A handbook of international trade in services

Put this way, it is obvious that trade in services matters,not just for the state of the services sector but for overall economic performance.The World Bank and others have done consider

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The performance of the services sector is vital for growth and poverty reduction indeveloping countries Directly because services are already a large if not the largest part

of their economy Indirectly because services like finance, communication, and port, as well as education and health, affect other sectors of the economy and theproductive potential of the people Today, in many countries around the world, inad-equate access to services hurts people, not just in their role as consumers, it alsoperpetuates poverty by undermining the productivity of firms and farms as well astheir ability to engage in trade

trans-When we talk about ‘‘trade’’ in services, it is not just trade in the conventional sense—where a product is produced in one country and sold to consumers in another country—but we mean the whole range of international transactions, including foreign investmentand international movement of people, as consumers or providers of services.Thus, services ‘‘trade’’ encompasses: cross border trade in road and air transport;consumption by foreigners of tourism services; foreign direct investment in banking,communication, and distribution; and the temporary migration of doctors, teachers,and construction workers Put this way, it is obvious that trade in services matters,not just for the state of the services sector but for overall economic performance.The World Bank and others have done considerable work on trade in goods We havealso been engaged in services sector reform in telecommunications, finance, transport,tourism, health, and education What has received comparatively less attention is trade

in services Many countries have, of course, implemented significant reforms in servicessectors, often with World Bank support, and liberalization has been a part of thesereforms But the outcomes have not always been satisfactory, especially in terms ofimproved access to services It is essential to understand why What could we have donebetter? What can we do better?

This Handbook shows that while openness and competition are necessary parts of areform program, they are not sufficient There is a need to strengthen the regulatoryframework and institute complementary policies that widen access to services Smallcountries in particular need also to pursue deeper regional integration to benefit fromthe economies of scale that are important in services from telecom to transport

I am glad to see that this Handbook builds on previous services sector work and is theresult of collaboration between sector experts and trade experts It builds on coursematerials that World Bank staff and many outside services trade experts prepared andpresented at various learning and knowledge exchange events around the world It aims

at providing an overview of the findings of theoretical and empirical research at theBank and other international organizations and in academia, as well as the experiences

of policy makers and negotiators in shaping the services trade reform agenda It aspires

at being both a useful reference for services trade practitioners in governments andinternational and national advisory bodies and an indispensable learning tool forstudents and professionals approaching services trade for the first time Learningactivities by the World Bank Institute (WBI) and research, operational, and advisoryactivities by the Bank related to services trade will continue to offer the opportunity toexpand and update the content of this volume This will allow future editions of thisHandbook to reflect progress in knowledge and changes in the international policyregime and negotiating environment with respect to services trade Hence, I see thisHandbook not so much as a collection of established facts but as a contribution to adynamic process of learning and discovering

