assessment problems of individual organizations. • Identify nonprudential measures that affect trade in The first section of this appendix discusses who regu- financial services lates, why financial services are regulated, and categorizes financial services. The second section describes how finan- Financial services play a significant role at the macroeco- cial services are regulated and highlights those measures nomic and microeconomic level. The management of relevant to a trade-related regulatory assessment. The macroeconomic policies affects the performance of the third section examines the main components of a regula- financial sector and is affected by the strength of financial tory assessment. A questionnaire to facilitate the regulatory institutions. At the microeconomic level, well-functioning mapping is available at http://www.worldbank.org/trade financial markets are necessary for the efficient allocation /RASTI. of financial resources (World Bank 2013). Cross-border exports of financial services have grown more rapidly than exports of both goods and other services Who Regulates Financial Services? exports in recent years (figure C.1). This growth explains the importance of financial services in international nego- Regulations that affect financial services are broad and affect tiations and developed countries’ interest in liberalizing many parties. Among other things, regulations prescribe financial services markets. which institutions are allowed to provide financial services, Financial services markets are complex and highly what services they are allowed to provide, how and to whom regulated. The economic literature offers various expla- they can provide services, and how and what kind of infor- nations of why regulation may be necessary; there is less mation should be provided to the public and regulators. consensus on what regulations should aim to protect— There is no single approach to regulating the financial the payment system, systemic stability, bank solvency, sector, and regulations are constantly evolving. Financial depositors—and how far regulation should go (Dewatripont services policies are usually defined by finance ministries and Tirole 1994; Barth, Caprio, and Levine 2006). and central bank authorities, which are normally indepen- Broadly speaking, regulations in this sector are justified dent of the executive branch, and approved by the legislative by the existence of asymmetries of information across branch. In some countries, a single authority regulates the agents and the need to protect depositors and investors. three broad financial services subsectors (banking, insur- Providers of financial resources have incomplete informa- ance, and securities). (In the United Kingdom, for example, tion about the level of solvency and integrity of borrowers, until recently, when responsibilities were transferred to the 97 98 Regulatory Assessment Toolkit Bank of England, these subsectors fell under the purview of activities, self-regulation has also been encouraged as an the Financial Services Authority.) Other countries main- alternative to government regulation. tain a structural separation of these activities, using two or Regulators may also be responsible for issuing three regulators. In other cases, regulation and supervision regulations for large numbers of participants in the of the banking sector fall under the mandate of the central financial market. In addition to regulating banking, bank, and securities and insurance are under the purview of insurance, and securities activities, regulators also have finance ministries or dedicated regulators. This separation to issue regulations for financial intermediaries such as creates coordination problems among regulators, who have insurance brokerage, auditing, and rating agencies. to exchange information to regulate financial conglomerates Financial services are characterized by constant innova- that provide a wide range of services (consolidated supervi- tion of new and more complex products and services that sion) and to assess risk exposures of financial institutions. In require regulations. Financial innovation strengthens the addition, if these financial conglomerates have international need for regulations to protect consumers. operations, cooperation with regulators responsible for their supervision in foreign countries is also required. For certain How Is the Financial Sector Regulated? The World Trade Organization (WTO 1997) delineates Figure C.1. Exports of Total Services and Financial four areas of public sector intervention in trade in financial Services, 1986–2011 services. Understanding these areas of regulatory interven- tion helps determine the scope of a Regulatory Assessment Share of total services (%) 1,400 10 of Services Trade and Investment (RASTI). Regulations Index (1986 = 100) 1,200 pertaining to monetary policies and exchange rate, as well 8 1,000 as prudential regulations, normally fall beyond the scope 800 6 of a RASTI. In contrast, nonprudential regulation, which 600 4 400 covers other nondiscriminatory regulations as well as mea- 2 sures governing trade in financial services, are at the center 200 0 0 of the RASTI (table C.1). 