Trade Note September 10, 2003 Services in a Development Round Much of the public discourse on the more elusive than for merchandise trade. Doha Development Agenda has For example, how far should services trade focused on trade in goods, particularly and investment liberalization be conditioned protectionist policies in agriculture. on strengthened prudential regulation? The negotiations on trade in services Would liberalization improve access to The have received surprisingly little essential services for the poor, and if not, World Bank attention. The neglect matters. The what must be done? Negotiating pressure Group potential gains from successful lends urgency to these questions but need liberalization of trade in services are not produce desirable outcomes. In previous www.worldbank.org huge. But producing an outcome that WTO negotiations, most countries erred on supports development is a much the side of caution and made few greater challenge in services than commitments to genuine liberalization; goods, and will require extraordinary others may have gone too far. For example intellectual, technical and political Gambia and Guyana have allowed support. unrestricted cross-border trade in financial services in their GATS commitments ­ and Consider the stakes. Recent research hence capital mobility ­ while the US and concludes that the increase in real EU did not. International income from a cut in services protection by half would be five times There are numerous examples of missed Trade larger than that generated from opportunities to increase competition. Thus, Department comparable goods trade liberalization. Indonesia, Malaysia, Pakistan, and others Countries that successfully reformed promised to protect foreign incumbents their financial and while offering new financial service telecommunications services sector suppliers inferior conditions of operation ­ have grown, on average, about 1.0 leading to less rather than more contestable percentage point faster than other markets. A decision on "duty-free" countries (Box 1). This reflects the electronic commerce created the legal By Aaditya key role of services such as finance, illusion of a liberated medium while the Mattoo transport and telecommunications, in much greater threat of discriminatory determining economic performance, quantitative and regulatory barriers was and the spillover benefits of ignored. The liberalization of maritime and liberalization as capital and labor air transport has not been seriously move across countries. negotiated because of the power of vested These notes summarize interests in industrial countries, even though recent research on global In principle, multilateral negotiations Sub-Saharan African countries pay transport trade issues. They reflect solely the views of the can help foster reforms in services by costs that are on average more than five author, and do not reducing costly protection through times greater than the tariffs they face. In necessarily reflect the views of the World Bank mutual agreement and lend credibility the Doha round new proposals have been Group or its Executive to reforms through legally binding put forward seeking further liberalization of Directors, or the countries commitments. In contrast to trade in financial services, greater protection of they represent. goods, however, there are fewer foreign incumbents, perpetuation of duty- straightforward prescriptions or rules free treatment for electronic commerce, and Trade Note 11 of thumb regarding beneficial reforms. continued exclusion of key transport Getting the elements and sequence of sectors. reforms right is both important and TRADE NOTE September 4, 2003 Box 1: Dynamic benefits of services trade reform Certain services industries clearly possess growth-generating characteristics. Thus, financial services play a central role in the transformation of savings to investment, telecommunications in the diffusion of knowledge, transport in a country's ability to participate in global trade, education and health services in building up the stock of human capital, and business services in reducing transactions costs and adding value to products. Barriers to entry in a number of services sectors, ranging from telecommunications to professional services, often are maintained not only against foreign suppliers but also against new domestic suppliers. Full liberalization can, therefore, lead to enhanced competition from both domestic and foreign suppliers. Greater foreign factor participation and increased competition together imply a larger scale of activity, and hence greater scope for generating the growth-enhancing effects. Even without scale effects, the import of foreign factors that characterizes services sector liberalization could still have positive effects because Figure 1: Services liberalization indices: Telecoms and financial services they are likely to bring technology with them. South Asia (3) Econometric evidence suggests that openness in services influences EAP (5) Financial long run growth performance (see Figure 1). After controlling for other SSA/MNA (17) Services ECA (3) determinants of growth, countries that fully reformed the financial LAC (18) High Income (26) services sector grew, on average, about 1.0 percentage point faster than other countries [during what period?]. An even greater impetus on SSA/MNA (42) growth was found to come from fully reforming1 both the ECA (3) South Asia (5) telecommunications and the financial services sectors. Estimates EAP (8) Telecoms LAC (21) suggest countries that fully liberalized both sectors grew, on average, High Income (21) about 1.5 percentage points faster than other countries. 