Franc¸ois J Bourguignon Senior Vice President and Chief Economist

The World Bank

April 2007

LIST OF ABBREVIATIONS xxi

PART I THE FRAMEWORK OF TRADE IN SERVICES

Aaditya Mattoo and Robert M Stern

Rudolf Adlung and Aaditya Mattoo

Brian Copeland and Aaditya Mattoo

PART II ANALYZING TRADE IN SERVICES

Andreas Maurer, Yann Marcus, Joscelyn Magdeleine, and Barbara d’Andrea

5 Empirical Analysis of Barriers to International Services Transactions

Alan V Deardorff and Robert M Stern

Aaditya Mattoo and Pierre Sauve´

PART III SECTORAL AND MODAL ANALYSIS

7 Financial Services and International Trade Agreements:

Wendy Dobson

8 Trade in Infrastructure Services: A Conceptual Framework 338

Philippa Dee and Christopher Findlay

Christopher Findlay

10 Trade in Services Telecommunications 389

Peter F Cowhey and Jonathan D Aronson

11 Trade in Health Services and the GATS 437

Richard Smith, Chantal Blouin, Nick Drager, and David P Fidler

12 E-Commerce Regulation: New Game, New Rules? 459

Carlos A Primo Braga

13 The Temporary Movement of Workers to Provide Services (GATS Mode 4) 480

L Alan Winters

Appendix A Guide to Services Negotiations 542

Geza Feketekuty

1.1 Trade in goods and services, 1985–2002 7

1.2 Developing countries’ share in world exports of goods and services, 1986–2002 8

1.3 Regional distribution of business services exports 8

1.4 Average growth rate of exports of business services, 1965–2000 9

1.5 Welfare gains from a 3% increase in developed countries’ temporary labor quota 11

1.6 Effects of telecommunications costs on trade in goods 12

1.7 Services liberalization indices: telecoms and financial services 13

1.8 Effects of services liberalization on economic growth 14

1.9 Effects of sequencing on mainlines 19

1.10 WTO Members have been reluctant to make market access commitments

on the movement of natural persons (Mode 4) 25

1.11 Sector focus of current commitments (developed/developing country

1.12 Sector focus of current commitments (acceding/non-acceding members) 27

2.1 Sector focus of current schedules, November 2005 55

2.2 Sector policy profile of MFN exemptions, September 2004 65

2.3 The impact of offers on the share of sectors subject to commitments

3.1 Welfare effects of service trade 90

3.2 Welfare effects of trade taxes 106

3.4 Foreign direct investment: competitive market 110

3.5 Impact of restrictions on market structure 113

3.6 FDI with average cost pricing 115

3.8 Trade in professional services with imperfect screening 118

3.9 Trade in professional services with reform of screening 119

3.10 National treatment vs recognition 121

3.11 External benefit from local production 122

3.12 Local product squeezed out by trade 123

3.13 Substitution between modes of supply 125

4.1 World trade in commercial services, total exports, 1980–2004 134

5.1 Perfect competition and perfect substitution between domestic

5.2 Imperfect competition and substitution between domestic

5.3 Domestic services firm with monopoly power and restrictions on foreign firms 175

5.4 Restrictiveness indexes for banking services for selected Asia–Pacific

economies, South Africa, and Turkey 190

5.5 Restrictiveness indexes for banking services for selected Western

6.B.6.1 Regionalism and trade in services in the Americas 280

7.1 Liberalization indices based on GATS commitments—core banking services 308

7.2 Liberalization indices based on GATS commitments—direct insurance services 309

8.1 Separating the natural monopoly and competitive elements of

9.1 Number of WTO members scheduling transport services 365

13.1 Remittances from overseas workers as percent of GDP and exports (1990–2000) 487

13.2 The costs of labor misallocation 494

13.3 The benefits of a small relaxation of mobility restrictions 495

1.1 Inadequacies of Statistical Domains with Regard to Modes of Supply 7

1.2 Developing Country Priorities in Alternative Negotiating Fora 23

1.3 Commitments for Telecommunications Reform 29

2.1 Measures that May Affect Services Trade under the Four Modes of Supply 51

2.2 Structure of a Schedule of Commitments 54

2.3 Commitments by Country Group, November 2005 56

2.4 Examples of Pre-commitments to Liberalization in Basic

2.5 Rationale for Regulation in Services and Potentially Relevant GATS Rules 68

2.6 Overview of Mode-specific Objectives as Contained in the Hong Kong

3.1.A Welfare Economics A: Lawyers that Move Counted in GDP of Abroad 91

3.1.B Welfare Economics B: Lawyers that Move Counted in GDP of Home 91

4.1 Correspondence Between Modes of Supply and Statistical Domains 140

4.2 Countries Reporting Exports of Selected BPM5 Services Components 158

4.3 Summary of BOP Trade in Services Data Dissemination by

4.4 Availability of Inward and Outward FATS Statistics in OECD Countries 160

5.1 International Services Transactions by Modes of Supply, 1997 170

5.2 Restriction Categories for Banking Services 180

5.4 Components of an Index of FDI Restrictions 188

5.5 FDI Restrictiveness Indexes for Selected APEC Economies

5.6 Constructed Ad Valorem Tariff Equivalent ‘‘Guesstimates’’

by 1-Digit ISIC Services Sectors for Selected Countries 193

5.7 International Air Passenger Transport: Bilateral Restriction

5.8 Tariff Equivalents of Barriers to Telecommunication Services

5.9 Estimated Tariff Equivalents in Traded Services: Gravity-model

5.10 Average Gross Operating Margins of Firms Listed on National Stock

Exchanges, 1994–96 by Country/Region 199

5.11 Average Gross Operating Margins of Services Firms Listed on

National Stock Exchanges, 1994–96, by Country/Region and by Sector 199

5.A.1 Price Impact of Regulation on Telecommunications Prices, 1997 (Percent

of Notional Price Existing under Benchmark Regulatory Regime) 207

5.A.2 Price Impacts of Regulation on Industrial Electricity Prices, 1996 209

5.A.3 Estimated Cost Impacts of Foreign and Domestic Barriers to Establishment

in Wholesale and Retail Food Distributors 210

5.A.4 Estimated Price Impacts of Foreign and Domestic Trade Restrictiveness

Indexes (TRI) on Net Interest Margins of Banks 211

5.A.5 Estimated Price and Cost Impacts of Restrictions on Engineering Services 212

5.A.6 Coefficient Estimates of Technical Efficiency in Telecommunications Services 213

5.A.7 Welfare Effects of Elimination of Services 216

6.1 Key Disciplines in RTAs Covering Services 240

6.2 Key Features of RTAs Covering Services 248

6.3 Key Provisions of GATS Article V (and V bis) 250

7.1 An Index of Openness in Financial Services, 1997 305

7.B.1.1 Main Provisions on Financial Services—Regional and Extra-Regional

Agreements of the Western Hemisphere 318

7.B.1.2 Main GATS plus Component in Financial Services Commitments

of Selected Western Hemisphere Countries 320

7.B.2.1 Foreign Ownership in China’s Local Banks 328

7.B.2.2 Non-performing Loans and Capital Adequacy of Banks 329

7.B.2.3 Important Events Related to the Qualified Foreign Institutional Investors (QFII) 331