19 6 19 8 19 0 19 2 94 19 6 20 8 20 0 20 2 04 20 6 20 8 10 8 8 9 9 9 9 0 0 0 0 19 19 20 Regulations for Monetary and Exchange Rate Policies Share in total services Financial services Total services The first area is monetary and exchange rate policies that Source: World Development Indicators Database. may affect financial services. These measures include Table C.1. Trade-Related Regulatory Assessment of Financial Services Cover in a trade-related regulatory assessment? Type of regulation Yes No Regulations aimed at setting Covers open market operations, required reserve ratios, monetary and exchange rate discount rates, and so forth policies Prudential regulations Protects investors, depositors, policyholders, and persons to whom a fiduciary duty is owed by a financial service supplier; ensures integrity and stability of financial system (examples of regulators include the Basel Committee on Banking Supervision, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors) Nonprudential regulation Nondiscriminatory Regulates authorizations, auditing regulations standards, scope of activities, services, and financial products Trade-related regulations Restricts foreign investment in acquiring assets, stipulates specific forms for providing services, and restricts national treatment Source: Based on WTO 1997. Appendix C: Financial Services 99 open market operations and those measures necessary Assessment of prudential regulations determines for the conduct of monetary and exchange rates policies whether these regulations are in place and whether (for example, regulations affecting foreign exchange trans- and how they are enforced by the regulatory authority. actions). Although these regulations can affect trade in It assesses the enforcement capacity of institutions financial services, they fall outside the scope of this regula- responsible for regulations of human and other tory assessment. resources. In general, trade agreements do not define prudential regulations, although they typically include minimum Prudential Regulations capital requirements, appropriate capital adequacy A second group of public policies that affect trade in finan- requirements for banks that reflect the risks undertaken, cial services are prudential regulations. What matters for risk management policies, concentration risk and large the financial sector is whether a country has in place the exposure limits, and transactions with related parties. The necessary regulations to protect depositors and ensure Basel Committee on Banking Supervision of the Bank the stability and integrity of the financial sector. In inter- for International Settlements has proposed a framework national trade agreements such as the General Agreement of minimum standards for sound supervisory practices on Trade in Services (GATS), the North American Free that are considered universally applicable. These Basel Trade Agreement (NAFTA), and others, prudential regula- Core Principles for Effective Banking Supervision (BCP), tions are “carved out”—that is, these provisions are gen- adopted by a large number of countries despite their non- erally excluded from the main liberalization obligations binding nature, cover access to the banking sector, bank- of the agreement. Therefore, prudential measures need ing sector supervision, and prudential regulations. Box C.1 not be eliminated or listed in countries’ commitments as explains how compliance with individual core principles is nonconforming measures but can be challenged under the assessed. dispute settlement system. The exclusion covers a wide Other financial services, such as insurance and secu- range of measures, including measures to protect inves- rities, have adopted similar regulatory principles, rec- tors, depositors, policyholders, or persons to whom a fidu- ommended by their international organizations. In ciary duty is owed by a financial service supplier or ones the insurance sector, the International Association of to ensure the integrity and stability of the financial system. Insurance Supervisors (IAIS) adopted 26 core principles Box C.1. Assessment of Compliance with Individual Core Principles The primary objective of an assessment should be to identify the nature and extent of any weaknesses in the banking supervisory system and compliance with individual core principles. Although the process of implementing the core principles starts with the assessment of compliance, assessment is a means to an end, not an objective in itself. It allows the supervisory authority (and in some instances the government) to initiate a strategy to improve the banking supervisory system, as necessary. For assessments of the core principles by external parties, the following four-grade scale is used: • Compliant. A country is considered compliant with a principle when all essential applicable criteria are met without any signifi- cant deficiencies. There may be instances where a country can demonstrate that a principle has been achieved by other means. Conversely, the essential criteria may not always be sufficient to achieve the objective of the principle; other measures may be needed for the aspect of banking supervision addressed by the principle to be effective. • Largely compliant. A country is considered largely compliant with a principle when only minor shortcomings are observed that do not raise concerns about the authority’s ability and clear intent to achieve full compliance with the principle within a pre- scribed period of time. The assessment “largely compliant” can be used when the system does not meet all essential criteria but the overall effectiveness is sufficient and no material risks are left unaddressed. • Materially noncompliant. A country is considered materially noncompliant with a principle when there are severe shortcomings, despite the existence of formal rules, regulations, and procedures, and there is evidence that supervision has clearly not been effective, practical implementation is weak, or the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. The “gap” between “largely compliant” and “materially noncompliant” is wide, and the choice between the two ratings may be difficult. • Noncompliant. A country is considered noncompliant with a principle when there has been no substantive implementation of the principle, several essential criteria are not complied with, or supervision is manifestly ineffective. A principle is considered “not applicable” when, in the view of the assessor, it does not apply given the structural, legal, and insti- tutional features of a country. Source: Adapted from BIS 2012. 