0 2 4 6 8 10 Source:Mattoo, Rathindran & Subramanian. (2001). While these estimates indicate that there are substantial gains from liberalizing key services sectors, it would be wrong to infer that these Greater liberalization in services is associated with more rapid growth gains can be realized by a mechanical opening up of services markets. Linear prediction Badly designed reform programs can substantially undercut the .059 GUY DNK benefits of liberalization. For example, if privatization of state ISL SWE GBR SLV NOR USA monopolies is conducted without concern to creating conditions of other NIC DOM CAN IND ARG SGP PAN CHL BEL MYS NLD FRA AUT competition, the result may be merely transfers of monopoly rents to for BRA CRI MLT MOZ FIN THA COL ESP URY EGY PER BOL AUS private, perhaps foreign, owners. Similarly, if increased entry into olling ITA LKA KOR TUN PRT MEX NZL GRC financial sectors is not accompanied by adequate prudential MAR JAM ZAF (contr TUR CYP CHE HND MWI PHL VEN supervision and full competition, the result may be insider lending and KEN rate ECU IDN poor investment decisions. Also, if policies to ensure universal service are not put in place, liberalization need not improve access to essential Growth factors) services for the poor. Managing reforms of services markets therefore -.024 AGO require that trade opening be accompanied with a careful combination 1 Composite services liberalization index 8.5 of competition and regulation. Source: Mattoo, Rathindran and Subramanian (2001) 1 The measure of reform included not just liberalization but also regulatory improvements. 2 TRADE NOTE September 4, 2003 At Cancun, services are unlikely to be an area of than has been allocated for the Doha round. It is disagreement. The Draft Ministerial Text suggests important that the commitments countries make that Ministers will recognize the progress made in reflect good economic policy rather than the the negotiations and urge participants to intensify dictates of domestic political economy or efforts to reach a successful conclusion. The international negotiating pressure. In the short run, progress so far consists of a large number of a stock-taking exercise to consider national and confidential but reportedly highly ambitious cross-country experience with services reform requests that Members (including a number of could do much to identify the areas where there is developing countries) have made to each other for little reason to defer market-opening and those greater market access, and reportedly disappointing where there is significant uncertainty and a offers of improved access submitted so far by thirty consequent need to temper negotiating demands. or so Members (including a number of developing countries). Negotiations on completing the GATS Sound domestic regulation ­ ranging from framework of rules (on safeguards, government prudential regulation in financial services to pro- procurement, subsidies and domestic regulation) ­ competitive regulation in a variety of network- underway since the conclusion of the Uruguay based services ­will be critical to realizing the Round ­ have also borne little fruit. Developing benefits of services liberalization. Regulatory country engagement in the negotiations has been institutions can be costly and require sophisticated inhibited by the perception that the "assessment" of skills. For example, even a bare-bones trade in services ­ mandated by the GATS as a telecommunications regulatory authority is likely to condition for the new round of negotiations ­ has cost around $2 million each year, or 5 per cent of not been adequately carried out; that their domestic government budget in a country like Dominica. regulatory institutions are ill-equipped to deal with the demands of a liberalized market; and that there A number of non-governmental organizations have is little prospect of meaningful liberalization in drawn valuable attention to the impact of services areas in which they have an export interest. liberalization on the poor. The problem here is not so much what the WTO (GATS) forces countries to As we look ahead, three types of initiatives are vital do or what it prevents them from doing, but what for multilateral services negotiations to support the GATS does not ­ indeed cannot ­ ensure: development: complementary action by national governments to help the poor benefit from liberalization. The denial · the mobilization of intellectual resources to or inadequate recognition of this problem can lead identify the elements of successful reform, to social costs and erode support for reform. In recent years a better ­though still inadequate ­ · technical and financial assistance to improve understanding has emerged of the universal access the regulatory environment, and policies that must complement market-based reforms. From telecommunications in Chile, Peru · political support to deliver improved market and India, to electricity in Guatemala, variations on access. a basic idea have been implemented: private providers competing for subsidies that are granted No country can participate meaningfully in on the basis of how they perform in supplying international services negotiations without services to the poor. But while the more advanced understanding how domestic reform is best developing countries have the institutions, implemented. This requires careful analysis--the resources and skills to implement these policies, experience with electricity in California and rail others need support. Such support needs to be transport in Britain suggests there is scope for based on a country-specific diagnosis of regulatory learning in all countries. Genuine ownership and requirements and assessments of the needs for understanding of reform strategies can only come assistance. Some such work is already underway, through active engagement by national for example, as part of the