7.B.2.4 Comparison of Some Indicators between China’s Banks and

7.B.2.5 China: A Summary of Implementing GATS Commitments

8.1 Access Charges with Structural Separation 349

8.2 Access Charges with Vertical Integration 350

9.1 Trade in Transport Services: Some Examples 363

11.1 Articles of GATS of Greatest Relevance to Health Policy 440

12.1 The Layers of Communication Systems 460

12.2 Regulatory Environments and Networks: Areas of Relevance for E-Commerce 461

12.3 Deeper Integration Issues Related to E-Commerce 471

13.1 The Temporary Movement of Unskilled and Skilled Workers:

13.2 Geographic Origin of Non-immigrants to the United States: Selected

Visa Categories of Most Relevance for Mode 4, 2001 485

13.3 Profile of H1B Beneficiaries by Top Ten Industries, United States, Fiscal 2001 486

13.4 Overseas Service Workers from the Philippines, by Occupation and

13.5 Commitments on Mode 4 by Type of Person (Horizontal

13.6 Economic Welfare by Region and Class of Worker 501

13.7 Percentage Changes in the Real Wages of Skilled and Unskilled Workers 501

13.8 Welfare Decomposed According to Effects of Increasing

13.9 Welfare Results for Sensitivity Analysis 504

13.A.1 Accounting Concepts for the Temporary Flow of Labor from

1.1 Why do Services Matter for Development? 10

1.2 Services Reform and Impact on Comparative Advantage 12

1.3 The Sequence of Reform Matters 18

1.5 Ensuring Barrier-Free Trade in Electronically Delivered Products 28

2.1 Classification of Services Proposed by the then GATT Secretariat 49

3.1 Some Stylized Facts about Services 86

3.2 Dynamic Benefits of Services Trade Liberalization 98

3.3 Impact of Restrictions and Substitutability between Modes 102

3.4 Fiscal Instruments: Is the Difficulty of Substitution Between Policy

3.5 Are There Good Reasons to Limit Entry? 116

4.1 Measuring Services Production 133

4.2 Different Types of Movement of Persons, Viewpoint of the Recipient Country 134

4.3 Patterns of Trade in Services Expansion 135

4.4 Measuring Trade in Services: The U.S Statistical Practices—Obie G Whichard 150

5.1 Russia’s WTO Accession: What Are the Macro-economic, Sector,

Labor Market, and Household Effects?—Thomas F Rutherford and David Tarr 171

6.1 The Standard Economics of Preferences 225

6.2 Harmonization and Mutual Recognition in Services: Promise and Pitfalls 243

6.3 Liberal Rules of Origin Can Minimize Investment Diversion 251

6.4 Demonstration Effect Regionalism: The Digital Trade Agenda and RTAs 260

6.5 Liberalizing Services Trade in the ASEAN Region—Carsten Fink 274

6.6 Regionalism and Trade in Services in the Americas—Sherry Stephenson 278

7.1 Liberalization of Trade in Financial Services: New Trends in the

Western Hemisphere—Patricio Contreras 316

7.2 China’s Financial Sector: Pre- and Post-WTO Reforms—Yan Wang 326

9.1 Inefficient Internal Transport System Contributes to the Concentration

of China’s Export Industries in Coastal Regions 357

9.2 Transport Services Categories in the GATS 361

9.3 Argentina’s Experience in Port Reform 368

9.4 Derailed British Railway Reforms 373

9.5 NAFTA and Mexico–U.S Liberalization of Cross-border Road Transport 381

9.6 Trade in Transport Services: Competition and Reliability: Issues and

10.1 Economic Principles of Telecommunications 392

10.2 Basic and Value-Added Telecommunications 403

10.3 Korea’s Final Schedule of Commitments on Telecom at the WTO 405

Annex Commitments of Costa Rica on Telecommunication Services in the

Context of the U.S.–Central America–Dominican Republic Free Trade

Agreement (DR-CAFTA)—Roberto Echandi 428

11.1 Health Policy Principles to Guide Liberalization of Health-Related Services 438

11.3 Modes of Service Supply under GATS and Health Opportunities and Risks 441

11.4 Key Questions for Monitoring the Impact of GATS 2000 on Health Policy 443

11.5 Checklist for Policy Makers on Trade in Health-Related Services 445

11.6 Elements of a General Framework for Country Analysis of GATS 445

11.7 The GATS and the Health of Poor People—Shantayanan Devarajan 457

13.1 The Indian Proposal on Mode 4 517

13.2 The United Kingdom’s GATS Visa Scheme 518

13.3 The Recruitment of Nurses in the U.S 523

13.4 The European Communities’ Offer on Mode 4, 2003 526

13.5 The Temporary Movement of Service Providers: The U.S.

Experience—Demetrios G Papademetriou 533

13.6 Mobility of Service Providers in the Caribbean Region—Sherry Stephenson 535

A.1 The Experience of Brazil in Trade in Services Negotiations—Fla´vio Marega 590

Rudolf Adlung , Senior Economist in the Trade in Services Division of the WTO Secretariat, World Trade Organization

Jonathan D Aronson , Executive Director, Annenberg Center for Communication, and Professor of Communication and International Relations, University of Southern California

Chantal Blouin , Senior Researcher, Trade and Development, Chercheure Principale, Commerce et De´veloppement, Ottawa, Canada

Patricio Contreras , at the time of writing, Chief Competitiveness Section, Department of Trade, Tourism and Competitiveness, Organization of American States; currently, Office of the Comp- troller of the Currency, Washington, DC

Brian Copeland , Professor, Department of Economics, University of British Columbia

Peter F Cowhey , Dean and Qualcomm Professor, Graduate School of International Relations and Pacific Studies University of California, San Diego

Barbara d’Andrea , Statistician, Economic Research and Statistics Division, International Trade Statistics Section, WTO

Alan V Deardorff , John W Sweetland Professor of International Economics and Professor of Economics and Public Policy, Department of Economics and Gerald R Ford School of Public Policy, University of Michigan

Philippa Dee , Visiting Fellow, Asia-Pacific School of Economics and Government, Australian National University

Shantayanan Devarajan , Chief Economist, South Asia Region, World Bank

Wendy Dobson , Professor and Director, Institute for International Business, Rotman School of Management, University of Toronto

Nick Drager , Senior Advisor, Department of Ethics, Trade, Human Rights and Law, World Health Organization

Roberto Echandi , Director, Small Economy Trade & Investment Center (SETIC), Professor of International Trade and Investment Law, Diplomatic Institute, Ministry of Foreign Affairs of Costa Rica

Geza Feketekuty , Consultant and President of the Institute for Trade and Commercial Diplomacy

David P Fidler , Professor, Indiana University School of Law

Christopher Findlay , Head of School, School of Economics, University of Adelaide

Carsten Fink , Senior Economist, International Trade Team, World Bank Institute, World Bank Geneva Office

Marc H Juhel , Transport and Logistics Adviser, World Bank

Joscelyn Magdeleine , Statistician, Economic Research and Statistics Division, International Trade Statistics Section, WTO

Fla´vio Marega , Counselor, Embassy of Brazil, Washington, DC

Aaditya Mattoo , Lead Economist, International Trade Group, Development Research Group, World Bank

Yann Marcus , Statistician, Economic Research and Statistics Division, International Trade tics Section, WTO

Statis-Andreas Maurer , Chief of Section, Economic Research and Statistics Division, International Trade Statistics Section, WTO

Demetrios G Papademetriou , President, Migration Policy Institute

Carlos A Primo Braga , Senior Adviser, International Trade Department, World Bank Geneva Office

Thomas F Rutherford , Ann Arbor, Michigan

Pierre Sauve´ , Visiting Fellow, International Trade Policy Unit, London School of Economics and Political Science

Richard Smith , Professor of Health System Economics, Department of Public Health and Policy, London School of Hygiene and Tropical Medicine