100 Regulatory Assessment Toolkit that cover all aspects of the supervisory framework (see acquiring assets, stipulate specific forms for providing IAIS 2011). These principles are similar to the ones pro- services, and restrict national treatment. Measures that posed for the banking sector by the Basel Committee. restrict market access and national treatment are the pri- A methodology for assessing compliance with them has mary concern of this regulatory assessment. been developed. For simplicity, these two last categories of regulations The International Organization of Securities are referred to as nonprudential regulations. When con- Commissions (IOSCO) has issued its Objectives and ducting a trade-related regulatory assessment, policy Principles of Securities Regulation. These principles aim makers should ask the following key questions regarding at guiding regulators and serving as a benchmark against nonprudential regulations (Sauvé 2010): which to measure progress toward effective regulation (see IOSCO 2011). They cover various securities activities, • Are there policy restrictions on new entry? If so, do such as issuers, auditors, collective investment schemes, such restrictions affect all new entrants or only entry market intermediaries, secondary markets, clearing and by foreign suppliers? Is there a limit on the number of settlements, and supervisors. IOSCO also provides a firms (or foreign firms) allowed in the market? methodology on how to assess compliance. • If entry is restricted, what are the reasons the govern- On the basis of these principles, the International ment provides? Where and how clearly are such limits Monetary Fund and the World Bank conduct the spelled out? Financial Sector Assessment Program (FSAP). This pro- • Are there services that locally established foreign suppli- gram, established in 1999, is a comprehensive, in-depth ers are not allowed to supply? analysis of a country’s financial sector that includes • Can foreign firms or service suppliers serve the market two main components: a financial stability assessment, on a cross-border basis (that is, without an established which examines the soundness of the banking and other presence)? financial sectors, including financial market supervision • Are there restrictions on cross-border purchases of against accepted international standards, and a financial certain categories of services by consumers (firms or development assessment, which examines the quality individuals) in the importing country? of the legal framework and the financial infrastructure • Can nonestablished foreign providers solicit business (IMF 2013). from foreign customers on a cross-border basis? The assessment proposed in this toolkit focuses on the • Are foreign suppliers required to establish a local presence trade-related aspects of financial regulations, which are the as a precondition for serving the importing market? core of trade agreement negotiations. • Does the state or designated providers hold exclusive rights in particular market segments? • Are there geographical limitations to serving the Nondiscriminatory Regulations market? A third group of measures refers to regulations that are • Are there limitations on the number of branches finan- not prudential in scope or necessary to conduct monetary cial institutions can open? and exchange rate policies but may restrict market access or national treatment. They include such measures as In some cases, prudential and nonprudential authorizations for opening a branch. These measures are regulations may overlap. There is overlap of regulations part of the regulatory assessment proposed to the extent that determine market access conditions such as licensing that they may affect trade in financial services. They aim criteria, transfer of significant ownership authorization, to assess the extent to which regulatory measures are nec- and terms and conditions imposed on major acquisition essary, whether less restrictive measures are available, and by financial institutions, as well as regulations regarding whether these measures are de facto applied to discrimi- the scope and definitions of activities that can be per- nate against foreign providers or restrict access. formed by banking institutions (permissible activities). A regulatory assessment must examine regulations that affect market access and operations to determine whether Trade-Related Regulations they go beyond prudential considerations. In these cases, A fourth category of regulations is intended to restrict the assessor should consider the opinions and advice of the participation of foreign suppliers in the local mar- relevant international organizations in order to provide ket. Regulations often restrict foreign investment from an adequate assessment of the trade-related impact. Appendix C: Financial Services 101 Key questions that have to be addressed in the regula- regions. The World Bank Services Trade Restrictions tory assessment related to licensing that are of particular Database collects information on regulatory measures importance in trade negotiations include the following: affecting banking and insurance providers and services. This database allows users to compare regulations affect- • If the number of providers is not restricted by