IMF and World Bank stakeholders informed by independent research. Financial Sector Assessment Programs. This takes time; in many cases, much more time 3 TRADE NOTE September 4, 2003 Finally, developing countries have a strong interest in securing access to foreign services markets. The question is whether this coincidence of interest Cross-border trade in a variety of business services can be harnessed to deliver greater openness. Two is flourishing with several developing countries ambitious proposals are worth considering. First, among the most dynamic exporters (Box 2). The all WTO Members could agree to lock-in the global benefits of such trade are huge: the United current openness of cross-border trade in services ­ States banking industry alone is estimated to have by making full commitments on market access and saved over $8 billion over the last four years, and national treatment under the GATS ­ while the cost savings for the world's top hundred recognizing that commitments in no way deprive financial institutions could be as high as $138 Members of the right to regulate. Second, billion annually. But such trade will also create Members could agree to liberalize the temporary adjustment pressures and could provoke a (say, at most one year) movement of service protectionist backlash ­ signs of which are already providers above a specified skill threshold, to fulfill visible in recent procurement restrictions and specific services contracts and as intra-corporate regulatory impediments. transferees. Greater freedom for the temporary movement of There is considerable scope for the WTO to play its service providers - notionally incorporated in the traditional role of facilitating reciprocal GATS but still highly restricted - would enable liberalization, not only by exploiting trade-offs developing countries to provide the labor across goods and services but also within services. component of construction, distribution, transport Utilizing this scope would make the GATS a real and a range of other services. Supplying such force for additional reform. But for the process to services through temporary movement potentially work, the services industries that stand to gain in offers a way to realize the gains from trade while high-income countries--those who would sell averting social and political costs in host countries, financial, telecommunications and other services in as well as brain drain type of negative effects for developing countries--must make a greater effort poor home countries. Recent research finds that if to counter protectionism at home in areas of OECD countries were to allow temporary access to developing country export interest as well as to foreign service providers equal to just 3 per cent of meet their needs for technical assistance. Only then their labor force, the gains to all countries would be will we witness a virtuous cycle of mutually over $150 billion ­ more than the gains from the beneficial liberalization rather than a bitter round of complete liberalization of all trade in goods. grudging concessions. 4 TRADE NOTE September 4, 2003 Box 2: Growing Stake of Developing Countries in Cross Border Trade in Business Services Regional Distribution of Other Business Services Exports The IMF Balance of Payments category "other business services" (i.e. (billion US dollars) other than services like banking, insurance and telecommunication) 300 includes a range of services that provide intermediate inputs throughout 250 the production process (for both goods and services). As the figure 200 1990 below shows, the bulk of such exports still originate in OECD 1995 150 2000 countries. But the exports of the European Union and the United States 100 2001 have grown by respectively 3.5 and 11.2 per cent per annum in the 50 second half of the 1990s, the exports of countries like India, Peru, 0 Israel, Romania and Brazil have grown at rates above 30 per cent per Africa and South Asia LAC East Asia OECD the Middle and the annum. Moreover, many other developing countries ­ including East Pacific Nicaragua, Argentina, Jamaica, China and Barbados ­ have witnessed Average Growth Rate of Exports of Other Business Services for selected countries, high rates of growth. during 1995-2000 India 44.6% 35.4% Note: "Other business services" includes: "merchanting and other trade Peru Israel 31.7% 31.6% related services", "operational leasing services", and "miscellaneous, Romania Brazil 30.5% business, professional and technical services". "Miscellaneous, Estonia 28.2% Nicaragua 26.8% business, professional and technical services" include: "legal, Argentina 25.5% Jamaica 23.4% accounting management, consulting, public relations services", Dominica 21.3% China 19.6% "advertising, market research, public opinion poll services", "research Barbados 13.5% Nigeria 13.5% and development services", "architectural, engineering, other technical Australia 12.1% Canada 12.1% services", "agricultural, mining, on-site processing services", "other United States 11.2% Mauritius 10.8% services" and "services between affiliated enterprises". Ghana 4.2% Europe 3.5% -5.6% Japan Further Reading Global Economic Prospects 2002: Making Trade Work for the World's Poor. Chapter 3 "Trade in Services: Using Openness to Grow" by Aaditya Mattoo. Mattoo, Aaditya, and Sacha Wunsch. 2003. "Securing Openness of Cross-Border Trade in Services: A Possible Approach". World Bank. This Trade Note was written by Aaditya Mattoo, Lead Economist in the Development Research Group. . The views expressed in this paper are personal and should not be attributed to the World Bank. This Trade Note can be downloaded at http://www.worldbank.org/trade. For recent research on trade in services, on which this note draws, see http://www.worldbank.org/trade/services 5