Sherry Stephenson , Director, Department of Trade, Tourism and Competitiveness, Executive Secretariat for Integral Development (SEDI), Organization of American States (OAS)

Robert M Stern , Professor of Economics and Public Policy (Emeritus), Department of Economics and Gerald R Ford School of Public Policy, University of Michigan

David Tarr , Consultant, Development Research Group, World Bank

Yan Wang , Senior Economist, Trade Team, World Bank Institute, World Bank

Obie G Whichard , Chief, International Investment Division, Bureau of Economic Analysis, U.S Department of Commerce

L Alan Winters , Director, Development Research Group, World Bank

Gianni Zanini , Lead Economist, World Bank Institute, World Bank

In addition to the editors and the authors of the various chapters, boxes, and annexes,many other people contributed to this volume Bernard Hoekman, manager of theBank’s research complex, and Roumeen Islam, manager of the World Bank Institute orWBI, helped mobilize the funding for this knowledge project and review its outputs.Philip English, now working in the Bank’s Africa Region, was instrumental in theoriginal commissioning of the various chapters and in reviewing early drafts Judith

L Jackson, an assistant to Professor Robert Stern, and Gustavo Garcia-Benavides, aconsultant in the WBI, assisted in assembling and editing the contributions of thevarious authors Maria Lourdes Penaflor Gosiengfiao and Diane Leslie Billups (staffassistants in the WBI) took care of administrative matters related to the commissioning

of the contributions and WBI learning events Finally, this project would not havebeen feasible without the financial contribution of the U.K government throughits Department for International Development (DFID) to the Bank’s trade researchprogram and to the WBI’s capacity building program

1993 SNA System of National Accounts, 1993

ABSs asset-backed securitizations

ADB Asian Development Bank

ADSLs Asymmetric Digital Subscriber Line systems

AITIC AITIC is an independent organization, based in Geneva, whose goal is to help

less-advantaged countries (LACs)

AMCs Asset Management Companies

ASEAN Association of Southeast Asian Nations

BATNA Best Alternative to an Agreement

BOC Bank of China

BD3 3rd edition of the OECD Benchmark Definition of Foreign Direct Investment BOP Balance of Payments

BPM5 5th edition of the Balance of Payments Manual (IMF)

BTA Basic Telecommunications Agreement

CARICOM Caribbean Community and Common Market

CBRC China Bank Regulation Commission

CCB China Construction Bank

CEPA Closer Economic Partnership Arrangement

CIRC China Insurance Regulatory Commission

COMESA Common Market for Eastern and Southern Africa

CPC Ver 1.0 Central Product Classification, Version 1.0

CSME Single Market and Economy

CSRC China Securities Regulatory Commission

DR-CAFTA U.S.–Central America–Dominican Republic Free Trade Agreement

EBOPS Extended Balance of Payments Services Classification

ENTs economic needs tests

EPA Economic Partnership Agreement

EU European Union

Eurostat Statistical Office of the European Communities

FATS Foreign Affiliates Trade in Services

FCC Federal Communications Commission

FDI Foreign Direct Investment

FSA Financial Services Agreement

FTA free trade area

GATS General Agreement on Trade in Services

GATT General Agreement on Tariffs and Trade

GDDS General Data Dissemination System (IMF)

GDP Gross Domestic Product

GNS/W/120 services sectoral classification list

ICAIS International Charges for Access to Internet Services ICANN Internet Corporation for Assigned Names and Numbers ICBC Industrial and Commercial Bank of China

ICE Costa Rican Institute of Electricity—‘‘ICE’’

ICFA ISIC Categories for Foreign Affiliates

ICSE-93 International Classification of Status in Employment ICT information and computer technology

ILO International Labour Organization

IMF International Monetary Fund

IPO Initial Public Offering

IPRs intellectual property rights

ISCO-88 International Standard Classification of Occupations ISIC International Standard Industrial Classification

ISP Internet service provider

IT information technology

ITE Internet traffic exchange

ITRS international transactions reporting system

ITU International Telecommunications Union

KT Korea Telecom

KTF a subsidiary of KT

LACs less-advantaged countries

LDCs least developed countries

LLDCs landlocked developing countries

M&A mergers and acquisitions

MBS mortgage-backed securitization

MERCOSUR South American Common Market

MFN Most-Favored Nation

MIC Ministry of Information and Communication

MSITS Manual on Statistics of International Trade in Services

MVNOs mobile virtual network operators

NAFTA North American Free Trade Agreement

n.a not available

NCA National Communications Authority (Ghana)

n.i.e not included elsewhere

NGO non-governmental organization

NPL Non-performing Loan

NTB Non-Tariff Barrier

OECD Organisation for Economic Co-operation and Development

QFII Qualified Foreign Institutional Investor

PCS digital cell phone network

PTO public telecommunications operator

PTT Post-Telephone-Telegraph

RIS Research and Information System (for the Non-Aligned and Other Developing

Countries)

RTA Regional Trade Agreement

SDDS Special Data Dissemination Standards (IMF)

SET Secured Electronic Transactions

SMEs small and medium enterprises

SNA System of National Accounts

TM temporary movement of natural persons; temporary labor mobility or migration TRAINS TRade Analysis and INformation System

TRIPS Agreement on Trade-Related Aspects of Intellectual Property Rights

UBO ultimate beneficial owner

UN United Nations

UNCTAD United Nations Conference on Trade and Development

UN-ESCAP United Nations—Economic and Social Commission for Asia and Pacific

UN ECLAC UN Economic Commission for Latin America and the Caribbean

UN ESCWA UN Economic and Social Commission for Western Asia

UNSD United Nations Statistics Division

UNU United Nations University (UNU)

USA United States of America

USAID U.S Agency for International Development

USD United States dollar

USTR U.S Office of the Trade Representative

VAT value-added-tax

VoIP voice over the Internet

WIPO World Intellectual Property Organization

WTO World Trade Organization

Part I

The Framework of Trade

in Services

But the beneWts from services liberalization are by no means automatic SigniWcantchallenges exist in introducing genuine competition, building the regulatory institu-tions that are needed to remedy market failures, appropriately sequencing service-sectorreforms, and establishing mechanisms that promote the availability of essential servicesespecially among the poor.