policy, ing services sectors across countries. When a country what are the main types of licenses that providers must maintains a monopoly in a market, for example, the obtain to operate in the market? restrictiveness index is 100, meaning that the market is • What regulatory agencies are responsible for issuing closed. The index covers a wide range of policies, includ- licenses? What are the conditions governing the ing licensing criteria, foreign ownership restrictions, granting of licenses? and other restrictions that apply to foreigners, for both • Are licenses required for domestic companies, foreign the insurance and banking sectors. It also distinguishes companies, or both? among modes of supply, in particular Modes 1 (cross- • Are foreign suppliers subject to different licensing border trade) and 3 (commercial presence) for financial conditions from domestic suppliers? Are additional services. requirements imposed on them? Developing regions regulate financial services more • Is the validity of a license and the right to supply the heavily than do countries in the Organisation for Economic market restricted temporally or geographically? Do Co-operation and Development (OECD) (figure C.2). The licenses grant exclusivity periods or market segments? relatively high level of regulation provides scope for adopt- • Where markets are regulated at both the national and ing more cost-effective regulations while preserving the subnational levels, are separate licenses required to stability of the financial market. supply services in each jurisdiction? Is a local presence Preconditions for effective banking supervision include required in each jurisdiction for licensing purposes? the following: • In sectors where policy limits the number of providers, through what mechanisms and according to what crite- • Sound and sustainable macroeconomic policies ria are licenses allocated? • A well-established framework for the formulation of • Once licenses have been allocated, are there restrictions financial stability policy on the ability of foreign suppliers to sell or dispose of • Good public infrastructure their licenses? • A clear framework for crisis management, recovery, and resolution What is the impact of nonprudential regulations on • An appropriate level of systemic protection (or public financial markets? When assessing the trade-related regu- safety net) latory environment in the financial sector, analysts can • Effective market discipline use indicators to compare a country’s performance with the results of the assessment. Recently, the World Bank Although these preconditions do not fall within their made publicly available the Global Financial Development sphere of competency, policy makers should be aware of Database, an extensive dataset of financial system character- their effects on the efficiency or effectiveness of regulation istics for 203 economies. It includes the following measures: and supervision. Regarding public infrastructure, various services are • The size of financial institutions and markets (financial needed to maintain a strong financial services sector. depth) Regulators have identified the following as critical (BIS • The degree to which individuals can and do use finan- 2012; IAIS 2011): cial services (access) • The efficiency of financial intermediaries and markets • A system of business laws (including corporate, in intermediating resources and facilitating financial bankruptcy, contract, consumer protection, and transactions (efficiency) private property laws) that is consistently enforced • The stability of financial institutions and markets and provides a mechanism for the fair resolution of (stability) (Čihák and others 2012) disputes • An efficient and independent judiciary How restrictive are nonprudential regulations? • Comprehensive and well-defined accounting principles Figure C.2 depicts the regulatory landscape in different and rules that are widely accepted internationally 102 Regulatory Assessment Toolkit Figure C.2 World Bank Services Trade Restrictiveness Index, by Region, 2008 50 45 40 Restrictiveness index 35 30 25 20 15 10 5 0 Europe OECD Latin America Sub-Saharan t Asia East Middle East South Asia and and Africa and Pacific and Central Asia the Caribbean North Africa Overall index Index for the financial sector Source: Services Trade Restrictions database. Note: OECD = Organisation for Economic Co-operation and Development. • A system of independent external audits to ensure that Any reforms, in particular, liberalization reforms, should users of financial statements, including banks, have inde- consider the state of the supporting public infrastructure. pendent assurance that the accounts provide a true and fair view of the financial position of the company and are Conclusion prepared according to established accounting principles, with auditors held accountable for their work Mapping of the financial services sector should include • The availability of competent, independent, and an analysis of the main laws and regulations that affect experienced professionals (such as accountants, audi- the market access, commercial presence, and operation tors, actuaries, and lawyers) whose work complies of financial institutions (Sauvé 2010). The assessor should with transparent technical and ethical standards and also consult additional sources, such as reports, stud- is enforced by official or professional bodies consistent ies, and the relevant academic literature. International with international standards and who are subject to organizations, such as the World Bank, International appropriate oversight Monetary Fund, the Bank for international Settlements, the • Well-defined rules