Even though governments can initiate reforms of services unilaterally, internationalengagement can play an important catalytic role In recognition of their rising role ininternational trade and the need for further liberalization, services were included in themultilateral trade architecture of the World Trade Organization (WTO) in the form ofthe General Agreement on Trade in Services (GATS) Services have featured prominently

as well in the process of WTO accession And services are increasingly important in thelarge and growing network of regional, and especially, of North–South trade agreementsconcluded of late or still under negotiation

1 Much of what follows in this Overview has been adapted from Mattoo (2005a) See also Mattoo (2001, 2005b, and 2006), Hoekman and Mattoo (2006), and Hoekman (2006).

In the negotiations under the Doha Development Agenda, however, services havereceived surprisingly little attention Much of the public discourse has focused onprotectionist policies in agriculture The neglect can be costly The potential gainsfrom reciprocal liberalization of trade in services are likely to be substantial, andprogress in services may be necessary for a positive outcome in other areas However,for these and future negotiations to be fruitful, countries must recognize mutualinterests in reciprocal liberalization, supported by broader international cooperation.First of all, developing countries must see the advantages of international agreement

to increase competition in services, enhance credibility of potential domestic reform,and strengthen domestic regulation But global cooperation is needed to providesupport for developing countries at four levels: in devising sound policy, strengtheningthe regulatory institutions, enhancing participation in the development of internationalstandards, and in ensuring access to essential services in the poorest areas

Second, industrial and developing countries must see advantages to allowing thetemporary movement of individual service providers Facilitating such movement willrequire greater cooperation between source and host countries than has been providedfor in the framework of GATS and other regional trade agreements and may be morefeasible in a bilateral context For example, source countries could undertake to screenservices providers and to accept and facilitate their return, and host countries wouldundertake to ensure that skilled migration stays temporary

Third, all countries must lock in the current openness of cross-border trade in a range

of services Such trade is probably the most dynamic dimension of international trade,

in which both industrial and developing countries have a growing stake, but over whichlooms the specter of protectionism provoked by the potential costs of adjustment.Finally, there is a strong case for regional cooperation in services Most regionalagreements in services have followed mechanically the precedent of regional agreements

in goods, and the framework of the GATS or NAFTA, and focused on the elimination

of explicit barriers to the entry of service providers Preferential liberalization in services

is diYcult because the required legislative changes are usually easier to accomplish on

a non-preferential basis, and services markets are ideally opened on an MFN ornon-preferential basis But perhaps the greatest cost of the existing approach is that it mayhave diverted attention and negotiating resources away from an area of much greater beneWt

in the regional context: cooperation on infrastructure services and regulation Such ation we show is both more feasible and desirable in the regional context with proximatecountries at a similar level of development than in the multilateral or EPA context

cooper-In view of the increasing importance of international trade in services, ongoingdomestic reforms, and the inclusion of services issues on the agendas of the multilateral,regional, and bilateral trade negotiations, there is an obvious need on the part of tradeoYcials, advisors, analysts, representatives of business and consumer associations, andstudents to enhance their understanding of the economic implications of services trade

and liberalization A Handbook of International Trade in Services has been produced withthe objective of contributing to this improved understanding.

Before turning to the individual chapters, some additional background informationthat places the services issues in context may be helpful for Handbook users In whatfollows, we Wrst discuss the four modes of supply of services that are covered by the GATS,the sources of services data, and the services growth experiences of selected countries andregions We then discuss how services reform can promote eYciency and growth at thesectoral level and economy-wide, pointing out that the beneWts of services liberalizationmay be diminished by Xaws in reform programs, the failure to provide for greater servicesaccess for the poor, and the need to take adjustment costs into account

We argue that domestic policy reforms should recognize the importance of increasingcompetition among service providers, the need for appropriate sequencing of reforms,and reduction of the importance of national monopolies Further, we stress thatinternational engagement is crucial to buttress domestic reform in order to achievereciprocal liberalization, greater credibility of reform, provision of external assistance tofacilitate domestic adjustment, reinforcement of the reform process, and promotion ofgreater harmonization and integration of policies The ongoing GATS negotiations are

an important and essential framework to support the international liberalization ofservices and should include the design of arrangements for aid to developing countries

to help promote services trade and promote greater cooperation on temporary tion There may also be greater scope for achieving deeper integration of particularservices sectors by means of regional services agreements

migra-Pattern of Trade in Services

Services include activities as disparate as transport of goods and people, Wnancial ation, communications, distribution, hotels and restaurants, education, health care, con-struction, and accounting In contrast to merchandise trade, services are often intangible,invisible and perishable, and usually require simultaneous production and consumption.The need in many cases for proximity between the consumer and the producer impliesthat one of them must move to make an international transaction possible Since theconventional deWnition of trade—where a product crosses the frontier—would miss out

intermedi-on a whole range of internatiintermedi-onal transactiintermedi-ons, the GATS took an unusually wide view oftrade, which is deWned (in Article I) to include four modes of supply:

Cross-border (mode 1): services supplied from the territory of one Member into theterritory of another An example is software services provided by a supplier in onecountry through mail or electronic means to consumers in another country

Consumption abroad (mode 2): services supplied in the territory of one Member tothe consumers of another Examples are where the consumer moves, e.g toconsume tourism or education services in another country Also covered are activitiessuch as ship-repair abroad, where only the property of the consumer moves Commercial presence (mode 3): services supplied through any type of business orprofessional establishment of one Member in the territory of another An example is

an insurance company owned by citizens of one country establishing a branch bymeans of foreign direct investment (FDI) in another country

Presence of natural persons (mode 4): services supplied by nationals of one Member inthe territory of another This mode includes both independent service suppliers andemployees of the services supplier of another Member Examples are a doctor of onecountry supplying through his physical presence services in another country, or theforeign employees of a foreign bank providing services on a temporary basis