governing, and adequate supervision International Organization of Securities Commissions, and of, other financial markets and, where appropriate, the International Association of Insurance Supervisors, their participants provide a wealth of resources. Within the World Bank, • Secure, efficient, and well-regulated payment and clear- the Bank Regulation and Supervision Survey (World Bank ing systems (including central counterparties) for the 2013) provides information on a wide range of issues settlement of financial transactions where counterparty related to banking regulation and supervision, includ- risks are effectively controlled and managed ing market entry and ownership conditions, ownership, • Efficient and effective credit bureaus that make avail- capital, activities, external auditing requirements, banking able credit information on borrowers or databases that sector characteristics, and governance settings. assist in the assessment of risks • Public availability of basic economic, financial, and social statistics. References Barth, James R., Gerard Caprio, Jr., and Ross Levine. 2006. Rethinking Bank Regulations: Till Angels Govern. Cambridge: Cambridge A RASTI will not address these infrastructure issues. In University Press. conducting one, however, it is necessary to fully under- BIS (Bank for International Settlements). 2012. Core Principles for Effective stand the context in which financial services are operating. Banking Supervision. Basel: BIS. Appendix C: Financial Services 103 Cˇ ihák, Martin, Asli Demirgüç-Kunt, Erik Feyen, and Ross Levine. Sauvé, Pierre. 2010. “Conducting a Trade-Related Regulatory Audit 2012. “Benchmarking Financial Systems around the World.” Policy in Financial Services.” In Financial Services and Preferential Trade Research Working Paper 6175, World Bank, Washington, DC. Agreements: Lessons from Latin America, ed. Mona Haddad and Dewatripont, Mathias, and Jean Tirole. 1994. The Prudential Regulation of Constantinos Stephanou, 101–20. Washington, DC: World Bank. Banks. Cambridge, MA: MIT Press. Services Trade Restrictions (database). World Bank, Washington, DC. Global Financial Development (database). World Bank, Washington, DC. http://iresearch.worldbank.org/servicetrade/home.htm. http://data.worldbank.org/data-catalog/global-financial-development. van Empel, Martin, and Anna Morner. 2000. “Financial Services and IAIS (International Association of Insurance Supervisors). 2011. Insurance Regional Integration.” In The Internationalization of Financial Services: Core Principles, Standards, Guidance and Assessment Methodology. Issues and Lessons for Developing Countries, ed. Stijn Claessens and Basel: IAIS. http://www.iaisweb.org/ICP-on-line-tool-689. Marion Jansen-Jacobs, 37–61. London: Kluwer Law International. IMF (International Monetary Fund). 2013.“Factsheet: The Financial World Bank. 2013. Global Financial Services Report: Rethinking the Sector Assessment Program (FSAP).” http://www.imf.org/external Role of the State in Finance. Washington, DC: World Bank. http:// /np/exr/facts/fsap.htm. go.worldbank.org/WFIEF81AP0. IOSCO (International Organization of Securities Commissions). 2011. World Development Indicators (database). World Bank, Washington, DC. Methodology for Assessing Implementation of the IOSCO Objectives and http://data.worldbank.org/data-catalog/world-development-indicators. Principles of Securities Regulation. Madrid: IOSCO. https://www.iosco WTO (World Trade Organization). 1997. Opening Markets in Financial .org/library/pubdocs/pdf/IOSCOPD359.pdf. Services and the Role of the GATS. WTO Special Studies, Geneva. Glossary Ad valorem equivalent. See tariff equivalent. Credence good. Good whose value is difficult or impos- Adverse selection. Phenomenon in which agents select an sible for a consumer to ascertain. Examples include car action based on private (asymmetric) information about repairs and vitamins. themselves or the good or service being transacted, with Cross-subsidization. Practice of charging higher prices to undesirable consequences for the other party to the trans- one group of consumers in order to subsidize prices for action. In insurance, for example, individuals who know another. that they represent higher risks tend to purchase more Disclosure regulation. The requirement that firms make comprehensive coverage, thereby reducing the profitability public any information regarding The quantity, quality, of the insurance company. and price of their outputs and, in some cases, the processes Asymmetric information. Situation in which one party to followed during production. a transaction has better information than another, allow- Distributional justice. Redistributing wealth and income ing it to exploit the other party’s incomplete knowledge. usually through fiscal policies, direct payments Or social Behind-the-border measures. Internal laws and regula- benefits, compulsory social security systems, or national tions not necessarily related to foreign trade. health and pension schemes. In services regulation, gov- Business processing outsourcing (bpo). Subset of out- ernments strive toward distributional justice by ensuring sourcing that involves the contracting of the operations consumer rights and setting minimum conditions for ser- and responsibilities of specific business functions (or pro- vices that, left unregulated, would not be accessible to con- cesses) to a third-party provider. sumers with little bargaining power. Capture. See regulatory capture. Dual residual. The increase in marginal cost unexplained by increases in factor prices (wages, the cost of capital, or Collusion. Agreement between rival companies or indi- the cost of intermediate