It would be useful if trade statistics for each service sector were available according toeach of the modes of supply This would enable an assessment both of the relativeimportance of diVerent modes of supply in a particular sector and of the impact ofmeasures aVecting each mode of supply However, the only services trade statisticsavailable on a global basis are the IMF Balance of Payments (BOP) Statistics, whichregister transactions between residents and non-residents According to BOP conven-tions, if factors of production move to another country for a period longer than one year(sometimes Xexibly interpreted), a change in residency is deemed to have occurred Theoutput generated by such factors that is sold in the host market is not recorded as trade

in the BOP Therefore, transactions involving commercial presence and stay of naturalpersons for durations of more than one year are not covered by the BOP statistics Thelimitations of the existing statistical domains in providing information on trade bydiVerent modes of supply are listed in Table 1.1

Nevertheless, the BOP statistics are revealing They show that services are the fastestgrowing sector of the global economy, and, as noted in Figure 1.1, trade in services hasgrown faster than in goods over the past decade Developing countries in particular havewitnessed even faster growth rates, and, as noted in Figure 1.2, their share in worldservices exports increased from 14 per cent in 1985–89 to nearly 20 per cent in 1998–2002.While some developing countries are increasingly investing abroad to provideservices—e.g Malaysia in environmental services, and South Africa in telecommunica-tions—most countries supply services via cross-border sales (e.g data processing),tourism services for visiting foreign consumers, and the movement abroad of individualservices providers (e.g professional services or construction workers) Developments ininformation and communication technology have dramatically increased the scope forcross-border exports of services, ranging from software development in the Philippines

to data processing in Barbados The IMF Balance of Payments category business servicescovers trade in all services other than transport and travel services As Figure 1.3 shows,

Figure 1.1 Trade in goods and services, 1985–2002

Table 1.1 Inadequacies of Statistical Domains with Regard to Modes of Supply

Cross-border supply (mode 1) BOP service statistics

(categories other than travel)

- BOP does not distinguish among cross-border supply, commercial presence (firms) and presence of natural persons (individuals) for less than one year

Consumption abroad (mode 2) BOP Statistics (mainly the

travel category)

- Travel also contains goods, and is not subdivided into the different categories of services consumed by travelers

- Some transactions related to this mode of supply are also in other BOP categories Commercial presence (mode 3) FDI and foreign affiliates

trade (FAT) statistics

- FDI statistics do not provide data on output (or sales); FDI definition does not match the definition of commercial presence

- Until recently, FAT statistics only existed for the United States Now other Organization for Economic Co-operation and Development— (OECD) countries have also started collecting such statistics using basic concepts and definitions contained in the Manual of Statistics

on International Trade in Services (http:// www.oecd.org/dataoecd/32/45/2404428.pdf) Presence of natural persons

(independent) (Mode 4)

BOP Statistics (mostly categories other than transport and travel)

- BOP do not distinguish between cross-border supply, presence of natural persons (individuals) and commercial presence for less than one year

- natural persons who are residents are not covered

Presence of natural persons

Figure 1.3 Regional distribution of business services exports

Note : The ‘‘Business Services’’ category includes Total Services minus Transportation, Travel and Government Services Alternatively, Business Services consist of: Communication, Construction, Insurance, Financial, Computer & info, Other business, Personal, cultural and recreational services, as well as Royalties and license fees.

Source : Adapted from IMF Balance of Payments Statistics.

most exports of business services still originate in OECD countries But Figure 1.4reveals that while the exports of the European Union and the United States have grown

at respectively 6 and 11 per cent per annum in the second half of the 1990s, the exports

of countries like India, Israel, Dominica and Brazil have grown at rates above 20 per centper annum Moreover, many other developing countries—including Mauritius, Nicar-agua, Barbados, and China—have witnessed high rates of growth

Service Reforms Can Promote Efficiency and Growth

Liberalization of trade in services, accompanied by the reform of complementarypolicies, can lead both to sectoral and economy-wide improvements in performance

Figure 1.4 Average growth rate of exports of business services, 1965–2000

Source : Adapted from IMF Balance of Payments Statistics.

Box 1.1 Why do Services Matter for Development?

In developing countries, the average share of services in GDP increased from around 40 per cent in 1965 to around

50 per cent in 1999, while in the OECD countries, the average share increased over the same period from 54 per cent

to over 60 per cent Among the fastest growing sectors in many countries are services like telecommunications, software, and Wnance EYcient services not only provide a direct beneWt to consumers, but also help shape overall economic performance An eYcient and well-regulated Wnancial sector leads to the eYcient transformation of savings

to investment, ensuring that resources are deployed wherever they have the highest returns; and facilitates better sharing in the economy Improved eYciency in telecommunications generates economy-wide beneWts as this service

risk-is a vital intermediate input and also crucial to the drisk-issemination and diVusion of knowledge—the spread of the Internet and the dynamism provided to economies around the world is telling testimony to the importance of telecommunications services Similarly, transport services contribute to the eYcient distribution of goods within a country, and are particularly important in inXuencing a country’s ability to participate in global trade Although these are the more prominent services, others are also crucial Business services such as accounting and legal services are important in reducing transaction costs—the high level of which is considered one of the most signiWcant impedi- ments to economic growth in Africa Education and health services are necessary in building up the stock of human capital Retail and wholesale services are a vital link between producers and consumers, and inXuence the eYciency with which resources are allocated to meet consumer needs Software development is the foundation of the modern knowledge-based economy Environmental services contribute to sustainable development by helping to alleviate the negative impact of economic activity on the environment.

production and prevents the realization of signiWcant gains in productivity As countriesreduce tariVs and other barriers to trade in goods, eVective rates of protection for manufac-turing industries may become negative if they continue to be confronted with input pricesthat are higher than they would be if services markets were competitive

A major beneWt of liberalization is likely to be access to a wider variety of services whoseproduction is subject to economies of scale Consumers derive not only a direct beneWtfrom diversity in services such as restaurants and entertainment, but also an indirectbeneWt because a wider variety of more specialized producer services, such as telecommu-nications and Wnance, can lower the costs of both goods and services production (Ethier,1982; Copeland, 2001) In such circumstances, smaller markets can be shown to have astrong interest in liberalizing trade in producer services, since this can oVset some of theincentives that Wrms have to locate in larger markets (Markusen, 1989) (See Box 1.1)

ECONOMY-WIDE EFFECTS

Estimates of beneWts vary for individual countries - from under 1 per cent to over 50 percent of GDP—depending on the initial levels of protection and the assumed reduction inbarriers In simulations of global service-trade liberalization, developed countriesgain more in absolute terms—which is not surprising given the relative size of theireconomies—but developing countries also see signiWcant increases in their GDP One

model predicts gains of between 1.6 per cent of GDP (for India) to 4.2 per cent ofGDP (for Thailand) if tariV-equivalents of protection were cut by one-third in allcountries (Chadha et al., 2003) The gains from liberalizing services may be substantiallygreater than those from liberalizing trade in goods, because current levels of protectionare higher and because liberalization would also create spillover beneWts from therequired movement of capital and labor For instance, one model Wnds that the welfaregains from a 50 per cent cut in services-sector protection would be Wve times larger thanthe gains from non-services sector trade liberalization (Robinson et al., 1999) Theseresults are particularly striking because they are derived from models that do not fullyallow for the temporary movement of individual service suppliers—potentially a majorsource of gain.

Temporary movement of workers oVers arguably the neatest solution to the dilemma

of how international migration is best managed, enabling the realization of gainsfrom trade while averting social and political costs in host countries and brain drainfrom poor countries Recent research Wnds that if OECD countries were to allowtemporary access to foreign service providers equal to just 3 per cent of their laborforce, the global gains would be over $150 billion—more than the gains from thecomplete liberalization of all trade in goods (Walmsley and Winters, 2005) Bothdeveloped and developing countries would share in these gains, and they would

be largest if both high-skilled mobility and low-skilled mobility were permitted.(See Figure 1.5.)

Unskilled Labor Skilled Labor

Figure 1.5 Welfare gains from a 3% increase in developed countries’ temporary labor quota

Note : Data in million US$.

Source: Adapted from Walmsley and Watson (2005).

ACCELERATOR EFFECTS ON GROWTH

Certain services industries clearly possess growth-generating characteristics more, barriers to entry in a number of services sectors, ranging from telecommunica-tions to professional services, are maintained not only against foreign suppliers but alsoagainst new domestic suppliers Full liberalization can, therefore, lead to enhancedcompetition from both domestic and foreign suppliers Greater foreign factor partici-pation and increased competition together imply a larger scale of activity, and hencegreater scope for generating the special growth-enhancing eVects Even without scaleeVects, the import of foreign factors that characterizes services-sector liberalization

Further-Box 1.2 Services Reform and Impact on Comparative Advantage

Reform of services policy has an impact not only on overall economic activity but also on its composition The profound eVect that transport costs have on trade and the distribution of economic activity across regions is increasingly well documented The impact of communication costs on trade costs has received less attention Fink

et al (2002) tested this relationship by incorporating alternative measures of communication costs in a model of bilateral trade They Wnd that international variations in communication costs indeed have a signiWcant inXuence on trade patterns More interestingly, estimates using disaggregated data reveal that the impact of communication costs

on trade in diVerentiated products is larger than on trade in homogenous products—by as much as one-third (Figure 1.6) The implication is that lower communication costs can shift a country’s comparative advantage towards more sophisticated communication-intensive diVerentiated goods and away from more standardized primary goods Source : Fink et al (2002).

Figure 1.6 Effects of telecommunications costs on trade in goods

Note : The chart is based on 1999 data and uses the Rauch classiWcation of goods.

Source : Adapted from Fink et al (2002).

could still have positive eVects because the foreign factors are likely to bring technologywith them If greater technology transfer accompanies services liberalization—eitherembodied in FDI or disembodied—the growth eVect will be stronger.

There is econometric evidence—relatively strong for the Wnancial sector and less strongbut nevertheless statistically signiWcant for the telecommunications sector—that openness

in services inXuences long-run growth performance (See Figure 1.7) After controlling forother determinants of growth, countries that fully liberalized the Wnancial services sector(in terms of the three dimensions noted above) grew, on average, about 1.0 percentagepoint faster than other countries An even greater impetus on growth was found to comefrom fully liberalizing both the telecommunications and the Wnancial services sectors.Estimates suggest that countries that fully liberalized both sectors grew, on average, about1.5 percentage points faster than other countries (See Figure 1.8) While these estimatesindicate that there are substantial gains from liberalizing key services sectors, it would bewrong to infer that these gains can be realized by a mechanical opening up of servicesmarkets A Xawed reform program can undermine the beneWts of liberalization

EFFECTS OF FLAWS IN REFORM PROGRAMS IN SERVICES

For example, if privatization of state monopolies is conducted without concern tocreating conditions of competition, the result may be merely transfers of monopolyrents to private owners (possibly foreigners) Similarly, if increased entry into Wnancial

Figure 1.7 Services liberalization indices: telecoms and financial services

High Income (21)

LAC (21)

EAP (8) South Asia (5)

ECA (3) SSA/MNA (42)

High Income (26)

LAC (18)

ECA (3) SSA/MNA (17)

EAP (5) South Asia (3)

Telecoms

Financial Services

Source : Adapted from Mattoo, Rathindran, and Subramanian (2006).