products). viduals to cooperate for their mutual benefit in a way that limits competition. Firms or individuals collude when Economic needs tests. A way for an institution to ascertain they divide a market, set prices, limit production, or limit whether one qualifies for support services. opportunities. Externality. Consequence of an activity that affects other Competition law. Competition law (often used in the tele- parties but is not reflected in the cost of the good or ser- communications, energy, and water sectors) ensures that vice produced. An externality is negative when the effect incumbent network operators, who enjoy monopolies, is harmful. Examples of negative externalities include allow access to their networks on reasonable terms. pollution and traffic congestion. An externality is positive when the effect is beneficial. Examples of positive exter- Concession. The granting of rights, land, or property by nalities include the effect of one person’s education on a government, local authority, corporation, individual, or others. other legal entity. Factor analysis. A statistical technique to derive weights Contagion. Scenario in which small shocks, which ini- based on data characteristics. tially affect only a few financial institutions or a particular region of an economy, spread to other financial institu- Factor. See latent variable. tions and countries whose economies were previously Franchising. Replacing competition within the market healthy, in a manner similar to the transmission of a med- with competition for the market. Under a franchising ical disease. scheme, firms bid for a license to be the exclusive service 105 106 Regulatory Assessment Toolkit provider for a particular activity within a geographical Licensing. Certification which may include holding a region, usually for a limited time. degree from certain Schools or institutions, demonstrat- Free-rider problem. Situation in which some individu- ing certain technical skills, having experience, or passing als or firms either consume more than their fair share an examination. or pay less than their fair share of the cost of a common Market failure. Situation in which the allocation of goods resource. Free riding can lead to the underproduction and services by a free market is not economically efficient, of a public good or excessive use of a common property as the result of information asymmetries, uncompetitive resource. markets, externalities, public goods, or other problems. Gravity equation. The gravity equation is a log-linear Minimum capital requirement. The amount of capital specification, in which trade between an exporting country a bank has to hold as required by its financial regulator; and an importing country is positively influenced by the these requirements are put in place to ensure that institu- size of each country and negatively affected by the distance tions do not become insolvent. between them. Monopoly. Situation in which a single person or enter- Gravity model. This model allows analysts to estimate prise is the only supplier of a good or service. trade barriers for a large number of countries and to avoid Monopsony. Market in which a single buyer faces many the demanding task of collecting information on services sellers. regulations. However, estimating a gravity model requires Multicollinearity. Statistical phenomenon in which two data that are broken down by trading partners, which are or more predictor variables in a multiple regression model scarce. are highly correlated, meaning that one can be linearly pre- Horizontal measure. These measures affect a wide range dicted from the others with a nontrivial degree of accuracy. of sectors––not just the laws and regulations governing In the presence of multicollinearity, the coefficient esti- a particular sector; for example, regulations on tourism mates of the multiple regression may change erratically in affect services providers in the tourism sector, but also response to small changes in the model or the data. affect regulations on buying and selling foreign currency, Nationality requirement. Requirement that a provider of laws on entry and stay of foreigners, etc. a good or service be a citizen of the country in which it is Information technology–enabled service (ITES). Industry sold. that provides services through the use of information tech- Natural monopoly. Situation in which the long-run aver- nology. Examples include claims processing; medical tran- age cost for production is lowest when a single firm pro- scription; and back-office operations such as accounting, duces a good or service, making participation by more than data processing, and data mining. one firm unviable. Natural monopolies exist where capital IT park. Area of land in which office buildings that house costs are very high, creating huge economies of scale and information technology companies are grouped together. high barriers to entry. Examples include public utilities. Joint venture requirement. Requirement that a foreign Nonprudential regulations. Regulations governing the firm form a joint venture with a domestic firm before it can ways in which financial institutions conduct of business operate in a country. that do not address the financial soundness of individual Juridical person. A legal entity that is not a natural per- financial institutions. Examples include reporting and son (such as a corporation created under state statutes) but disclosure requirements and restrictions on interest or having a distinct identity and legal rights and obligations deposit rates. under the law. Nudging. Use of positive reinforcement and indirect Latent variable. A statistical term, latent variables are suggestions to try to influence the motives, incentives, inferred (through a mathematical model) from a much and decision making of groups or individuals. larger set of variables. Oligopoly. Market controlled by a small number of sellers. Lerner index. Index named after economist abba lerner Pareto efficiency. Allocation of resources in which it is that describes a firm’s market power. It is defined by impossible to make any one individual better off without P − MC making at least one individual worse off. L= , P Performance requirements. Category of host coun- Where p is the market price set by the firm and mc c is the try operational measures imposed on foreign affiliates to firm’s marginal cost. induce them to act in ways considered beneficial for the Glossary 107 host economy. Most common requirements relate to local to the public’s demand for the correction of inefficient or content, export performance, domestic equity, joint ven- inequitable market practices. tures, technology transfer, and employment of nation- Regulatory capture. Situation in which a regulatory als. Requirements can be mandatory (a precondition for agency, created to act in the public interest, instead entry or access) or voluntary (a condition for obtaining an advances the concerns of interest groups that dominate the incentive). industry it is charged with regulating. Pigovian tax. Tax applied to a market activity that gener- Regulatory competition. Practice in which law makers use ates negative externalities in order to improve an ineffi- regulation to compete to attract businesses or other actors cient market outcome. to operate in their jurisdiction. Predatory pricing. Practice of selling a good or service at Regulatory failure. Situation in which intervention by a a very low price in an attempt to drive competitors out of regulatory agency fails to improve the allocation of goods the market or create barriers to entry for potential new and resources. One cause of regulatory failure is regulatory competitors. capture. Price fixing. Agreement among firms or individuals to buy Rent. Any payment in excess of the normal level that takes or sell a good or service at an agreed upon price. place in a competitive market. Primal residual. An increase in a firm’s production vol- Reputation premium. A professional can charge a higher ume that cannot be explained by increases in the factors rate if he/she has established a good reputation in the field. of production such as capital, intermediate products, and Residency requirement. Requirement that a provider of a labor. good or service live in the country in which it is sold. Principal component analysis. A mathematical procedure Systemic risk. Risk of collapse of an entire financial system that uses orthogonal transformation to convert a set of or market. observations of possibly correlated variables into a set of Tariff equivalent. Nontariff barrier that has the same effect values of linearly uncorrelated variables. as a tariff. Examples include import quotas and licensing Private interest theory. A theory that regulators are moti- restrictions. vated by a narrow concept of self-interest and that given a Tradable permit. Part of a market-driven approach to conflict between the public’s interest and their own private reducing greenhouse gas emissions in which a government interests, the public’s interest will lose. first sets a total quantity of emissions and then divides it Proportionality. Principle that the means used to achieve among firms, giving each a tradable emissions entitlement. an end must be as limited as possible. Polluters that can reduce their emissions relatively cheaply Prudential regulations. Regulations governing the may find it profitable to do so and to sell their emissions fi nancial soundness of licensed fi nancial institutions permits to other firms. Firms that find it expensive to cut imposed in order to prevent financial system instabil- emissions may purchase extra permits, which allow them ity and avoid losses of deposits held by unsophisticated to pollute more. investors. Examples include capital adequacy require- Universal access. The push for “universal access” is a ments, liquidity requirements, and loan loss provision- movement to ensure that services are offered in all levels of ing mandates. society, not just in profitable areas. Public good. Good that is both nonexcludable and nonri- Universal service. Practice of providing a baseline level of valrous, in that individuals cannot be effectively excluded services to every resident of a country. from use and use by one individual does not reduce the Yardstick competiton. Under this approach, regulators availability of the good to others. Examples include national assess the performance of an infrastructure service pro- defense and lighthouses. vider by comparing it with a provider in another location Public interest theory. Theory first developed by arthur (such as in a neighboring country), and they adjust the pigou that holds that regulation is supplied in response regulations accordingly. ECO-AUDIT Environmental Benefits Statement The World Bank is committed to preserving Saved: endangered forests and natural resources. • 9 trees The Office of the Publisher has chosen • 2 million BTUs of to print Regulatory Assessment Toolkit total energy on recycled paper with 50 percent • 400 Ibs. of net postconsumer fiber in accordance with the greenhouse gases recommended standards for paper usage set • 2,174 gallons of water by the Green Press Initiative, a nonprofit • 146 Ibs. of solid waste program supporting publishers in using fiber that is not sourced from endangered forests. 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