Figure 1.8 Effects of services liberalization on economic growth

coef = 00410704, se = 00141945, t = 2.89

Composite services liberalization index

− 033807

.038741

URY THA

CYP TUN

ECU TUR BRAISL

VEN CRI

CHL COL

KEN

PANSGPBEL

GRC

USA

JAM PRT

GBR MLT

AUS SWE

NZL CAN DNK

FRA MAR DOM

ITA

FIN PER ESP NOR

Source : Adapted from Mattoo, Rathindran, and Subramanian (2006).

sectors is not accompanied by adequate prudential supervision and full competition, theresult may be insider lending and poor investment decisions Also, if policies to ensureuniversal service are not put in place, liberalization need not improve access to essentialservices for the poor Managing reforms of services markets therefore requires integrat-ing trade opening with a careful combination of competition and regulation

South Africa’s experience with liberalizing telecommunications services is instructive.The Government recognized the need for a more eYcient supply of services It decided tosell a 30 percent equity stake of the public incumbent, Telkom, to a strategic investor and

to grant the newly privatized entity a Wve-year monopoly period for Wxed-line telephoneservices It was hoped that market exclusivity would facilitate rapid infrastructure rollout

to previously under-serviced areas But the program has had mixed results Even thoughnetwork growth picked up, Telkom did not meet its rollout obligations and sought torenegotiate the targets speciWed in its monopoly license The cost of the Wxed-linemonopoly was also reXected in Telkom’s rising price–cost margin, with gains in product-ivity leading to higher margins rather than lower prices (Hodge, 1999) Finally, despite

some improvement, labor productivity was only a quarter that of leading internationaloperators, with the lack of competition in the domestic market identiWed as a majorcontributing factor Continued restrictions on domestic and foreign entry appear to haveprevented the realization of the full beneWts of competitive markets.

In addition to competition, the institutional and regulatory framework plays a criticalrole For example, in the 1990s, Wnancial reforms were introduced in many Africancountries but have been less successful than expected (World Bank, 2001) Some of thereasons for the disappointing results are directly related to the Wnancial system, whileothers pertain to the more general economic environment The restructuring of state-owned banks was not suYcient to change the behavior of the Wnancial institutions.Public authorities still pressured these institutions to lend money to loss-making publicenterprises Liberalization failed to trigger competition in the banking sector, andgovernments were mostly reluctant to close down distressed state banks Furthermore,liberalization of interest rates in a setting characterized by uncontrolled Wscal deWcits had

a pernicious eVect on domestic public debt, which in turn led to larger deWcits Finally,and crucially, there was a lack of adequate regulation and supervision mechanisms tomonitor the functioning of the Wnancial system

The collapse of the Korean economy in 1997 also reveals the precariousness of

Wnancial liberalization in an imperfect policy environment Korea did liberalizeits Wnancial markets substantially, but it encouraged the development of a highly fragile

Wnancial structure By liberalizing short-term (but not long-term) foreign borrowing,the Korean authorities made it possible for the larger and better-known banks andchaebols to assume heavy indebtedness in short-term foreign currency debt Meanwhile,the second tier of large chaebols greatly increased their short-term indebtedness in thedomestic Wnancial markets (funded indirectly through foreign borrowing of the banks).The funds borrowed were being invested in over-expansion of productive capacity Atthe same time, Wnancial regulation and supervision were fragmented with responsibil-ities spread unclearly between the Bank of Korea and several parts of the Ministry ofFinance In addition, Korea had a restrictive regime in terms of foreign bank entry Untilthe 1997 Wnancial crisis, the Korean banking system was virtually closed to foreignbanks, in contrast to some other East Asian countries, such as Hong Kong, which wasalmost completely open for all Wnancial services This restrictive regime impeded thedevelopment of the local institutions and may have contributed to the large capitaloutXows as foreign creditors refused to rollover their loans

EFFECTS ON PRICES OF SERVICES FOR THE POOR

Opening up essential services to foreign or domestic competition could have an adverse eVect

on the poor—which is often cited as a reason for the persistence of public monopolies.However, a more eYcient solution is to have regulations with a social purpose

If a country is a relatively ineYcient producer of a service, liberalization and theresultant foreign competition are likely to lead to a decline in domestic prices andimprovement in quality But there is a twist Frequently, the prices pre-liberalization arenot determined by the market but are set administratively and kept artiWcially low forcertain categories of end-users and/or types of services products Thus, rural borrowersmay pay lower interest rates than urban borrowers, and prices of local telephone callsand public transport may be kept lower than cost of provision This structure of prices isoften sustained through cross-subsidization within public monopolies or throughgovernment Wnancial support.

Liberalization threatens these arrangements Elimination of restrictions on entryimplies an end to cross-subsidization because it is no longer possible for Wrms tomake extra-normal proWts in certain market segments New entrants may focus onthe most proWtable market segments (‘‘cream-skimming’’), such as urban areas, wherenetwork costs are lower and incomes higher And privatization could mean the end ofgovernment support The result is that even though the sector becomes more eYcientand average prices decline, the prices for certain end-users may actually increase and/oravailability decline

The evidence on the relationship between competitive market structures and wideraccess to services is mixed In some cases, a positive relationship has been observed inservices like basic telecommunications, especially in countries where initial conditionsare feeble, as exempliWed by a low teledensity or service rationing (long waiting lists forobtaining connections) However, there is also evidence that Wnancial services liberal-ization in some countries has had an adverse eVect on access to credit for rural areas andthe poor There is a need accordingly to create mechanisms to ensure that the poor haveadequate access to services in liberalized markets

EFFECTS ON ADJUSTMENT COSTS

DiVerent modes of supply have diVerent eVects on factor markets Cross-border tradeand consumption abroad resemble goods trade in their implications The impact of themovement of factors depends critically on whether they are substitutes or complementsfor domestic factor services Given the structure of factor prices in poor countries, wewould typically expect liberalization to lead to an inXow of capital and skilled workers.Such inXows would tend to be to the advantage of the unskilled poor—increasingemployment opportunities and wages Interestingly, it has been shown that even whenforeigners compete with local skilled workers in a services sector, the productivityboost to the sector from allowing foreigners access could lead to an increase in thedemand for domestic skilled workers—the scale eVect could outweigh the substitutioneVect (Markusen et al., 2000) Given these predictions, why are workers in developing